##### Table of Contents





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, 2011

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 has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No   ̈

Indicate by check mark 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         |  |  ̈
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the 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 April 26, 2011
|Common stock, $0.01 par value |  | 50,513,722                   









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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Table of Contents



|                               |  |                                                                                       |    |      |    | 
|------------------------------ |  | ------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                               |  |                                                                                       |    | Page |   
|PART I - FINANCIAL INFORMATION |  |                                                                                       | 3  |     
|Item 1.                        |  | Financial Statements                                                                  |    |      | 3  | 
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |    |      | 34 | 
|Item 3.                        |  | Quantitative and Qualitative Disclosures about Market Risk                            |    |      | 80 | 
|Item 4.                        |  | Controls and Procedures                                                               |    |      | 81 | 
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                       | 82 |     
|Item 1.                        |  | Legal Proceedings                                                                     |    |      | 82 | 
|Item 1A.                       |  | Risk Factors                                                                          |    |      | 82 | 
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |    |      | 82 | 
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |    |      | 82 | 
|Item 4.                        |  | (Removed and Reserved)                                                                |    |      | 82 | 
|Item 5.                        |  | Other Information                                                                     |    |      | 82 | 
|Item 6.                        |  | Exhibits                                                                              |    |      | 82 | 
|                               | 
|SIGNATURES                     |  |                                                                                       | 83 |     



2



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##### Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands, except per share data)



|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                 |  | March 31,2011 |           |   | December 31,2010 |  
|                                                                                                                                                                 |  | (unaudited)   |           |   |                  |  
|Assets                                                                                                                                                           |  |               |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                        |  |               |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                          |  | $             | 188,545   |   |                  | $ | 223,017   |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Total cash and cash equivalents                                                                                                                                  |  |               | 188,545   |   |                  |   | 223,017   |  
|                                                                                                                                                                 |  |              
|Federal Home Loan Bank (FHLB) stock, at cost                                                                                                                   |  |               | 6,785     |   |                  |   | 6,785     |  
|Investment securities available for sale, at fair value                                                                                                          |  |               | 274,103   |   |                  |   | 218,775   |  
|Mortgage loans held for sale                                                                                                                                     |  |               | 279       |   |                  |   | 4,793     |  
|Commercial loans held for sale                                                                                                                                   |  |               | 60,346    |   |                  |   | 66,157    |  
|                                                                                                                                                                 |  |              
|Loans, gross                                                                                                                                                     |  |               | 764,227   |   |                  |   | 793,426   |  
|Less: allowance for loan losses                                                                                                                                  |  |               | (26,954   | ) |                  |   | (26,934   | )
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Loans, net                                                                                                                                                       |  |               | 737,273   |   |                  |   | 766,492   |  
|                                                                                                                                                                 |  |              
|Premises and equipment, net                                                                                                                                      |  |               | 28,072    |   |                  |   | 28,109    |  
|Accrued interest receivable                                                                                                                                      |  |               | 5,017     |   |                  |   | 4,702     |  
|Foreclosed real estate                                                                                                                                           |  |               | 16,244    |   |                  |   | 19,983    |  
|Income tax refund receivable                                                                                                                                     |  |               | 7,436     |   |                  |   | 7,436     |  
|Other                                                                                                                                                            |  |               | 9,111     |   |                  |   | 8,998     |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Total assets                                                                                                                                                     |  | $             | 1,333,211 |   |                  | $ | 1,355,247 |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|                                                                                                                                                                 |  |              
|Liabilities and shareholders equity                                                                                                                             |  |               |           |   |                  |   |           |  
|Liabilities                                                                                                                                                      |  |               |           |   |                  |   |           |  
|Deposits                                                                                                                                                         |  |               |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                                              |  | $             | 156,323   |   |                  | $ | 141,281   |  
|Interest-bearing                                                                                                                                                 |  |               | 1,021,367 |   |                  |   | 1,032,081 |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Total deposits                                                                                                                                                   |  |               | 1,177,690 |   |                  |   | 1,173,362 |  
|                                                                                                                                                                 |  |              
|Retail repurchase agreements                                                                                                                                     |  |               | 23,641    |   |                  |   | 20,720    |  
|FHLB borrowings                                                                                                                                                  |  |               | 5,000     |   |                  |   | 35,000    |  
|Accrued interest payable                                                                                                                                         |  |               | 955       |   |                  |   | 1,187     |  
|Other                                                                                                                                                            |  |               | 10,080    |   |                  |   | 11,079    |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                |  |               | 1,217,366 |   |                  |   | 1,241,348 |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|                                                                                                                                                                 |  |              
|Shareholders equity                                                                                                                                             |  |               |           |   |                  |   |           |  
|Preferred stock - par value $0.01 per share; authorized 2,500,000 shares; none issued and outstanding                                                            |  |               |          |   |                  |   |          |  
|Common stock - par value $0.01 per share; authorized 75,000,000 shares; 50,513,722 and 47,409,078 issued and outstanding at
March 31, 2011 and December 31, 2010 |  |               | 505       |   |                  |   | 474       |  
|Capital surplus                                                                                                                                                  |  |               | 141,194   |   |                  |   | 133,112   |  
|Retained earnings (deficit)                                                                                                                                      |  |               | (19,188   | ) |                  |   | (13,108   | )
|Accumulated other comprehensive loss, net of tax                                                                                                                 |  |               | (6,666    | ) |                  |   | (6,579    | )
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                       |  |               | 115,845   |   |                  |   | 113,899   |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  
|                                                                                                                                                                 |  |              
|Total liabilities and shareholders equity                                                                                                                       |  | $             | 1,333,211 |   |                  | $ | 1,355,247 |  
|                                                                                                                                                                 |  |               |           |   |                  |   |           |  

See Notes to Consolidated Financial Statements



3



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

(in thousands, except per share date) (unaudited)



|                                                                |  |                                     |            |   |      |   |           |  
|--------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ---- | - | --------- | -
|                                                                |  | For the three months endedMarch 31, |           
|                                                                |  | 2011                                |            |   | 2010 |  
|Interest income                                                 |  |                                     |            |   |      |   |           |  
|Interest earned on cash and cash equivalents                    |  | $                                   | 105        |   |      | $ | 67        |  
|Dividends received on FHLB stock                                |  |                                     | 14         |   |      |   | 4         |  
|Interest earned on investment securities available for sale     |  |                                     |            |   |      |   |           |  
|U.S. Treasury and federal agencies (taxable)                    |  |                                     | 6          |   |      |   | 7         |  
|State and municipal (nontaxable)                                |  |                                     | 545        |   |      |   | 385       |  
|Collateralized mortgage obligations (taxable)                   |  |                                     | 555        |   |      |   | 613       |  
|Other mortgage-backed (taxable)                                 |  |                                     | 200        |   |      |   | 198       |  
|Interest and fees earned on loans                               |  |                                     | 11,569     |   |      |   | 13,605    |  
|                                                                |  |                                     |            |   |      |   |           |  
|Total interest income                                           |  |                                     | 12,994     |   |      |   | 14,879    |  
|                                                                |  |                                    
|Interest expense                                                |  |                                     |            |   |      |   |           |  
|Interest paid on deposits                                       |  |                                     | 2,676      |   |      |   | 3,563     |  
|Interest paid on retail repurchase agreements                   |  |                                     | 11         |   |      |   | 14        |  
|Interest paid on commercial paper                               |  |                                     |           |   |      |   | 10        |  
|Interest paid on FHLB borrowings                                |  |                                     | 49         |   |      |   | 493       |  
|                                                                |  |                                     |            |   |      |   |           |  
|Total interest expense                                          |  |                                     | 2,736      |   |      |   | 4,080     |  
|                                                                |  |                                     |            |   |      |   |           |  
|Net interest income                                             |  |                                     | 10,258     |   |      |   | 10,799    |  
|                                                                |  |                                    
|Provision for loan losses                                       |  |                                     | 5,500      |   |      |   | 10,750    |  
|                                                                |  |                                     |            |   |      |   |           |  
|Net interest income after provision for loan losses             |  |                                     | 4,758      |   |      |   | 49        |  
|                                                                |  |                                     |            |   |      |   |           |  
|                                                                |  |                                    
|Noninterest income                                              |  |                                     |            |   |      |   |           |  
|Service charges on deposit accounts, net                        |  |                                     | 1,762      |   |      |   | 1,950     |  
|Fees for trust and investment management and brokerage services |  |                                     | 691        |   |      |   | 651       |  
|Mortgage-banking                                                |  |                                     | 376        |   |      |   | 429       |  
|Automatic teller machine                                        |  |                                     | 232        |   |      |   | 231       |  
|Merchant services                                               |  |                                     | 10         |   |      |   | 794       |  
|Bankcard services                                               |  |                                     | 76         |   |      |   | 156       |  
|Investment securities gains, net                                |  |                                     |           |   |      |   | 8         |  
|Other                                                           |  |                                     | 425        |   |      |   | 278       |  
|                                                                |  |                                     |            |   |      |   |           |  
|Total noninterest income                                        |  |                                     | 3,572      |   |      |   | 4,497     |  
|                                                                |  |                                    
|Noninterest expense                                             |  |                                     |            |   |      |   |           |  
|Salaries and other personnel                                    |  |                                     | 6,551      |   |      |   | 6,137     |  
|Occupancy                                                       |  |                                     | 1,183      |   |      |   | 1,171     |  
|Furniture and equipment                                         |  |                                     | 985        |   |      |   | 967       |  
|Professional services                                           |  |                                     | 510        |   |      |   | 547       |  
|FDIC deposit insurance assessment                               |  |                                     | 958        |   |      |   | 715       |  
|Marketing                                                       |  |                                     | 414        |   |      |   | 295       |  
|Foreclosed real estate writedowns and expenses                  |  |                                     | 833        |   |      |   | 1,012     |  
|Loss on commercial loans held for sale                          |  |                                     | 1,151      |   |      |   |          |  
|Other                                                           |  |                                     | 1,773      |   |      |   | 2,036     |  
|                                                                |  |                                     |            |   |      |   |           |  
|Total noninterest expense                                       |  |                                     | 14,358     |   |      |   | 12,880    |  
|                                                                |  |                                     |            |   |      |   |           |  
|                                                                |  |                                    
|Net loss before provision (benefit) for income taxes            |  |                                     | (6,028     | ) |      |   | (8,334    | )
|                                                                |  |                                    
|Provision (benefit) for income taxes                            |  |                                     | 52         |   |      |   | (3,042    | )
|                                                                |  |                                     |            |   |      |   |           |  
|                                                                |  |                                    
|Net loss                                                        |  | $                                   | (6,080     | ) |      | $ | (5,292    | )
|                                                                |  |                                     |            |   |      |   |           |  
|                                                                |  |                                    
|Common and per share data                                       |  |                                     |            |   |      |   |           |  
|Net loss - basic                                                |  | $                                   | (0.12      | ) |      | $ | (0.82     | )
|Net loss - diluted                                              |  |                                     | (0.12      | ) |      |   | (0.82     | )
|Cash dividends                                                  |  |                                     |           |   |      |   |          |  
|Book value                                                      |  |                                     | 2.29       |   |      |   | 10.93     |  
|                                                                |  |                                    
|Weighted average common shares outstanding - basic              |  |                                     | 49,453,501 |   |      |   | 6,455,598 |  
|Weighted average common shares outstanding - diluted            |  |                                     | 49,453,501 |   |      |   | 6,455,598 |  

See Notes to
Consolidated Financial Statements



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders Equity and Comprehensive Income (Loss)

(dollars in thousands, except per share data) (unaudited)



|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|--------------------------------------------------------------------------- |  | -------------------- | ---------- |  | ----------- | - | ------ | -------------- |  | - | ------------------------- |  |  | ----------------------------------------------- | ------- | - | ----- | - | ------ | - |  | - | ------- | -
|                                                                            |  | Shares ofcommonstock |            |  | Commonstock |   |        | Capitalsurplus |  |   | Retainedearnings(deficit) |  |  | Accumulatedothercomprehensiveincome (loss), net |         |   | Total |  
|Balance at December 31, 2009                                                |  |                      | 6,495,130  |  |             | $ | 32,282 |                |  | $ | 2,599                     |  |  | $                                               | 47,094  |   |       | $ | (6,960 | ) |  | $ | 75,015  |  
|                                                                            |  |                      |            |  |             |  
|Net loss                                                                    |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 | (5,292  | ) |       |   |        |   |  |   | (5,292  | )
|                                                                            |  |                      |            |  |             |  
|Other comprehensive income (loss), net of tax                               |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|                                                                            |  |                      |            |  |             |  
|Investment securities available for sale                                    |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $715  |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   | 1,169  |   |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $3 |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   | (5     | ) |  |   |         |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Net unrealized gain on investment securities available for sale             |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   | 1,164   |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Comprehensive loss                                                          |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   | (4,128  | )
|                                                                            |  |                      |            |  |             |  
|Compensation expense related to stock option plan                           |  |                      |            |  |             |   |        |                |  |   | 7                         |  |  |                                                 |         |   |       |   |        |   |  |   | 7       |  
|Common stock issued pursuant to restricted stock plan                       |  |                      |           |  |             |   | 13     |                |  |   | 71                        |  |  |                                                 |         |   |       |   |        |   |  |   | 84      |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Balance at March 31, 2010                                                   |  |                      | 6,495,130  |  |             | $ | 32,295 |                |  | $ | 2,677                     |  |  | $                                               | 41,802  |   |       | $ | (5,796 | ) |  | $ | 70,978  |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|                                                                            |  |                      |            |  |             |  
|Balance at December 31, 2010                                                |  |                      | 47,409,078 |  |             | $ | 474    |                |  | $ | 133,112                   |  |  | $                                               | (13,108 | ) |       | $ | (6,579 | ) |  | $ | 113,899 |  
|                                                                            |  |                      |            |  |             |  
|Net loss                                                                    |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 | (6,080  | ) |       |   |        |   |  |   | (6,080  | )
|                                                                            |  |                      |            |  |             |  
|Other comprehensive income (loss), net of tax                               |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|                                                                            |  |                      |            |  |             |  
|Investment securities available for sale                                    |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $53   |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   | (87    | ) |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $0 |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |       |   |  |   |         |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Net unrealized loss on investment securities available for sale             |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   | (87     | )
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Comprehensive loss                                                          |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   | (6,167  | )
|                                                                            |  |                      |            |  |             |  
|Common stock issued pursuant to restricted stock plan                       |  |                      | 34,614     |  |             |   |       |                |  |   | 162                       |  |  |                                                 |         |   |       |   |        |   |  |   | 162     |  
|Common stock issued pursuant to Follow-On Offering                          |  |                      | 3,070,030  |  |             |   | 31     |                |  |   | 7,920                     |  |  |                                                 |         |   |       |   |        |   |  |   | 7,951   |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  
|Balance at March 31, 2011                                                   |  |                      | 50,513,722 |  |             | $ | 505    |                |  | $ | 141,194                   |  |  | $                                               | (19,188 | ) |       | $ | (6,666 | ) |  | $ | 115,845 |  
|                                                                            |  |                      |            |  |             |   |        |                |  |   |                           |  |  |                                                 |         |   |       |   |        |   |  |   |         |  

See Notes to Consolidated Financial Statements



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)



|                                                                                               |  |                                     |          |   |      |   |         |  
|---------------------------------------------------------------------------------------------- |  | ----------------------------------- | -------- | - | ---- | - | ------- | -
|                                                                                               |  | For the three monthsended March 31, |         
|Operating Activities                                                                           |  | 2011                                |          |   | 2010 |  
|Net loss                                                                                       |  | $                                   | (6,080   | ) |      | $ | (5,292  | )
|Adjustments to reconcile net loss to net cash provided by operating activities                 |  |                                     |          |   |      |   |         |  
|Depreciation                                                                                   |  |                                     | 598      |   |      |   | 625     |  
|Amortization of unearned discounts / premiums on investment securities available for sale,
net |  |                                     | 1,327    |   |      |   | 31      |  
|Decrease in income tax refunds receivable                                                      |  |                                     |         |   |      |   | 20,131  |  
|Provision for loan losses                                                                      |  |                                     | 5,500    |   |      |   | 10,750  |  
|Gain on sales of mortgage loans held for sale, net                                             |  |                                     | (300     | ) |      |   | (343    | )
|Loss on commercial loans held for sale                                                         |  |                                     | 1,151    |   |      |   |        |  
|Writedowns, gains and losses of sales of foreclosed real estate                                |  |                                     | 515      |   |      |   | 799     |  
|Loss on prepayment of FHLB advances                                                            |  |                                     | 136      |   |      |   |        |  
|Investment securities gains                                                                    |  |                                     |         |   |      |   | (8      | )
|Originations of mortgage loans held for sale                                                   |  |                                     | (11,410  | ) |      |   | (15,008 | )
|Proceeds from sale of mortgage loans held for sale                                             |  |                                     | 16,224   |   |      |   | 18,114  |  
|Compensation expense related to stock options granted                                          |  |                                     |         |   |      |   | 7       |  
|Restricted stock compensation expense                                                          |  |                                     | 162      |   |      |   | 84      |  
|Increase in interest receivable and other assets, net                                          |  |                                     | (374     | ) |      |   | (3,364  | )
|Increase (decrease) in interest payable and other liabilities, net                             |  |                                     | (1,231   | ) |      |   | 1,000   |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|Net cash provided by operating activities                                                      |  |                                     | 6,218    |   |      |   | 27,526  |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|                                                                                               |  |                                    
|Investing Activities                                                                           |  |                                     |          |   |      |   |         |  
|Proceeds from sales of investment securities available for sale                                |  |                                     |         |   |      |   | 40,191  |  
|Proceeds from maturities of investment securities available for sale                           |  |                                     | 38,870   |   |      |   | 13,245  |  
|Purchases of investment securities available for sale                                          |  |                                     | (107,031 | ) |      |   | (51,233 | )
|Repayments on mortgage-backed investment securities available for sale                         |  |                                     | 11,365   |   |      |   | 3,743   |  
|Proceeds from sale of commercial loans held for sale                                           |  |                                     | 2,132    |   |      |   |        |  
|Repayments on commercial loans held for sale                                                   |  |                                     | 596      |   |      |   |        |  
|Decreases in loans, net                                                                        |  |                                     | 21,887   |   |      |   | 19,769  |  
|Proceeds on sale of foreclosed real estate                                                     |  |                                     | 6,988    |   |      |   | 2,053   |  
|Purchases of premises and equipment, net                                                       |  |                                     | (561     | ) |      |   | (1,245  | )
|                                                                                               |  |                                     |          |   |      |   |         |  
|Net cash (used for) provided by investing activities                                           |  |                                     | (25,754  | ) |      |   | 26,523  |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|                                                                                               |  |                                    
|Financing Activities                                                                           |  |                                     |          |   |      |   |         |  
|Increase (decrease) in transaction, money market, and savings deposit accounts,
net            |  |                                     | 31,418   |   |      |   | (584    | )
|Decrease in time deposit accounts, net                                                         |  |                                     | (27,090  | ) |      |   | (85,717 | )
|Increase in retail repurchase agreements, net                                                  |  |                                     | 2,921    |   |      |   | 5,872   |  
|Decrease in commercial paper, net                                                              |  |                                     |         |   |      |   | (113    | )
|Repayment of FHLB borrowings                                                                   |  |                                     | (30,136  | ) |      |   | (5,000  | )
|Proceeds from issuance of common stock, net                                                    |  |                                     | 7,951    |   |      |   |        |  
|Proceeds from issuance of convertible debt                                                     |  |                                     |         |   |      |   | 380     |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|Net cash used for financing activities                                                         |  |                                     | (14,936  | ) |      |   | (85,162 | )
|                                                                                               |  |                                     |          |   |      |   |         |  
|Net change in cash and due from banks                                                          |  |                                     | (34,472  | ) |      |   | (31,113 | )
|Cash and due from banks at beginning of period                                                 |  |                                     | 223,017  |   |      |   | 188,073 |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|Cash and due from banks at end of period                                                       |  | $                                   | 188,545  |   |      | $ | 156,960 |  
|                                                                                               |  |                                     |          |   |      |   |         |  
|                                                                                               |  |                                    
|Supplemental cash flow disclosures                                                             |  |                                     |          |   |      |   |         |  
|Cash paid (received) during the period for:                                                    |  |                                     |          |   |      |   |         |  
|Interest expense                                                                               |  | $                                   | 2,968    |   |      | $ | 4,572   |  
|Income tax refunds received, net                                                               |  |                                     |         |   |      |   | 20,933  |  
|Significant noncash activities                                                                 |  |                                     |          |   |      |   |         |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of
tax   |  |                                     | (87      | ) |      |   | 1,164   |  
|Loans transferred from gross loans to commercial loans held for sale                           |  |                                     | 1,224    |   |      |   |        |  
|Commercial loans held for sale transferred to foreclosed real estate                           |  |                                     | 3,156    |   |      |   |        |  
|Gross loans transferred to foreclosed real estate, at fair value                               |  |                                     | 608      |   |      |   | 3,893   |  

See Notes to
Consolidated Financial Statements



6



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements



|1. | Summary of Significant Accounting Policies
|-- | ------------------------------------------

Nature of Operations

Palmetto Bancshares, Inc. (the Company, which may be
referred to in this Quarterly Report on Form 10-Q as we, us, or our) is a regional bank holding company organized in 1982 under the laws of South Carolina and is headquartered in Greenville, South Carolina.
Through the Companys subsidiary, The Palmetto Bank (the Bank), which began operations in 1904, and the Banks wholly-owned subsidiary, Palmetto Capital, we provide a broad array of commercial banking, consumer banking, trust
and investment management, and brokerage services throughout our primary market area of northwest South Carolina.

Principles of
Consolidation / Basis of Presentation

The accompanying Consolidated Financial Statements include the accounts of the Company, which
includes our wholly-owned subsidiary, the Bank, and the Banks wholly-owned subsidiary, Palmetto Capital, and other subsidiaries of the Bank. In managements opinion, all significant intercompany accounts and transactions have been
eliminated in consolidation, and all adjustments necessary for a fair presentation of the financial condition and results of operations for periods presented have been included. Any such adjustments are of a normal and recurring nature. Assets held
by the Company or its subsidiary in a fiduciary or agency capacity for customers are not included in the Companys Consolidated Financial Statements because those items do not represent assets of the Company or its subsidiary. The accounting
and financial reporting policies of the Company conform, in all material respects, to accounting principles generally accepted in the United States of America (GAAP) and to general practices within the financial services industry.

The Consolidated Financial Statements as of and for the three months ended March 31, 2011 and 2010 contained in this Quarterly Report on
Form 10-Q have not been audited by our independent registered public accounting firm. The Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q adopted
by the Securities and Exchange Commission (the SEC). Accordingly, the Consolidated Financial Statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in
conjunction with the Consolidated Financial Statements, and notes thereto, for the year ended December 31, 2010, included in our Annual Report on Form 10-K filed with the SEC on February 28, 2011.

Subsequent Events

Subsequent events are
events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the
balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after
that date. The Company has reviewed events occurring through the date of this filing and no subsequent events have occurred requiring accrual or disclosure in these financial statements in addition to any included herein.

Business Segments

Operating segments
are components of an enterprise about which separate financial information is available and are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. Public enterprises are required
to report a measure of segment profit or loss, certain specific revenue and expense items for each segment, segment assets, and information about the way that the operating segments were determined, among other items.

The Company considers business segments by analyzing distinguishable components that are engaged in providing individual products, services, or groups of
related products or services and that are subject to risks and returns that are different from those of other business segments. When determining whether products and services are related, the Company considers the nature of the products or
services, the nature of the production processes, the type or class of customer for which the products or services are designed, and the methods used to distribute the products or provide the services.



7



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



During 2009 and 2010, the Company realigned its organizational structure and began the process of more
specifically delineating its businesses. However, at this time the Company does not yet have in place a reporting structure to separately report and evaluate various lines of businesses. Accordingly, at March 31, 2011 the Company had one
reportable operating segment.

Use of Estimates

In preparing our Consolidated Financial Statements, the Companys management makes estimates and assumptions that impact the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities as of the date of the Consolidated Financial Statements for the periods presented. Actual results could differ from these estimates and assumptions. Therefore, the results of operations for the three months ended
March 31, 2011 are not necessarily indicative of the results of operations that may be expected in future periods or for the year ended December 31, 2011.

Reclassifications

Certain amounts previously presented in our Consolidated Financial
Statements for prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods net loss or shareholders equity as previously reported.

Risk and Uncertainties

In the normal
course of business, the Company encounters two significant types of overall risk: economic and regulatory. There are three main components of economic risk: credit risk, market risk, and concentration of credit risk. Credit risk is the risk of
default on the Companys loan portfolio resulting from borrowers inability or unwillingness to make contractually required payments, or default on repayment of investment securities. Market risk primarily includes interest rate risk. The
Company is exposed to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or different bases, than its interest-earning assets. Market risk also reflects the risk of declines in the valuation
of loans held for sale, the value of the collateral underlying loans and the value of real estate held by the Company. Concentration of credit risk refers to the risk that, if the Company extends a significant portion of its total outstanding credit
to borrowers in a specific geographical area or industry or on the security of a specific form of collateral, the Company may experience disproportionately high levels of default and losses if those borrowers, or the value of such type of
collateral, is adversely impacted by economic or other factors that are particularly applicable to such borrowers or collateral. Concentration of credit risk is also similarly applicable to the investment securities portfolio.

The Company and the Bank are subject to the regulations of various government agencies. These regulations can and do change significantly from period to
period. The Company and the Bank also undergo periodic examinations by regulatory agencies, which may subject them to changes with respect to asset valuations, amount of required allowance for loan loss, capital levels or operating restrictions.

Recently Adopted / Issued Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-02 Receivables (Topic 310): A Creditors Determination of Whether a
Restructuring Is a Troubled Debt Restructuring(ASU 2011-02). ASU 2011-02 amends Topic 310 of the FASB Accounting Standards Codification to clarify when creditors should classify loan modifications as troubled debt restructurings. As
amended, Topic 310 states that a troubled debt restructuring occurs when a creditor, for economic or legal reasons related to a debtors financial difficulties, grants a concession to the debtor that it wouldnt otherwise consider. For
public entities, the amendments promulgated by ASU 2011-02 are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. For
purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The provisions of ASU 2011-02 could result in more loan
modifications being classified as troubled debt restructurings, which could affect the aggregate amount of the Companys TDRs and therefore the calculation of the allowance for loan losses, and increase disclosures. The Company is in the
process of evaluating the impact of ASU 2011-02 on its financial position, results of operations and cash flows.



8



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



In July 2010, the FASB issued Accounting Standards Update No. 2010-20 Receivables (Topic 310):
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). ASU 2010-20 expanded disclosures related to allowance for credit losses and the credit quality of financing receivables.
The update requires the allowance and other credit quality disclosures to be provided on a disaggregated basis. The Company adopted the period-end disclosure provisions of this update as of December 31, 2010. Accordingly, the Company adopted
the activity-based disclosure provisions of this amendment during the first quarter 2011.

Other accounting standards that have been recently
issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Companys financial position, results of operations, or cash flows.

Accumulated Other Comprehensive Income (Loss)

The Company discloses changes in
comprehensive income in the Consolidated Statements of Changes in Shareholders Equity and Comprehensive Income (Loss). Comprehensive income (loss) includes all changes in shareholders equity during a period except those resulting from
transactions with shareholders.

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



|                                                                 |  |                                     |        |   |      |   |        |  
|---------------------------------------------------------------- |  | ----------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                 |  | For the three months endedMarch 31, |       
|                                                                 |  | 2011                                |        |   | 2010 |  
|Net unrealized Gains on Investment Securities Available for Sale |  |                                     |        |   |      |   |        |  
|Balance, beginning of period                                     |  | $                                   | 1,264  |   |      | $ | 306    |  
|Other comprehensive income (loss):                               |  |                                     |        |   |      |   |        |  
|Unrealized holding gains (losses) arising during the period      |  |                                     | (140   | ) |      |   | 1,884  |  
|Income tax (expense) benefit                                     |  |                                     | 53     |   |      |   | (715   | )
|Less: Reclassification adjustment for gains included in net loss |  |                                     |       |   |      |   | (8     | )
|Income tax expense (benefit)                                     |  |                                     |       |   |      |   | 3      |  
|                                                                 |  |                                     |        |   |      |   |        |  
|                                                                 |  |                                     | (87    | ) |      |   | 1,164  |  
|                                                                 |  |                                     |        |   |      |   |        |  
|Balance, end of period                                           |  |                                     | 1,177  |   |      |   | 1,470  |  
|                                                                 |  |                                     |        |   |      |   |        |  
|                                                                 |  |                                    
|Net unrealized Losses on Impact of Defined Benefit Pension Plan  |  |                                     |        |   |      |   |        |  
|Balance, beginning of period                                     |  |                                     | (7,843 | ) |      |   | (7,266 | )
|Other comprehensive loss:                                        |  |                                     |        |   |      |   |        |  
|Impact of FASB ASC 715                                           |  |                                     |       |   |      |   |       |  
|Income tax benefit                                               |  |                                     |       |   |      |   |       |  
|                                                                 |  |                                     |        |   |      |   |        |  
|                                                                 |  |                                     |       |   |      |   |       |  
|                                                                 |  |                                     |        |   |      |   |        |  
|Balance, end of period                                           |  |                                     | (7,843 | ) |      |   | (7,266 | )
|                                                                 |  |                                     |        |   |      |   |        |  
|                                                                 |  | $                                   | (6,666 | ) |      | $ | (5,796 | )
|                                                                 |  |                                     |        |   |      |   |        |  
|                                                                 |  |                                    
|Total other comprehensive income (loss), end of period           |  | $                                   | (87    | ) |      | $ | 1,164  |  
|Net loss                                                         |  |                                     | (6,080 | ) |      |   | (5,292 | )
|                                                                 |  |                                     |        |   |      |   |        |  
|Comprehensive loss                                               |  | $                                   | (6,167 | ) |      | $ | (4,128 | )
|                                                                 |  |                                     |        |   |      |   |        |  

The Company made a $1.3 million contribution to the pension plan during March 2011; however, the market value of pension
plan assets is only assessed and adjusted through accumulated other comprehensive income (loss) annually, if necessary.



|2. | Cash and Cash Equivalents
|-- | -------------------------

Noninterest-Earning Deposits with Financial Institutions

There were no noninterest-earning deposits with financial institutions included in the Cash and due from banks line item in the Consolidated Balance Sheets at March 31, 2011 and December 31,
2010.

Required Reserve Balances

The Federal Reserve Act requires each depository institution to maintain reserves against certain liabilities as prescribed by regulations of the Board of Governors of the Federal Reserve (the
Federal Reserve). The Bank reports these liabilities to the Federal Reserve on a weekly basis. Weekly reporting institutions maintain reserves on these liabilities with a 30-day lag. For the maintenance period ended on April 20,
2011, based on reported liabilities from March 8, 2011 through March 21, 2011, the Federal Reserve required the Bank to maintain reserves of $12.3 million. After taking into consideration the Companys levels of vault cash, reserves
of $2.5 million were required to be maintained with the Federal Reserve.

Concentrations and Restrictions



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



In an effort to manage counterparty risk, the Company generally does not sell federal funds to other
financial institutions. Federal funds are essentially uncollateralized overnight loans. The Company regularly evaluates the risk associated with the counterparties to these potential transactions to ensure that it would not be exposed to any
significant risks with regard to cash and cash equivalent balances.

Cash and cash equivalents pledged as collateral and therefore restricted
at the dates indicated are as follows (in thousands).



|                                                     |  |               |       |  |                  |   |       | 
|---------------------------------------------------- |  | ------------- | ----- |  | ---------------- | - | ----- | 
|                                                     |  | March 31,2011 |       |  | December 31,2010 |  
|Merchant credit card agreements                      |  | $             | 452   |  |                  | $ | 451   | 
|Contractually restricted balances for check clearing |  |               | 1,929 |  |                  |   | 1,929 | 
|                                                     |  |               |       |  |                  |   |       | 
|Total                                                |  | $             | 2,381 |  |                  | $ | 2,380 | 
|                                                     |  |               |       |  |                  |   |       | 

In April 2011, $1.0 million of the contractually restricted balances for check clearing were freed of restriction and
returned to the Company.



|3. | Investment Securities Available for Sale
|-- | ----------------------------------------

The following tables summarize the amortized cost, gross unrealized gains and losses included in accumulated other comprehensive income, and fair values of investment securities available for sale at the
dates indicated (in thousands). At March 31, 2011 and December 31, 2010 the Company did not have any investment securities classified as held to maturity.



|                                               |  |                   |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|---------------------------------------------- |  | ----------------- | ------- |  | -------------------- | - | ----- | --------------------- |  | - | ---------- | - |  | - | ------- | 
|                                               |  | March 31, 2011    |        
|                                               |  | Amortizedcost     |         |  | Grossunrealizedgains |   |       | Grossunrealizedlosses |  |   | Fair value |  
|State and municipal                            |  | $                 | 104,288 |  |                      | $ | 1,695 |                       |  | $ | (324       | ) |  | $ | 105,659 | 
|Collateralized mortgage obligations            |  |                   | 148,480 |  |                      |   | 973   |                       |  |   | (918       | ) |  |   | 148,535 | 
|Other mortgage-backed (federal agencies)       |  |                   | 19,439  |  |                      |   | 596   |                       |  |   | (126       | ) |  |   | 19,909  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|                                               |  |                   |         | 
|Total investment securities available for sale |  | $                 | 272,207 |  |                      | $ | 3,264 |                       |  | $ | (1,368     | ) |  | $ | 274,103 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|                                               | 
|                                               |  | December 31, 2010 |        
|                                               |  | Amortizedcost     |         |  | Grossunrealizedgains |   |       | Grossunrealizedlosses |  |   | Fair value |  
|U.S. Treasury and federal agencies             |  | $                 | 37,430  |  |                      | $ | 2     |                       |  | $ | (6         | ) |  | $ | 37,426  | 
|State and municipal                            |  |                   | 51,243  |  |                      |   | 1,687 |                       |  |   | (468       | ) |  |   | 52,462  | 
|Collateralized mortgage obligations            |  |                   | 107,876 |  |                      |   | 671   |                       |  |   | (376       | ) |  |   | 108,171 | 
|Other mortgage-backed (federal agencies)       |  |                   | 20,189  |  |                      |   | 647   |                       |  |   | (120       | ) |  |   | 20,716  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|                                               |  |                   |         | 
|Total investment securities available for sale |  | $                 | 216,738 |  |                      | $ | 3,007 |                       |  | $ | (970       | ) |  | $ | 218,775 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 

In April 2011, the Company purchased additional mortgage-backed and state and municipal investment securities aggregating
approximately $12.4 million and sold its remaining private-table CMO for $2.3 million, recognizing a $56 thousand gain.

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



10



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|---------------------------------------------- |  | ------------------- | -- |  | ------------------- | - | ------ | --------------------- |  | - | ----- |  |  | ---------- | - |  | --------------------- | - | ----- | - |  | - | ---------- |  |  | --------------------- | -- |  |  | - | ------- |  |  | - | ----- | 
|                                               |  | March 31, 2011      |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #     |  |  | Fair value |   |  | Grossunrealizedlosses |   |       | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     |   |  |                     | $ |       |                       |  | $ |      |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       |   |  |  | $ |        |  |  | $ |      | 
|State and municipal                            |  |                     | 24 |  |                     |   | 16,021 |                       |  |   | 324   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 24 |  |  |   | 16,021  |  |  |   | 324   | 
|Collateralized mortgage obligations            |  |                     | 20 |  |                     |   | 72,738 |                       |  |   | 842   |  |  |            | 3 |  |                       |   | 7,261 |   |  |   | 76         |  |  |                       | 23 |  |  |   | 79,999  |  |  |   | 918   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,600  |                       |  |   | 126   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 3  |  |  |   | 6,600   |  |  |   | 126   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               |  |                     |    |  |                     |   |        |                       | 
|Total investment securities available for sale |  |                     | 47 |  |                     | $ | 95,359 |                       |  | $ | 1,292 |  |  |            | 3 |  |                       | $ | 7,261 |   |  | $ | 76         |  |  |                       | 50 |  |  | $ | 102,620 |  |  | $ | 1,368 | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               | 
|                                               |  | December 31, 2010   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #     |  |  | Fair value |   |  | Grossunrealizedlosses |   |       | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 2  |  |                     | $ | 21,428 |                       |  | $ | 6     |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       | 2  |  |  | $ | 21,428  |  |  | $ | 6     | 
|State and municipal                            |  |                     | 12 |  |                     |   | 7,211  |                       |  |   | 468   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 12 |  |  |   | 7,211   |  |  |   | 468   | 
|Collateralized mortgage obligations            |  |                     | 10 |  |                     |   | 38,295 |                       |  |   | 376   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 10 |  |  |   | 38,295  |  |  |   | 376   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,861  |                       |  |   | 120   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 3  |  |  |   | 6,861   |  |  |   | 120   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               |  |                     |    |  |                     |   |        |                       | 
|Total investment securities available for sale |  |                     | 27 |  |                     | $ | 73,795 |                       |  | $ | 970   |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       | 27 |  |  | $ | 73,795  |  |  | $ | 970   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 

Other-Than-Temporary Impairment

Based on its other-than-temporary impairment analysis at March 31, 2011, the Company concluded that gross unrealized losses detailed in the preceding table were not other-than-temporarily impaired as
of that date.

Ratings

The
following table summarizes Moodys ratings, by segment, of the investment securities available for sale based on fair value, at March 31, 2011. An Aaa rating is based not only on the credit of the issuer, but may also include consideration
of the structure of the securities and the credit quality of the collateral.



|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|----------------------------- |  | ----------------- | --- | - | --------------------------------- |  | --- | -------------------------------------- |  |  | --- | -
|                              |  | Stateandmunicipal |     |   | Collateralizedmortgageobligations |  |     | Othermortgage-backed(federal agencies) | 
|Aaa                           |  |                   | 14  | % |                                   |  | 100 | %                                      |  |  | 100 | %
|Aa1-A3                        |  |                   | 56  |   |                                   |  |    |                                        |  |  |    |  
|Baa1                          |  |                   | 5   |   |                                   |  |    |                                        |  |  |    |  
|Not rated or withdrawn rating |  |                   | 25  |   |                                   |  |    |                                        |  |  |    |  
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|Total                         |  |                   | 100 | % |                                   |  | 100 | %                                      |  |  | 100 | %
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  

The following table summarizes by Standard and Poors ratings, by segment, of the investment securities available for
sale based on fair value, at March 31, 2011.



|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|----------------------------- |  | ----------------- | --- | - | --------------------------------- |  | --- | -------------------------------------- |  |  | --- | -
|                              |  | Stateandmunicipal |     |   | Collateralizedmortgageobligations |  |     | Othermortgage-backed(federal agencies) | 
|Aaa                           |  |                   | 18  | % |                                   |  | 100 | %                                      |  |  | 100 | %
|Aa+-A                         |  |                   | 53  |   |                                   |  |    |                                        |  |  |    |  
|Not rated or withdrawn rating |  |                   | 29  |   |                                   |  |    |                                        |  |  |    |  
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|Total                         |  |                   | 100 | % |                                   |  | 100 | %                                      |  |  | 100 | %
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  

One state and municipal security totaling $203 thousand was not rated by either Moodys or Standard and Poors.

Maturities

The following
table summarizes the amortized cost and estimated fair value of investment securities available for sale at March 31, 2011 by contractual maturity (in thousands). Expected maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations. Collateralized mortgage obligations and other mortgage-backed securities are shown separately since they are not due at a single maturity date.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                    |  |                |         |  |            |   |         | 
|--------------------------------------------------- |  | -------------- | ------- |  | ---------- | - | ------- | 
|                                                    |  | Amortized cost |         |  | Fair value |  
|Due in one year or less                             |  | $              | 3,500   |  |            | $ | 3,549   | 
|Due after one year through five years               |  |                | 23,538  |  |            |   | 24,634  | 
|Due after five year through ten years               |  |                | 38,227  |  |            |   | 38,693  | 
|Due after ten years                                 |  |                | 39,023  |  |            |   | 38,783  | 
|Collateralized mortgage obligations                 |  |                | 148,480 |  |            |   | 148,535 | 
|Other mortgage-backed securities (federal agencies) |  |                | 19,439  |  |            |   | 19,909  | 
|                                                    |  |                |         |  |            |   |         | 
|Total investment securities available for sale      |  | $              | 272,207 |  |            | $ | 274,103 | 
|                                                    |  |                |         |  |            |   |         | 

The weighted average life of investment securities available for sale was 4.5 years, based on expected prepayment
activity, at March 31, 2011. Since 62% of the portfolio, based on amortized cost, consists of collateralized mortgage obligations or other mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because
borrowers generally have the right to prepay obligations before the underlying mortgages mature.

Pledged

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



|                                 |  |               |         |  |                  |   |         | 
|-------------------------------- |  | ------------- | ------- |  | ---------------- | - | ------- | 
|                                 |  | March 31,2011 |         |  | December 31,2010 |  
|Public funds deposits            |  | $             | 97,531  |  |                  | $ | 67,260  | 
|FHLB advances and line of credit |  |               | 24,654  |  |                  |   | 48,344  | 
|                                 |  |               |         |  |                  |   |         | 
|Total                            |  | $             | 122,185 |  |                  | $ | 115,604 | 
|                                 |  |               |         |  |                  |   |         | 

Concentrations

The following table summarizes issuer concentrations of collateralized mortgage obligations whose aggregate book values exceed 10% of shareholders equity at March 31, 2011 (dollars in
thousands).



|            |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|----------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer      |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Freddie Mac |  | $                   | 48,389 |  |                         | $ | 48,357 |                                              |  |  | 41.7 | %
|Fannie Mae  |  |                     | 39,506 |  |                         |   | 39,381 |                                              |  |  | 34.0 | %
|Ginnie Mae  |  |                     | 55,769 |  |                         |   | 56,038 |                                              |  |  | 48.4 | %

The following table summarizes issuer
concentrations of other mortgage-backed investment securities whose book values exceed 10% of shareholders equity at March 31, 2011 (dollars in thousands).



|           |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|---------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer     |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Fannie Mae |  | $                   | 14,772 |  |                         | $ | 14,300 |                                              |  |  | 12.3 | %

Although there are no state and municipal
investment securities with state issuer concentrations whose aggregate book values exceed 10% of shareholders equity at March 31, 2011, three state issuers, Michigan, Texas, and South Carolina, exceeded 9% of shareholders equity at
March 31, 2011. These securities represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities portfolio at March 31, 2011.

Realized Gains and Losses

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



|                   |  |                                      |   |  |      |   |        |  
|------------------ |  | ------------------------------------ | - |  | ---- | - | ------ | -
|                   |  | For the three months
ended March 31, |  
|                   |  | 2011                                 |   |  | 2010 |  
|Realized gains     |  | $                                    |  |  |      | $ | 1,147  |  
|Realized losses    |  |                                      |  |  |      |   | (1,139 | )
|                   |  |                                      |   |  |      |   |        |  
|Net realized gains |  | $                                    |  |  |      | $ | 8      |  
|                   |  |                                      |   |  |      |   |        |  



|4. | Loans
|-- | -----



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



The tabular disclosures in this Note include amounts related to commercial loans held for sale, which
are reported separately from the Companys gross loan portfolio on the Consolidated Balance Sheets and are subject to different accounting and reporting requirements. Inclusion of commercial loans held for sale with the related disclosures for
loans held for investment provides a more accurate and relevant picture of the Companys loan exposures based on the characteristics of commercial loans held for sale.

Composition

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



|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|------------------------------------ |  | -------------- | ------- | - | ----------------- |  | ----- | ----- |  | - | ---------- | - |  |  | ----- | -
|                                     |  | March 31, 2011 |         |   | December 31, 2010 | 
|                                     |  | Total          |         |   | % of total        |  |       | Total |  |   | % of total |  
|Commercial real estate               |  | $              | 543,683 |   |                   |  | 65.9  | %     |  | $ | 573,822    |   |  |  | 66.8  | %
|Single-family residential            |  |                | 175,332 |   |                   |  | 21.3  |       |  |   | 178,980    |   |  |  | 20.8  |  
|Commercial and industrial            |  |                | 48,624  |   |                   |  | 5.9   |       |  |   | 47,812     |   |  |  | 5.6   |  
|Consumer                             |  |                | 50,884  |   |                   |  | 6.2   |       |  |   | 52,652     |   |  |  | 6.1   |  
|Other                                |  |                | 6,050   |   |                   |  | 0.7   |       |  |   | 6,317      |   |  |  | 0.7   |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Total loans                          |  | $              | 824,573 |   |                   |  | 100.0 | %     |  | $ | 859,583    |   |  |  | 100.0 | %
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Less: Commercial loans held for sale |  |                | (60,346 | ) |                   |  |       |       |  |   | (66,157    | ) |  |  |       |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Loans, gross                         |  | $              | 764,227 |   |                   |  |       |       |  | $ | 793,426    |   |  |  |       |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  

Loans included in the preceding table are net of participations sold, unearned income, charge-offs, and
unamortized deferred fees and costs on originated loans. Participations sold totaled $12.3 million and $12.5 million at March 31, 2011 and December 31, 2010, respectively. Unearned income, deferred fees and costs, and discounts and
premiums totaled $279 thousand and $299 thousand at March 31, 2011 and December 31, 2010, respectively.

Pledged

To borrow from the Federal Home Loan Bank (the FHLB), members must pledge collateral. Acceptable collateral includes, among other types of
collateral, a variety of residential, multifamily, home equity lines and second mortgages, and qualifying commercial loans. At March 31, 2011 and December 31, 2010, $362.9 million and $393.7 million of gross loans, respectively, were
pledged to collateralize FHLB advances and letters of credit of which $87.0 million and $92.5 million, respectively, was available as lendable collateral.

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that are
available for use by the Company. Effective March 11, 2011, the Company may borrow from the FHLB for terms up to 3 years, subject to availability of collateral. Previously from January 2010 to March 2011, the maximum maturity for potential
borrowings was overnight. Any future potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues. The Federal Reserve has the discretion to deny approval of borrowing
requests.

Concentrations

The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at March 31, 2011 (dollars in thousands). Of the
aggregate balance of commercial loans held for sale, 99.4% are commercial real estate loans based on FDIC code.



13



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                     |  |                                              |         |  |                                                              |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|---------------------------------------------------- |  | -------------------------------------------- | ------- |  | ------------------------------------------------------------ | - | ------ | ------------------------------- |  | - | ------------------------------------------------- |  |  | ----------------------------------- | ---- | - |  |  | ----- | -
|                                                     |  | Commercialreal 
estateincluded ingross loans |         |  | Commercialreal estateincluded
incommercialloans heldfor sale |   |        | Totalcommercialreal estateloans |  |   | % of gross loansand commercialloans held for sale |  |  | % of Bankstotal 
regulatorycapital |     
|Secured by commercial real estate                    |  |                                              |         |  |                                                              |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Construction, land development, and other land loans |  | $                                            | 112,579 |  |                                                              | $ | 8,884  |                                 |  | $ | 121,463                                           |  |  |                                     | 14.7 | % |  |  | 91.8  | %
|Multifamily residential                              |  |                                              | 18,143  |  |                                                              |   | 7,475  |                                 |  |   | 25,618                                            |  |  |                                     | 3.1  |   |  |  | 19.4  |  
|Nonfarm nonresidential                               |  |                                              | 352,977 |  |                                                              |   | 43,625 |                                 |  |   | 396,602                                           |  |  |                                     | 48.1 |   |  |  | 299.8 |  
|                                                     |  |                                              |         |  |                                                              |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Total loans secured by commercial real estate        |  | $                                            | 483,699 |  |                                                              | $ | 59,984 |                                 |  | $ | 543,683                                           |  |  |                                     | 65.9 | % |  |  | 411.0 | %
|                                                     |  |                                              |         |  |                                                              |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  

The following table further categorizes loans secured by commercial real estate at March 31, 2011 (dollars in
thousands).



|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|----------------------------------------------------------------- |  | -------------------------------------------- | ------- |  | -------------------------------------------------------------- | - | ------ | ------------------------------- |  | - | ------------------------------------------------- |  |  | ----------------------------------- | ---- | - |  |  | ----- | -
|                                                                  |  | Commercialreal 
estateincluded ingross loans |         |  | Commercialreal 
estateincluded incommercialloans 
heldfor sale |   |        | Totalcommercialreal estateloans |  |   | % of gross loansand 
commercialloans held forsale |  |  | % of Bankstotal 
regulatorycapital |     
|Development commercial real estate loans                          |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Land - unimproved (commercial or residential)                     |  | $                                            | 43,714  |  |                                                                | $ | 1,161  |                                 |  | $ | 44,875                                            |  |  |                                     | 5.4  | % |  |  | 33.9  | %
|Land development - commercial                                     |  |                                              | 12,515  |  |                                                                |   | 463    |                                 |  |   | 12,978                                            |  |  |                                     | 1.6  |   |  |  | 9.8   |  
|Land development - residential                                    |  |                                              | 41,541  |  |                                                                |   | 7,260  |                                 |  |   | 48,801                                            |  |  |                                     | 5.9  |   |  |  | 36.9  |  
|Commercial construction:                                          |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Retail                                                            |  |                                              | 4,420   |  |                                                                |   |       |                                 |  |   | 4,420                                             |  |  |                                     | 0.5  |   |  |  | 3.3   |  
|Office                                                            |  |                                              | 239     |  |                                                                |   |       |                                 |  |   | 239                                               |  |  |                                     | 0.0  |   |  |  | 0.2   |  
|Multifamily                                                       |  |                                              | 1,250   |  |                                                                |   |       |                                 |  |   | 1,250                                             |  |  |                                     | 0.2  |   |  |  | 1.0   |  
|Industrial and warehouse                                          |  |                                              | 930     |  |                                                                |   |       |                                 |  |   | 930                                               |  |  |                                     | 0.1  |   |  |  | 0.7   |  
|Miscellaneous commercial                                          |  |                                              | 3,312   |  |                                                                |   |       |                                 |  |   | 3,312                                             |  |  |                                     | 0.4  |   |  |  | 2.5   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Total development commercial real estate loans                    |  |                                              | 107,921 |  |                                                                |   | 8,884  |                                 |  |   | 116,805                                           |  |  |                                     | 14.1 |   |  |  | 88.3  |  
|                                                                  |  |                                              |         |  |                                                               
|Existing and other commercial real estate loans                   |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Hotel / motel                                                     |  |                                              | 18,143  |  |                                                                |   | 7,475  |                                 |  |   | 25,618                                            |  |  |                                     | 3.1  |   |  |  | 19.4  |  
|Retail                                                            |  |                                              | 55,764  |  |                                                                |   | 33,378 |                                 |  |   | 89,142                                            |  |  |                                     | 10.8 |   |  |  | 67.4  |  
|Office                                                            |  |                                              | 15,735  |  |                                                                |   | 4,313  |                                 |  |   | 20,048                                            |  |  |                                     | 2.4  |   |  |  | 15.2  |  
|Multifamily                                                       |  |                                              | 23,270  |  |                                                                |   | 1,409  |                                 |  |   | 24,679                                            |  |  |                                     | 3.0  |   |  |  | 18.7  |  
|Industrial and warehouse                                          |  |                                              | 11,945  |  |                                                                |   | 1,489  |                                 |  |   | 13,434                                            |  |  |                                     | 1.6  |   |  |  | 10.2  |  
|Healthcare                                                        |  |                                              | 12,891  |  |                                                                |   |       |                                 |  |   | 12,891                                            |  |  |                                     | 1.6  |   |  |  | 9.7   |  
|Miscellaneous commercial                                          |  |                                              | 115,207 |  |                                                                |   | 2,570  |                                 |  |   | 117,777                                           |  |  |                                     | 14.3 |   |  |  | 89.0  |  
|Residential construction - speculative                            |  |                                              | 863     |  |                                                                |   |       |                                 |  |   | 863                                               |  |  |                                     | 0.1  |   |  |  | 0.6   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Total existing and other commercial real estate loans             |  |                                              | 253,818 |  |                                                                |   | 50,634 |                                 |  |   | 304,452                                           |  |  |                                     | 36.9 |   |  |  | 230.2 |  
|                                                                  |  |                                              |         |  |                                                               
|Commercial real estate owner occupied and residential loans       |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Commercial - owner occupied                                       |  |                                              | 118,165 |  |                                                                |   | 466    |                                 |  |   | 118,631                                           |  |  |                                     | 14.4 |   |  |  | 89.7  |  
|Commercial construction - owner occupied                          |  |                                              | 1,711   |  |                                                                |   |       |                                 |  |   | 1,711                                             |  |  |                                     | 0.2  |   |  |  | 1.3   |  
|Residential construction - contract                               |  |                                              | 2,084   |  |                                                                |   |       |                                 |  |   | 2,084                                             |  |  |                                     | 0.3  |   |  |  | 1.5   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|Total commercial real estate owner occupied and residential loans |  |                                              | 121,960 |  |                                                                |   | 466    |                                 |  |   | 122,426                                           |  |  |                                     | 14.9 |   |  |  | 92.5  |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  
|                                                                  |  |                                              |         |  |                                                               
|Total loans secured by commercial real estate                     |  | $                                            | 483,699 |  |                                                                | $ | 59,984 |                                 |  | $ | 543,683                                           |  |  |                                     | 65.9 | % |  |  | 411.0 | %
|                                                                  |  |                                              |         |  |                                                                |   |        |                                 |  |   |                                                   |  |  |                                     |      |   |  |  |       |  

Asset Quality

Credit Quality Indicators. The Company regularly monitors the credit quality of its loan portfolio. Credit quality refers to the current and expected ability of borrowers to repay their obligations
according to the contractual terms of such loans. Credit quality is evaluated through assignment of individual loan grades, as well as past-due and performing status analysis. Credit quality indicators allow the Company to assess the inherent loss
on certain individual and pools of loans. See Note 4 of the Companys Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on February 28, 2011, for a
more detailed discussion of loan grading criteria and other credit quality indicators.

The following table summarizes the Companys
internal credit quality indicators on gross loans and commercial loans held for sale, by class, at March 31, 2011 (in thousands).



14



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------------------------------- | ------- |  | ---------------------- | - | ------ | --------------------- |  | - | ----------------------------------------------------- |  |  | -------------------------- | ------ |  |  | - | ------- | -
|                                                                        |  | Construction, 
landdevelopmentand other landloans |         |  | Multifamilyresidential |   |        | Nonfarmnonresidential |  |   | Commercialreal estatein 
commercialloans heldfor sale |  |  | Totalcommercialreal estate |       
|Grade 1                                                                 |  | $                                                 |        |  |                        | $ |       |                       |  | $ |                                                      |  |  | $                          |       |  |  | $ |        |  
|Grade 2                                                                 |  |                                                   |        |  |                        |   |       |                       |  |   | 813                                                   |  |  |                            |       |  |  |   | 813     |  
|Grade 3                                                                 |  |                                                   | 9,748   |  |                        |   | 3,685  |                       |  |   | 124,399                                               |  |  |                            |       |  |  |   | 137,832 |  
|Grade 4                                                                 |  |                                                   | 10,075  |  |                        |   | 543    |                       |  |   | 101,119                                               |  |  |                            |       |  |  |   | 111,737 |  
|Grade W                                                                 |  |                                                   | 7,482   |  |                        |   | 1,069  |                       |  |   | 21,854                                                |  |  |                            |       |  |  |   | 30,405  |  
|Grade 5                                                                 |  |                                                   | 7,232   |  |                        |   | 11,068 |                       |  |   | 41,341                                                |  |  |                            | 4,060  |  |  |   | 63,701  |  
|Grade 6                                                                 |  |                                                   | 35,894  |  |                        |   | 1,754  |                       |  |   | 59,655                                                |  |  |                            | 38,314 |  |  |   | 135,617 |  
|Grade 7                                                                 |  |                                                   | 17,837  |  |                        |   |       |                       |  |   | 3,252                                                 |  |  |                            | 17,610 |  |  |   | 38,699  |  
|Not risk rated*                                                         |  |                                                   | 24,312  |  |                        |   | 24     |                       |  |   | 543                                                   |  |  |                            |       |  |  |   | 24,879  |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|                                                                        |  | $                                                 | 112,580 |  |                        | $ | 18,143 |                       |  | $ | 352,976                                               |  |  | $                          | 59,984 |  |  | $ | 543,683 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|Less: Commercial real estate included in commercial loans held for sale |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   | (59,984 | )
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|Total                                                                   |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  | $ | 483,699 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  

* -Consumer real estate loans of $24.3 million, included within construction, land development, and other land loans, are
not risk rated, in accordance with our policy



|              |  |                          |        | 
|------------- |  | ------------------------ | ------ | 
|              |  | Commercial andindustrial |       
|Grade 1       |  | $                        | 1,916  | 
|Grade 2       |  |                          | 433    | 
|Grade 3       |  |                          | 16,659 | 
|Grade 4       |  |                          | 16,837 | 
|Grade W       |  |                          | 4,123  | 
|Grade 5       |  |                          | 1,212  | 
|Grade 6       |  |                          | 5,251  | 
|Grade 7       |  |                          | 1,242  | 
|Not graded ** |  |                          | 951    | 
|              |  |                          |        | 
|Total         |  | $                        | 48,624 | 
|              |  |                          |        | 

** - Primarily represents indirect auto loans underwritten as consumer loans but classified as commercial and industrial
since loans were made to the customers business. These loans were subsequently rated as Grade 3 credits in April 2011.



|                                                                                 |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   |         |  
|-------------------------------------------------------------------------------- |  | ------------------------------------------------- | ------ |  | ---------------------------------------------- | - | ------- | ----------------------------------------------- |  | - | -------------------------------------------------------------- |  |  | ------------------------------------- | --- |  |  | - | ------- | -
|                                                                                 |  | Single-familyresidential revolving,open end loans |        |  | Single-familyresidential closed end,first lien |   |         | Single-familyresidential closed end,junior lien |  |   | Single-familyresidential loans incommercial loans heldfor sale |  |  | Total 
single-familyresidential loans |    
|Performing                                                                       |  | $                                                 | 57,433 |  |                                                | $ | 100,620 |                                                 |  | $ | 8,041                                                          |  |  | $                                     |    |  |  | $ | 166,094 |  
|Nonperforming                                                                    |  |                                                   | 875    |  |                                                |   | 7,395   |                                                 |  |   | 606                                                            |  |  |                                       | 362 |  |  |   | 9,238   |  
|                                                                                 |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   |         |  
|Total                                                                            |  | $                                                 | 58,308 |  |                                                | $ | 108,015 |                                                 |  | $ | 8,647                                                          |  |  | $                                     | 362 |  |  | $ | 175,332 |  
|                                                                                 |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   |         |  
|Less: Single-family residential loans included in commercial loans held for sale |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   | (362    | )
|                                                                                 |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   |         |  
|Total                                                                            |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  | $ | 174,970 |  
|                                                                                 |  |                                                   |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                       |     |  |  |   |         |  



|              |  |              |    |  |                |   |        |                |  |   |        | 
|------------- |  | ------------ | -- |  | -------------- | - | ------ | -------------- |  | - | ------ | 
|              |  | Credit cards |    |  | Consumer-other |   |        | Total Consumer | 
|Performing    |  | $            |   |  |                | $ | 50,380 |                |  | $ | 50,380 | 
|Nonperforming |  |              | 26 |  |                |   | 478    |                |  |   | 504    | 
|              |  |              |    |  |                |   |        |                |  |   |        | 
|Total         |  | $            | 26 |  |                | $ | 50,858 |                |  | $ | 50,884 | 
|              |  |              |    |  |                |   |        |                |  |   |        | 



|              |  |       |       | 
|------------- |  | ----- | ----- | 
|              |  | Other |      
|Performing    |  | $     | 6,050 | 
|Nonperforming |  |       |      | 
|              |  |       |       | 
|Total         |  | $     | 6,050 | 
|              |  |       |       | 

The following table summarizes the Companys internal credit quality indicators on gross loans and commercial loans
held for sale, by class, at December 31, 2010 (in thousands).



15



---

##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------------------------------- | ------- |  | ---------------------- | - | ------ | --------------------- |  | - | ----------------------------------------------------- |  |  | -------------------------- | ------ |  |  | - | ------- | -
|                                                                        |  | Construction, 
landdevelopmentand other landloans |         |  | Multifamilyresidential |   |        | Nonfarmnonresidential |  |   | Commercialreal estatein 
commercialloans heldfor sale |  |  | Totalcommercialreal estate |       
|Grade 1                                                                 |  | $                                                 | 53      |  |                        | $ |       |                       |  | $ |                                                      |  |  | $                          |       |  |  | $ | 53      |  
|Grade 2                                                                 |  |                                                   |        |  |                        |   |       |                       |  |   | 834                                                   |  |  |                            |       |  |  |   | 834     |  
|Grade 3                                                                 |  |                                                   | 13,188  |  |                        |   | 3,728  |                       |  |   | 131,695                                               |  |  |                            |       |  |  |   | 148,611 |  
|Grade 4                                                                 |  |                                                   | 9,146   |  |                        |   | 549    |                       |  |   | 99,182                                                |  |  |                            |       |  |  |   | 108,877 |  
|Grade W                                                                 |  |                                                   | 10,654  |  |                        |   | 1,085  |                       |  |   | 28,268                                                |  |  |                            |       |  |  |   | 40,007  |  
|Grade 5                                                                 |  |                                                   | 7,550   |  |                        |   | 11,168 |                       |  |   | 41,046                                                |  |  |                            | 4,114  |  |  |   | 63,878  |  
|Grade 6                                                                 |  |                                                   | 34,157  |  |                        |   | 1,769  |                       |  |   | 59,440                                                |  |  |                            | 42,450 |  |  |   | 137,816 |  
|Grade 7                                                                 |  |                                                   | 21,071  |  |                        |   |       |                       |  |   | 3,622                                                 |  |  |                            | 18,661 |  |  |   | 43,354  |  
|Not risk rated*                                                         |  |                                                   | 29,512  |  |                        |   | 28     |                       |  |   | 852                                                   |  |  |                            |       |  |  |   | 30,392  |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|                                                                        |  | $                                                 | 125,331 |  |                        | $ | 18,327 |                       |  | $ | 364,939                                               |  |  | $                          | 65,225 |  |  | $ | 573,822 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|Less: Commercial real estate included in commercial loans held for sale |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   | (65,225 | )
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  
|Total                                                                   |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  | $ | 508,597 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                       |  |  |                            |        |  |  |   |         |  

* -Consumer real estate loans of $29.5 million, included within construction, land development, and other land loans, are
not risk rated, in accordance with our policy



|           |  |                          |        | 
|---------- |  | ------------------------ | ------ | 
|           |  | Commercial andindustrial |       
|Grade 1    |  | $                        | 1,932  | 
|Grade 2    |  |                          | 487    | 
|Grade 3    |  |                          | 22,027 | 
|Grade 4    |  |                          | 10,534 | 
|Grade W    |  |                          | 3,778  | 
|Grade 5    |  |                          | 1,171  | 
|Grade 6    |  |                          | 5,779  | 
|Grade 7    |  |                          | 1,736  | 
|Not graded |  |                          | 368    | 
|           |  |                          |        | 
|Total      |  | $                        | 47,812 | 
|           |  |                          |        | 



|                                                                                 |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   |         |  
|-------------------------------------------------------------------------------- |  | -------------------------------------------------- | ------ |  | ---------------------------------------------- | - | ------- | ----------------------------------------------- |  | - | -------------------------------------------------------------- |  |  | ------------------------------------ | --- |  |  | - | ------- | -
|                                                                                 |  | Single-familyresidential 
revolving,open end loans |        |  | Single-familyresidential closed end,first lien |   |         | Single-familyresidential closed end,junior lien |  |   | Single-familyresidential loans incommercial loans heldfor sale |  |  | Total single-familyresidential loans |    
|Performing                                                                       |  | $                                                  | 58,874 |  |                                                | $ | 101,414 |                                                 |  | $ | 8,289                                                          |  |  | $                                    |    |  |  | $ | 168,577 |  
|Nonperforming                                                                    |  |                                                    | 998    |  |                                                |   | 7,607   |                                                 |  |   | 866                                                            |  |  |                                      | 932 |  |  |   | 10,403  |  
|                                                                                 |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   |         |  
|Total                                                                            |  | $                                                  | 59,872 |  |                                                | $ | 109,021 |                                                 |  | $ | 9,155                                                          |  |  | $                                    | 932 |  |  | $ | 178,980 |  
|                                                                                 |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   |         |  
|Less: Single-family residential loans included in commercial loans held for sale |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   | (932    | )
|                                                                                 |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   |         |  
|Total                                                                            |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  | $ | 178,048 |  
|                                                                                 |  |                                                    |        |  |                                                |   |         |                                                 |  |   |                                                                |  |  |                                      |     |  |  |   |         |  



|              |  |              |     |  |                |   |        |                |  |   |        | 
|------------- |  | ------------ | --- |  | -------------- | - | ------ | -------------- |  | - | ------ | 
|              |  | Credit cards |     |  | Consumer-other |   |        | Total Consumer | 
|Performing    |  | $            | 126 |  |                | $ | 52,041 |                |  | $ | 52,167 | 
|Nonperforming |  |              | 26  |  |                |   | 459    |                |  |   | 485    | 
|              |  |              |     |  |                |   |        |                |  |   |        | 
|Total         |  | $            | 152 |  |                | $ | 52,500 |                |  | $ | 52,652 | 
|              |  |              |     |  |                |   |        |                |  |   |        | 



|              |  |       |       | 
|------------- |  | ----- | ----- | 
|              |  | Other |      
|Performing    |  | $     | 6,317 | 
|Nonperforming |  |       |      | 
|              |  |       |       | 
|Total         |  | $     | 6,317 | 
|              |  |       |       | 

The following table summarizes delinquencies, by class, at March 31, 2011 (in thousands).



16



---

##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | ------------------ | ----- |  | ---------------------------------------- | - | ------- | --------------------------------------- |  | - | -------------- |  |  | ------- | ------- | - | ----------- | - | ------- | - |  | - | ------- | -
|                                                             |  | 30-89 DaysPast
Due |       |  | Greater than90 Days PastDueon Nonaccrual |   |         | RecordedInvestment > 90Daysand Accruing |  |   | TotalPast 
Due |  |  | Current |         |   | Total loans |  
|Construction, land development and other land loans          |  | $                  | 2,415 |  |                                          | $ | 52,386  |                                         |  | $ |               |  |  | $       | 54,801  |   |             | $ | 66,662  |   |  | $ | 121,463 |  
|Multifamily residential                                      |  |                    |      |  |                                          |   | 7,475   |                                         |  |   |               |  |  |         | 7,475   |   |             |   | 18,143  |   |  |   | 25,618  |  
|Nonfarm nonresidential                                       |  |                    | 1,271 |  |                                          |   | 14,063  |                                         |  |   |               |  |  |         | 15,334  |   |             |   | 381,268 |   |  |   | 396,602 |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total commercial real estate                                 |  |                    | 3,686 |  |                                          |   | 73,924  |                                         |  |   |               |  |  |         | 77,610  |   |             |   | 466,073 |   |  |   | 543,683 |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |       |  |                                          |  
|Single-family real estate, revolving, open end loans         |  |                    | 559   |  |                                          |   | 875     |                                         |  |   | 10             |  |  |         | 1,444   |   |             |   | 56,864  |   |  |   | 58,308  |  
|Single-family real estate, closed end, first lien            |  |                    | 2,634 |  |                                          |   | 7,395   |                                         |  |   | 187            |  |  |         | 10,216  |   |             |   | 98,161  |   |  |   | 108,377 |  
|Single-family real estate, closed end, junior lien           |  |                    | 159   |  |                                          |   | 606     |                                         |  |   |               |  |  |         | 765     |   |             |   | 7,882   |   |  |   | 8,647   |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total single-family residential                              |  |                    | 3,352 |  |                                          |   | 8,876   |                                         |  |   | 197            |  |  |         | 12,425  |   |             |   | 162,907 |   |  |   | 175,332 |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |       |  |                                          |  
|Commercial and industrial                                    |  |                    | 416   |  |                                          |   | 1,795   |                                         |  |   |               |  |  |         | 2,211   |   |             |   | 46,413  |   |  |   | 48,624  |  
|                                                             |  |                    |       |  |                                          |  
|Credit cards                                                 |  |                    |      |  |                                          |   | 26      |                                         |  |   |               |  |  |         | 26      |   |             |   |        |   |  |   | 26      |  
|All other consumer                                           |  |                    | 512   |  |                                          |   | 478     |                                         |  |   |               |  |  |         | 990     |   |             |   | 49,868  |   |  |   | 50,858  |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total consumer                                               |  |                    | 512   |  |                                          |   | 504     |                                         |  |   |               |  |  |         | 1,016   |   |             |   | 49,868  |   |  |   | 50,884  |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |       |  |                                          |  
|Farmland                                                     |  |                    | 521   |  |                                          |   |        |                                         |  |   |               |  |  |         | 521     |   |             |   | 3,036   |   |  |   | 3,557   |  
|Obligations of states and political subdivisions of the U.S. |  |                    |      |  |                                          |   |        |                                         |  |   |               |  |  |         |        |   |             |   | 961     |   |  |   | 961     |  
|Other                                                        |  |                    |      |  |                                          |   |        |                                         |  |   |               |  |  |         |        |   |             |   | 1,532   |   |  |   | 1,532   |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total                                                        |  |                    | 8,487 |  |                                          |   | 85,099  |                                         |  |   | 197            |  |  |         | 93,783  |   |             |   | 730,790 |   |  |   | 824,573 |  
|Less: Commercial loans held for sale                         |  |                    |      |  |                                          |   | (22,662 | )                                       |  |   |               |  |  |         | (22,662 | ) |             |   | (37,684 | ) |  |   | (60,346 | )
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total gross loans                                            |  | $                  | 8,487 |  |                                          | $ | 62,437  |                                         |  | $ | 197            |  |  | $       | 71,121  |   |             | $ | 693,106 |   |  | $ | 764,227 |  
|                                                             |  |                    |       |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  

The following table summarizes delinquencies, by class, at December 31, 2010 (in thousands).



|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | ------------------ | ------ |  | ---------------------------------------- | - | ------- | --------------------------------------- |  | - | -------------- |  |  | ------- | ------- | - | ----------- | - | ------- | - |  | - | ------- | -
|                                                             |  | 30-89 DaysPast
Due |        |  | Greater than90 Days
PastDueon Nonaccrual |   |         | RecordedInvestment > 90Daysand Accruing |  |   | TotalPast 
Due |  |  | Current |         |   | Total loans |  
|Construction, land development and other land loans          |  | $                  | 7,240  |  |                                          | $ | 52,528  |                                         |  | $ |               |  |  | $       | 59,768  |   |             | $ | 76,686  |   |  | $ | 136,454 |  
|Multifamily residential                                      |  |                    |       |  |                                          |   | 7,943   |                                         |  |   |               |  |  |         | 7,943   |   |             |   | 18,327  |   |  |   | 26,270  |  
|Nonfarm nonresidential                                       |  |                    | 2,566  |  |                                          |   | 18,781  |                                         |  |   |               |  |  |         | 21,347  |   |             |   | 389,751 |   |  |   | 411,098 |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total commercial real estate                                 |  |                    | 9,806  |  |                                          |   | 79,252  |                                         |  |   |               |  |  |         | 89,058  |   |             |   | 484,764 |   |  |   | 573,822 |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |        |  |                                          |  
|Single-family real estate, revolving, open end loans         |  |                    | 687    |  |                                          |   | 998     |                                         |  |   |               |  |  |         | 1,685   |   |             |   | 58,187  |   |  |   | 59,872  |  
|Single-family real estate, closed end, first lien            |  |                    | 3,004  |  |                                          |   | 7,607   |                                         |  |   |               |  |  |         | 10,611  |   |             |   | 99,342  |   |  |   | 109,953 |  
|Single-family real estate, closed end, junior lien           |  |                    | 280    |  |                                          |   | 866     |                                         |  |   |               |  |  |         | 1,146   |   |             |   | 8,009   |   |  |   | 9,155   |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total single-family residential                              |  |                    | 3,971  |  |                                          |   | 9,471   |                                         |  |   |               |  |  |         | 13,442  |   |             |   | 165,538 |   |  |   | 178,980 |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |        |  |                                          |  
|Commercial and industrial                                    |  |                    | 371    |  |                                          |   | 2,197   |                                         |  |   | 68             |  |  |         | 2,636   |   |             |   | 45,176  |   |  |   | 47,812  |  
|                                                             |  |                    |        |  |                                          |  
|Credit cards                                                 |  |                    |       |  |                                          |   | 26      |                                         |  |   |               |  |  |         | 26      |   |             |   | 126     |   |  |   | 152     |  
|All other consumer                                           |  |                    | 937    |  |                                          |   | 459     |                                         |  |   |               |  |  |         | 1,396   |   |             |   | 51,104  |   |  |   | 52,500  |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total consumer                                               |  |                    | 937    |  |                                          |   | 485     |                                         |  |   |               |  |  |         | 1,422   |   |             |   | 51,230  |   |  |   | 52,652  |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|                                                             |  |                    |        |  |                                          |  
|Farmland                                                     |  |                    |       |  |                                          |   |        |                                         |  |   |               |  |  |         |        |   |             |   | 3,667   |   |  |   | 3,667   |  
|Obligations of states and political subdivisions of the U.S. |  |                    |       |  |                                          |   |        |                                         |  |   |               |  |  |         |        |   |             |   | 990     |   |  |   | 990     |  
|Other                                                        |  |                    |       |  |                                          |   |        |                                         |  |   |               |  |  |         |        |   |             |   | 1,660   |   |  |   | 1,660   |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total                                                        |  |                    | 15,085 |  |                                          |   | 91,405  |                                         |  |   | 68             |  |  |         | 106,558 |   |             |   | 753,025 |   |  |   | 859,583 |  
|Less: Commercial loans held for sale                         |  |                    |       |  |                                          |   | (27,940 | )                                       |  |   |               |  |  |         | (27,940 | ) |             |   | (38,217 | ) |  |   | (66,157 | )
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  
|Total gross loans                                            |  | $                  | 15,085 |  |                                          | $ | 63,465  |                                         |  | $ | 68             |  |  | $       | 78,618  |   |             | $ | 714,808 |   |  | $ | 793,426 |  
|                                                             |  |                    |        |  |                                          |   |         |                                         |  |   |                |  |  |         |         |   |             |   |         |   |  |   |         |  

While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest income of $550
thousand would have been reported during the three months ended March 31, 2011 had loans classified as nonaccrual during the period performed in accordance with their original terms. As a result, the Companys earnings did not include this
interest income.

Troubled Debt Restructurings. At March 31, 2011, the principal balance of troubled debt restructurings totaled
$53.3 million, of which loans totaling $18.2 million are classified as commercial loans held for sale.



17



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



In addition, at March 31, 2011, $3.4 million troubled debt restructurings were also in nonaccrual
status. During the three months ended March 31, 2011, one troubled debt restructuring of $876 thousand was removed from this classification as it was performing in accordance with its restructured terms. At December 31, 2010, the principal
balance of troubled debt restructurings totaled $44.9 million, of which loans totaling $17.2 million are classified as commercial loans held for sale.

Impaired Loans. The following table summarizes the composition of and information relative to impaired loans, by class, at March 31, 2011 (in thousands).



|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|------------------------------------------------------- |  | ------------------ | ------ |  | ------------------------------ | - | ------- | ---------------- |  | - | ------------------ |  |  | ---------------------- | ------ |  | ------------------ | - | ------ | ---------------------- |  | - | ---------------- |  |  | - | ------- |  |  | - | ----- | 
|                                                        |  | Gross Loans        |        |  | Commercial Loans Held for Sale |   |         | Total Loans      | 
|                                                        |  | RecordedInvestment |        |  | UnpaidPrincipalBalance         |   |         | RelatedAllowance |  |   | RecordedInvestment |  |  | UnpaidPrincipalBalance |        |  | RecordedInvestment |   |        | UnpaidPrincipalBalance |  |   | RelatedAllowance | 
|With no related allowance recorded:                     |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 35,123 |  |                                | $ | 54,143  |                  |  |   |                    |  |  | $                      | 8,884  |  |                    | $ | 21,699 |                        |  | $ | 44,007           |  |  | $ | 75,842  |  |  |   |       | 
|Multifamily residential                                 |  |                    |       |  |                                |   |        |                  |  |   |                    |  |  |                        | 7,475  |  |                    |   | 13,543 |                        |  |   | 7,475            |  |  |   | 13,543  |  |  |   |       | 
|Nonfarm nonresidential                                  |  |                    | 4,343  |  |                                |   | 8,006   |                  |  |   |                    |  |  |                        | 18,985 |  |                    |   | 28,584 |                        |  |   | 23,328           |  |  |   | 36,590  |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 39,466 |  |                                |   | 62,149  |                  |  |   |                    |  |  |                        | 35,344 |  |                    |   | 63,826 |                        |  |   | 74,810           |  |  |   | 125,975 |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                                |   |        |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|Single-family real estate, closed end, first lien       |  |                    | 2,292  |  |                                |   | 7,161   |                  |  |   |                    |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 2,654            |  |  |   | 7,643   |  |  |   |       | 
|Single-family real estate, closed end, junior lien      |  |                    |       |  |                                |   |        |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 2,292  |  |                                |   | 7,161   |                  |  |   |                    |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 2,654            |  |  |   | 7,643   |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Commercial and industrial                               |  |                    | 93     |  |                                |   | 3,106   |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   | 93               |  |  |   | 3,106   |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans with no related allowance recorded |  | $                  | 41,851 |  |                                | $ | 72,416  |                  |  |   |                    |  |  | $                      | 35,706 |  |                    | $ | 64,308 |                        |  | $ | 77,557           |  |  | $ | 136,724 |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|With an allowance recorded:                             |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 9,805  |  |                                | $ | 9,805   |                  |  | $ | 3,911              |  |  |                        |        |  |                    |   |        |                        |  | $ | 9,805            |  |  | $ | 9,805   |  |  | $ | 3,911 | 
|Multifamily residential                                 |  |                    |       |  |                                |   |        |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 17,457 |  |                                |   | 21,684  |                  |  |   | 2,340              |  |  |                        |        |  |                    |   |        |                        |  |   | 17,457           |  |  |   | 21,684  |  |  |   | 2,340 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 27,262 |  |                                |   | 31,489  |                  |  |   | 6,251              |  |  |                        |        |  |                    |   |        |                        |  |   | 27,262           |  |  |   | 31,489  |  |  |   | 6,251 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                                |   |        |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 1,791  |  |                                |   | 1,791   |                  |  |   | 147                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,791            |  |  |   | 1,791   |  |  |   | 147   | 
|Single-family real estate, closed end, junior lien      |  |                    | 162    |  |                                |   | 162     |                  |  |   | 55                 |  |  |                        |        |  |                    |   |        |                        |  |   | 162              |  |  |   | 162     |  |  |   | 55    | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 1,953  |  |                                |   | 1,953   |                  |  |   | 202                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,953            |  |  |   | 1,953   |  |  |   | 202   | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Commercial and industrial                               |  |                    | 1,367  |  |                                |   | 1,436   |                  |  |   | 796                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,367            |  |  |   | 1,436   |  |  |   | 796   | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans with an allowance recorded         |  | $                  | 30,582 |  |                                | $ | 34,878  |                  |  | $ | 7,249              |  |  |                        |        |  |                    |   |        |                        |  | $ | 30,582           |  |  | $ | 34,878  |  |  | $ | 7,249 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Total:                                                  |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 44,928 |  |                                | $ | 63,948  |                  |  | $ | 3,911              |  |  | $                      | 8,884  |  |                    | $ | 21,699 |                        |  | $ | 53,812           |  |  | $ | 85,647  |  |  | $ | 3,911 | 
|Multifamily residential                                 |  |                    |       |  |                                |   |        |                  |  |   |                   |  |  |                        | 7,475  |  |                    |   | 13,543 |                        |  |   | 7,475            |  |  |   | 13,543  |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 21,800 |  |                                |   | 29,690  |                  |  |   | 2,340              |  |  |                        | 18,985 |  |                    |   | 28,584 |                        |  |   | 40,785           |  |  |   | 58,274  |  |  |   | 2,340 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 66,728 |  |                                |   | 93,638  |                  |  |   | 6,251              |  |  |                        | 35,344 |  |                    |   | 63,826 |                        |  |   | 102,072          |  |  |   | 157,464 |  |  |   | 6,251 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                                |   |        |                  |  |   |                   |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 4,083  |  |                                |   | 8,952   |                  |  |   | 147                |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 4,445            |  |  |   | 9,434   |  |  |   | 147   | 
|Single-family real estate, closed end, junior lien      |  |                    | 162    |  |                                |   | 162     |                  |  |   | 55                 |  |  |                        |       |  |                    |   |       |                        |  |   | 162              |  |  |   | 162     |  |  |   | 55    | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 4,245  |  |                                |   | 9,114   |                  |  |   | 202                |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 4,607            |  |  |   | 9,596   |  |  |   | 202   | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                                |   |         |                 
|Commercial and industrial                               |  |                    | 1,460  |  |                                |   | 4,542   |                  |  |   | 796                |  |  |                        |       |  |                    |   |       |                        |  |   | 1,460            |  |  |   | 4,542   |  |  |   | 796   | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans                                    |  | $                  | 72,433 |  |                                | $ | 107,294 |                  |  | $ | 7,249              |  |  | $                      | 35,706 |  |                    | $ | 64,308 |                        |  | $ | 108,139          |  |  | $ | 171,602 |  |  | $ | 7,249 | 
|                                                        |  |                    |        |  |                                |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 

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



18



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



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

Interest income recognized on impaired loans during the three months ended March 31, 2011 was $621 thousand. The
average balance of total impaired loans was $107.9 million for the same period.

Allowance for Loan Losses

The following table summarizes the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at and for the periods
indicated (in thousands).



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|---------------------------------------------- |  | ------------------------------------------------ | ------- |  | --------------------------------------------------- | - | ------- | ------------------------ |  | - | -------- |  |  | ----- | ------ |  | ----- | - | ----- |  |  | - | ------- |  |  | - | --------- | 
|                                               |  | At and for the three months ended March 31, 2011 |         |  | At and for thethree months endedMarch 31, 2010Total |  
|                                               |  | CommercialReal Estate                            |         |  | Single-familyResidential                            |   |         | Commercial andIndustrial |  |   | Consumer |  |  | Other |        |  | Total |   |      
|Allowance for loan losses:                     |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|Allowance for loan losses, beginning of period |  | $                                                | 18,979  |  |                                                     | $ | 4,061   |                          |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  |  |  | $ | 24,079    | 
|Provision for loan losses                      |  |                                                  | 3,983   |  |                                                     |   | 936     |                          |  |   | 479      |  |  |       | 57     |  |       |   | 45    |  |  |   | 5,500   |  |  |   | 10,750    | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Loan charge-offs                               |  |                                                  | 4,145   |  |                                                     |   | 856     |                          |  |   | 435      |  |  |       | 170    |  |       |   | 183   |  |  |   | 5,789   |  |  |   | 7,242     | 
|Loan recoveries                                |  |                                                  | 35      |  |                                                     |   | 50      |                          |  |   | 30       |  |  |       | 56     |  |       |   | 138   |  |  |   | 309     |  |  |   | 839       | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|Net loans charged-off                          |  |                                                  | 4,110   |  |                                                     |   | 806     |                          |  |   | 405      |  |  |       | 114    |  |       |   | 45    |  |  |   | 5,480   |  |  |   | 6,403     | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Allowance for loan losses, end of period       |  | $                                                | 18,852  |  |                                                     | $ | 4,191   |                          |  | $ | 2,566    |  |  | $     | 1,318  |  |       | $ | 27    |  |  | $ | 26,954  |  |  | $ | 28,426    | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Individually evaluated for impairment          |  | $                                                | 6,251   |  |                                                     | $ | 202     |                          |  | $ | 796      |  |  | $     |       |  |       | $ |      |  |  | $ | 7,249   |  |  | $ | 6,997     | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Collectively evaluated for impairment          |  |                                                  | 12,601  |  |                                                     |   | 3,989   |                          |  |   | 1,770    |  |  |       | 1,318  |  |       |   | 27    |  |  |   | 19,705  |  |  |   | 21,429    | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|Allowance for loan losses, end of period       |  | $                                                | 18,852  |  |                                                     | $ | 4,191   |                          |  | $ | 2,566    |  |  | $     | 1,318  |  |       | $ | 27    |  |  | $ | 26,954  |  |  | $ | 28,426    | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Gross loans, end of period:                    |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|Individually evaluated for impairment          |  | $                                                | 66,728  |  |                                                     | $ | 4,245   |                          |  | $ | 1,460    |  |  | $     |       |  |       | $ |      |  |  | $ | 72,433  |  |  | $ | 107,399   | 
|                                               |  |                                                  |         |  |                                                     |   |        
|Collectively evaluated for impairment          |  |                                                  | 416,971 |  |                                                     |   | 170,725 |                          |  |   | 47,164   |  |  |       | 50,884 |  |       |   | 6,050 |  |  |   | 691,794 |  |  |   | 902,848   | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 
|Total gross loans                              |  | $                                                | 483,699 |  |                                                     | $ | 174,970 |                          |  | $ | 48,624   |  |  | $     | 50,884 |  |       | $ | 6,050 |  |  | $ | 764,227 |  |  | $ | 1,010,247 | 
|                                               |  |                                                  |         |  |                                                     |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         |  |  |   |           | 



|5. | Commercial Loans Held for Sale and Valuation Allowance
|-- | ------------------------------------------------------

In September 2010, the Company began to market for sale a pool of specifically identified commercial loans. Through March 31, 2011 ten of these loans with a gross book value of $12.4 million were
sold, of which $2.0 million were closed in the three months ended March 31, 2011.

The Company is continuing its efforts to market and
sell the remaining commercial loans held for sale. At March 31, 2011, commercial loans held for sale totaled $60.3 million. Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these loans to their fair
value less estimated costs to sell based on updated valuations.



|6. | Premises and Equipment, net
|-- | ---------------------------

The
following table summarizes premises and equipment balances, net at the dates indicated (in thousands).



|                              |  |               |         |   |                  |   |         |  
|----------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                              |  | March 31,2011 |         |   | December 31,2010 |  
|Land                          |  | $             | 6,534   |   |                  | $ | 6,534   |  
|Buildings                     |  |               | 19,396  |   |                  |   | 19,386  |  
|Leasehold improvements        |  |               | 5,208   |   |                  |   | 5,200   |  
|Furniture and equipment       |  |               | 12,646  |   |                  |   | 12,571  |  
|Software                      |  |               | 4,061   |   |                  |   | 3,562   |  
|Bank automobiles              |  |               | 106     |   |                  |   | 137     |  
|Capital lease asset           |  |               | 1,378   |   |                  |   | 1,085   |  
|                              |  |               |         |   |                  |   |         |  
|Premises and equipment, gross |  |               | 49,329  |   |                  |   | 48,475  |  
|                              |  |              
|Accumulated depreciation      |  |               | (21,257 | ) |                  |   | (20,366 | )
|                              |  |               |         |   |                  |   |         |  
|Premises and equipment, net   |  | $             | 28,072  |   |                  | $ | 28,109  |  
|                              |  |               |         |   |                  |   |         |  

Depreciation expense for the three months ended March 31, 2011 and 2010 was $598 thousand and $625 thousand,
respectively.

At March 31, 2011, a vacant bank-owned branch facility with a net book value of $235 thousand is under contract for sale
and included in Other assets in the Consolidated Balance Sheets, and in April 2011 the Company began marketing for sale a piece of vacant land with a book value of $728 thousand.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|7. | Mortgage-Banking Activities
|-- | ---------------------------

Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at March 31, 2011 and December 31, 2010,
respectively, and are excluded from the Consolidated Balance Sheets.

The book value of mortgage-servicing rights was $2.9 million at both
March 31, 2011 and December 31, 2010. Mortgage-servicing rights are included within Other assets in the Consolidated Balance Sheets. The fair value of mortgage-servicing rights at March 31, 2011 and December 31, 2010 was $3.5
million and $3.6 million, respectively.

Mortgage-Servicing Rights Activity

The following table summarizes the changes in mortgage-servicing rights at the dates and for the periods indicated (in thousands).



|                                                                                     |  |                                     |       |   |      |   |       |  
|------------------------------------------------------------------------------------ |  | ----------------------------------- | ----- | - | ---- | - | ----- | -
|                                                                                     |  | For the three monthsended March 31, |      
|                                                                                     |  | 2011                                |       |   | 2010 |  
|Mortgage-servicing rights portfolio, net of valuation allowance, beginning of period |  | $                                   | 2,896 |   |      | $ | 3,039 |  
|Capitalized mortgage-servicing rights                                                |  |                                     | 170   |   |      |   | 166   |  
|Mortgage-servicing rights portfolio amortization and impairment                      |  |                                     | (212  | ) |      |   | (191  | )
|                                                                                     |  |                                     |       |   |      |   |       |  
|Mortgage-servicing rights portfolio, net of valuation allowance, end of period       |  | $                                   | 2,854 |   |      | $ | 3,014 |  
|                                                                                     |  |                                     |       |   |      |   |       |  

Valuation Allowance

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



|                                                              |  |                                     |    |  |      |   |    |  
|------------------------------------------------------------- |  | ----------------------------------- | -- |  | ---- | - | -- | -
|                                                              |  | For the three monthsended March 31, |   
|                                                              |  | 2011                                |    |  | 2010 |  
|Valuation allowance, beginning of period                      |  | $                                   | 39 |  |      | $ | 40 |  
|Additions charged to and (reduction credited from) operations |  |                                     | 2  |  |      |   | (2 | )
|                                                              |  |                                     |    |  |      |   |    |  
|Valuation allowance, end of period                            |  | $                                   | 41 |  |      | $ | 38 |  
|                                                              |  |                                     |    |  |      |   |    |  



|8. | Foreclosed Real Estate and Repossessed Personal Property
|-- | --------------------------------------------------------

Composition

The following table summarizes foreclosed real estate and repossessed personal
property at the dates indicated (in thousands).



|                                                               |  |               |        |  |                  |   |        | 
|-------------------------------------------------------------- |  | ------------- | ------ |  | ---------------- | - | ------ | 
|                                                               |  | March 31,2011 |        |  | December 31,2010 |  
|Foreclosed real estate                                         |  | $             | 16,244 |  |                  | $ | 19,983 | 
|Repossessed personal property                                  |  |               | 141    |  |                  |   | 104    | 
|                                                               |  |               |        |  |                  |   |        | 
|Total foreclosed real estate and repossessed personal property |  | $             | 16,385 |  |                  | $ | 20,087 | 
|                                                               |  |               |        |  |                  |   |        | 

Foreclosed Real Estate Activity

The following table summarizes the changes in the foreclosed real estate portfolio at the dates and for the periods indicated (in thousands). Foreclosed real estate is net of participations sold of $3.3
million and $8.2 million at March 31, 2011 and March 31, 2010, respectively.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                   |  |                                           |        |   |      |   |        |  
|-------------------------------------------------- |  | ----------------------------------------- | ------ | - | ---- | - | ------ | -
|                                                   |  | At and for the threemonths endedMarch 31, |       
|                                                   |  | 2011                                      |        |   | 2010 |  
|Foreclosed real estate, beginning of period        |  | $                                         | 19,983 |   |      | $ | 27,826 |  
|Plus: New foreclosed real estate                   |  |                                           | 3,764  |   |      |   | 3,893  |  
|Less: Proceeds from sale of foreclosed real estate |  |                                           | (6,988 | ) |      |   | (2,053 | )
|Less: Gain on sale of foreclosed real estate       |  |                                           | 81     |   |      |   | 271    |  
|Less: Provision charged to expense                 |  |                                           | (596   | ) |      |   | (1,070 | )
|                                                   |  |                                           |        |   |      |   |        |  
|Foreclosed real estate, end of period              |  | $                                         | 16,244 |   |      | $ | 28,867 |  
|                                                   |  |                                           |        |   |      |   |        |  

Subsequent to March 31, 2011, 7 properties with an aggregate net carrying amount of $174 thousand were sold at an
immaterial loss. At April 26, 2011, 9 additional properties with an aggregate net carrying amount of $2.0 million were under contract for sale to close in the second quarter of 2011.



|9. | Deposits
|-- | --------

Composition

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



|                                           |  |               |           |  |                  |   |           | 
|------------------------------------------ |  | ------------- | --------- |  | ---------------- | - | --------- | 
|                                           |  | March 31,2011 |           |  | December 31,2010 |  
|Transaction deposit accounts               |  | $             | 453,080   |  |                  | $ | 434,108   | 
|Money market deposit accounts              |  |               | 149,902   |  |                  |   | 143,143   | 
|Savings deposit accounts                   |  |               | 55,159    |  |                  |   | 49,472    | 
|Time deposit accounts $100,000 and greater |  |               | 244,303   |  |                  |   | 247,169   | 
|Time deposit accounts less than $100,000   |  |               | 275,246   |  |                  |   | 299,470   | 
|                                           |  |               |           |  |                  |   |           | 
|Total deposits                             |  | $             | 1,177,690 |  |                  | $ | 1,173,362 | 
|                                           |  |               |           |  |                  |   |           | 

At March 31, 2011, $664 thousand of overdrawn transaction deposit accounts were reclassified to loans, compared with
$692 thousand at December 31, 2010. The Company had no brokered deposits at March 31, 2011 or December 31, 2010.

Interest
Expense on Deposit Accounts

The following table summarizes interest expense on deposits for the periods indicated (in thousands).



|                                         |  |                                     |       |  |      |   |       | 
|---------------------------------------- |  | ----------------------------------- | ----- |  | ---- | - | ----- | 
|                                         |  | For the three monthsended March 31, |      
|                                         |  | 2011                                |       |  | 2010 |  
|Transaction deposit accounts             |  | $                                   | 49    |  |      | $ | 61    | 
|Money market deposit accounts            |  |                                     | 81    |  |      |   | 161   | 
|Savings deposit accounts                 |  |                                     | 16    |  |      |   | 32    | 
|Time deposit accounts                    |  |                                     | 2,530 |  |      |   | 3,309 | 
|                                         |  |                                     |       |  |      |   |       | 
|Total interest expense on total deposits |  | $                                   | 2,676 |  |      | $ | 3,563 | 
|                                         |  |                                     |       |  |      |   |       | 



|10. | Borrowings
|--- | ----------

Correspondent Bank
Line of Credit

At March 31, 2011, the Company had access to an unsecured line of credit from a correspondent bank. The following
table summarizes the Companys line of credit funding utilization and availability at the dates indicated (in thousands).



|                                                          |  |               |       |  |                  |   |       | 
|--------------------------------------------------------- |  | ------------- | ----- |  | ---------------- | - | ----- | 
|                                                          |  | March 31,2011 |       |  | December 31,2010 |  
|Correspondent bank line of credit accomodations           |  | $             | 5,000 |  |                  | $ | 5,000 | 
|Utilized correspondent bank line of credit accomodations  |  |               |      |  |                  |   |      | 
|                                                          |  |               |       |  |                  |   |       | 
|Available correspondent bank line of credit accomodations |  | $             | 5,000 |  |                  | $ | 5,000 | 
|                                                          |  |               |       |  |                  |   |       | 

In April 2011, we obtained an uncommitted overnight variable rate line of credit from a correspondent bank totaling $25
million. If drawn upon, the



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



Company will be required to pledge investment securities with a fair vale equal to approximately 110% of the amount borrowed. These correspondent bank lines of credit funding source may be
canceled at any time at the correspondent banks discretion.

FHLB Borrowings

As disclosed in Note 3, Investment Securities Available for Sale, and Note 4, Loans, the Company pledges investment securities and loans to collateralize
FHLB advances and letters of credit. Additionally, the Company may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value
percentages, as calculated by the FHLB.

The Company is a member of the FHLB of Atlanta, which is one of twelve regional FHLBs that administer
home financing credit for depository institutions. As an FHLB member, the Company is required to purchase and maintain stock in the FHLB. No ready market exists for FHLB stock, and this stock has no quoted market value. Purchases and
redemptions are normally transacted each quarter to adjust the Companys investment to an amount based on the FHLB requirements, which are generally based on the amount of borrowings the Company has outstanding with the FHLB. Requests for
redemptions of FHLB stock are met at the discretion of the FHLB. The carrying value of this stock was $6.8 million at both March 31, 2011 and December 31, 2010, respectively. In April 2011 the FHLB of Atlanta repurchased $727 thousand of
the FHLB stock owned by the Company. The stock was repurchased at book value therefore no gain or loss was recognized.

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



|                                                                                                             |  |               |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                             |  | March 31,2011 |         |   | December 31,2010 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $             | 86,977  |   |                  | $ | 92,464  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |               | 23,273  |   |                  |   | 46,275  |  
|                                                                                                             |  |              
|Advances and letters of credit                                                                               |  |               |         |   |                  |   |         |  
|FHLB advances                                                                                                |  |               | (5,000  | ) |                  |   | (35,000 | )
|Letters of credit                                                                                            |  |               | (50,000 | ) |                  |   | (50,000 | )
|                                                                                                             |  |              
|Excess                                                                                                       |  |               | 54,985  |   |                  |   | 53,303  |  

At March 31, 2011, the Company
had one outstanding FHLB advance totaling $5 million. The advance bears interest at a fixed rate of 3.61% and matures in April 2013. The FHLB advance is subject to a prepayment fee in the event of full or partial repayment prior to maturity. In
January 2011, the Company prepaid $30.0 million of FHLB advances resulting in a prepayment penalty of $136 thousand.

Federal Reserve
Discount Window

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as
collateral to cover the various Federal Reserve System services that are available for use by the Company. Primary credit is available through the Discount Window to generally sound depository institutions on a very short-term basis, typically
overnight, at a rate above the Federal Open Market Committee target rate for federal funds. The Companys maximum maturity for potential borrowings is overnight. Although the Company has not drawn on this availability since its establishment in
2009, any potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues, and the Federal Reserve has the discretion to deny approval of borrowing requests.



|11. | Shareholders Equity
|--- | --------------------

Authorized Common Shares

The Company has
authorized common stock of 75.0 million shares. In October 2010, the Company issued 39,975,980 shares of common stock to a group of institutional investors in a private placement (the Private Placement). An additional 1,230,029
shares were issued in December 2010 and January 2011 to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional investors in the first quarter 2011 in a follow-on offering related to the Private
Placement. In connection these share issuances,



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



the Company received gross proceeds of $106 million and $8 million in the fourth quarter 2010 and first quarter 2011, respectively. Of the proceeds received, $96 million and $8 million were
contributed to the Bank in fourth quarter 2010 and first quarter 2011, respectively.

As a result of the share issuances noted above,
remaining authorized but unissued common shares were 24,486,278 at April 26, 2011.

During August 2010, the Companys
shareholders approved an amendment to the Companys Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock from 25.0 million shares to 75.0 million shares and reduce the par
value of the common stock from $5.00 per share to $0.01 per share.

As disclosed in Note 14, Equity Based Compensation, as of April 26,
2011 the Company has reserved a total of 274,656 shares for future issuance under various equity incentive plans.

Authorized Preferred
Shares

The Company has authorized preferred stock of 2.5 million shares with such preferences, limitations and relative rights,
within legal limits, of the class, or one or more series within the class, as are set by the Board of Directors. To date, the Company has not issued any preferred shares.

Cash Dividends

The Board of Directors has not declared or paid a dividend on our common
stock since the first quarter 2009. Under the terms of a Consent Order the Bank entered into with the regulatory agencies in June 2010 (the Consent Order), payment of common dividends requires prior notification to and non-objection from
the applicable banking regulators.

Recapitalization

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



|12. | Income Taxes
|--- | ------------

During 2009, the
U.S. Congress extended the net operating loss carryback period from two years to five years for qualifying institutions. Effective January 1, 2010, the available carryback years for net operating losses under the Internal Revenue Code rules
reverted from five years back to two years. At December 31, 2010, the Company had additional carryback capacity to recapture up to $7.4 million of taxes paid in 2008. Accordingly, the Companys income tax receivable of $7.4 million at
December 31, 2010 was primarily the result of its taxable net operating loss for the year ended December 31, 2010 which was carried back to 2008. In March 2011, after filing its 2010 federal income tax return, the Company filed a request
for refund for this amount and the refund was received in April 2011.

As of March 31, 2011, net deferred tax assets, before any
valuation allowance, of $22.9 million are recorded in the Companys Consolidated Balance Sheets. The net deferred tax asset is fully offset by a valuation allowance of $22.9 million as a result of uncertainty surrounding the ultimate
realization of these tax benefits. Based on the Companys projections of future taxable income over the next three years, cumulative tax losses over the previous two years, net operating loss carry forward limitations as discussed below and
available tax planning strategies, the Company initially recorded a valuation allowance against the net deferred tax asset in December 2010. The Companys ongoing analysis indicates that a full valuation allowance is appropriate at
March 31, 2011 as well. The Private Placement consummated in October 2010 was considered a change in control under the Internal Revenue Service rules. Accordingly, the Company was required to evaluate potential limitation or deferral of
its ability to carry forward pre-acquisition net operating losses and to determine the amount of net unrealized pre-acquisition built-in losses, which also limits the amount of net operating losses that may be used in the future. As a result of the
analysis, the Company currently estimates that future utilization of net operating loss carry forwards and built-in losses of $46 million generated prior to October 7, 2010 will be limited to $1.1 million per year.

Provision for income taxes was $52 thousand in the first quarter 2011. The provision for income taxes in the first quarter 2011 reflects the additional
valuation allowance in excess of the tax benefit generated in the current period that is necessary to fully offset the net deferred tax asset of $22.9 million at March 31, 2011.



|13. | Employee Benefit Plans
|--- | ----------------------

401(k)
Plan



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



During the three months ended March 31, 2011 and 2010, the Company made matching contributions to
the employee 401(k) plan totaling $98 thousand and $98 thousand, respectively.

Defined Benefit Pension Plan

Historically, the Company has offered a noncontributory, defined benefit pension plan that covered all full-time employees having at least twelve months
of continuous service and having attained age 21. In 2007, the Company notified employees that it would cease accruing pension benefits for employees with regard to the noncontributory, defined benefit pension plan. Although no previously accrued
benefits were lost, employees no longer accrue benefits for service subsequent to 2007.

The Company recognizes the funded status of the
defined benefit postretirement plan in the Consolidated Balance Sheets. Gains and losses, prior service costs and credits, and any remaining transition amounts that had not yet been recognized through net periodic benefit cost as of
December 31, 2007 are recognized in accumulated other comprehensive income, net of tax impacts, until they are amortized as a component of net periodic cost.

The Companys net accrued liability is included in Other liabilities in the Consolidated Balance Sheets and totaled $4.1 million and $5.2 million at March 31, 2011 and December 31, 2010,
respectively.

The fair value of plan assets totaled $15.5 million and $13.9 million at March 31, 2011 and December 31, 2010,
respectively.

Cost of Defined Benefit Pension Plan. The following table summarizes the adjusted net periodic expense (income)
components for the Companys defined benefit pension plan, which is included in Salaries and other personnel expense in the Consolidated Statements of Income (Loss), for the periods indicated (in thousands).



|                                   |  |                                     |      |   |      |   |      |  
|---------------------------------- |  | ----------------------------------- | ---- | - | ---- | - | ---- | -
|                                   |  | For the three months endedMarch 31, |     
|                                   |  | 2011                                |      |   | 2010 |  
|Interest cost                      |  | $                                   | 251  |   |      | $ | 227  |  
|Expected return on plan assets     |  |                                     | (274 | ) |      |   | (227 | )
|Amortization of net actuarial loss |  |                                     | 197  |   |      |   | 158  |  
|                                   |  |                                     |      |   |      |   |      |  
|Net periodic pension expense       |  | $                                   | 174  |   |      | $ | 158  |  
|                                   |  |                                     |      |   |      |   |      |  

As a result of the Companys decision to curtail the plan effective on January 1, 2008, no costs relative to
service costs have been necessary since that date as employees no longer accrue benefits for services rendered.

Current and Future
Expected Contributions. The Pension Protection Act of 2006 imposed a number of burdens on pension plans with an asset to liability ratio of less than 80% with additional burdens imposed if the asset to liability ratio falls below 60%. Due
primarily to the utilization of a lower discount rate for determining the present value of the liabilities (provided by the IRS based on the 24 month average of bond yields), the Companys plan was 73% funded at January 1, 2011 and, as a
result, in March 2011, the Company contributed $1.3 million to the pension plan. This contribution increased the Companys asset to liability ratio to the 80% threshold level. The Company anticipates additional employer contributions in the
amount of $374 thousand will be made for the 2011 plan year.



|14. | Equity Based Compensation
|--- | -------------------------

Stock Option Plan

General. Stock
option awards have been granted under the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan. The Plan terminated in 2007 and no options have been granted under the Plan since then. However, the termination did not impact options previously
granted under the Plan. All outstanding options expire at various dates through December 31, 2016. Of these, 120,010 stock option awards remained outstanding at March 31, 2011 with exercise prices ranging from $15.00 to $30.40 per share.
All stock option awards granted have a vesting term of five years and an exercise period of ten years.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



Stock Option Compensation Expense. The compensation expense for stock options charged against
pretax income during the three months ended March 31, 2011 was less than $1 thousand. There was no income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation expense.
The compensation expense that was charged against pretax income during the same period of 2010 for stock options was $7 thousand. The total income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible
portion of this compensation expense was $1 thousand. Estimates of forfeitures are made at the time of grant and were not expected to be significant; therefore, compensation expense is being recognized for all equity based awards.

At March 31, 2011 and December 31, 2010, based on options outstanding at that time, the total compensation expense related to unvested stock
option awards granted under the Companys stock option plan but not yet recognized was less than $1 thousand and $1 thousand, respectively, before the impact of income taxes. Stock option compensation expense is recognized on a straight-line
basis over the vesting period of the option. This remaining compensation expense related to unvested stock option awards is expected to be fully recognized during 2011.

Stock Option Activity. The following table summarizes stock option activity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan for the periods indicated.



|                                 |  |                          |         |   |                                 |   |       | 
|-------------------------------- |  | ------------------------ | ------- | - | ------------------------------- | - | ----- | 
|                                 |  | Stock optionsoutstanding |         |   | Weighted-averageexercise 
price |  
|Outstanding at December 31, 2009 |  |                          | 147,210 |   |                                 | $ | 21.80 | 
|Exercised                        |  |                          | (14,400 | ) |                                 |   | 15.00 | 
|                                 |  |                          |         |   |                                 |   |       | 
|Outstanding at March 31, 2010    |  |                          | 132,810 |   |                                 | $ | 22.54 | 
|                                 |  |                          |         |   |                                 |   |       | 
|                                 |  |                         
|Outstanding at December 31, 2010 |  |                          | 120,010 |   |                                 | $ | 22.93 | 
|Forfeited                        |  |                          |        |   |                                 |   |      | 
|                                 |  |                          |         |   |                                 |   |       | 
|Outstanding at March 31, 2011    |  |                          | 120,010 |   |                                 | $ | 22.93 | 
|                                 |  |                          |         |   |                                 |   |       | 

The following table summarizes information regarding stock options outstanding and exercisable at March 31, 2011.



|                                           |  |                                             |         |  |                                                  |  |      |                                |  |   |                                             |  |  |                                |         |  |  |   |       | 
|------------------------------------------ |  | ------------------------------------------- | ------- |  | ------------------------------------------------ |  | ---- | ------------------------------ |  | - | ------------------------------------------- |  |  | ------------------------------ | ------- |  |  | - | ----- | 
|                                           |  | Options outstanding                         |         |  | Options exercisable                              | 
|Exercise price or range of exercise prices |  | Number of stockoptionsoutstanding at3/31/11 |         |  | Weighted-averageremainingcontractual life(years) |  |      | Weighted-average exerciseprice |  |   | Number of stockoptionsexercisable at3/31/11 |  |  | Weighted-average exerciseprice |        
|$15.00 to $20.00                           |  |                                             | 40,010  |  |                                                  |  | 1.31 |                                |  | $ | 17.75                                       |  |  |                                | 40,010  |  |  | $ | 17.75 | 
|$23.30 to $26.60                           |  |                                             | 51,200  |  |                                                  |  | 3.12 |                                |  |   | 24.47                                       |  |  |                                | 51,200  |  |  |   | 24.47 | 
|$27.30 to $30.40                           |  |                                             | 28,800  |  |                                                  |  | 4.79 |                                |  |   | 27.39                                       |  |  |                                | 28,640  |  |  |   | 27.37 | 
|                                           |  |                                             |         |  |                                                  |  |      |                                |  |   |                                             |  |  |                                |         |  |  |   |       | 
|Total                                      |  |                                             | 120,010 |  |                                                  |  | 2.91 |                                |  |   | 22.93                                       |  |  |                                | 119,850 |  |  |   | 22.92 | 
|                                           |  |                                             |         |  |                                                  |  |      |                                |  |   |                                             |  |  |                                |         |  |  |   |       | 

At March 31, 2011, the fair value of the Companys common stock did not exceed the exercise price of any
options outstanding and exercisable, and therefore the stock options had no intrinsic value.

Restricted Stock Plan

Under the 2008 Restricted Stock Plan, 250,000 shares of common stock have been reserved for issuance subject to its anti-dilution provisions. Forfeitures
are returned to the available pool of common stock for future issuance. The following table summarizes restricted stock activity at the date and for the periods indicated.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                                   |  |                           |         |   |                             |   |       | 
|------------------------------------------------------------------ |  | ------------------------- | ------- | - | --------------------------- | - | ----- | 
|                                                                   |  | Shares ofrestricted stock |         |   | Weighted-average grantprice |  
|Shares available for issuance under the 2008 Restricted Stock Plan |  |                           | 250,000 |   |                             |   |       | 
|2009 Grants                                                        |  |                           | (55,040 | ) |                             | $ | 35.63 | 
|2009 Forfeitures                                                   |  |                           | 10,000  |   |                             |   | 42.00 | 
|2010 Grants                                                        |  |                           | (18,500 | ) |                             |   | 2.60  | 
|2010 Forfeitures                                                   |  |                           | 2,800   |   |                             |   | 42.00 | 
|2011 Grants                                                        |  |                           | (34,614 | ) |                             |   | 2.60  | 
|2011 Forfeitures                                                   |  |                           |        |   |                             |   |      | 
|                                                                   |  |                           |         |   |                             |   |       | 
|Remaining shares available for issuance at March 31, 2011          |  |                           | 154,646 |   |                             |   |       | 
|                                                                   |  |                           |         |   |                             |   |       | 

January 2011, 34,614 shares of restricted stock with a total value of $90 thousand were granted to the nine
non-management directors of the Company as compensation for their annual Board retainers. These restricted stock awards were fully vested at the date of grant.

The value of the restricted stock awarded is established as the fair value of the stock at the time of the grant. The Company measures compensation expense for restricted stock awards at fair value
and recognizes compensation expense over the service period for grants that have time / service-based vesting provisions. The compensation expense that was charged against pretax income during the three months ended March 31, 2011 for
restricted stock awards granted prior to the first quarter 2011 was $72 thousand. There was no income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation expense. For the
three months ended March 31, 2010, compensation expense for restricted stock awards was $84 thousand and the income tax benefit with regard to the deductible portion of this compensation expense was $30 thousand. Forfeitures are accounted for
by eliminating compensation expense for unvested shares as forfeitures occur. At March 31, 2011, based on restricted stock awards outstanding at that time, the total pretax compensation expense related to unvested restricted stock awards
granted under the restricted stock plan but not yet recognized was $848 thousand. This expense is expected to be recognized through 2015.

With the exception of the restricted stock awards granted to directors in January 2011, shares of restricted stock granted to employees and directors
under the Plan are subject to pro rata restrictions as to continuous employment and service as a director, respectively, for a specified time period following the date of grant, currently five years. During this period, the holder is entitled to
full voting rights and dividends.

Palmetto Bancshares, Inc. 2011 Stock Plan

In February 2011, the Board of Directors approved the Palmetto Bancshares, Inc. 2011 Stock Plan (the 2011 Plan) to further support the alignment of management and shareholder interests. The
2011 Plan allows for the Board of Directors to grant a total of 2 million stock options and / or restricted stock awards to employees and directors. The Board is seeking shareholder approval for the 2011 Plan, and the Company has included a
proposal for approval of the 2011 Plan in the definitive proxy statement for the annual shareholders meeting scheduled for May 19, 2011.



|15. | Average Share Information
|--- | -------------------------

The
following table summarizes the reconciliation of the numerators and denominators of the basic and diluted net loss per common share computations for the periods indicated.



|                                                                |  |                                     |            |   |      |   |           |  
|--------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ---- | - | --------- | -
|                                                                |  | For the three months endedMarch 31, |           
|                                                                |  | 2011                                |            |   | 2010 |  
|Weighted average common shares outstanding - basic              |  |                                     | 49,453,501 |   |      |   | 6,455,598 |  
|Dilutive impact resulting from potential common share issuances |  |                                     |           |   |      |   |          |  
|                                                                |  |                                     |            |   |      |   |           |  
|Weighted average common shares outstanding - diluted            |  |                                     | 49,453,501 |   |      |   | 6,455,598 |  
|                                                                |  |                                     |            |   |      |   |           |  
|                                                                |  |                                    
|Per Share Data                                                  |  |                                     |            |   |      |   |           |  
|Net loss - basic                                                |  | $                                   | (0.12      | ) |      | $ | (0.82     | )
|Net loss - diluted                                              |  |                                     | (0.12      | ) |      |   | (0.82     | )

Basic net income (loss) per share is
computed by dividing net income (loss) available to common



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



shareholders by the weighted average number of shares of common stock outstanding during the period. For diluted net income per share, the denominator is increased to include the number of
additional common shares that would have been outstanding if dilutive potential common shares had been issued. If dilutive, common stock equivalents are calculated for stock options and restricted stock shares using the treasury stock method. No
potential common shares were included in the computation of the diluted loss per share amount for the three months ended March 31, 2011 and 2010 as inclusion would be anti-dilutive given the Companys net loss during the respective
periods.



|16. | Commitments, Guarantees, and Other Contingencies
|--- | ------------------------------------------------

Lending Commitments and Standby Letters of Credit

Unused lending commitments to customers
are not recorded in the Consolidated Balance Sheets until funds are advanced. For commercial customers, lending commitments generally take the form of unused revolving credit arrangements to finance customers working capital requirements. For
retail customers, lending commitments are generally unused lines of credit secured by residential property. The Company routinely extends lending commitments for both floating and fixed rate loans.

The following table summarizes the contractual amounts of the Companys unused lending commitments relating to extension of credit with off-balance
sheet risk at March 31, 2011 (in thousands).



|                                                                                        |  |   |         | 
|--------------------------------------------------------------------------------------- |  | - | ------- | 
|Commitments to extend credit:                                                           |  |   |         | 
|Revolving, open-end lines secured by single-family residential properties               |  | $ | 48,110  | 
|Commercial real estate, construction, and land development loans secured by real estate |  |   |         | 
|Single-family residential construction loan commitments                                 |  |   | 1,954   | 
|Commercial real estate, other construction loan, and land development loan commitments  |  |   | 12,072  | 
|Commercial and industrial loan commitments                                              |  |   | 14,479  | 
|Overdraft protection line commitments                                                   |  |   | 28,986  | 
|Other                                                                                   |  |   | 6,671   | 
|                                                                                        |  |   |         | 
|Total commitments to extend credit                                                      |  | $ | 112,272 | 
|                                                                                        |  |   |         | 

Standby letters of credit are issued for customers in connection with contracts between customers and third parties. Letters
of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The maximum potential amount of undiscounted future payments related to letters of credit was $3.1 million and $2.7 million at
March 31, 2011 and December 31, 2010, respectively.

The reserve for unfunded commitments at March 31, 2011 and
December 31, 2010 was $150 thousand and $99 thousand, respectively, and is recorded in Other liabilities in the Consolidated Balance Sheets.

Loan Participations

With regard to participations sold disclosed in Note 4, Loans, and
Note 8, Foreclosed Real Estate and Repossessed Personal Property, the Company serves as the lead bank and is therefore responsible for certain administration and other management functions as agent to the participating banks. The participation
agreements include certain standard representations and warranties related to the Companys duties to the participating banks.

Derivatives

See Note 17, Derivative
Financial Instruments and Hedging Activities, for further discussion regarding the Companys off-balance sheet arrangements and commitments related to its derivative loan commitments and freestanding derivatives.

Long-Term Contractual Obligations

In
addition to the contractual commitments and arrangements previously described, the Company enters into other contractual obligations in the ordinary course of business. The following table summarizes these contractual obligations at March 31,
2011 (in thousands) except obligations for employee benefit plans as these obligations are paid from separately identified assets. See Note 13, Employee Benefit Plans, for discussion regarding employee benefit plans.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                              |  |                   |         |  |                            |   |         |                             |  |   |                |  |  |       |    |  |  |   |         | 
|----------------------------- |  | ----------------- | ------- |  | -------------------------- | - | ------- | --------------------------- |  | - | -------------- |  |  | ----- | -- |  |  | - | ------- | 
|Other contractual obligations |  | Less thanone year |         |  | Over onethroughthree years |   |         | Over threethrough fiveyears |  |   | Over fiveyears |  |  | Total |   
|Time deposit accounts         |  | $                 | 333,876 |  |                            | $ | 181,849 |                             |  | $ | 3,789          |  |  | $     | 35 |  |  | $ | 519,549 | 

There have been no other significant
changes in future real property operating lease obligations or FHLB advances as reported in our Annual Report on Form 10-K for the year ended December 31, 2010.

Recourse Liability on Credit Card Accounts

In connection with the sale of the credit card
portfolio in December 2010, the Company is subject to a recourse obligation on certain credit card accounts with outstanding balances of $329 thousand at March 31, 2011. The Company has a reserve of $61 thousand established to absorb estimated
losses in connection with these accounts.

Legal Proceedings

The Company is subject to actual and threatened legal proceedings and other claims arising out of the conduct of its business. Some of these suits and proceedings seek damages, fines, or penalties. These
suits and proceedings are being defended by or contested on the Companys behalf. On the basis of information presently available, the Company does not believe that existing proceedings and claims will have a material effect on its financial
position or results of operations.



|17. | Derivative Financial Instruments and Hedging Activities
|--- | -------------------------------------------------------

At March 31, 2011 and December 31, 2010, the Companys only derivative instruments related to residential mortgage lending activities. The Company originates certain residential loans with
the intention of selling these loans. Between the time the Company enters into an interest rate lock commitment to originate a residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in
market prices related to these commitments. The Company also enters into forward sale agreements of to be issued loans. The commitments to originate residential loans and forward sales commitments are freestanding derivative instruments
and are recorded on the Consolidated Balance Sheets at fair value. They do not qualify for hedge accounting treatment. Fair value adjustments are recorded within Mortgage-banking in the Consolidated Statements of Income (Loss).

At March 31, 2011, commitments to originate conforming loans totaled $7.0 million. At March 31, 2011, these derivative loan commitments had
positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $122 thousand. At December 31, 2010, commitments to originate conforming loans totaled $12.2 million. At December 31, 2010, these derivative
loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $103 thousand and negative fair values, included with Other liabilities in the Consolidated Balance Sheets, totaling $40 thousand.
The net change in derivative loan commitment fair values during the three months ended March 31, 2011 and 2010 resulted in net derivative loan commitment income of $59 thousand and $51 thousand, respectively.

Forward sales commitments totaled $4.9 million at March 31, 2011. At March 31, 2011, forward sales commitments had positive fair values,
included within Other assets in the Consolidated Balance Sheets, totaling $22 thousand and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $17 thousand. Forward sales commitments totaled $19.6
million at December 31, 2010. At December 31, 2010, forward sales commitments had positive fair values, included with Other assets in the Consolidated Balance Sheets, totaling $175 thousand and negative fair values, included within Other
liabilities in the Consolidated Balance Sheets, totaling $96 thousand. The net change in forward sales commitment fair values during the three months ended March 31, 2011 and 2010, resulted in a loss of $75 thousand and $76 thousand,
respectively.



|18. | Disclosures Regarding Fair Value
|--- | --------------------------------

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes assets and liabilities measured at fair value on a recurring basis at the dates indicated, aggregated by the level in the fair value hierarchy within which those
measurements fall (in thousands).



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|-------------------------------------------------------- |  | ----------------- | ------ |  | ------- | - | ------- | ------- |  | - | ----- |  |  | - | ------- | 
|                                                         |  | March 31, 2011    |       
|                                                         |  | Level 1           |        |  | Level 2 |   |         | Level 3 |  |   | Total | 
|Assets                                                   |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Investment securities available for sale                 |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|State and municipal                                      |  | $                 | 40,640 |  |         | $ | 65,019  |         |  | $ |      |  |  | $ | 105,659 | 
|Collateralized mortgage obligations                      |  |                   | 12,634 |  |         |   | 135,901 |         |  |   |      |  |  |   | 148,535 | 
|Other mortgage-backed (federal agencies)                 |  |                   |       |  |         |   | 19,909  |         |  |   |      |  |  |   | 19,909  | 
|Derivative financial instruments                         |  |                   |       |  |         |   | 144     |         |  |   |      |  |  |   | 144     | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Total assets measured at fair value on a recurring basis |  | $                 | 53,274 |  |         | $ | 220,973 |         |  | $ |      |  |  | $ | 274,247 | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|                                                         |  |                   |        | 
|Liabilities                                              |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Derivative financial instruments                         |  | $                 |       |  |         | $ | 17      |         |  | $ |      |  |  | $ | 17      | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|                                                         | 
|                                                         |  | December 31, 2010 |       
|                                                         |  | Level 1           |        |  | Level 2 |   |         | Level 3 |  |   | Total | 
|Assets                                                   |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Investment securities available for sale                 |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|U.S. Treasury and federal agencies                       |  | $                 |       |  |         | $ | 37,426  |         |  | $ |      |  |  | $ | 37,426  | 
|State and municipal                                      |  |                   | 7,530  |  |         |   | 44,932  |         |  |   |      |  |  |   | 52,462  | 
|Collateralized mortgage obligations                      |  |                   | 25,992 |  |         |   | 82,179  |         |  |   |      |  |  |   | 108,171 | 
|Other mortgage-backed (federal agencies)                 |  |                   |       |  |         |   | 20,716  |         |  |   |      |  |  |   | 20,716  | 
|Derivative financial instruments                         |  |                   |       |  |         |   | 278     |         |  |   |      |  |  |   | 278     | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Total assets measured at fair value on a recurring basis |  | $                 | 33,522 |  |         | $ | 185,531 |         |  | $ |      |  |  | $ | 219,053 | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|                                                         |  |                   |        | 
|Liabilities                                              |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Derivative financial instruments                         |  | $                 |       |  |         | $ | 136     |         |  | $ |      |  |  | $ | 136     | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

For financial assets measured at fair value on a nonrecurring basis that were reflected in the balance sheet, the following tables summarize the level of
valuation assumptions used to determine each adjustment and the carrying value of the related individual assets as of the periods indicated (in thousands).



|                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|----------------------------------------------------------- |  | ----------------- | ----- |  | ------- | - | ------ | ------- |  | - | ------ |  |  | - | ------- | 
|                                                            |  | March 31, 2011    |      
|                                                            |  | Level 1           |       |  | Level 2 |   |        | Level 3 |  |   | Total  | 
|Assets                                                      |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Mortgage loans held for sale                                |  | $                 |      |  |         | $ | 279    |         |  | $ |       |  |  | $ | 279     | 
|Commercial loans held for sale                              |  |                   |      |  |         |   | 22,483 |         |  |   | 37,863 |  |  |   | 60,346  | 
|Impaired loans in gross loans                               |  |                   |      |  |         |   | 46,722 |         |  |   | 4,863  |  |  |   | 51,585  | 
|Foreclosed real estate and repossessed personal property    |  |                   | 1,543 |  |         |   | 14,403 |         |  |   | 439    |  |  |   | 16,385  | 
|                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Total assets measured at fair value on a nonrecurring basis |  | $                 | 1,543 |  |         | $ | 83,887 |         |  | $ | 43,165 |  |  | $ | 128,595 | 
|                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|                                                            | 
|                                                            |  | December 31, 2010 |      
|                                                            |  | Level 1           |       |  | Level 2 |   |        | Level 3 |  |   | Total  | 
|Assets                                                      |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Mortgage loans held for sale                                |  | $                 |      |  |         | $ | 4,793  |         |  | $ |       |  |  | $ | 4,793   | 
|Commercial loans held for sale                              |  |                   | 1,303 |  |         |   | 21,231 |         |  |   | 43,623 |  |  |   | 66,157  | 
|Impaired loans in gross loans                               |  |                   |      |  |         |   | 43,920 |         |  |   | 6,649  |  |  |   | 50,569  | 
|Foreclosed real estate and repossessed personal property    |  |                   | 5,999 |  |         |   | 13,939 |         |  |   | 149    |  |  |   | 20,087  | 
|                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Total assets measured at fair value on a nonrecurring basis |  | $                 | 7,302 |  |         | $ | 83,883 |         |  | $ | 50,421 |  |  | $ | 141,606 | 
|                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 

Carrying Amounts and Estimated Fair Value Financial Assets and Liabilities Not Measured at Fair Value

The following table summarizes the carrying amount and fair values for other financial instruments included in the Consolidated Balance Sheets at the
dates indicated (in thousands). The methodologies used to determine fair value are disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2010. The Company has used managements best estimate of fair
value based on those methodologies. Thus, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an
actual sale or settlement, are not taken into consideration in the fair values presented.



30



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



|                  |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|----------------- |  | -------------- | --------- |  | ----------------- | - | --------- | -------------- |  | - | ---------- |  |  | - | --------- | 
|                  |  | March 31, 2011 |           |  | December 31, 2010 |  
|                  |  | Carryingamount |           |  | Fair value        |   |           | Carryingamount |  |   | Fair value | 
|Assets            |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Loans (1)         |  | $              | 685,688   |  |                   | $ | 676,645   |                |  | $ | 715,923    |  |  | $ | 709,018   | 
|                  |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Total assets      |  | $              | 685,688   |  |                   | $ | 676,645   |                |  | $ | 715,923    |  |  | $ | 709,018   | 
|                  |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|                  |  |                |           | 
|Liabilities       |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Deposits          |  | $              | 1,177,690 |  |                   | $ | 1,185,496 |                |  | $ | 1,173,362  |  |  | $ | 1,178,905 | 
|FHLB advances     |  |                | 5,000     |  |                   |   | 5,107     |                |  |   | 35,000     |  |  |   | 35,224    | 
|                  |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Total liabilities |  | $              | 1,182,690 |  |                   | $ | 1,190,603 |                |  | $ | 1,208,362  |  |  | $ | 1,214,129 | 
|                  |  |                |           |  |                   |   |           |                |  |   |            |  |  |   |           | 



|(1) | Includes Loans, net less impaired loans valued based on the fair value of underlying collateral.
|--- | ------------------------------------------------------------------------------------------------



|19. | Regulatory Capital Requirements and Dividend Restrictions
|--- | ---------------------------------------------------------

Capital Requirements

The following table summarizes the Companys and the Banks
actual and required capital ratios at the dates indicated (dollars in thousands). The Company and the Bank were classified in the well-capitalized category at March 31, 2011 and December 31, 2010. In connection with the Consent Order, the
Bank is subject to a minimum Tier 1 leverage ratio of 8.00%, which is higher than the statutory well-capitalized minimum ratio of 5.00%.

Since March 31, 2011, no conditions or events have occurred, of which the Company is aware, that have resulted in a material change in the
Companys or the Banks risk category other than as reported in this Quarterly Report on Form 10-Q.



|                                       |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|-------------------------------------- |  | ------ | ------- |  | ----------------------------- |  | ----- | ---------------------------------------------------------------- |  | - | ------ |  |  | ------ | ---- | - | ----- | - | ------ |  |  |  | ----- | -
|                                       |  | Actual |         |  | For capital adequacy
purposes |  |       | To be well capitalized under
prompt corrective action provisions | 
|                                       |  | amount |         |  | ratio                         |  |       | amount                                                           |  |   | ratio  |  |  | amount |      |   | ratio |  
|At March 31, 2011                      |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Total capital to risk-weighted assets  |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  | $      | 133,867 |  |                               |  | 15.00 | %                                                                |  | $ | 71,418 |  |  |        | 8.00 | % |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 132,274 |  |                               |  | 14.80 |                                                                  |  |   | 71,489 |  |  |        | 8.00 |   |       | $ | 89,361 |  |  |  | 10.00 | %
|                                       |  |        |         |  |                               | 
|Tier 1 capital to risk-weighted assets |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  |        | 122,511 |  |                               |  | 13.72 |                                                                  |  |   | 35,709 |  |  |        | 4.00 |   |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 120,907 |  |                               |  | 13.53 |                                                                  |  |   | 35,744 |  |  |        | 4.00 |   |       |   | 53,616 |  |  |  | 6.00  |  
|                                       |  |        |         |  |                               | 
|Tier 1 leverage ratio                  |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  |        | 122,511 |  |                               |  | 9.26  |                                                                  |  |   | 52,931 |  |  |        | 4.00 |   |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 120,907 |  |                               |  | 9.13  |                                                                  |  |   | 52,972 |  |  |        | 4.00 |   |       |   | 66,215 |  |  |  | 5.00  |  
|                                       |  |        |         |  |                               | 
|At December 31, 2010                   |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Total capital to risk-weighted assets  |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  | $      | 132,118 |  |                               |  | 14.43 | %                                                                |  | $ | 73,261 |  |  |        | 8.00 | % |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 130,632 |  |                               |  | 14.25 |                                                                  |  |   | 73,339 |  |  |        | 8.00 |   |       | $ | 91,674 |  |  |  | 10.00 | %
|                                       |  |        |         |  |                               | 
|Tier 1 capital to risk-weighted assets |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  |        | 120,478 |  |                               |  | 13.16 |                                                                  |  |   | 36,631 |  |  |        | 4.00 |   |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 118,981 |  |                               |  | 12.98 |                                                                  |  |   | 36,669 |  |  |        | 4.00 |   |       |   | 55,004 |  |  |  | 6.00  |  
|                                       |  |        |         |  |                               | 
|Tier 1 leverage ratio                  |  |        |         |  |                               |  |       |                                                                  |  |   |        |  |  |        |      |   |       |   |        |  |  |  |       |  
|Company                                |  |        | 120,478 |  |                               |  | 8.22  |                                                                  |  |   | 58,634 |  |  |        | 4.00 |   |       |   | n/a    |  |  |  | n/a   |  
|Bank                                   |  |        | 118,981 |  |                               |  | 8.12  |                                                                  |  |   | 58,624 |  |  |        | 4.00 |   |       |   | 73,280 |  |  |  | 5.00  |  

Recent Regulatory Developments

The Company and the Bank are subject to periodic examination by various regulatory agencies. In November 2009, the FDIC and the State
Board (collectively, the Supervisory Authorities) conducted their annual joint examination of the Bank. Beginning in October 2009, the Companys Board of Directors and the Regulatory Oversight Committee of the Board of Directors met
periodically with the FDIC to receive



31



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



status reports on their examination, and the Board received the final report of examination in April 2010. Effective June 10, 2010, the Bank agreed to the issuance of a Consent Order. The
Consent Order includes requirements regarding the Banks capital position and other requirements, including that the Bank:



| |  |  | Achieve and maintain, within 120 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted
assets and Tier 1 capital at least equal to 8% of total assets;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Determine, within 30 days of the last day of the calendar quarter, its capital ratios. If any capital measure falls below the established minimum,
within 30 days provide a written plan to the supervisory authorities describing the means and timing by which the Bank shall increase such ratios to or in excess of the established minimums;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Establish, within 30 days from the effective date of the Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored
by the Banks Board of Directors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Develop, within 60 days from the effective date of the Consent Order, a written analysis and assessment of the Banks management and staffing
needs;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Notify the supervisory authorities in writing of the resignation or termination of any of the Banks directors or senior executive officers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Eliminate, within 10 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified
Loss and 50% of those assets classified Doubtful;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its policy to ensure the adequacy of the Banks allowance for loan
and lease losses, which must provide for a review of the Banks allowance for loan and lease losses at least once each calendar quarter;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce classified assets, which shall include, among other
things, a reduction of the Banks risk exposure in relationships with assets in excess of $1,000,000 which are criticized as Substandard, Doubtful, or Special Mention;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Revise, within 60 days from the effective date of the Consent Order, its policies and procedures for managing the Banks Adversely Classified
Other Real Estate Owned;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in
whole or in part, Loss or Doubtful and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or
in part, Substandard or Special Mention and is uncollected, unless the Banks board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the
Bank;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Perform, within 90 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Banks Concentrations of
Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review, within 60 days from the effective date of the Consent Order and annually thereafter, the Banks loan policies and procedures for adequacy
and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Banks lending functions and ensure their implementation;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adopt, within 60 days from the effective date of the Consent Order, an effective internal loan review and grading system to provide for the periodic
review of the Banks loan portfolio in order to identify and categorize the Banks loans, and other extensions of credit which are carried on the Banks books as loans, on the basis of credit quality;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its written profit plan to ensure the Bank has a realistic,
comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank, the major areas in and means by which the Bank will seek to improve the
Banks operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and
adequately support major projected income and expense components of the plan, and coordination of the Banks loan, investment, and operating policies and budget and profit planning with the funds management policy;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its written plan addressing liquidity, contingent funding, and asset
liability management;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements(Continued)



| |  |  | Eliminate, within 30 days from the effective date of the Consent Order, all violations of law and regulation or contraventions of policy set forth in
the FDICs safety and soundness examination of the Bank in November 2009;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Limit asset growth to 10% per annum;
| | - |  | ------------------------------------



| |  |  | Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the
prior approval of the supervisory authorities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Not offer an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on its website unless
otherwise specifically permitted by the FDIC. On April 1, 2010 the Bank was notified by the FDIC that it had determined that the geographic areas in which it operates were considered high-rate areas. Accordingly, the Bank is able to offer
interest rates on deposits up to 75 basis points over the prevailing interest rates in its geographic areas. The FDIC informed the Company that this high-rate determination is also effective for calendar year 2011; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Furnish, by within 30 days from the effective date of the Consent Order and within 30 days of the end of each quarter thereafter, written progress
reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Bank intends to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof the Bank has submitted all documentation required as of
this date to the FDIC and State Board. There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of the Banks compliance will be made by the FDIC and the State Board.
However, the Bank believes it is currently in compliance with all provisions of the Consent Order except for the requirement to reduce the total amount of its criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The
Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first date being December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. The Bank reduced its
criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. The Banks next incremental deadline, June 5, 2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the
September 30, 2009 balances. As of April 26, 2011, the Bank has reduced its criticized assets by 60.4% ($130.7 million). Failure to meet the requirements of the Consent Order could result in additional regulatory requirements, which could
ultimately lead to the Bank being taken into receivership by the FDIC. In addition, the Supervisory Authorities may amend the Consent Order based on the results of their ongoing examinations.



33



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##### Table of Contents

Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations

The following discussion and analysis presents the more significant factors impacting our financial condition as
of March 31, 2011 and results of operations and cash flows for the three months ended March 31, 2011. This discussion should be read in conjunction with, and is intended to supplement, all of the other Items presented in this Quarterly
Report on Form 10-Q and our Consolidated Financial Statements and the notes thereto for the year ended December 31, 2010 included in our Annual Report on Form 10-K and 10 K/A for that period. Results for the three months ended
March 31, 2011 are not necessarily indicative of the results for the year ended December 31, 2011 or any future period. Percentage calculations contained herein have been calculated based on actual not rounded results.

Forward-Looking Statements

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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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##### Table of Contents

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



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



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



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



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



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



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



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



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



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



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



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



| |  |  | Other risks and uncertainties detailed in this Quarterly Report on Form 10-Q, and from time to time in our other filings with the SEC.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------

These risks are exacerbated by the state of national and international financial markets, and we are unable to predict what
impact these uncertain market conditions will have on us. During 2008 and 2009, the capital and credit markets experienced extended volatility and disruption which continued to impact the Company in 2010 and 2011. There can be no assurance that
these unprecedented developments will not continue to materially and adversely impact our business, financial condition, and results of operations, as well as our ability to maintain sufficient capital or other funding for liquidity and business
purposes.

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



35



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##### Table of Contents

Selected Financial Data

The following consolidated selected financial data should be read in conjunction with Item 1. Financial Statements and Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations (dollars in thousands, except per share data) (unaudited).



|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|---------------------------------------------------------------------- |  | --------------------------------- | ---------- | -- | ---------------- | - | ---------- | ------------------------ |  | - | ------------ | -- |  | ------------- | --------- | -- |  | - | --------- | ---------------- |  |  |  |  |  | - | ---------- | --
|                                                                       |  | At and for the three months ended |            |    |                  |   |            | At and for theyear ended | 
|                                                                       |  | March 31,2011                     |            |    | December 31,2010 |   |            | September 30,2010        |  |   | June 30,2010 |    |  | March 31,2010 |           |    |  |   |           | December 31,2010 | 
|STATEMENTS OF INCOME (LOSS)                                            |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Interest income                                                        |  | $                                 | 12,994     |    |                  | $ | 13,442     |                          |  | $ | 13,856       |    |  | $             | 14,450    |    |  | $ | 14,879    |                  |  |  |  |  |  | $ | 56,627     |   
|Interest expense                                                       |  |                                   | 2,736      |    |                  |   | 3,682      |                          |  |   | 3,888        |    |  |               | 3,716     |    |  |   | 4,080     |                  |  |  |  |  |  |   | 15,366     |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Net interest income                                                    |  |                                   | 10,258     |    |                  |   | 9,760      |                          |  |   | 9,968        |    |  |               | 10,734    |    |  |   | 10,799    |                  |  |  |  |  |  |   | 41,261     |   
|Provision for loan losses                                              |  |                                   | 5,500      |    |                  |   | 10,500     |                          |  |   | 13,100       |    |  |               | 12,750    |    |  |   | 10,750    |                  |  |  |  |  |  |   | 47,100     |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Net interest income (expense)
after provision for loan losses          |  |                                   | 4,758      |    |                  |   | (740       | )                        |  |   | (3,132       | )  |  |               | (2,016    | )  |  |   | 49        |                  |  |  |  |  |  |   | (5,839     | ) 
|Noninterest income                                                     |  |                                   | 3,572      |    |                  |   | 4,370      |                          |  |   | 4,270        |    |  |               | 3,730     |    |  |   | 4,497     |                  |  |  |  |  |  |   | 16,867     |   
|Noninterest expense                                                    |  |                                   | 14,358     |    |                  |   | 22,155     |                          |  |   | 22,497       |    |  |               | 15,040    |    |  |   | 12,880    |                  |  |  |  |  |  |   | 72,572     |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Net loss before provision (benefit) for income taxes                   |  |                                   | (6,028     | )  |                  |   | (18,525    | )                        |  |   | (21,359      | )  |  |               | (13,326   | )  |  |   | (8,334    | )                |  |  |  |  |  |   | (61,544    | ) 
|Provision (benefit) for income taxes                                   |  |                                   | 52         |    |                  |   | 14,073     |                          |  |   | (7,580       | )  |  |               | (4,793    | )  |  |   | (3,042    | )                |  |  |  |  |  |   | (1,342     | ) 
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Net loss                                                               |  | $                                 | (6,080     | )  |                  | $ | (32,598    | )                        |  | $ | (13,779      | )  |  | $             | (8,533    | )  |  | $ | (5,292    | )                |  |  |  |  |  | $ | (60,202    | ) 
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|COMMON AND PER SHARE DATA                                              |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Net loss per common share:                                             |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Basic                                                                  |  | $                                 | (0.12      | )  |                  | $ | (0.74      | )                        |  | $ | (2.13        | )  |  | $             | (1.32     | )  |  | $ | (0.82     | )                |  |  |  |  |  | $ | (3.78      | ) 
|Diluted                                                                |  |                                   | (0.12      | )  |                  |   | (0.74      | )                        |  |   | (2.13        | )  |  |               | (1.32     | )  |  |   | (0.82     | )                |  |  |  |  |  |   | (3.78      | ) 
|Cash dividends per common share                                        |  |                                   |           |    |                  |   |           |                          |  |   |             |    |  |               |          |    |  |   |          |                  |  |  |  |  |  |   |           |   
|Book value per common share                                            |  |                                   | 2.29       |    |                  |   | 2.40       |                          |  |   | 7.60         |    |  |               | 9.64      |    |  |   | 10.93     |                  |  |  |  |  |  |   | 2.40       |   
|Outstanding common shares                                              |  |                                   | 50,513,722 |    |                  |   | 47,409,078 |                          |  |   | 6,495,130    |    |  |               | 6,495,130 |    |  |   | 6,495,130 |                  |  |  |  |  |  |   | 47,409,078 |   
|Weighted average common shares outstandingbasic                       |  |                                   | 49,453,501 |    |                  |   | 43,973,313 |                          |  |   | 6,455,598    |    |  |               | 6,455,598 |    |  |   | 6,455,598 |                  |  |  |  |  |  |   | 15,913,000 |   
|Weighted average common shares outstandingdiluted                     |  |                                   | 49,453,501 |    |                  |   | 43,973,313 |                          |  |   | 6,455,598    |    |  |               | 6,455,598 |    |  |   | 6,455,598 |                  |  |  |  |  |  |   | 15,913,000 |   
|Dividend payout ratio                                                  |  |                                   | n/a        | %  |                  |   | n/a        | %                        |  |   | n/a          | %  |  |               | n/a       | %  |  |   | n/a       | %                |  |  |  |  |  |   | n/a        | % 
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|PERIOD-END BALANCES                                                    |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Assets                                                                 |  | $                                 | 1,333,211  |    |                  | $ | 1,355,247  |                          |  | $ | 1,379,632    |    |  | $             | 1,386,959 |    |  | $ | 1,347,564 |                  |  |  |  |  |  | $ | 1,355,247  |   
|Investment securities available for sale, at fair value                |  |                                   | 274,103    |    |                  |   | 218,775    |                          |  |   | 129,571      |    |  |               | 112,316   |    |  |   | 115,893   |                  |  |  |  |  |  |   | 218,775    |   
|Total loans                                                            |  |                                   | 824,852    |    |                  |   | 864,376    |                          |  |   | 919,844      |    |  |               | 969,142   |    |  |   | 1,011,368 |                  |  |  |  |  |  |   | 864,376    |   
|Deposits (including traditional and nontraditional)                    |  |                                   | 1,201,331  |    |                  |   | 1,194,082  |                          |  |   | 1,220,673    |    |  |               | 1,216,049 |    |  |   | 1,168,978 |                  |  |  |  |  |  |   | 1,194,082  |   
|FHLB borrowings                                                        |  |                                   | 5,000      |    |                  |   | 35,000     |                          |  |   | 96,000       |    |  |               | 96,000    |    |  |   | 96,000    |                  |  |  |  |  |  |   | 35,000     |   
|Convertible debt                                                       |  |                                   |           |    |                  |   |           |                          |  |   | 380          |    |  |               | 380       |    |  |   | 380       |                  |  |  |  |  |  |   |           |   
|Shareholders' equity                                                   |  |                                   | 115,845    |    |                  |   | 113,899    |                          |  |   | 49,374       |    |  |               | 62,643    |    |  |   | 70,978    |                  |  |  |  |  |  |   | 113,899    |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|AVERAGE BALANCES                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Assets                                                                 |  | $                                 | 1,322,690  |    |                  | $ | 1,464,771  |                          |  | $ | 1,392,873    |    |  | $             | 1,371,747 |    |  | $ | 1,367,982 |                  |  |  |  |  |  | $ | 1,399,592  |   
|Interest-earning assets                                                |  |                                   | 1,269,221  |    |                  |   | 1,393,765  |                          |  |   | 1,320,359    |    |  |               | 1,304,274 |    |  |   | 1,283,045 |                  |  |  |  |  |  |   | 1,325,651  |   
|Investment securities available for sale, at fair value                |  |                                   | 231,176    |    |                  |   | 175,715    |                          |  |   | 132,223      |    |  |               | 115,274   |    |  |   | 117,702   |                  |  |  |  |  |  |   | 135,379    |   
|Total loans                                                            |  |                                   | 846,823    |    |                  |   | 901,564    |                          |  |   | 945,312      |    |  |               | 994,587   |    |  |   | 1,031,740 |                  |  |  |  |  |  |   | 967,882    |   
|Deposits (including traditional and nontraditional)                    |  |                                   | 1,184,624  |    |                  |   | 1,223,542  |                          |  |   | 1,221,131    |    |  |               | 1,192,535 |    |  |   | 1,181,492 |                  |  |  |  |  |  |   | 1,204,835  |   
|Other short-term borrowings                                            |  |                                   | 1          |    |                  |   | 1          |                          |  |   | 1            |    |  |               |          |    |  |   | 2         |                  |  |  |  |  |  |   | 1          |   
|FHLB borrowings                                                        |  |                                   | 5,666      |    |                  |   | 89,367     |                          |  |   | 95,997       |    |  |               | 95,998    |    |  |   | 99,666    |                  |  |  |  |  |  |   | 95,231     |   
|Convertible debt                                                       |  |                                   |           |    |                  |   | 29         |                          |  |   | 380          |    |  |               | 380       |    |  |   | 4         |                  |  |  |  |  |  |   | 199        |   
|Shareholders' equity                                                   |  |                                   | 120,042    |    |                  |   | 139,250    |                          |  |   | 62,832       |    |  |               | 70,705    |    |  |   | 76,648    |                  |  |  |  |  |  |   | 87,463     |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|SELECT PERFORMANCE RATIOS                                              |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Return on average assets                                               |  |                                   | (1.86      | )% |                  |   | (8.83      | )%                       |  |   | (3.92        | )% |  |               | (2.50     | )% |  |   | (1.57     | )%               |  |  |  |  |  |   | (4.30      | )%
|Return on average shareholders' equity                                 |  |                                   | (20.54     | )  |                  |   | (92.88     | )                        |  |   | (87.00       | )  |  |               | (48.41    | )  |  |   | (28.00    | )                |  |  |  |  |  |   | (68.83     | ) 
|Net interest margin                                                    |  |                                   | 3.28       |    |                  |   | 2.78       |                          |  |   | 3.00         |    |  |               | 3.30      |    |  |   | 3.41      |                  |  |  |  |  |  |   | 3.11       |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|CAPITAL RATIOS                                                         |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Average shareholders' equity as a percentage of average assets         |  |                                   | 9.08       | %  |                  |   | 9.51       | %                        |  |   | 4.51         | %  |  |               | 5.15      | %  |  |   | 5.60      | %                |  |  |  |  |  |   | 6.25       | % 
|Shareholders' equity as a percentage of assets, at period end          |  |                                   | 8.69       |    |                  |   | 8.40       |                          |  |   | 3.58         |    |  |               | 4.52      |    |  |   | 5.27      |                  |  |  |  |  |  |   | 8.40       |   
|Tier 1 risk-based capital                                              |  |                                   | 13.72      |    |                  |   | 13.16      |                          |  |   | 4.35         |    |  |               | 5.81      |    |  |   | 6.82      |                  |  |  |  |  |  |   | 13.16      |   
|Total risk-based capital                                               |  |                                   | 15.00      |    |                  |   | 14.43      |                          |  |   | 5.63         |    |  |               | 7.08      |    |  |   | 8.09      |                  |  |  |  |  |  |   | 14.43      |   
|Tier 1 leverage ratio                                                  |  |                                   | 9.26       |    |                  |   | 8.22       |                          |  |   | 3.03         |    |  |               | 4.34      |    |  |   | 5.30      |                  |  |  |  |  |  |   | 8.22       |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|                                                                       |  |                                   |            |    |                  |   |           
|ASSET QUALITY INFORMATION                                              |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|Allowance for loan losses                                              |  | $                                 | 26,954     |    |                  | $ | 26,934     |                          |  | $ | 29,339       |    |  | $             | 28,383    |    |  | $ | 28,426    |                  |  |  |  |  |  | $ | 26,934     |   
|Nonaccrual loans                                                       |  |                                   | 85,099     |    |                  |   | 91,405     |                          |  |   | 90,773       |    |  |               | 91,653    |    |  |   | 113,181   |                  |  |  |  |  |  |   | 91,405     |   
|Nonperforming assets                                                   |  |                                   | 101,484    |    |                  |   | 111,492    |                          |  |   | 113,411      |    |  |               | 118,280   |    |  |   | 142,161   |                  |  |  |  |  |  |   | 111,492    |   
|Net loans charged-off                                                  |  |                                   | 5,480      |    |                  |   | 12,453     |                          |  |   | 9,786        |    |  |               | 12,793    |    |  |   | 6,403     |                  |  |  |  |  |  |   | 41,435     |   
|Allowance for loan losses as a percentage of gross loans               |  |                                   | 3.53       | %  |                  |   | 3.39       | %                        |  |   | 3.55         | %  |  |               | 2.93      | %  |  |   | 2.81      | %                |  |  |  |  |  |   | 3.39       | % 
|Nonaccrual loans as a percentage of gross loans, commercial loans held |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   
|for sale, and foreclosed assets                                        |  |                                   | 10.12      |    |                  |   | 10.39      |                          |  |   | 9.67         |    |  |               | 9.22      |    |  |   | 10.89     |                  |  |  |  |  |  |   | 10.39      |   
|Nonperforming assets as a percentage of assets                         |  |                                   | 7.61       |    |                  |   | 8.23       |                          |  |   | 8.22         |    |  |               | 8.53      |    |  |   | 10.55     |                  |  |  |  |  |  |   | 8.23       |   
|Net loans charged-off as a percentage of average gross loans           |  |                                   | 2.85       |    |                  |   | 6.09       |                          |  |   | 4.12         |    |  |               | 5.17      |    |  |   | 2.53      |                  |  |  |  |  |  |   | 4.39       |   
|                                                                       |  |                                   |            |    |                  |   |            |                          |  |   |              |    |  |               |           |    |  |   |           |                  |  |  |  |  |  |   |            |   





36



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##### Table of Contents

Executive Summary of First Quarter 2011 Financial Results

Context for the Three Months Ended March 31, 2011 and the Company

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

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

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

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



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



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



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



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



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



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



| |  |  | High levels of unemployment nationally and in our local markets, which have begun to improve but for which uncertainty continues about whether the
trend will continue to improve.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Additional context specific to the Company includes the following:



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



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



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



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



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



37



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##### Table of Contents

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



| |  |  | In planning for the retirement of the former Chief Executive Officer of the Company and the Chief Executive Officer of the Bank (who also served as the
President, Chief Operating Officer, and Chief Accounting Officer of the Company), effective July 1, 2009 the Company named Samuel L. Erwin as Chief Executive Officer and President of the Bank and Lee S. Dixon as Chief Operating Officer of the
Company and the Bank. Subsequently, Mr. Erwin also assumed the title of Chief Executive Officer of the Company on January 1, 2010, and Mr. Dixon assumed additional responsibilities as Chief Risk Officer of the Company and the Bank in
October 2009 and as the Chief Financial Officer of the Company and the Bank from July 1, 2010 to February 2, 2011. Messrs. Erwin and Dixon have proven bank turn around and operational capabilities and rapidly developed and implemented the
Companys Strategic Project Plan in June 2009 as summarized below.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and 2010, we realigned our organizational structure and began the process of more specifically delineating our businesses. Additional
organizational and senior management changes included designating an internal executive to be responsible for our Commercial Bank in August 2009 and another internal executive to be responsible for our Wealth Management business in October 2010. In
addition, the Company hired a new Chief Credit Officer in July 2009, a new Retail Banking Executive in October 2010, a new Chief Financial Officer in November 2010, and a new Chief Information Officer to start in May 2011.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Significant deterioration in asset quality during 2009 resulting in a net loss for 2009 which was the first annual net loss in the history of the
Company since the Great Depression in the 1930s. Asset quality challenges continued in 2010 and into 2011; primarily as a result of these credit losses we also incurred net losses in 2010 and for the three months ended March 31, 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Strategic repositioning and reduction of the balance sheet to reduce commercial real estate loan concentrations and individually larger and more
complex loans originated during 2004 through 2008, as well as intentional reduction in the amount of federal funds purchased, FHLB advances, and higher priced certificates of deposit used to fund loan growth during that period. Loans (including
commercial loans held for sale) decreased $331.8 million from March 31, 2009 (peak quarter end loans) to March 31, 2011. Borrowings and certificates of deposits also decreased $200.0 million from June 30, 2009 (peak quarter end
borrowings).
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



|                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                 |  |                             
|---------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------
|Component              |  | Primary Emphasis                                                                                                                                                                                                                                                                                                                                                                                                |  | Time Horizon                
|Strategic Project Plan |  |   Manage through the extended recession and volatile economic environment
   Execute the Strategic
Project Plan related to credit quality, earnings, liquidity, and capital (the Strategic Project Plan is described in more detail below), including preparation for a potential formal agreement with the bank regulatory agencies and raising additional
capital                                           |  | June 2009  October 2010    
|Annual Strategic Plans |  |   Strategic planning at the corporate and department level for calendar years 2010 and 2011 in
the context of the uncertain economic environment    Acceleration of overcoming the growth hump/life cycle stage of maturity resulting from fast growth reaching a high of $1.5 billion in assets
   Positioning the Bank to
return to profitability in the post-capital raise and post-recession environment |  | Calendar years 2010 and
2011



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|                   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |                  
|------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------
|Bank of the Future |  |   Reinventing the Bank to be the bank of the future 
  Determining the customer of tomorrow and refining our products, services, and
distribution channels to meet their expectations    Adapting to the rapidly changing financial services landscape, including lower earnings due to the low interest rate environment, potential regulatory restrictions on historical sources
of income, and higher compliance costs    Intended listing of common stock on the NASDAQ stock exchange 
  Preparing for growth through organic growth given banking market disruption in our geographic
markets and the potential for growth through mergers and acquisitions |  | Two to five years

We believe it is critical to focus on all three strategic initiatives simultaneously to optimize long-term shareholder value. As a result, management and
the Board of Directors focused a tremendous amount of time and effort on addressing all three initiatives in 2009, 2010 and into 2011 with the overall objectives being: 1) to aggressively deal with our credit quality, earnings and capital issues as
quickly as possible and 2) to accelerate into a much shorter time frame the reinvention of The Palmetto Bank that might otherwise normally take several years to accomplish. While the National Bureau of Economic Research concluded that
the recession officially ended in June 2009, the impact of the recession is continuing to be felt by the banking industry and the Company. Accordingly, our focus has been and continues to be centered on managing through the effects of the recession
to position the Company to return to profitability once the economy begins to recover.

The consummation of the Private Placement in October
2010 and subsequent follow-on offering in which the Company received $113.9 million of gross proceeds is a significant step forward in the implementation of these strategic initiatives. The Private Placement resulted in the Companys and the
Banks capital adequacy ratios exceeding the well-capitalized minimums. In addition, while financial challenges remain, the completion of the Private Placement repositioned the Company from a defensive posture to a more offensive oriented
posture in terms of balance sheet management, market presence, customer retention, and new customer acquisition.

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

Summary Financial Results and Company Response

The national and local economy and the banking industry continue to deal with the effects of the most pronounced recession in decades. In South Carolina, unemployment rose significantly throughout 2009
and into 2010 and is higher than the national average. In addition, residential and commercial real estate projects are depressed with significant deterioration in values. As a result, the impact in our geographic area and to individual borrowers
was severe. As a result of the extended recession, our financial results in 2009, 2010 and through the first three months of 2011 were significantly impacted by the following in comparison to our historical financial results.



| |  |  | Provision for loan losses totaling $5.5 million in first quarter 2011 and $47.1 million and $73.4 million in 2010 and 2009, respectively, compared to
$5.6 million in 2008.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loss on commercial loans held for sale totaling $1.2 million in first quarter 2011 and $7.6 million in 2010 compared to none in 2009 and 2008.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Net loss from writedowns, expenses, operations, and sales of foreclosed real estate totaling $833 thousand in first quarter 2011 and $11.7 million and
$3.2 million in 2010 and 2009, respectively, compared to $516 thousand in 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Foregone interest of $860 thousand in first quarter 2011 and $4.7 million and $3.7 million in 2010 and 2009, respectively, compared to none in 2008 on
cash invested at the Federal Reserve at 25 basis points to maintain liquidity versus the average yield on our investment securities of 2.29%, 2.75% and 4.75%, respectively.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Higher FDIC deposit insurance assessments totaling $1.0 million in first quarter 2011 and $4.5 million and $3.3 million in 2010 and 2009, respectively,
compared to $786 thousand in 2008 due to industry wide increases in general assessment rates, our voluntary participation in the FDICs Transaction Account Guarantee Program, our capital classification being below well-capitalized throughout
most of 2010, and an industry-wide special assessment in 2009.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | Full valuation allowance recorded against deferred tax assets in December 2010 and March 2011 resulting in the elimination or deferral of tax benefits
that would have otherwise been available to reduce our net losses in first quarter 2011 and the year ended December 31, 2010.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In total, the above events impacted pretax earnings by $9.3 million during the three months ended March 31, 2011. Compared to the same periods of 2008, the above events reduced our pretax earnings by
approximately $72.3 million and $76.7 million for the years ended December 31, 2010, and 2009, respectively. In addition, the valuation allowance recorded against the net deferred tax asset reduced after-tax earnings by $20.5 million in 2010.
We believe consummation of the Private Placement and successful completion of the Strategic Project Plan will result in significant improvement to our earnings going forward.

The credit-related costs associated with the recession are significant for banks. Beginning in the fourth quarter of 2008 and continuing throughout 2009, 2010 and into 2011, construction, acquisition and
development real estate projects have slowed down, guarantors are financially stressed, and increasing credit losses have surfaced. During 2009 and into 2010, delinquencies over 90 days increased resulting in an increase in nonaccrual loans
indicating significant credit quality deterioration and probable losses. In particular, loans secured by real estate including acquisition, construction and development projects demonstrated stress given reduced cash flows of individual borrowers,
limited bank financing and credit availability, and slow property sales. This deterioration has manifested itself in our borrowers in several ways: decreases in cash flows from underlying properties supporting the loans (e.g., slower property sales
for development type projects or lower occupancy rates or rental rates for operating properties), decreases in cash flows from the borrowers themselves, increased pressure on guarantors due to illiquid and diminished personal balance sheets
resulting from investing additional personal capital in the projects, and declines in fair values of real estate related assets, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers are no longer willing
to sell the assets at such deep discounts.

This resulted in a significant increase in the level of nonperforming assets through
March 31, 2010, with a continued elevated level of such assets through March 31, 2011. While nonperforming assets are still high, we have now experienced four consecutive quarters of a reduction with an overall reduction of 28.6% since the
peak at March 31, 2010. In addition, the migration of loans into nonaccrual status declined in the first quarter 2011.

In addition, many
of these loans are collateral dependent real estate loans for which we are required to write down the loans to fair value less estimated selling costs with the fair values determined primarily based on third party appraisals. During 2009 and 2010,
appraised values decreased significantly and continue to be depressed in 2011, even in comparison to appraisals received when the loans were originated in 2006 to 2009, and upon reappraisal since origination. As a result, our evaluation of our loan
portfolio and foreclosed assets in 2009, 2010 and through the first three months of 2011 resulted in significant credit losses.

Regulatory
Consent Order

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



|                                                                                               |  |                                                                      
|---------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------
|Requirements of the Consent Order                                                              |  | Banks Compliance Status                                             
|Achieve and maintain, within 120 days from the effective
date of the Consent Order, Total Risk |  | We believe we have complied with this provision of the Consent
Order.



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|                                                                                                                                                                                                                                                                                                                                                  |  |                                                                                                                                                                                                                    
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets.                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                  | 
|Determine, within 30 days of the last day of the calendar
quarter, its capital ratios. If any capital measure falls below the established minimum, within 30 days provide a written plan to the supervisory authorities describing the means and timing by which the Bank shall increase such ratios to or in
excess of the established minimums. |  | Based on current capital levels, this provision of the Consent Order has not been
applicable.                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                  | 
|Establish, within 30 days from the effective date of the
Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored by the Banks Board of Directors.                                                                                                                                                           |  | We have implemented a plan to monitor compliance with the Consent Order.                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                  | 
|Develop, within 60 days from the effective date of the
Consent Order, a written analysis and assessment of the Banks management and staffing needs.                                                                                                                                                                                              |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                  | 
|Notify the supervisory authorities in writing of the
resignation or termination of any of the Banks directors or senior executive officers.                                                                                                                                                                                                      |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                  | 
|Eliminate, within 10 days from the effective date of the
Consent Order, by charge-off or collection, all assets or portions of assets classified Loss and 50% of those assets classified Doubtful.                                                                                                                                            |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                  | 
|Review and update, within 60 days from the effective date of
the Consent Order, its policy to ensure the adequacy of the Banks allowance for loan and lease losses, which must provide for a review of the Banks allowance for loan and lease losses at least once each calendar quarter.                                                       |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                  | 
|Submit, within 60 days from the effective date of the
Consent Order, a written plan to reduce classified assets, which shall include, among other things, a reduction of the Banks risk exposure in relationships with assets in excess of $1,000,000 which are criticized as Substandard,
Doubtful, or Special Mention.                   |  | To date, we believe we have complied with this provision of the Consent Order. The
Supervisory Authorities may also amend the requirements of the Consent Order based on the results of their ongoing examinations.
|                                                                                                                                                                                                                                                                                                                                                  | 
|Revise, within 60 days from the effective date of the
Consent Order, its policies and procedures for managing the Banks Adversely Classified Other Real Estate Owned.                                                                                                                                                                            |  | We believe we have complied with this provision of the Consent
Order.                                                                                                                                              



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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged
off or classified, in whole or in part, Loss or Doubtful and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been
criticized, in whole or in part, Substandard or Special Mention and is uncollected, unless the Banks board of directors determines that failure to extend further credit to a particular borrower would be detrimental to
the best interests of the Bank.                                                                                                                                                                                                                                    |  | We believe we have complied with this provision of the
Consent Order.                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Perform, within 90 days from the effective date of the
Consent Order, a risk segmentation analysis with respect to the Banks Concentrations of Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | As part of our Strategic Project Plan summarized below, we have performed a risk
segmentation analysis of our concentrations of credit and developed a plan to reduce our concentration in commercial real estate. We continue to monitor our concentrations and, in particular, are working aggressively to reduce our concentrations in
commercial real estate. We submitted our plan to the Supervisory Authorities in August 2010.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review, within 60 days from the effective date of the
Consent Order and annually thereafter, the Banks loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Banks lending functions and
ensure their implementation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Adopt, within 60 days from the effective date of the Consent
Order, an effective internal loan review and grading system to provide for the periodic review of the Banks loan portfolio in order to identify and categorize the Banks loans, and other extensions of credit which are carried on the
Banks books as loans, on the basis of credit quality.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review and update, within 60 days from the effective date of
the Consent Order, its written profit plan to ensure the Bank has a realistic, comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank,
the major areas in and means by which the Bank will seek to improve the Banks operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with
budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Banks loan, investment, and operating policies and budget and
profit planning with the funds management policy. |  | We have prepared annual budgets for 2010 and 2011 that were approved by the Banks
Board of Directors. We submitted the budgets to the Supervisory Authorities in August 2010.                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review and update, within 60 days from the effective date of
the Consent Order, its written plan addressing liquidity, contingent funding, and asset liability management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Eliminate, within 30 days from the effective date of the
Consent Order, all violations of law and regulation or contraventions of policy set forth in the FDICs safety and soundness examination of the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  | We believe we have complied with this provision of the Consent
Order.                                                                                                                                                                                                                                                                                                                                                                 



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|                                                                                                                                                                                                                                                                                          |  |                                                                                                                                                          
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Bank in November 2009.                                                                                                                                                                                                                                                                    |  |                                                                                                                                                          
|                                                                                                                                                                                                                                                                                          | 
|Not accept, renew, or rollover any brokered deposits unless
it is in compliance with the requirements of 12 C.F.R. § 337.6(b).                                                                                                                                                            |  | Prior to and at March 31, 2011, the Bank did not have any brokered
deposits.                                                                             
|                                                                                                                                                                                                                                                                                          | 
|Limit asset growth to 10% per annum.                                                                                                                                                                                                                                                      |  | We believe we have complied with this provision of the Consent Order.                                                                                    
|                                                                                                                                                                                                                                                                                          | 
|Not declare or pay any dividends or bonuses or make any
distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the Supervisory Authorities.                                                                                         |  | We believe we have complied with this provision of the Consent Order.                                                                                    
|                                                                                                                                                                                                                                                                                          | 
|Not offer an effective yield on deposits of more than 75
basis points over the national rates published by the FDIC weekly on its website unless otherwise specifically permitted by the FDIC.                                                                                            |  | We believe we have complied with this provision of the Consent Order.                                                                                    
|                                                                                                                                                                                                                                                                                          | 
|Furnish, by within 30 days from the effective date of the
Consent Order and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order. |  | We believe we have complied with this provision of the Consent Order, and we have
submitted the required progress reports to the Supervisory Authorities.

We intend to take all actions necessary to enable the
Bank to comply with the requirements of the Consent Order, and, as noted above, as of the date hereof we have submitted all documentation required thus far to the Supervisory Authorities. There can be no assurance that the Bank will be able to
comply fully with the provisions of the Consent Order, and the determination of our compliance will be made by the Supervisory Authorities. However, we believe we are currently in compliance with all provisions of the Consent Order except for the
requirement to reduce the total amount of our criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first
date being December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. We reduced our criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. Our next incremental deadline,
June 5, 2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of April 26, 2011, we have reduced our criticized assets by 60.4% ($130.7 million). Failure to meet the
requirements of the Consent Order could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC. In addition, the Supervisory Authorities may amend the Consent Order based on
the results of their ongoing examinations.

Strategic Project Plan

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

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

Credit Quality. Given the negative asset quality trends within our loan
portfolio, which began in 2008, accelerated during 2009, and continued throughout 2010 and into 2011, we have worked aggressively to



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identify and quantify potential losses and execute plans to reduce problem assets. The credit quality plan includes, among other things:



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



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



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



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



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



| |  | We are actively marketing problem assets for sale. Nonperforming assets declined $10.0 million (9.0%) during the first quarter 2011, and by 28.6%
since the peak at March 31, 2010. The decline during the first quarter 2011 was the fourth consecutive quarterly decline in nonperforming assets.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In September 2010, we began marketing for sale a pool of commercial loans. Through March 31, 2011, we sold ten loans with a gross book value of
$12.4 million. We are continuing our efforts to sell the remaining loans held for sale. At March 31, 2011, we had commercial loans held for sale aggregating $60.3 million.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Credit quality indicators improved in the first quarter 2011 as we experienced reductions in charge-offs, and in migration of loans to nonaccrual status,
and reductions in past dues and nonperforming assets at March 31, 2011. We continue to monitor our loan portfolio very carefully and are aggressively working to reduce our problem assets.

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



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



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



| |  |  | Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB, Federal Reserve and other secured
borrowings. In April 2011, we entered into a Master Repurchase Agreement resulting in a new line of credit from a correspondent bank totaling $25 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accelerating the filing of our income tax refund claims resulting in refunds received totaling $27.6 million in 2010 and 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in
other earning assets. Maintaining this cash balance reduced our interest income when compared with investing these funds at the average yield on our investment securities. Following the consummation of our Private Placement in October 2010, we have
redeployed, through March 31, 2011, $208.5 million of this cash into investment securities and prepaid $91 million of FHLB advances which were scheduled to mature in January through April 2011. We will continue to monitor the level of cash
balances in relation to expected liquidity needs and may make further purchases of investment securities during 2011.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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At April 26, 2011, funding sources included cash invested at the Federal Reserve totaling $163.9
million, approximately $2.9 million in available retail repurchase agreement capacity, $80.4 million from the FHLB, and our correspondent bank lines of credit totaling $30.0 million.

Capital. At March 31, 2011, as a result of the consummation of the Private Placement in October 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds and
the requirements of the Consent Order. In addition, to preserve our capital, we have:



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



| |  |  | Reduced our loan portfolio (including commercial loans held for sale) by $331.8 million and total assets by $68.9 million since March 31, 2009.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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



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



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

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



| |  |  | With respect to net interest income, we implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain criteria.
At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%. In 2010 and again in March 2011, we introduced loan specials intended to generate additional loan
volume for residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest
rates, during 2010 we also borrowed longer-term advances from the FHLB, and extended maturities on certain CD specials to lock in the low interest rates at the time of the specials. In December 2010 and January 2011, we used excess cash earning 25
basis points to prepay $91.0 million of FHLB advances bearing interest at an average rate of 1.58%.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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

Summary

In summary, during the three months ended March 31, 2011, we continued to be impacted by the negative financial conditions of our borrowers, further deterioration in real estate values and the
economy in general;



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however we have also made substantial progress on the execution of the Strategic Project Plan adopted in June 2009. We believe that raising capital, combined with an improving economy and our
continued focus on credit quality and earnings improvements, will accelerate our return to profitability in the post-recession environment. We believe that we may return to profitability, on a quarterly basis, at some point during 2012. However, as
discussed in this report, our performance is subject to numerous risks and uncertainties, many of which are beyond our control, and we can provide no assurances regarding when or if we will return to profitability.

Critical Accounting Policies and Estimates

Our significant accounting policies are fundamental to understanding our financial condition and results of operations because some accounting policies require the use of estimates and assumptions that
may impact the value of assets or liabilities and financial results. Accounting for these critical areas requires subjective and complex judgments and could be subject to revision as new information becomes available. Our policies governing the
accounting for our allowance for loan losses and the related reserve for unfunded commitments, commercial loans held for sale and the related valuation allowance, mortgage-servicing rights portfolio, goodwill, foreclosed real estate, the realization
of our net deferred tax asset, defined benefit pension plan, the valuation of our common stock, and the determination of fair value of financial instruments were determined to be critical. On an annual basis, management, in conjunction with our
independent registered public accounting firm, discusses the critical accounting estimates with the Audit Committee of our Board of Directors. For additional information regarding our critical accounting policies and estimates, refer to our Annual
Report on Form 10-K/A for the year ended December 31, 2010.

Financial Condition

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

Overview



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands)



|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|------------------------------------------------------- |  | ------------- | ----------- | - | ---------------- | - | --------- | -------------- |  | - | --------------- | - |  |  | ----- | --
|                                                        |  | March 31,2011 |             |   | December 31,2010 |   |           | Dollarvariance |  |   | Percentvariance |  
|Assets                                                  |  |               | (unaudited) |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Cash and cash equivalents                               |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Cash and due from banks                                 |  | $             | 188,545     |   |                  | $ | 223,017   |                |  | $ | (34,472         | ) |  |  | (15.5 | )%
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Total cash and cash equivalents                         |  |               | 188,545     |   |                  |   | 223,017   |                |  |   | (34,472         | ) |  |  | (15.5 | ) 
|                                                        |  |               |             |  
|FHLB stock, at cost                                     |  |               | 6,785       |   |                  |   | 6,785     |                |  |   |                |   |  |  |      |   
|Investment securities available for sale, at fair value |  |               | 274,103     |   |                  |   | 218,775   |                |  |   | 55,328          |   |  |  | 25.3  |   
|Mortgage loans held for sale                            |  |               | 279         |   |                  |   | 4,793     |                |  |   | (4,514          | ) |  |  | (94.2 | ) 
|Commercial loans held for sale                          |  |               | 60,346      |   |                  |   | 66,157    |                |  |   | (5,811          | ) |  |  | (8.8  | ) 
|                                                        |  |               |             |  
|Loans, gross                                            |  |               | 764,227     |   |                  |   | 793,426   |                |  |   | (29,199         | ) |  |  | (3.7  | ) 
|Less: allowance for loan losses                         |  |               | (26,954     | ) |                  |   | (26,934   | )              |  |   | (20             | ) |  |  | 0.1   |   
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Loans, net                                              |  |               | 737,273     |   |                  |   | 766,492   |                |  |   | (29,219         | ) |  |  | (3.8  | ) 
|                                                        |  |               |             |  
|Premises and equipment, net                             |  |               | 28,072      |   |                  |   | 28,109    |                |  |   | (37             | ) |  |  | (0.1  | ) 
|Accrued interest receivable                             |  |               | 5,017       |   |                  |   | 4,702     |                |  |   | 315             |   |  |  | 6.7   |   
|Foreclosed real estate                                  |  |               | 16,244      |   |                  |   | 19,983    |                |  |   | (3,739          | ) |  |  | (18.7 | ) 
|Income tax refund receivable                            |  |               | 7,436       |   |                  |   | 7,436     |                |  |   |                |   |  |  |      |   
|Other                                                   |  |               | 9,111       |   |                  |   | 8,998     |                |  |   | 113             |   |  |  | 1.3   |   
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Total assets                                            |  | $             | 1,333,211   |   |                  | $ | 1,355,247 |                |  | $ | (22,036         | ) |  |  | (1.6  | )%
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|                                                        |  |               |             |  
|Liabilities and shareholders equity                    |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Liabilities                                             |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Deposits                                                |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Noninterest-bearing                                     |  | $             | 156,323     |   |                  | $ | 141,281   |                |  | $ | 15,042          |   |  |  | 10.6  | % 
|Interest-bearing                                        |  |               | 1,021,367   |   |                  |   | 1,032,081 |                |  |   | (10,714         | ) |  |  | (1.0  | ) 
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Total deposits                                          |  |               | 1,177,690   |   |                  |   | 1,173,362 |                |  |   | 4,328           |   |  |  | 0.4   |   
|                                                        |  |               |             |  
|Retail repurchase agreements                            |  |               | 23,641      |   |                  |   | 20,720    |                |  |   | 2,921           |   |  |  | 14.1  |   
|FHLB borrowings                                         |  |               | 5,000       |   |                  |   | 35,000    |                |  |   | (30,000         | ) |  |  | (85.7 | ) 
|Accrued interest payable                                |  |               | 955         |   |                  |   | 1,187     |                |  |   | (232            | ) |  |  | (19.5 | ) 
|Other                                                   |  |               | 10,080      |   |                  |   | 11,079    |                |  |   | (999            | ) |  |  | (9.0  | ) 
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Total liabilities                                       |  |               | 1,217,366   |   |                  |   | 1,241,348 |                |  |   | (23,982         | ) |  |  | (1.9  | ) 
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|                                                        |  |               |             |  
|Shareholders equity                                    |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Preferred stock                                         |  |               |            |   |                  |   |          |                |  |   |                |   |  |  |      |   
|Common stock                                            |  |               | 505         |   |                  |   | 474       |                |  |   | 31              |   |  |  | 6.5   |   
|Capital surplus                                         |  |               | 141,194     |   |                  |   | 133,112   |                |  |   | 8,082           |   |  |  | 6.1   |   
|Retained earnings (deficit)                             |  |               | (19,188     | ) |                  |   | (13,108   | )              |  |   | (6,080          | ) |  |  | 46.4  |   
|Accumulated other comprehensive loss, net of tax        |  |               | (6,666      | ) |                  |   | (6,579    | )              |  |   | (87             | ) |  |  | 1.3   |   
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|Total shareholders equity                              |  |               | 115,845     |   |                  |   | 113,899   |                |  |   | 1,946           |   |  |  | 1.7   |   
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   
|                                                        |  |               |             |  
|Total liabilities and shareholders equity              |  | $             | 1,333,211   |   |                  | $ | 1,355,247 |                |  | $ | (22,036         | ) |  |  | (1.6  | )%
|                                                        |  |               |             |   |                  |   |           |                |  |   |                 |   |  |  |       |   

Cash and Cash Equivalents

Cash and cash equivalents decreased $34.5 million at March 31, 2011 from December 31, 2010 primarily as a result of reinvestment of excess liquidity into higher-yielding investment securities
and repayment of FHLB advances in January 2011. Carrying excess cash has a negative impact on our interest income since we only earn 25 basis points on our deposits with the Federal Reserve versus investing this cash in higher earning assets.
Accordingly, since consummation of the Private Placement in October 2010, we began redeploying this cash by investing $101.5 million in investment securities in the fourth quarter 2010 and $107.0 million in the first quarter 2011, prepaying $91.0
million of FHLB advances in December 2010 and January 2011, and not pursuing retention of higher priced certificates of deposits that matured in the fourth quarter 2010 and first quarter 2011. Redeploying our excess cash resulted in an improvement
in our net interest margin to 3.28% in the first quarter 2011 compared to 2.78% in the fourth quarter 2010.

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

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



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|                                                     |  |               |       |  |                  |   |       | 
|---------------------------------------------------- |  | ------------- | ----- |  | ---------------- | - | ----- | 
|                                                     |  | March 31,2011 |       |  | December 31,2010 |  
|Merchant credit card agreements                      |  | $             | 452   |  |                  | $ | 451   | 
|Contractually restricted balances for check clearing |  |               | 1,929 |  |                  |   | 1,929 | 
|                                                     |  |               |       |  |                  |   |       | 
|Total                                                |  | $             | 2,381 |  |                  | $ | 2,380 | 
|                                                     |  |               |       |  |                  |   |       | 

In April 2011, $1.0 million of the contractually restricted balances for check clearing were freed of restriction and
returned to the Company.

Investment Activities

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

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



|                                               |  |                |         |  |                   |  |       |       |  |   |            |  |  |  |       |  
|---------------------------------------------- |  | -------------- | ------- |  | ----------------- |  | ----- | ----- |  | - | ---------- |  |  |  | ----- | -
|                                               |  | March 31, 2011 |         |  | December 31, 2010 | 
|                                               |  | Total          |         |  | % of total        |  |       | Total |  |   | % of total | 
|U.S. Treasury and federal agencies             |  | $              |        |  |                   |  |      | %     |  | $ | 37,426     |  |  |  | 17.1  | %
|State and municipal                            |  |                | 105,659 |  |                   |  | 38.5  |       |  |   | 52,462     |  |  |  | 24.0  |  
|Collateralized mortgage obligations            |  |                | 148,535 |  |                   |  | 54.2  |       |  |   | 108,171    |  |  |  | 49.4  |  
|Other mortgage-backed (federal agencies)       |  |                | 19,909  |  |                   |  | 7.3   |       |  |   | 20,716     |  |  |  | 9.5   |  
|                                               |  |                |         |  |                   |  |       |       |  |   |            |  |  |  |       |  
|                                               |  |                |         | 
|Total investment securities available for sale |  | $              | 274,103 |  |                   |  | 100.0 | %     |  | $ | 218,775    |  |  |  | 100.0 | %
|                                               |  |                |         |  |                   |  |       |       |  |   |            |  |  |  |       |  

Average balances of investment securities available for sale increased to $231.2 million during the three months ended
March 31, 2011 from $175.7 million during the three months ended December 31, 2010 and $117.7 million during the three months ended March 31, 2010. This increase was the result of purchases in the third quarter 2010 of U.S. Treasury
and federal agencies to provide additional securities to pledge as collateral for FHLB borrowings, as well as reinvestment of our excess cash into securities during the fourth quarter 2010 and first quarter 2011. Investments in the fourth quarter
2010 and first quarter 2011 consisted primarily of government and agency CMOs at an average yield of 1.30%, and AA or better rated municipal securities at an average yield of 3.10%, which was more favorable than other investment securities of
comparable credit quality and duration at that time. At March 31, 2011, municipal securities issued in Michigan, Texas and South Carolina represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities
portfolio. The most recent Company purchase of a municipal security from Michigan was in 2007.

The fair value of the investment securities
available for sale portfolio represented 20.6% of total assets at March 31, 2011 and 16.1% of total assets at December 31, 2010.

Subsequent to March 31, 2011, in April 2011, we purchased additional mortgage-backed and state and municipal investment securities aggregating
approximately $12.4 million. We also sold our remaining private-label CMO for $2.3 million, recognizing a gain of $56 thousand.

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



|                                               |  |                |         |  |                   |   |         |               |  |   |           |  |  |   |         | 
|---------------------------------------------- |  | -------------- | ------- |  | ----------------- | - | ------- | ------------- |  | - | --------- |  |  | - | ------- | 
|                                               |  | March 31, 2011 |         |  | December 31, 2010 |  
|                                               |  | Amortizedcost  |         |  | Fairvalue         |   |         | Amortizedcost |  |   | Fairvalue | 
|U.S. Treasury and federal agencies             |  | $              |        |  |                   | $ |        |               |  | $ | 37,430    |  |  | $ | 37,426  | 
|State and municipal                            |  |                | 104,288 |  |                   |   | 105,659 |               |  |   | 51,243    |  |  |   | 52,462  | 
|Collateralized mortgage obligations            |  |                | 148,480 |  |                   |   | 148,535 |               |  |   | 107,876   |  |  |   | 108,171 | 
|Other mortgage-backed (federal agencies)       |  |                | 19,439  |  |                   |   | 19,909  |               |  |   | 20,189    |  |  |   | 20,716  | 
|                                               |  |                |         |  |                   |   |         |               |  |   |           |  |  |   |         | 
|Total investment securities available for sale |  | $              | 272,207 |  |                   | $ | 274,103 |               |  | $ | 216,738   |  |  | $ | 218,775 | 
|                                               |  |                |         |  |                   |   |         |               |  |   |           |  |  |   |         | 

Pledged. Public depositors from state and local municipalities typically require that the Bank pledge investment
grade securities to the accounts to ensure repayment. Although the funds are usually a low cost,



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relatively stable source of funding for the Bank, availability depends on the particular governments fiscal policies and cash flow needs.

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



|                                 |  |               |         |  |                  |   |         | 
|-------------------------------- |  | ------------- | ------- |  | ---------------- | - | ------- | 
|                                 |  | March 31,2011 |         |  | December 31,2010 |  
|Public funds deposits            |  | $             | 97,531  |  |                  | $ | 67,260  | 
|FHLB advances and line of credit |  |               | 24,654  |  |                  |   | 48,344  | 
|                                 |  |               |         |  |                  |   |         | 
|Total                            |  | $             | 122,185 |  |                  | $ | 115,604 | 
|                                 |  |               |         |  |                  |   |         | 

In April 2011, the Company obtained a $25 million secured overnight line of credit with another bank. This line of credit,
if drawn upon, will require the pledge of investment securities with a fair value equal to approximately 110% of the amount borrowed.

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



|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|---------------------------------------------- |  | ------------------- | -- |  | ------------------- | - | ------ | --------------------- |  | - | ----- |  |  | ---------- | - |  | --------------------- | - | ----- | - |  | - | ---------- |  |  | --------------------- | -- |  |  | - | ------- |  |  | - | ----- | 
|                                               |  | March 31, 2011      |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #     |  |  | Fair value |   |  | Grossunrealizedlosses |   |       | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     |   |  |                     | $ |       |                       |  | $ |      |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       |   |  |  | $ |        |  |  | $ |      | 
|State and municipal                            |  |                     | 24 |  |                     |   | 16,021 |                       |  |   | 324   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 24 |  |  |   | 16,021  |  |  |   | 324   | 
|Collateralized mortgage obligations            |  |                     | 20 |  |                     |   | 72,738 |                       |  |   | 842   |  |  |            | 3 |  |                       |   | 7,261 |   |  |   | 76         |  |  |                       | 23 |  |  |   | 79,999  |  |  |   | 918   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,600  |                       |  |   | 126   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 3  |  |  |   | 6,600   |  |  |   | 126   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               |  |                     |    |  |                     |   |        |                       | 
|Total investment securities available for sale |  |                     | 47 |  |                     | $ | 95,359 |                       |  | $ | 1,292 |  |  |            | 3 |  |                       | $ | 7,261 |   |  | $ | 76         |  |  |                       | 50 |  |  | $ | 102,620 |  |  | $ | 1,368 | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               | 
|                                               |  | December 31, 2010   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #     |  |  | Fair value |   |  | Grossunrealizedlosses |   |       | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 2  |  |                     | $ | 21,428 |                       |  | $ | 6     |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       | 2  |  |  | $ | 21,428  |  |  | $ | 6     | 
|State and municipal                            |  |                     | 12 |  |                     |   | 7,211  |                       |  |   | 468   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 12 |  |  |   | 7,211   |  |  |   | 468   | 
|Collateralized mortgage obligations            |  |                     | 10 |  |                     |   | 38,295 |                       |  |   | 376   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 10 |  |  |   | 38,295  |  |  |   | 376   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,861  |                       |  |   | 120   |  |  |            |  |  |                       |   |      |   |  |   |           |  |  |                       | 3  |  |  |   | 6,861   |  |  |   | 120   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 
|                                               |  |                     |    |  |                     |   |        |                       | 
|Total investment securities available for sale |  |                     | 27 |  |                     | $ | 73,795 |                       |  | $ | 970   |  |  |            |  |  |                       | $ |      |   |  | $ |           |  |  |                       | 27 |  |  | $ | 73,795  |  |  | $ | 970   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |       |  |  |            |   |  |                       |   |       |   |  |   |            |  |  |                       |    |  |  |   |         |  |  |   |       | 

Gross unrealized losses increased $498 thousand from December 31, 2010 to March 31, 2011, primarily within the
collateralized mortgage obligation sector of the investment securities portfolio as a result of an increase in treasury yields over the periods presented. Based on our other-than-temporary impairment analysis at March 31, 2011 and
December 31, 2010, we concluded that gross unrealized losses detailed in the preceding table were not other-than-temporarily impaired as of that date.

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

Ratings. The following table summarizes Moodys Investors Services (Moodys) ratings, by
segment, of investment securities available for sale based on fair value, at March 31, 2011. An Aaa rating is based not only on the credit of the issuer, but may also include consideration of the structure of the securities and the credit
quality of the collateral.



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|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|----------------------------- |  | ----------------- | --- | - | --------------------------------- |  | --- | -------------------------------------- |  |  | --- | -
|                              |  | Stateandmunicipal |     |   | Collateralizedmortgageobligations |  |     | Othermortgage-backed(federal agencies) | 
|Aaa                           |  |                   | 14  | % |                                   |  | 100 | %                                      |  |  | 100 | %
|Aa1-A3                        |  |                   | 56  |   |                                   |  |    |                                        |  |  |    |  
|Baa1                          |  |                   | 5   |   |                                   |  |    |                                        |  |  |    |  
|Not rated or withdrawn rating |  |                   | 25  |   |                                   |  |    |                                        |  |  |    |  
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|Total                         |  |                   | 100 | % |                                   |  | 100 | %                                      |  |  | 100 | %
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  

The following table summarizes by Standard and Poors ratings, by segment, of the investment securities available for
sale based on fair value, at March 31, 2011.



|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|----------------------------- |  | ----------------- | --- | - | --------------------------------- |  | --- | -------------------------------------- |  |  | --- | -
|                              |  | Stateandmunicipal |     |   | Collateralizedmortgageobligations |  |     | Othermortgage-backed(federal agencies) | 
|Aaa                           |  |                   | 18  | % |                                   |  | 100 | %                                      |  |  | 100 | %
|Aa+-A                         |  |                   | 53  |   |                                   |  |    |                                        |  |  |    |  
|Not rated or withdrawn rating |  |                   | 29  |   |                                   |  |    |                                        |  |  |    |  
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  
|Total                         |  |                   | 100 | % |                                   |  | 100 | %                                      |  |  | 100 | %
|                              |  |                   |     |   |                                   |  |     |                                        |  |  |     |  

One state and municipal security totaling $203 thousand was not rated by Moodys or Standard and Poors.

Maturities. The weighted average life of investment securities available for sale was 4.5 years, based on expected prepayment
activity, at March 31, 2011. Since 62% of the portfolio, based on amortized cost, is collateralized mortgage obligations or other mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because borrowers
generally have the right to prepay obligations before the underlying mortgages mature. Given the general expectation of a rising interest rate environment, we are intentionally investing in shorter-term duration securities to minimize our interest
rate risk if interest rates begin to rise.

Concentrations. The following table summarizes issuer concentrations of collateralized
mortgage obligations whose aggregate book values exceed 10% of shareholders equity at March 31, 2011 (dollars in thousands).



|            |  |                      |        |  |                          |   |        |                                              |  |  |      |  
|----------- |  | -------------------- | ------ |  | ------------------------ | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer      |  | Aggregatefair 
value |        |  | Aggregateamortized 
cost |   |        | Amortized cost as a % ofshareholders equity | 
|Freddie Mac |  | $                    | 48,389 |  |                          | $ | 48,357 |                                              |  |  | 41.7 | %
|Fannie Mae  |  |                      | 39,506 |  |                          |   | 39,381 |                                              |  |  | 34.0 | %
|Ginnie Mae  |  |                      | 55,769 |  |                          |   | 56,038 |                                              |  |  | 48.4 | %

The following table summarizes issuer
concentrations of other mortgage-backed investment securities whose book values exceed 10% of shareholders equity at March 31, 2011 (dollars in thousands).



|           |  |                      |        |  |                          |   |        |                                              |  |  |      |  
|---------- |  | -------------------- | ------ |  | ------------------------ | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer     |  | Aggregatefair 
value |        |  | Aggregateamortized 
cost |   |        | Amortized cost as a % ofshareholders equity | 
|Fannie Mae |  | $                    | 14,772 |  |                          | $ | 14,300 |                                              |  |  | 12.3 | %

Although there are no state and municipal
investment securities with state issuer concentrations whose aggregate book values exceed 10% of shareholders equity at March 31, 2011, three state issuers, Michigan, Texas, and South Carolina, exceeded 9% of shareholders equity at
March 31, 2011. These securities represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities portfolio at March 31, 2011.

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



|                   |  |                                      |   |  |      |   |        |  
|------------------ |  | ------------------------------------ | - |  | ---- | - | ------ | -
|                   |  | For the three months
ended March 31, |  
|                   |  | 2011                                 |   |  | 2010 |  
|Realized gains     |  | $                                    |  |  |      | $ | 1,147  |  
|Realized losses    |  |                                      |  |  |      |   | (1,139 | )
|                   |  |                                      |   |  |      |   |        |  
|Net realized gains |  | $                                    |  |  |      | $ | 8      |  
|                   |  |                                      |   |  |      |   |        |  

Lending Activities



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General. Loans continue to be the largest component of our assets. During the three months ended
March 31, 2011, gross loans declined approximately $29.2 million (3.7%) as a result of repayments, sales and charge-offs. In addition, commercial loans held for sale declined $5.8 million (8.8%) as we continue to actively seek to
reduce our commercial real estate loan portfolio to improve our credit quality and reduce our concentration in commercial real estate. Based on our risk assessment of borrowers, during 2010, we also implemented risk-based loan pricing and interest
rate floors, or minimum interest rates, both at origination and renewal. In addition, we are proactively addressing the reduction of our nonperforming assets through restructurings, charge-offs, and sales. Overall, the demand for new loans from
credit-worthy borrowers is weak such that repayments are outpacing new loans originated.

Commercial Loans Held for Sale. In September
2010, we began marketing for sale a pool of specifically identified commercial loans. Our marketing efforts continued through the first quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan
basis and are balancing the desire to reduce problem loans with preservation of capital. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general and our Company in
particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the
first quarter 2011, such prices continue to reflect heavy discounting. In many cases, we have not accepted certain discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their
recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order. To date, we have sold commercial loans held for sale with a gross book value of $12.4 million.

We are continuing our efforts to sell the remaining loans held for sale. At March 31, 2011, we had commercial loans held for sale aggregating $60.3
million. These loans are carried at the lower of cost or fair value, and a valuation allowance of $853 thousand was recorded against the loans held for sale resulting in a net carrying amount in the Consolidated Balance Sheets of $60.3 million. Of
the aggregate balance of commercial loans held for sale, 99.4% are commercial real estate loans based on FDIC code. Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to fair value, which was based
on updated appraisals received during the first quarter or internal valuations, less estimated costs to sell. There can be no assurances that the loans will be sold, or that bids will be offered, at the currently recorded balances. Accordingly, to
the extent we accept bids for these loans, we may receive less than the current net carrying amount of the loans and incur a corresponding incremental loss on any such loan sales.

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

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



|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|------------------------------------ |  | -------------- | ------- | - | ----------------- |  | ----- | ----- |  | - | ---------- | - |  |  | ----- | -
|                                     |  | March 31, 2011 |         |   | December 31, 2010 | 
|                                     |  | Total          |         |   | % of total        |  |       | Total |  |   | % of total |  
|                                     |  |                |         |  
|Commercial real estate               |  | $              | 543,683 |   |                   |  | 65.9  | %     |  | $ | 573,822    |   |  |  | 66.8  | %
|Single-family residential            |  |                | 175,332 |   |                   |  | 21.3  |       |  |   | 178,980    |   |  |  | 20.8  |  
|Commercial and industrial            |  |                | 48,624  |   |                   |  | 5.9   |       |  |   | 47,812     |   |  |  | 5.6   |  
|Consumer                             |  |                | 50,884  |   |                   |  | 6.2   |       |  |   | 52,652     |   |  |  | 6.1   |  
|Other                                |  |                | 6,050   |   |                   |  | 0.7   |       |  |   | 6,317      |   |  |  | 0.7   |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Total loans                          |  | $              | 824,573 |   |                   |  | 100.0 | %     |  | $ | 859,583    |   |  |  | 100.0 | %
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Less: Commercial loans held for sale |  |                | (60,346 | ) |                   |  |       |       |  |   | (66,157    | ) |  |  |       |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  
|Loans, gross                         |  | $              | 764,227 |   |                   |  |       |       |  | $ | 793,426    |   |  |  |       |  
|                                     |  |                |         |   |                   |  |       |       |  |   |            |   |  |  |       |  

Loans included in the preceding loan composition table are net of participations sold. Participations sold reflect
two loans totaling $12.3 million at March 31, 2011 and $12.5 million at December 31, 2010. With regard to participations sold, we serve as the lead bank and are therefore responsible for certain



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administration and other management functions as agent to the participating banks. We are in active discussions with the participating banks to keep them informed of the status of these loans and
determine loan workout plans.

Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at
March 31, 2011 and December 31, 2010, respectively, and are not included in our Consolidated Balance Sheets.

Pledged. To
borrow from the FHLB, members must pledge collateral. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. At March 31, 2011 and
December 31, 2010, $362.9 million and $393.7 million of gross loans, respectively, were pledged to collateralize FHLB advances and letters of credit, of which $87.0 million and $92.5 million, respectively, was available as lendable collateral.

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as collateral to
cover the various Federal Reserve System services that we utilize.

Concentrations. General. During 2009, 2010 and continuing into
2011, we increased our monitoring of borrower and industry sector concentrations and are limiting additional credit exposure to these concentrations, in particular the segments of our loan portfolio secured by commercial real estate. In addition, we
are proactively executing loan workout plans with a particular focus on reducing our concentrations in these segments. In addition, we are evaluating the potential sale, individually or in bulk, of performing and nonperforming commercial loans. In
September 2010, we began marketing for sale commercial loans to reduce our nonperforming assets and concentration in commercial real estate.

Loan Type / Industry Concentration. The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at March 31,
2011 (dollars in thousands).



|                                                     |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|---------------------------------------------------- |  | ------------------------------------------- | ------- |  | ------------------------------------------------------------ | - | ------ | ------------------------------- |  | - | ----------------------------------------------- |  |  | -------------------------------- | ---- | - |  |  | ----- | -
|                                                     |  | Commercialreal estateincluded ingross loans |         |  | Commercialreal estateincluded incommercialloans heldfor sale |   |        | Totalcommercialreal estateloans |  |   | % of grossloans andcommercialloans heldfor sale |  |  | % ofBankstotalregulatorycapital |     
|Secured by commercial real estate                    |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Construction, land development, and other land loans |  | $                                           | 112,579 |  |                                                              | $ | 8,884  |                                 |  | $ | 121,463                                         |  |  |                                  | 14.7 | % |  |  | 91.8  | %
|Multifamily residential                              |  |                                             | 18,143  |  |                                                              |   | 7,475  |                                 |  |   | 25,618                                          |  |  |                                  | 3.1  |   |  |  | 19.4  |  
|Nonfarm nonresidential                               |  |                                             | 352,977 |  |                                                              |   | 43,625 |                                 |  |   | 396,602                                         |  |  |                                  | 48.1 |   |  |  | 299.8 |  
|                                                     |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Total loans secured by commercial real estate        |  | $                                           | 483,699 |  |                                                              | $ | 59,984 |                                 |  | $ | 543,683                                         |  |  |                                  | 65.9 | % |  |  | 411.0 | %
|                                                     |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  

The following table further categorizes loans secured by commercial real estate at March 31, 2011 (dollars in
thousands).



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|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|----------------------------------------------------------------- |  | ------------------------------------------- | ------- |  | ------------------------------------------------------------ | - | ------ | ------------------------------- |  | - | ----------------------------------------------- |  |  | -------------------------------- | ---- | - |  |  | ----- | -
|                                                                  |  | Commercialreal estateincluded ingross loans |         |  | Commercialreal estateincluded incommercialloans heldfor sale |   |        | Totalcommercialreal estateloans |  |   | % of grossloans andcommercialloans heldfor sale |  |  | % ofBankstotalregulatorycapital |     
|Development commercial real estate loans                          |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Land - unimproved (commercial or residential)                     |  | $                                           | 43,714  |  |                                                              | $ | 1,161  |                                 |  | $ | 44,875                                          |  |  |                                  | 5.4  | % |  |  | 33.9  | %
|Land development - commercial                                     |  |                                             | 12,515  |  |                                                              |   | 463    |                                 |  |   | 12,978                                          |  |  |                                  | 1.6  |   |  |  | 9.8   |  
|Land development - residential                                    |  |                                             | 41,541  |  |                                                              |   | 7,260  |                                 |  |   | 48,801                                          |  |  |                                  | 5.9  |   |  |  | 36.9  |  
|Commercial construction:                                          |  |                                             |        |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Retail                                                            |  |                                             | 4,420   |  |                                                              |   |       |                                 |  |   | 4,420                                           |  |  |                                  | 0.5  |   |  |  | 3.3   |  
|Office                                                            |  |                                             | 239     |  |                                                              |   |       |                                 |  |   | 239                                             |  |  |                                  | 0.0  |   |  |  | 0.2   |  
|Multifamily                                                       |  |                                             | 1,250   |  |                                                              |   |       |                                 |  |   | 1,250                                           |  |  |                                  | 0.2  |   |  |  | 1.0   |  
|Industrial and warehouse                                          |  |                                             | 930     |  |                                                              |   |       |                                 |  |   | 930                                             |  |  |                                  | 0.1  |   |  |  | 0.7   |  
|Miscellaneous commercial                                          |  |                                             | 3,312   |  |                                                              |   |       |                                 |  |   | 3,312                                           |  |  |                                  | 0.4  |   |  |  | 2.5   |  
|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Total development commercial real estate loans                    |  |                                             | 107,921 |  |                                                              |   | 8,884  |                                 |  |   | 116,805                                         |  |  |                                  | 14.1 |   |  |  | 88.3  |  
|                                                                  |  |                                             |         |  |                                                             
|Existing and other commercial real estate loans                   |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Hotel / motel                                                     |  |                                             | 18,143  |  |                                                              |   | 7,475  |                                 |  |   | 25,618                                          |  |  |                                  | 3.1  |   |  |  | 19.4  |  
|Retail                                                            |  |                                             | 55,764  |  |                                                              |   | 33,378 |                                 |  |   | 89,142                                          |  |  |                                  | 10.8 |   |  |  | 67.4  |  
|Office                                                            |  |                                             | 15,735  |  |                                                              |   | 4,313  |                                 |  |   | 20,048                                          |  |  |                                  | 2.4  |   |  |  | 15.2  |  
|Multifamily                                                       |  |                                             | 23,270  |  |                                                              |   | 1,409  |                                 |  |   | 24,679                                          |  |  |                                  | 3.0  |   |  |  | 18.7  |  
|Industrial and warehouse                                          |  |                                             | 11,945  |  |                                                              |   | 1,489  |                                 |  |   | 13,434                                          |  |  |                                  | 1.6  |   |  |  | 10.2  |  
|Healthcare                                                        |  |                                             | 12,891  |  |                                                              |   |       |                                 |  |   | 12,891                                          |  |  |                                  | 1.6  |   |  |  | 9.7   |  
|Miscellaneous commercial                                          |  |                                             | 115,207 |  |                                                              |   | 2,570  |                                 |  |   | 117,777                                         |  |  |                                  | 14.3 |   |  |  | 89.0  |  
|Residential construction - speculative                            |  |                                             | 863     |  |                                                              |   |       |                                 |  |   | 863                                             |  |  |                                  | 0.1  |   |  |  | 0.6   |  
|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Total existing and other commercial real estate loans             |  |                                             | 253,818 |  |                                                              |   | 50,634 |                                 |  |   | 304,452                                         |  |  |                                  | 36.9 |   |  |  | 230.2 |  
|                                                                  |  |                                             |         |  |                                                             
|Commercial real estate owner occupied and residential loans       |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Commercial - owner occupied                                       |  |                                             | 118,165 |  |                                                              |   | 466    |                                 |  |   | 118,631                                         |  |  |                                  | 14.4 |   |  |  | 89.7  |  
|Commercial construction - owner occupied                          |  |                                             | 1,711   |  |                                                              |   |       |                                 |  |   | 1,711                                           |  |  |                                  | 0.2  |   |  |  | 1.3   |  
|Residential construction - contract                               |  |                                             | 2,084   |  |                                                              |   |       |                                 |  |   | 2,084                                           |  |  |                                  | 0.3  |   |  |  | 1.5   |  
|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|Total commercial real estate owner occupied and residential loans |  |                                             | 121,960 |  |                                                              |   | 466    |                                 |  |   | 122,426                                         |  |  |                                  | 14.9 |   |  |  | 92.5  |  
|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  
|                                                                  |  |                                             |         |  |                                                             
|Total loans secured by commercial real estate                     |  | $                                           | 483,699 |  |                                                              | $ | 59,984 |                                 |  | $ | 543,683                                         |  |  |                                  | 65.9 | % |  |  | 411.0 | %
|                                                                  |  |                                             |         |  |                                                              |   |        |                                 |  |   |                                                 |  |  |                                  |      |   |  |  |       |  

Asset Quality. Given the negative credit quality trends that began in 2008, accelerated during 2009, and continued
through 2010 and into 2011, we have performed extensive analysis of our non-consumer loan portfolio, with particular focus on commercial real estate loans. The analyses included internal and external loan reviews that required detailed, written
analyses for the loans reviewed and vetting of the risk rating, accrual status, and collateral valuation of the loans by the loan officers, our senior management team, external consultants, and an external loan review firm. Of particular
significance is that these reviews have currently identified 30 specifically identified borrower relationships (43 individual loans) that have resulted in $73.6 million (62%) of the $118.9 million of net loan charge-offs, writedowns on loans
held for sale, and writedowns on foreclosed assets recorded in the past nine quarters. In general, these loans have one or more of the following common characteristics:



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



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



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

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

As part of the credit quality plan, to continue
addressing the impact of the economic environment on our loan portfolio, we are continuing our detailed review of the loan portfolio and are focused on executing detailed loan workout plans for all of our problem loans led by a team of seasoned
commercial lenders and



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using external loan workout consulting expertise. It is clear that some of our borrowers are continuing to face financial stress manifesting itself in the following ways:



| |  |  | Decreased cash flows from the underlying properties supporting the loans,
| | - |  | -------------------------------------------------------------------------



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



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

We also continue to review our lending policies and
procedures and credit administration function. To this end, during 2009, 2010, and thus far in 2011 we implemented several enhancements as follows:



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



| |  |  | Loan Policy: In 2009, 2010 and 2011, we amended our loan policy to, among other changes, adjust lending limit approval authorities, prohibit
out-of-market loans to borrowers for which we do not have a previously existing relationship, prohibit brokered loans and update for new regulatory appraisal guidelines.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | Training: During 2010 and 2011, we conducted additional training including external specialists in the areas of problem loan workout and negotiating
skills, analysis of personal financial statements and business tax returns, cash flow analysis, perfecting security interests in collateral, appraisals, Small Business Administration programs and credit underwriting.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

At March 31, 2011, nonperforming assets decreased $10.0 million (9.0%) from December 31, 2010, representing a total decline of 28.6% from
the peak at March 31, 2010 and the fourth consecutive quarterly decline. However, we continue to have a high-risk loan portfolio given the concentration in commercial real estate and the number of individually large criticized loans.

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



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|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|------------------------------------------------------- |  | ------------- | --------- | - | ---------------- | - | --------- | ----------------- |  | - | ------------ | - |  | ------------- | --------- | - | ---------------- | - | --------- | - |  | - | --------- | -
|                                                        |  | March 31,2011 |           |   | December 31,2010 |   |           | September 30,2010 |  |   | June 30,2010 |   |  | March 31,2010 |           |   | December 31,2009 |  
|                                                        |  |               |           |   |                  |  
|Construction, land development and other land loans     |  | $             | 52,386    |   |                  | $ | 52,528    |                   |  | $ | 42,914       |   |  | $             | 37,733    |   |                  | $ | 54,347    |   |  | $ | 47,901    |  
|Multifamily residential                                 |  |               | 7,475     |   |                  |   | 7,943     |                   |  |   | 8,022        |   |  |               | 9,352     |   |                  |   | 9,827     |   |  |   | 9,844     |  
|Nonfarm nonresidential                                  |  |               | 14,063    |   |                  |   | 18,781    |                   |  |   | 25,787       |   |  |               | 28,200    |   |                  |   | 31,910    |   |  |   | 23,330    |  
|Single-family real estate, revolving, open end loans    |  |               | 875       |   |                  |   | 998       |                   |  |   | 987          |   |  |               | 535       |   |                  |   | 279       |   |  |   | 127       |  
|Single-family real estate, closed end, first lien       |  |               | 7,395     |   |                  |   | 7,607     |                   |  |   | 6,473        |   |  |               | 7,991     |   |                  |   | 7,801     |   |  |   | 7,079     |  
|Single-family real estate, closed end, junior lien      |  |               | 606       |   |                  |   | 866       |                   |  |   | 969          |   |  |               | 633       |   |                  |   | 392       |   |  |   | 446       |  
|Commercial and industrial                               |  |               | 1,795     |   |                  |   | 2,197     |                   |  |   | 4,776        |   |  |               | 6,330     |   |                  |   | 7,917     |   |  |   | 7,475     |  
|Credit cards                                            |  |               | 26        |   |                  |   | 26        |                   |  |   | 400          |   |  |               | 398       |   |                  |   | 298       |   |  |   | 372       |  
|All other consumer                                      |  |               | 478       |   |                  |   | 459       |                   |  |   | 445          |   |  |               | 433       |   |                  |   | 362       |   |  |   | 312       |  
|Farmland                                                |  |               |          |   |                  |   |          |                   |  |   |             |   |  |               | 48        |   |                  |   | 48        |   |  |   | 50        |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|Total nonaccrual loans                                  |  |               | 85,099    |   |                  |   | 91,405    |                   |  |   | 90,773       |   |  |               | 91,653    |   |                  |   | 113,181   |   |  |   | 96,936    |  
|                                                        |  |               |           |   |                  |  
|Real estate acquired in settlement of loans             |  |               | 16,244    |   |                  |   | 19,983    |                   |  |   | 22,508       |   |  |               | 26,521    |   |                  |   | 28,867    |   |  |   | 27,826    |  
|                                                        |  |               |           |   |                  |  
|Repossessed automobiles acquired in settlement of loans |  |               | 141       |   |                  |   | 104       |                   |  |   | 130          |   |  |               | 106       |   |                  |   | 113       |   |  |   | 188       |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|Total foreclosed assets                                 |  |               | 16,385    |   |                  |   | 20,087    |                   |  |   | 22,638       |   |  |               | 26,627    |   |                  |   | 28,980    |   |  |   | 28,014    |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|Total nonperforming assets                              |  | $             | 101,484   |   |                  | $ | 111,492   |                   |  | $ | 113,411      |   |  | $             | 118,280   |   |                  | $ | 142,161   |   |  | $ | 124,950   |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|                                                        |  |               |           |   |                  |  
|Less: Nonaccrual commercial loans held for sale         |  |               | (22,654   | ) |                  |   | (27,940   | )                 |  |   | (47,957      | ) |  |               |          |   |                  |   |          |   |  |   |          |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|                                                        |  |               |           |   |                  |  
|Adjusted nonperforming assets                           |  | $             | 78,830    |   |                  | $ | 83,552    |                   |  | $ | 65,454       |   |  | $             | 118,280   |   |                  | $ | 142,161   |   |  | $ | 124,950   |  
|                                                        |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|                                                        |  |               |           |   |                  |  
|Loans*                                                  |  | $             | 824,573   |   |                  | $ | 859,583   |                   |  | $ | 916,128      |   |  | $             | 967,244   |   |                  | $ | 1,010,247 |   |  | $ | 1,040,312 |  
|                                                        |  |               |           |   |                  |  
|Total assets                                            |  |               | 1,333,211 |   |                  |   | 1,355,247 |                   |  |   | 1,379,632    |   |  |               | 1,386,959 |   |                  |   | 1,347,564 |   |  |   | 1,435,763 |  
|                                                        |  |               |           |   |                  |  
|Total nonaccrual loans as a percentage of:              |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|loans* and foreclosed assets                            |  |               | 10.12     | % |                  |   | 10.39     | %                 |  |   | 9.67         | % |  |               | 9.22      | % |                  |   | 10.89     | % |  |   | 9.07      | %
|total assets                                            |  |               | 6.38      |   |                  |   | 6.74      |                   |  |   | 6.58         |   |  |               | 6.61      |   |                  |   | 8.40      |   |  |   | 6.75      |  
|                                                        |  |               |           |   |                  |  
|Total nonperforming assets as a percentage of:          |  |               |           |   |                  |   |           |                   |  |   |              |   |  |               |           |   |                  |   |           |   |  |   |           |  
|loans* and foreclosed assets                            |  |               | 12.07     | % |                  |   | 12.67     | %                 |  |   | 12.08        | % |  |               | 11.90     | % |                  |   | 13.68     | % |  |   | 11.70     | %
|total assets                                            |  |               | 7.61      |   |                  |   | 8.23      |                   |  |   | 8.22         |   |  |               | 8.53      |   |                  |   | 10.55     |   |  |   | 8.70      |  



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

Loans placed in nonaccrual status during the three months ended March 31, 2011 resulted from loans becoming delinquent on contractual payments due to deterioration in the financial condition of the
borrowers or guarantors such that full payment of principal or interest was not expected due to personal cash flows from the borrowers and guarantors being inadequate to service the loans, interest reserves on the loans being depleted, a decrease in
operating cash flows from the underlying properties supporting the loans, or a decline in fair values of the collateral resulting in lower cash proceeds from property sales. Loans migrating into nonaccrual status in the first quarter 2011 totaled
$10.1 million compared to an average of $27 million the previous seven quarters.

Nineteen loans with a balance greater than $1 million
comprised approximately 59% of our nonaccrual loans at March 31, 2011. The following table summarizes the composition of these loans by collateral type (dollars in thousands).





|                                                                      |  |                                    |        |  |                            |  |    |  
|--------------------------------------------------------------------- |  | ---------------------------------- | ------ |  | -------------------------- |  | -- | -
|                                                                      |  | Total nonaccrual loans >$1 million |        |  | % of total nonaccrualloans | 
|                                                                      |  |                                   
|Residential / residential lots / golf course development              |  | $                                  | 37,442 |  |                            |  | 44 | %
|Multifamily residential                                               |  |                                    | 6,995  |  |                            |  | 8  |  
|Real estate for commercial use                                        |  |                                    | 4,367  |  |                            |  | 5  |  
|Marina                                                                |  |                                    | 1,198  |  |                            |  | 2  |  
|                                                                      |  |                                    |        |  |                            |  |    |  
|Total nonaccrual loans > $1 million secured by commercial real estate |  | $                                  | 50,002 |  |                            |  | 59 | %
|                                                                      |  |                                    |        |  |                            |  |    |  

Additionally, five of these loans (25% based on the principal balance at March 31, 2011) were purchased participations
and six of these loans (26% based on the principal balance at March 31, 2011) are out-of-market loans. In 2009, we amended our loan policy to preclude originating any new loans of these kinds.



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While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest
income of $500 thousand would have been reported during the three months ended March 31, 2011 had loans classified as nonaccrual during the period performed in accordance with their original terms. As a result, our earnings did not include this
interest income.

The following table summarizes the changes in the Foreclosed real estate portfolio at the dates and for the periods
indicated (in thousands). Foreclosed real estate is net of participations sold of $3.3 million (two properties) at March 31, 2011.



|                                                   |  |                                             |        |   |      |   |        |  
|-------------------------------------------------- |  | ------------------------------------------- | ------ | - | ---- | - | ------ | -
|                                                   |  | At and for the three
months ended March 31, |       
|                                                   |  | 2011                                        |        |   | 2010 |  
|Foreclosed real estate, beginning of period        |  | $                                           | 19,983 |   |      | $ | 27,826 |  
|Plus: New foreclosed real estate                   |  |                                             | 3,764  |   |      |   | 3,893  |  
|Less: Proceeds from sale of foreclosed real estate |  |                                             | (6,988 | ) |      |   | (2,053 | )
|Less: Gain on sale of foreclosed real estate       |  |                                             | 81     |   |      |   | 271    |  
|Less: Provision charged to expense                 |  |                                             | (596   | ) |      |   | (1,070 | )
|                                                   |  |                                             |        |   |      |   |        |  
|Foreclosed real estate, end of period              |  | $                                           | 16,244 |   |      | $ | 28,867 |  
|                                                   |  |                                             |        |   |      |   |        |  

The following table summarizes the Foreclosed real estate portfolio, by FDIC code, at March 31, 2011 (in thousands).



|                                                     |  |   |        | 
|---------------------------------------------------- |  | - | ------ | 
|Construction, land development, and other land loans |  | $ | 6,320  | 
|Single-family residential                            |  |   | 1,826  | 
|Nonfarm, nonresidential                              |  |   | 8,098  | 
|                                                     |  |   |        | 
|Total real estate acquired in settlement of loans    |  | $ | 16,244 | 
|                                                     |  |   |        | 

Four individual properties greater than $1 million comprised approximately 42% of our foreclosed real estate portfolio at
March 31, 2011. Of these properties, 45% were mixed used retail / office, 17% were retail offices, 23% were residential lots, and 15% were commercial lots. Additionally, none of these properties were participations. One of the four was the
result of out-of-market loans.

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

During the three months ended March 31, 2011, we sold 14 properties with an aggregate net carrying amount of $5.9 million in total foreclosed real
estate sales at a net gain of $81 thousand.

Subsequent to March 31, 2011, 7 properties with an aggregate net carrying amount of $174
thousand were sold at an immaterial loss. At April 26, 2011, 9 additional properties with an aggregate net carrying amount of $2.0 million were under contract for sale scheduled to close in the second quarter of 2011.

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



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Troubled Debt Restructurings. Troubled debt restructurings are loans that have undergone concessionary
adjustments and were restructured from their original contractual terms due to financial difficulty of the borrower, for example, reduction in the contractual interest rate below that at which the borrower could obtain new credit from another
lender. As part of our proactive actions to resolve problem loans and the resulting determination of our individual loan workout plans, we may restructure loans to assist borrowers facing cash flow challenges in the current economic environment to
facilitate ultimate repayment of the loan. At March 31, 2011, the principal balance of troubled debt restructurings, in gross loans and commercial loans held for sale, totaled $53.3 million, of which loans totaling $18.2 million are classified
as commercial loans held for sale. In addition, at March 31, 2011, $3.4 million troubled debt restructurings were also in nonaccrual status.

Historically, we have not split loans into two legally separate loans. However, at March 31, 2011, we had four loans that had been legally split into separate loans (commonly referred to as an A/B
loan structure), with both the A and B loans accounted for as troubled debt restructures. Restructuring these loans into legally separate loans resulted in charge-offs of $381 thousand of the B loans during the three months ended March 31,
2011. Additionally, an additional charge-off of $181 thousand was taken during the first quarter of 2011 related to a loan that had been legally split during 2010. All of the A loans are currently performing in accordance with their terms. The
aggregate balances of the A and B loans at March 31, 2011 were $8.2 million and $11.2 million, respectively.

Fourteen individual loans
greater than $1 million comprised $41.4 million (78%) of our troubled debt restructurings, including commercial loans held for sale, at March 31, 2011. Two of the loans experienced rate concessions, two experienced term concessions, six
experienced rate and term concessions, and four experienced a reduction in required principal paydowns. At March 31, 2011, 13 of the loans totaling $39.9 million are performing as expected under the new terms.

A troubled debt restructuring can be removed from this classification in years after the restructuring if both of the following conditions exist: the
restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of the restructuring for a new loan with comparable risk, and the loan is not impaired based on the terms
specified by the restructuring agreement. For the three months ended March 31, 2011, one troubled debt restructuring of $876 thousand was removed from troubled debt restructuring status as it was performing in accordance with its restructured
terms.

In April 2011, the FASB issued ASU 2011-02. We are currently evaluating the potential impact of this new standard on our loan
portfolio and allowance for loan losses.

Potential Problem Loans. Potential problem loans consist of commercial loans not already classified
as nonaccrual for which questions exist as to the current sound worth and paying capacity of the borrower or of the collateral pledged, if any, have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan, and are
characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. We monitor these loans closely and review performance on a regular basis. As of March 31, 2011, total potential problem loans (loans
classified as substandard and doubtful) totaled $112.9 million, of which $33.6 million were in commercial loans held for sale. Total potential problem loans decreased 23.2% from their peak of $147.5 million at June 30, 2010.

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

The allowance for loan losses remained relatively flat at $27.0 million, or 3.53% of gross loans, at March 31, 2011, compared to $26.9 million, or
3.39%, at December 31, 2010. The increasing coverage percentage is a function of a decreasing loan portfolio. We believed it was appropriate for the provision for loan losses to cover net charge-offs in the first quarter 2011 as we continue to
have high levels of classified and criticized assets and nonperforming loans. While we have been actively deleveraging our commercial real estate portfolio since 2009, we still maintain a heavy concentration in commercial real estate loans. In
addition,



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appraised values on commercial real estate may be starting to stabilize, although it is too soon to conclude that the values have hit bottom.

The March 31, 2011 allowance for loan losses, and, therefore indirectly the provision for loan losses for the three months ended March 31,
2011, was determined based on the following specific factors, though not intended to be an all inclusive list:



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



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



| |  |  | The level of real estate development loans, in which the majority of our losses have occurred, although such loans have decreased to 14.7% of the loan
portfolio, including commercial loans held for sale, at March 31, 2011 from 15.9% at December 31, 2010,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The asset quality trends in our loan portfolio, including a high level of nonperforming assets at March 31, 2011, which while still at an elevated
level, decreased for the past four consecutive quarters,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The trend in our criticized and classified loans, which while still at an elevated level, decreased 4.6% and 6.4%, respectively, from the previous
quarter and represents the fourth consecutive quarterly decline,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



| |  |  | Depressed appraised values and market assumptions used to value real estate dependent loans.
| | - |  | --------------------------------------------------------------------------------------------

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



|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|---------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | - | ------------------------------------- | - | --------- | ---- |  | - | ------- | -
|                                                                                   |  | At and for the three monthsended March 31, |         |   | At and for the yearended December 31, |  
|                                                                                   |  | 2011                                       |         |   | 2010                                  |   |           | 2010 | 
|Allowance for loan losses, beginning of period                                     |  | $                                          | 26,934  |   |                                       | $ | 24,079    |      |  | $ | 24,079  |  
|                                                                                   |  |                                            |        
|Provision for loan losses                                                          |  |                                            | 5,500   |   |                                       |   | 10,750    |      |  |   | 47,100  |  
|                                                                                   |  |                                            |        
|Less: Allowance reclassified as commercial loans held for sale valuation allowance |  |                                            |        |   |                                       |   |          |      |  |   | 2,358   |  
|                                                                                   |  |                                            |        
|Less: Allowance reclassified in credit card portfolio sale                         |  |                                            |        |   |                                       |   |          |      |  |   | 452     |  
|                                                                                   |  |                                            |        
|Loan charged-off                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|Commercial real estate                                                             |  |                                            | 4,145   |   |                                       |   | 5,270     |      |  |   | 33,481  |  
|Single-family residential                                                          |  |                                            | 856     |   |                                       |   | 1,176     |      |  |   | 4,214   |  
|Commercial and industrial                                                          |  |                                            | 435     |   |                                       |   | 282       |      |  |   | 3,135   |  
|Consumer                                                                           |  |                                            | 170     |   |                                       |   | 514       |      |  |   | 1,483   |  
|Other                                                                              |  |                                            | 183     |   |                                       |   |          |      |  |   | 647     |  
|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|Total loans charged-off                                                            |  |                                            | 5,789   |   |                                       |   | 7,242     |      |  |   | 42,960  |  
|                                                                                   |  |                                            |        
|Recoveries                                                                         |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|Commercial real estate                                                             |  |                                            | 35      |   |                                       |   | 363       |      |  |   | 544     |  
|Single-family residential                                                          |  |                                            | 50      |   |                                       |   | 66        |      |  |   | 98      |  
|Commercial and industrial                                                          |  |                                            | 30      |   |                                       |   | 145       |      |  |   | 154     |  
|Consumer                                                                           |  |                                            | 56      |   |                                       |   | 265       |      |  |   | 729     |  
|Other                                                                              |  |                                            | 138     |   |                                       |   |          |      |  |   |        |  
|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|Total loans recovered                                                              |  |                                            | 309     |   |                                       |   | 839       |      |  |   | 1,525   |  
|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|                                                                                   |  |                                            |        
|Net loans charged-off                                                              |  |                                            | 5,480   |   |                                       |   | 6,403     |      |  |   | 41,435  |  
|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|                                                                                   |  |                                            |        
|Allowance for loan losses, end of period                                           |  | $                                          | 26,954  |   |                                       | $ | 28,426    |      |  | $ | 26,934  |  
|                                                                                   |  |                                            |         |   |                                       |   |           |      |  |   |         |  
|                                                                                   |  |                                            |        
|Average gross loans                                                                |  | $                                          | 779,306 |   |                                       | $ | 1,028,302 |      |  | $ | 943,101 |  
|                                                                                   |  |                                            |        
|Ending gross loans                                                                 |  |                                            | 764,227 |   |                                       |   | 1,010,247 |      |  |   | 793,426 |  
|                                                                                   |  |                                            |        
|Nonaccrual loans                                                                   |  |                                            | 85,099  |   |                                       |   | 113,181   |      |  |   | 91,405  |  
|                                                                                   |  |                                            |        
|Net loans charged-off as a percentage of average gross loans                       |  |                                            | 2.85    | % |                                       |   | 2.53      | %    |  |   | 4.39    | %
|                                                                                   |  |                                            |        
|Allowance for loan losses as a percentage of ending gross loans                    |  |                                            | 3.53    |   |                                       |   | 2.81      |      |  |   | 3.39    |  
|                                                                                   |  |                                            |        
|Allowance for loan losses as a percentage of nonaccrual loans                      |  |                                            | 31.67   |   |                                       |   | 25.12     |      |  |   | 29.47   |  



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In addition to loans charged-off in their entirety in the ordinary course of business, included within loans
charged-off for the three months ended March 31, 2011 were $4.3 million in gross loan charge-offs relating to loans individually evaluated for impairment. The determination was made to take partial charge-offs on certain collateral dependent
loans based on the status of the underlying real estate projects or our expectation that these loans would be foreclosed on and we would take possession of the collateral. The loan charge-offs were recorded to writedown the loans to the fair value
of the collateral less estimated costs to sell, which are generally based on fair values from third party appraisals.

We analyze individual
loans within the portfolio and make allocations to the allowance for loan losses based on each individual loans specific factors and other circumstances that impact the collectability of the loan. The population of loans evaluated to be
potential impaired loans includes all troubled debt restructurings and all loans with interest reserves, as well as significant individual loans classified as doubtful or on nonaccrual status. At March 31, 2011, we had one loan totaling $3.0
million with a Bank-funded interest reserve. Based on its performance, this loan was not considered impaired.

In situations where a loan is
determined to be impaired because it is probable that all principal and interest due according to the terms of the loan agreement will not be collected as scheduled, the loan is excluded from the general reserve calculation described below and is
evaluated individually for impairment. The impairment analysis is based on the determination of the most probable source of repayment, which is typically liquidation of the underlying collateral but may also include discounted future cash flows
or, in rare cases, the market value of the loan itself. At March 31, 2011, $79.1 million of our loans evaluated individually for impairment, including commercial loans held for sale, were valued based on collateral value, $27.4 million were
valued based on discounted future cash flows and $1.6 million were valued based on a loans observable market price.

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

The following table summarizes the composition of and information relative to impaired loans, by
class, at March 31, 2011 (in thousands).



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|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|------------------------------------------------------- |  | ------------------ | ------ |  | ----------------------------- | - | ------- | ---------------- |  | - | ------------------ |  |  | ---------------------- | ------ |  | ------------------ | - | ------ | ---------------------- |  | - | ---------------- |  |  | - | ------- |  |  | - | ----- | 
|                                                        |  | Gross Loans        |        |  | Commercial LoansHeld for Sale |   |         | Total Loans      | 
|                                                        |  | RecordedInvestment |        |  | UnpaidPrincipalBalance        |   |         | RelatedAllowance |  |   | RecordedInvestment |  |  | UnpaidPrincipalBalance |        |  | RecordedInvestment |   |        | UnpaidPrincipalBalance |  |   | RelatedAllowance | 
|With no related allowance recorded:                     |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 35,123 |  |                               | $ | 54,143  |                  |  |   |                    |  |  | $                      | 8,884  |  |                    | $ | 21,699 |                        |  | $ | 44,007           |  |  | $ | 75,842  |  |  |   |       | 
|Multifamily residential                                 |  |                    |       |  |                               |   |        |                  |  |   |                    |  |  |                        | 7,475  |  |                    |   | 13,543 |                        |  |   | 7,475            |  |  |   | 13,543  |  |  |   |       | 
|Nonfarm nonresidential                                  |  |                    | 4,343  |  |                               |   | 8,006   |                  |  |   |                    |  |  |                        | 18,985 |  |                    |   | 28,584 |                        |  |   | 23,328           |  |  |   | 36,590  |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 39,466 |  |                               |   | 62,149  |                  |  |   |                    |  |  |                        | 35,344 |  |                    |   | 63,826 |                        |  |   | 74,810           |  |  |   | 125,975 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |        |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|Single-family real estate, closed end, first lien       |  |                    | 2,292  |  |                               |   | 7,161   |                  |  |   |                    |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 2,654            |  |  |   | 7,643   |  |  |   |       | 
|Single-family real estate, closed end, junior lien      |  |                    |       |  |                               |   |        |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 2,292  |  |                               |   | 7,161   |                  |  |   |                    |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 2,654            |  |  |   | 7,643   |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Commercial and industrial                               |  |                    | 93     |  |                               |   | 3,106   |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   | 93               |  |  |   | 3,106   |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Total impaired loans with no related allowance recorded |  | $                  | 41,851 |  |                               | $ | 72,416  |                  |  |   |                    |  |  | $                      | 35,706 |  |                    | $ | 64,308 |                        |  | $ | 77,557           |  |  | $ | 136,724 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|With an allowance recorded:                             |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 9,805  |  |                               | $ | 9,805   |                  |  | $ | 3,911              |  |  |                        |        |  |                    |   |        |                        |  | $ | 9,805            |  |  | $ | 9,805   |  |  | $ | 3,911 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |        |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 17,457 |  |                               |   | 21,684  |                  |  |   | 2,340              |  |  |                        |        |  |                    |   |        |                        |  |   | 17,457           |  |  |   | 21,684  |  |  |   | 2,340 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 27,262 |  |                               |   | 31,489  |                  |  |   | 6,251              |  |  |                        |        |  |                    |   |        |                        |  |   | 27,262           |  |  |   | 31,489  |  |  |   | 6,251 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |        |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 1,791  |  |                               |   | 1,791   |                  |  |   | 147                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,791            |  |  |   | 1,791   |  |  |   | 147   | 
|Single-family real estate, closed end, junior lien      |  |                    | 162    |  |                               |   | 162     |                  |  |   | 55                 |  |  |                        |        |  |                    |   |        |                        |  |   | 162              |  |  |   | 162     |  |  |   | 55    | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 1,953  |  |                               |   | 1,953   |                  |  |   | 202                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,953            |  |  |   | 1,953   |  |  |   | 202   | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Commercial and industrial                               |  |                    | 1,367  |  |                               |   | 1,436   |                  |  |   | 796                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,367            |  |  |   | 1,436   |  |  |   | 796   | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Total impaired loans with an allowance recorded         |  | $                  | 30,582 |  |                               | $ | 34,878  |                  |  | $ | 7,249              |  |  |                        |        |  |                    |   |        |                        |  | $ | 30,582           |  |  | $ | 34,878  |  |  | $ | 7,249 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Total:                                                  |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 44,928 |  |                               | $ | 63,948  |                  |  | $ | 3,911              |  |  | $                      | 8,884  |  |                    | $ | 21,699 |                        |  | $ | 53,812           |  |  | $ | 85,647  |  |  | $ | 3,911 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |        |                  |  |   |                   |  |  |                        | 7,475  |  |                    |   | 13,543 |                        |  |   | 7,475            |  |  |   | 13,543  |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 21,800 |  |                               |   | 29,690  |                  |  |   | 2,340              |  |  |                        | 18,985 |  |                    |   | 28,584 |                        |  |   | 40,785           |  |  |   | 58,274  |  |  |   | 2,340 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 66,728 |  |                               |   | 93,638  |                  |  |   | 6,251              |  |  |                        | 35,344 |  |                    |   | 63,826 |                        |  |   | 102,072          |  |  |   | 157,464 |  |  |   | 6,251 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |        |                  |  |   |                   |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 4,083  |  |                               |   | 8,952   |                  |  |   | 147                |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 4,445            |  |  |   | 9,434   |  |  |   | 147   | 
|Single-family real estate, closed end, junior lien      |  |                    | 162    |  |                               |   | 162     |                  |  |   | 55                 |  |  |                        |       |  |                    |   |       |                        |  |   | 162              |  |  |   | 162     |  |  |   | 55    | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 4,245  |  |                               |   | 9,114   |                  |  |   | 202                |  |  |                        | 362    |  |                    |   | 482    |                        |  |   | 4,607            |  |  |   | 9,596   |  |  |   | 202   | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Commercial and industrial                               |  |                    | 1,460  |  |                               |   | 4,542   |                  |  |   | 796                |  |  |                        |       |  |                    |   |       |                        |  |   | 1,460            |  |  |   | 4,542   |  |  |   | 796   | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |         |                 
|Total impaired loans                                    |  | $                  | 72,433 |  |                               | $ | 107,294 |                  |  | $ | 7,249              |  |  | $                      | 35,706 |  |                    | $ | 64,308 |                        |  | $ | 108,139          |  |  | $ | 171,602 |  |  | $ | 7,249 | 
|                                                        |  |                    |        |  |                               |   |         |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 

Interest income recognized on impaired loans during the three months ended March 31, 2011 was $621 thousand. The
average balance of total impaired loans was $107.9 million for the same period.

At December 31, 2010, the balance of impaired loans,
including commercial loans held for sale, was $107.7 million. Of that balance, $24.9 million of the impaired loans had a related allowance for loan losses of $6.3 million. The average balance of impaired loans was $105.7 million for the year ended
December 31, 2010 and $102.1 million for the three months ended March 31, 2010.

We calculate our general allowance by applying our
historical loss factors to each sector of the loan portfolio. For consistency of comparison on a quarterly basis, we utilize a five-year look-back period when computing historical loss rates. However, given the increase in charge-offs beginning in
2009, during 2010 and 2011 we also used a three-year look-back period for computing historical loss rates as another reference point in determining the allowance for loan losses.

We adjust these historical loss percentages for qualitative environmental factors derived from macroeconomic indicators and other factors. Qualitative factors we considered in the determination of
the March 31, 2011 allowance for loan losses include pervasive factors that generally impact borrowers across the loan portfolio (such as unemployment and consumer price index) and factors that have specific implications to particular loan
portfolios (such as residential home sales or commercial development). Factors evaluated may include changes in delinquent, nonaccrual and troubled debt restructured loan trends, trends in risk ratings and net loans charged-off, concentrations of
credit, competition and legal and regulatory requirements, trends in the nature and volume of the loan portfolio, national and local economic and business conditions, collateral valuations, the experience and depth of lending management, lending



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policies and procedures, underwriting standards and practices, the quality of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other external factors.
The general reserve calculated using the historical loss rates and qualitative factors is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.

The following table summarizes the allocation of the allowance for loan losses, by portfolio segment, at March 31, 2011 (in thousands).



|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|---------------------------------------------- |  | --------------------- | ------- |  | ------------------------ | - | ------- | ------------------------ |  | - | -------- |  |  | ----- | ------ |  | ----- | - | ----- |  |  | - | ------- | 
|                                               |  | CommercialReal Estate |         |  | Single-familyResidential |   |         | Commercial andIndustrial |  |   | Consumer |  |  | Other |        |  | Total |  
|Allowance for loan losses:                     |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, beginning of period |  | $                     | 18,979  |  |                          | $ | 4,061   |                          |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  | 
|Provision for loan losses                      |  |                       | 3,983   |  |                          |   | 936     |                          |  |   | 479      |  |  |       | 57     |  |       |   | 45    |  |  |   | 5,500   | 
|                                               |  |                       |         |  |                          |  
|Loan charge-offs                               |  |                       | 4,145   |  |                          |   | 856     |                          |  |   | 435      |  |  |       | 170    |  |       |   | 183   |  |  |   | 5,789   | 
|Loan recoveries                                |  |                       | 35      |  |                          |   | 50      |                          |  |   | 30       |  |  |       | 56     |  |       |   | 138   |  |  |   | 309     | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Net loans charged-off                          |  |                       | 4,110   |  |                          |   | 806     |                          |  |   | 405      |  |  |       | 114    |  |       |   | 45    |  |  |   | 5,480   | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                               |  |                       |         |  |                          |  
|Allowance for loan losses, end of period       |  | $                     | 18,852  |  |                          | $ | 4,191   |                          |  | $ | 2,566    |  |  | $     | 1,318  |  |       | $ | 27    |  |  | $ | 26,954  | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                               |  |                       |         |  |                          |  
|Individually evaluated for impairment          |  | $                     | 6,251   |  |                          | $ | 202     |                          |  | $ | 796      |  |  | $     |       |  |       | $ |      |  |  | $ | 7,249   | 
|                                               |  |                       |         |  |                          |  
|Collectively evaluated for impairment          |  |                       | 12,601  |  |                          |   | 3,989   |                          |  |   | 1,770    |  |  |       | 1,318  |  |       |   | 27    |  |  |   | 19,705  | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                               |  |                       |         |  |                          |  
|Allowance for loan losses, end of period       |  | $                     | 18,852  |  |                          | $ | 4,191   |                          |  | $ | 2,566    |  |  | $     | 1,318  |  |       | $ | 27    |  |  | $ | 26,954  | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                               |  |                       |         |  |                          |  
|Gross loans, end of period:                    |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Individually evaluated for impairment          |  | $                     | 66,728  |  |                          | $ | 4,245   |                          |  | $ | 1,460    |  |  | $     |       |  |       | $ |      |  |  | $ | 72,433  | 
|                                               |  |                       |         |  |                          |  
|Collectively evaluated for impairment          |  |                       | 416,971 |  |                          |   | 170,725 |                          |  |   | 47,164   |  |  |       | 50,884 |  |       |   | 6,050 |  |  |   | 691,794 | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                               |  |                       |         |  |                          |  
|Total gross loans                              |  | $                     | 483,699 |  |                          | $ | 174,970 |                          |  | $ | 48,624   |  |  | $     | 50,884 |  |       | $ | 6,050 |  |  | $ | 764,227 | 
|                                               |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 

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

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

We believe that the
allowance for loan losses at March 31, 2011 is appropriate and adequate to cover probable inherent losses in the loan portfolio. However, underlying assumptions may be impacted in future periods by changes in economic conditions, the impact of
regulatory examinations, and the discovery of information with respect to borrowers that was not known to us at the time of the issuance of our Consolidated Financial Statements. Therefore, our assumptions may or may not prove valid. Thus, there can
be no assurance that loan losses in future periods, including potential incremental losses resulting from the sale of the commercial loans held for sale, will not exceed the current allowance for loan losses amount or that future increases in the
allowance for loan losses will not be required. Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future
additions to the allowance for loan losses, thus adversely impacting our business, financial condition, results of operations, and cash flows.

Commercial Loans Held for Sale Valuation Allowance. At March 31, 2011, commercial loans held for sale are carried at the lower of cost or
fair value, and reflect a valuation allowance of $853 thousand recorded against the loans held for sale resulting in a net carrying amount in the Consolidated Balance Sheets of $60.3



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million. A valuation allowance is recorded against the loans held for sale for the excess of the recorded investment in the loan over the fair value less estimated selling costs.

In September 2010, we began marketing for sale a pool of specifically identified commercial loans. Our marketing efforts continued through the first
quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan basis and are balancing the desire to reduce problem loans with preservation of capital. In general, we believe potential buyers are making
bids at heavily discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to
rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the first quarter 2011, such prices continue to reflect heavy discounting. In many cases, we have not accepted such discounted bids. In certain cases,
however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order.

Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to fair value, which was based on
updated appraisals received during the first quarter, less estimated costs to sell, or internal valuations, as applicable.

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



|                                                             |  |                                                            |        |  |                                                     |   |       |  
|------------------------------------------------------------ |  | ---------------------------------------------------------- | ------ |  | --------------------------------------------------- | - | ----- | -
|                                                             |  | Commercial loans heldfor sale, prior tovaluation allowance |        |  | Valuation allowanceon commercial loansheld for sale |  
|Beginning balance at December 31, 2010                       |  | $                                                          | 68,491 |  |                                                     | $ | 2,334 |  
|                                                             |  |                                                           
|Additions:                                                   |  |                                                            |        |  |                                                     |   |       |  
|Loans held for investment transferred to loans held for sale |  |                                                            | 1,224  |  |                                                     |   |      |  
|Net recovery of valuation for ending loans held for sale     |  |                                                            |       |  |                                                     |   | (36   | )
|                                                             |  |                                                            |        |  |                                                     |   |       |  
|Total additions                                              |  |                                                            | 1,224  |  |                                                     |   | (36   | )
|                                                             |  |                                                            |        |  |                                                     |   |       |  
|                                                             |  |                                                           
|Reductions:                                                  |  |                                                            |        |  |                                                     |   |       |  
|Loans held for sale sold                                     |  |                                                            | 1,974  |  |                                                     |   |      |  
|Transfers to foreclosed real estate                          |  |                                                            | 3,319  |  |                                                     |   | 163   |  
|Direct writedowns on loans held for sale                     |  |                                                            | 2,624  |  |                                                     |   | 1,282 |  
|Net paydowns                                                 |  |                                                            | 598    |  |                                                     |   |      |  
|                                                             |  |                                                            |        |  |                                                     |   |       |  
|Total reductions                                             |  |                                                            | 8,515  |  |                                                     |   | 1,445 |  
|                                                             |  |                                                            |        |  |                                                     |   |       |  
|                                                             |  |                                                           
|Ending balance at March 31, 2011                             |  | $                                                          | 61,200 |  |                                                     | $ | 853   |  
|                                                             |  |                                                            |        |  |                                                     |   |       |  

Premises and Equipment, net

Premises and equipment, net decreased by $37 thousand (0.1%) during the three months ended March 31, 2011.

At March 31, 2011, a vacant bank-owned branch facility with a net book value of $235 thousand is under contract for sale and included in Other assets in the Consolidated Balance Sheets, and in April
2011 the Company began marketing for sale vacant land with a book value of $728 thousand.

Deferred Tax Asset, net

As of December 31, 2010, prior to any valuation allowance, gross deferred tax assets totaling $25.9 million and gross deferred tax liabilities
totaling $5.4 million were recorded in the Companys Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the previous three years, limitations on future
utilization of various deferred tax assets under the Internal Revenue Code, and available tax planning strategies, we recorded a valuation allowance against the net deferred tax asset in the amount of $20.5 million through a charge against income
tax expense (benefit) at December 31, 2010. At March 31, 2011, as a result of the first quarter loss, gross deferred tax assets increased to $28.2 million while gross deferred tax liabilities declined to $5.3 million. Based on a continued
evaluation of the factors considered at December 31, 2010, including the limitation on the future utilization of net operating losses as discussed below, we recorded an additional valuation allowance against the net deferred tax asset to fully
offset the income tax benefit that otherwise would have been recorded.



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

Analysis of our ability to realize deferred tax
assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax
asset for financial reporting purposes at March 31, 2011 and December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate
sufficient taxable income in the future, we will be able to utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net
operating losses we will be able to utilize and therefore how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.

Deposit Activities

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

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



|                                                 |  |               |           |  |                  |  |       |       |  |   |           |  |  |  |       |  
|------------------------------------------------ |  | ------------- | --------- |  | ---------------- |  | ----- | ----- |  | - | --------- |  |  |  | ----- | -
|                                                 |  | March 31,2011 |           |  | December 31,2010 | 
|                                                 |  | Total         |           |  | % oftotal        |  |       | Total |  |   | % oftotal | 
|Noninterest-bearing transaction deposit accounts |  | $             | 156,323   |  |                  |  | 13.3  | %     |  | $ | 141,281   |  |  |  | 12.0  | %
|Interest-bearing transaction deposit accounts    |  |               | 296,757   |  |                  |  | 25.2  |       |  |   | 292,827   |  |  |  | 25.0  |  
|                                                 |  |               |           |  |                  |  |       |       |  |   |           |  |  |  |       |  
|Transaction deposit accounts                     |  |               | 453,080   |  |                  |  | 38.5  |       |  |   | 434,108   |  |  |  | 37.0  |  
|                                                 |  |               |           | 
|Money market deposit accounts                    |  |               | 149,902   |  |                  |  | 12.7  |       |  |   | 143,143   |  |  |  | 12.2  |  
|Savings deposit accounts                         |  |               | 55,159    |  |                  |  | 4.7   |       |  |   | 49,472    |  |  |  | 4.2   |  
|Time deposit accounts                            |  |               | 519,549   |  |                  |  | 44.1  |       |  |   | 546,639   |  |  |  | 46.6  |  
|                                                 |  |               |           |  |                  |  |       |       |  |   |           |  |  |  |       |  
|Total deposits                                   |  | $             | 1,177,690 |  |                  |  | 100.0 | %     |  | $ | 1,173,362 |  |  |  | 100.0 | %
|                                                 |  |               |           |  |                  |  |       |       |  |   |           |  |  |  |       |  

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

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

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



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

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

As a result of the Private Placement in October 2010, we did not pursue
retention of higher priced certificates of deposits that matured in the fourth quarter 2010 and first quarter 2011.

At March 31, 2011,
traditional deposit accounts as a percentage of liabilities were 96.7% compared with 94.5% at December 31, 2010. Interest-bearing deposits decreased $10.7 million during the three months ended March 31, 2011, primarily due to higher priced
time deposit accounts not being retained at maturity as part of our balance sheet management efforts. Noninterest-bearing deposits increased $15.0 million during the same period, primarily as a result of focused efforts to grow core deposits and
seasonal increases in balances. Traditional deposit accounts continue to be our primary source of funding, and, as part of our liquidity plan, we are proactively pursuing deposit retention initiatives with our deposit customers. We are also pursuing
strategies to increase our transaction deposit accounts as a proportion of our total deposits.

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

Borrowing Activities

Borrowings as a percentage of total liabilities decreased from 4.5% at December 31, 2010 to 2.4% at March 31, 2011. The decrease was due to less
reliance on such borrowed funding sources as liquidity was provided through core deposit growth, and cash retention of proceeds from loan payments and maturing securities. We also utilized excess cash balances in January 2011 to prepay $30.0 million
of FHLB advances.

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



|                             |  |                |        |  |                   |  |       |       |  |   |            |  |  |  |       |  
|---------------------------- |  | -------------- | ------ |  | ----------------- |  | ----- | ----- |  | - | ---------- |  |  |  | ----- | -
|                             |  | March 31, 2011 |        |  | December 31, 2010 | 
|                             |  | Total          |        |  | % of total        |  |       | Total |  |   | % of total | 
|Retail repurchase agreements |  | $              | 23,641 |  |                   |  | 82.5  | %     |  | $ | 20,720     |  |  |  | 37.2  | %
|FHLB advances                |  |                | 5,000  |  |                   |  | 17.5  |       |  |   | 35,000     |  |  |  | 62.8  |  
|                             |  |                |        |  |                   |  |       |       |  |   |            |  |  |  |       |  
|Total borrowed funds         |  | $              | 28,641 |  |                   |  | 100.0 | %     |  | $ | 55,720     |  |  |  | 100.0 | %
|                             |  |                |        |  |                   |  |       |       |  |   |            |  |  |  |       |  



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

Wholesale Funding. Wholesale funding options include lines of credit from correspondent banks, FHLB advances, and
the Federal Reserve Discount Window. Such funding provides us with the ability to access the type of funding needed at the time and amount needed at market rates. This provides us with the flexibility to tailor borrowings to our specific needs.
Interest rates on such borrowings vary from time to time in response to general economic conditions.

Correspondent Bank Line of Credit. At
March 31, 2011, the Company had access to an unsecured line of credit from a correspondent bank. The following table summarizes the Companys line of credit funding utilization and availability at the dates indicated (in thousands).



|                                                          |  |               |       |  |                  |   |       | 
|--------------------------------------------------------- |  | ------------- | ----- |  | ---------------- | - | ----- | 
|                                                          |  | March 31,2011 |       |  | December 31,2010 |  
|Correspondent bank line of credit accomodations           |  | $             | 5,000 |  |                  | $ | 5,000 | 
|                                                          |  |              
|Utilized correspondent bank line of credit accomodations  |  |               |      |  |                  |   |      | 
|                                                          |  |               |       |  |                  |   |       | 
|                                                          |  |              
|Available correspondent bank line of credit accomodations |  | $             | 5,000 |  |                  | $ | 5,000 | 
|                                                          |  |               |       |  |                  |   |       | 

In April 2011, we obtained an uncommitted overnight variable rate line of credit from a correspondent bank totaling $25
million. If drawn upon, the Company will be require to pledge investment securities with a fair vale equal to approximately 110% of the amount borrowed. These correspondent bank lines of credit funding source may be canceled at any time at the
correspondent banks discretion.

FHLB Borrowings. We pledge investment securities and loans to collateralize FHLB advances and letters of
credit. Additionally, we may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages, as calculated by the FHLB.
Effective March 2011, we may borrow from the FHLB for terms up to 3 years, subject to availability of collateral. Previously, from January 2010 to March 2011 the maximum maturity for potential borrowings was overnight.

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



|                                                                                                             |  |               |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                             |  | March 31,2011 |         |   | December 31,2010 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $             | 86,977  |   |                  | $ | 92,464  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |               | 23,273  |   |                  |   | 46,275  |  
|                                                                                                             |  |              
|Advances and letters of credit                                                                               |  |               |         |   |                  |   |         |  
|FHLB advances                                                                                                |  |               | (5,000  | ) |                  |   | (35,000 | )
|Letters of credit                                                                                            |  |               | (50,000 | ) |                  |   | (50,000 | )
|                                                                                                             |  |              
|Excess                                                                                                       |  |               | 54,985  |   |                  |   | 53,303  |  

At March 31, 2011, the Company
had one outstanding FHLB advance totaling $5 million. The advance bears interest at a fixed rate of 3.61% and matures in April 2013. This FHLB advance is subject to a prepayment fee in the event of full or partial repayment prior to maturity.

In January 2011, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing cost, we
prepaid $30.0 million of FHLB advances.

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



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Capital

At March 31, 2011, as a result of the consummation of the Private Placement in October 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds as well as the
minimum capital ratios established in the Consent Order.

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



|                                                               |  |                                            |         |   |      |   |        |  
|-------------------------------------------------------------- |  | ------------------------------------------ | ------- | - | ---- | - | ------ | -
|                                                               |  | At and for the three monthsended March 31, |        
|                                                               |  | 2011                                       |         |   | 2010 |  
|Total shareholders equity                                     |  | $                                          | 115,845 |   |      | $ | 70,978 |  
|Average shareholders equity                                   |  |                                            | 120,042 |   |      |   | 76,648 |  
|                                                               |  |                                           
|Shareholders equity as a percentage of assets                 |  |                                            | 8.69    | % |      |   | 5.27   | %
|Average shareholders equity as a percentage of average assets |  |                                            | 9.08    |   |      |   | 5.60   |  
|                                                               |  |                                           
|Cash dividends per common share                                |  | $                                          |        |   |      | $ |       |  
|Dividend payout ratio                                          |  |                                            | n/a     | % |      |   | n/a    | %

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



|                                                                                   |  |                                            |        |   |      |   |        |  
|---------------------------------------------------------------------------------- |  | ------------------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                   |  | For the three month periods endedMarch 31, |       
|                                                                                   |  | 2011                                       |        |   | 2010 |  
|Net Unrealized Gains on Investment Securities Available for Sale                   |  |                                            |        |   |      |   |        |  
|Balance, beginning of period                                                       |  | $                                          | 1,264  |   |      | $ | 306    |  
|Other comprehensive income (loss):                                                 |  |                                            |        |   |      |   |        |  
|Unrealized holding gains (losses) arising during the period                        |  |                                            | (140   | ) |      |   | 1,884  |  
|Income tax (expense) benefit                                                       |  |                                            | 53     |   |      |   | (715   | )
|Less: Reclassification adjustment for (gains) losses included in net (loss) income |  |                                            |       |   |      |   | (8     | )
|Income tax expense (benefit)                                                       |  |                                            |       |   |      |   | 3      |  
|                                                                                   |  |                                            |        |   |      |   |        |  
|                                                                                   |  |                                            | (87    | ) |      |   | 1,164  |  
|                                                                                   |  |                                            |        |   |      |   |        |  
|Balance, end of period                                                             |  |                                            | 1,177  |   |      |   | 1,470  |  
|                                                                                   |  |                                            |        |   |      |   |        |  
|                                                                                   |  |                                           
|Net Unrealized Gains on Impact of Defined Benefit Pension Plan                     |  |                                            |        |   |      |   |        |  
|Balance, beginning of period                                                       |  |                                            | (7,843 | ) |      |   | (7,266 | )
|Other comprehensive loss:                                                          |  |                                            |        |   |      |   |        |  
|Impact of FASB ASC 715                                                             |  |                                            |       |   |      |   |       |  
|Income tax benefit                                                                 |  |                                            |       |   |      |   |       |  
|                                                                                   |  |                                            |        |   |      |   |        |  
|                                                                                   |  |                                            |       |   |      |   |       |  
|                                                                                   |  |                                            |        |   |      |   |        |  
|Balance, end of period                                                             |  |                                            | (7,843 | ) |      |   | (7,266 | )
|                                                                                   |  |                                            |        |   |      |   |        |  
|                                                                                   |  | $                                          | (6,666 | ) |      | $ | (5,796 | )
|                                                                                   |  |                                            |        |   |      |   |        |  
|                                                                                   |  |                                           
|Total other comprehensive income (loss), end of period                             |  | $                                          | (87    | ) |      | $ | 1,164  |  
|Net loss                                                                           |  |                                            | (6,080 | ) |      |   | (5,292 | )
|                                                                                   |  |                                            |        |   |      |   |        |  
|Comprehensive loss                                                                 |  | $                                          | (6,167 | ) |      | $ | (4,128 | )
|                                                                                   |  |                                            |        |   |      |   |        |  



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The market value of pension plan assets is assessed and adjusted through accumulated other comprehensive
income (loss) annually, if necessary.

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

Basel III. Internationally, both the Basel Committee and the Financial Stability Board (established in April 2009 by the G-20 Finance Ministers
and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and liquidity buffers within
the banking system through Basel III. In September 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to
4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by January 2019. The U.S. federal banking agencies
support this agreement. In December 2010, the Basel Committee issued the Basel III rules text that outlines the details and time-lines of global regulatory standards on bank capital adequacy and liquidity. According to the Basel Committee, the
Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress,
and the introduction of two global liquidity standards.

Private Placement. In October 2010 we consummated a private placement in which
institutional investors purchased $103.9 million of shares of the Companys common stock at $2.60 per share. As a result, the Companys and the Banks capital adequacy ratios exceed the minimum capital adequacy ratios to be
categorized as well-capitalized and those required by the Consent Order for the Bank.

In addition, the investors have preemptive
rights with respect to public or private offerings of the Companys common stock (or rights to purchase, or securities convertible into or exercisable for, common stock) during a 24-month period after the closing of the Private Placement to
enable the investors to maintain their percentage interests of the Companys common stock beneficially owned, subject to certain exceptions, including an exception that permits the Company to conduct a common stock offering following the
closing of the Private Placement of up to $10 million directed to the Companys shareholders as of the close of business on October 6, 2010. With respect to our legacy shareholders, at December 31, 2010, we had issued 776,123 shares
of common stock for proceeds of $2.0 million, and in January 2011 we issued an additional 453,906 shares for proceeds of $1.2 million. Under the terms of the Private Placement, the institutional investors who participated in the Private Placement
had the right to purchase any unsubscribed shares from the follow-on offering to the legacy shareholders. As a result, in the first quarter 2011, we issued to these institutional investors 2,616,124 shares of common stock at $2.60 per share for net
proceeds of $6.8 million, resulting in the $10 million offering being fully subscribed. The net proceeds of the offerings were contributed to the Bank as an additional capital contribution.

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

Due to the Consent Order we may not accept brokered deposits unless the FDIC grants a waiver. Although we currently do not utilize brokered deposits as a
funding source, if we were to seek to begin using such a funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we
would normally be restricted from offering an effective yield on deposits of more than 75 basis points over the national rates



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

The balance of gross deferred income taxes at March 31, 2011 represented deferred tax assets and liabilities arising from temporary
differences between the financial reporting and income tax bases of various items as of that date. As of December 31, 2010, we determined that it was not more likely than not that the net deferred tax asset could be supported as realizable,
given the financial results for the year and change in control resulting from the Private Placement that was consummated in October 2010. Based on this determination, as described in more detail in Financial Condition - Deferred Tax Asset, we
recorded a valuation allowance for financial reporting purposes at December 31, 2010. Based on our evaluation of the deferred tax asset at March 31, 2011, we recorded an incremental valuation allowance to fully offset our deferred tax
asset at March 31, 2011.

Additionally, for regulatory capital purposes, deferred tax assets are limited to the assets which can be
realized through (i) carryback to prior years or (ii) taxable income in the next twelve months. At March 31, 2011, all of our net deferred tax asset was excluded from Tier 1 and total capital based on these criteria. We will continue
to evaluate the realizability of our deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. The evaluation may result in the inclusion of some of the deferred tax asset in regulatory capital in future
periods.

Since March 31, 2011, no conditions or events have occurred of which we are aware, that have resulted in a material change in
the Companys or the Banks regulatory capital category other than as reported in this Quarterly Report on Form 10-Q.

Equity. We have authorized common stock and preferred stock of 75 million and 2.5 million shares, respectively. In the Private
Placement, 39,975,980 shares of common stock were issued in October 2010, 1,230,029 shares were issued in connection with the follow-on offering to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional
investors in the Private Placement in the first quarter 2011, resulting in remaining authorized but unissued common shares of 24,486,278 at April 26, 2011. To date, we have not issued any shares of preferred stock.

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

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

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

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

One of the requirements of the Private Placement is that the Company will use its reasonable best efforts to list the
shares of our common stock on NASDAQ or another national securities exchange within nine months of the closing date of the Private Placement on October 7, 2010. While we intend to list our



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common stock on NASDAQ, no assurances can be provided at this time that we will meet such listing requirements or be granted approval by the NASDAQ to be listed.

Derivative Activities

See Part I
 Financial Information, Item 1. Financial Statements, Note 17 for disclosures regarding our derivative financial instruments and hedging activities.

Liquidity

General

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

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

Liquidity
resources and balances at March 31, 2011, contained herein, are an accurate depiction of our activity during the period and, except as noted, have not materially changed to date.

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



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



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



| |  |  | Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB, Federal Reserve and other secured
borrowings. In April 2011, we entered into a Master Repurchase Agreement resulting in a new line of credit from a correspondent bank totaling $25 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accelerating the filing of income tax refund claims resulting in refunds received totaling $27.6 million in 2010 and 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in
other earning assets. Following the consummation of our Private Placement in October 2010, we have redeployed, through March 31, 2011, $208.5 million of this cash into investment securities and prepaid $91 million of FHLB advances which were
scheduled to mature in January through April 2011. We will continue to monitor the level of cash balances in relation to expected liquidity needs and may make further purchases of investment securities during 2011.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Cash Flow Needs

In the normal course of
business, we enter into various transactions, some of which, in accordance with accounting principles generally accepted in the U.S., are not recorded in our Consolidated Balance Sheets.



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These transactions may involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the Consolidated Balance Sheets, if any.

Lending Commitments and Standby Letters of Credit. See Part I  Financial Information, Item 1. Financial Statements, Note 16 contained
herein for disclosures regarding our commitments, guarantees, and other contingencies.

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

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

In an effort to retain capital during this period of economic uncertainty, the Board of Directors reduced the quarterly dividend for the first quarter of
2009. Subsequent to the first quarter 2009, the Board of Directors suspended the quarterly common stock dividend. The Board of Directors believes that suspension of the dividend was prudent to protect our capital base. In addition, payment of a
dividend on our common stock requires prior notification to and non-objection from the applicable banking regulators. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as
to when and if future dividends will be reinstated, and at what level, because they are dependent on our financial condition, results of operations, and / or cash flows, as well as capital and dividend regulations from the FDIC and others.

Long-Term Contractual Obligations. In addition to the contractual commitments and arrangements previously described, the Company
enters into other contractual obligations in the ordinary course of business. The following table summarizes these contractual obligations at March 31, 2011 (in thousands) except obligations for employee benefit plans as these obligations are
paid from separately identified assets. See Note 13, Employee Benefit Plans, for discussion regarding these employee benefit plans.



|                              |  |                   |         |  |                             |   |         |                             |  |   |                |  |  |       |    |  |  |   |         | 
|----------------------------- |  | ----------------- | ------- |  | --------------------------- | - | ------- | --------------------------- |  | - | -------------- |  |  | ----- | -- |  |  | - | ------- | 
|Other contractual obligations |  | Less thanone year |         |  | Over onethroughthree 
years |   |         | Over threethrough fiveyears |  |   | Over fiveyears |  |  | Total |   
|Time deposit accounts         |  | $                 | 333,876 |  |                             | $ | 181,849 |                             |  | $ | 3,789          |  |  | $     | 35 |  |  | $ | 519,549 | 

There have been no other significant
changes in future real property operating lease obligations or FHLB advances as reported in our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 2010.

Short-Term Contractual and Noncontractual Obligations. There have been no significant changes in short-term contractual or noncontractual obligations as reported in our Annual Report on Form 10-K and Form
10-K/A for the year ended December 31, 2010.



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First Quarter 2011 Earnings Review

Overview

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

(dollars in thousands, except per share data) (unaudited)



|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|--------------------------------------------------------------- |  | ------------------------------------ | -------------- | - | ---- | --------------- | --------- | - |  | - | ------ | - |  |  | ------- | --
|                                                                |  | For the three months
ended March 31, |                |   |      |                 |           |   | 
|                                                                |  |                                      | Dollarvariance |   |      | Percentvariance |          
|                                                                |  | 2011                                 |                |   | 2010 |                 |           |  
|Interest income                                                 |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Interest earned on cash and cash equivalents                    |  | $                                    | 105            |   |      | $               | 67        |   |  | $ | 38     |   |  |  | 56.7    | % 
|Dividends received on FHLB stock                                |  |                                      | 14             |   |      |                 | 4         |   |  |   | 10     |   |  |  | 250.0   |   
|Interest earned on investment securities available for sale     |  |                                      | 1,306          |   |      |                 | 1,203     |   |  |   | 103    |   |  |  | 8.6     |   
|Interest and fees earned on loans                               |  |                                      | 11,569         |   |      |                 | 13,605    |   |  |   | (2,036 | ) |  |  | (15.0   | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Total interest income                                           |  |                                      | 12,994         |   |      |                 | 14,879    |   |  |   | (1,885 | ) |  |  | (12.7   | ) 
|                                                                |  |                                      |                |  
|Interest expense                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Interest paid on deposits                                       |  |                                      | 2,676          |   |      |                 | 3,563     |   |  |   | (887   | ) |  |  | (24.9   | ) 
|Interest paid on retail repurchase agreements                   |  |                                      | 11             |   |      |                 | 14        |   |  |   | (3     | ) |  |  | (21.4   | ) 
|Interest paid on commercial paper                               |  |                                      |               |   |      |                 | 10        |   |  |   | (10    | ) |  |  | (100.0  | ) 
|Interest paid on FHLB borrowings                                |  |                                      | 49             |   |      |                 | 493       |   |  |   | (444   | ) |  |  | (90.1   | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Total interest expense                                          |  |                                      | 2,736          |   |      |                 | 4,080     |   |  |   | (1,344 | ) |  |  | (32.9   | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Net interest income                                             |  |                                      | 10,258         |   |      |                 | 10,799    |   |  |   | (541   | ) |  |  | (5.0    | ) 
|                                                                |  |                                      |                |  
|Provision for loan losses                                       |  |                                      | 5,500          |   |      |                 | 10,750    |   |  |   | (5,250 | ) |  |  | (48.8   | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Net interest income after provision for loan losses             |  |                                      | 4,758          |   |      |                 | 49        |   |  |   | 4,709  |   |  |  | 9,610.2 |   
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Noninterest income                                              |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Service charges on deposit accounts, net                        |  |                                      | 1,762          |   |      |                 | 1,950     |   |  |   | (188   | ) |  |  | (9.6    | ) 
|Fees for trust and investment management and brokerage services |  |                                      | 691            |   |      |                 | 651       |   |  |   | 40     |   |  |  | 6.1     |   
|Mortgage-banking                                                |  |                                      | 376            |   |      |                 | 429       |   |  |   | (53    | ) |  |  | (12.4   | ) 
|Automatic teller machine                                        |  |                                      | 232            |   |      |                 | 231       |   |  |   | 1      |   |  |  | 0.4     |   
|Merchant services                                               |  |                                      | 10             |   |      |                 | 794       |   |  |   | (784   | ) |  |  | (98.7   | ) 
|Bankcard services                                               |  |                                      | 76             |   |      |                 | 156       |   |  |   | (80    | ) |  |  | (51.3   | ) 
|Investment securities gains, net                                |  |                                      |               |   |      |                 | 8         |   |  |   | (8     | ) |  |  | (100.0  | ) 
|Other                                                           |  |                                      | 425            |   |      |                 | 278       |   |  |   | 147    |   |  |  | 52.9    |   
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Total noninterest income                                        |  |                                      | 3,572          |   |      |                 | 4,497     |   |  |   | (925   | ) |  |  | (20.6   | ) 
|                                                                |  |                                      |                |  
|Noninterest expense                                             |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Salaries and other personnel                                    |  |                                      | 6,551          |   |      |                 | 6,137     |   |  |   | 414    |   |  |  | 6.7     |   
|Occupancy                                                       |  |                                      | 1,183          |   |      |                 | 1,171     |   |  |   | 12     |   |  |  | 1.0     |   
|Furniture and equipment                                         |  |                                      | 985            |   |      |                 | 967       |   |  |   | 18     |   |  |  | 1.9     |   
|Professional services                                           |  |                                      | 510            |   |      |                 | 547       |   |  |   | (37    | ) |  |  | (6.8    | ) 
|FDIC deposit insurance assessment                               |  |                                      | 958            |   |      |                 | 715       |   |  |   | 243    |   |  |  | 34.0    |   
|Marketing                                                       |  |                                      | 414            |   |      |                 | 295       |   |  |   | 119    |   |  |  | 40.3    |   
|Foreclosed real estate writedowns and expenses                  |  |                                      | 833            |   |      |                 | 1,012     |   |  |   | (179   | ) |  |  | (17.7   | ) 
|Loss on commercial loans held for sale                          |  |                                      | 1,151          |   |      |                 |          |   |  |   | 1,151  |   |  |  | 100.0   |   
|Other                                                           |  |                                      | 1,773          |   |      |                 | 2,036     |   |  |   | (263   | ) |  |  | (12.9   | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Total noninterest expense                                       |  |                                      | 14,358         |   |      |                 | 12,880    |   |  |   | 1,478  |   |  |  | 11.5    |   
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Net loss before provision (benefit) for income taxes            |  |                                      | (6,028         | ) |      |                 | (8,334    | ) |  |   | 2,306  |   |  |  | (27.7   | ) 
|                                                                |  |                                      |                |  
|Provision (benefit) for income taxes                            |  |                                      | 52             |   |      |                 | (3,042    | ) |  |   | 3,094  |   |  |  | (101.7  | ) 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Net loss                                                        |  | $                                    | (6,080         | ) |      | $               | (5,292    | ) |  | $ | (788   | ) |  |  | 14.9    | % 
|                                                                |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|                                                                |  |                                      |                |  
|Common and per share data                                       |  |                                      |                |   |      |                 |           |   |  |   |        |   |  |  |         |   
|Net loss - basic                                                |  | $                                    | (0.12          | ) |      | $               | (0.82     | ) |  | $ | 0.70   |   |  |  | (85.4   | )%
|Net loss - diluted                                              |  |                                      | (0.12          | ) |      |                 | (0.82     | ) |  |   | 0.70   |   |  |  | (85.4   | ) 
|Cash dividends                                                  |  |                                      |               |   |      |                 |          |   |  |   |       |   |  |  |        |   
|Book value                                                      |  |                                      | 2.29           |   |      |                 | 10.93     |   |  |   | (8.64  | ) |  |  | (79.0   | ) 
|                                                                |  |                                      |                |  
|Weighted average common shares outstanding - basic              |  |                                      | 49,453,501     |   |      |                 | 6,455,598 |   |  |   |        |   |  |  |         |   
|Weighted average common shares outstanding - diluted            |  |                                      | 49,453,501     |   |      |                 | 6,455,598 |   |  |   |        |   |  |  |         |   

Summary

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



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consulting firms in 2010 that specialize in assessment of banking products and services, revenue enhancements, and efficiency reviews.

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



| |  | With respect to net interest income, we implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain criteria.
At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%. In 2010 and into 2011, we introduced loan specials intended to generate additional loan volume for
residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest rates,
during 2010 we also borrowed longer-term advances from the FHLB, and extended maturities on certain CD specials to lock in the low interest rates at the time of the specials. In December 2010 and January 2011, we used excess cash earning 25 basis
points to prepay $91.0 million of FHLB advances bearing interest at an average rate of 1.58%.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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

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

Net Interest Income

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

During the second half of 2008 and continuing through 2011, the financial markets experienced significant volatility resulting from the continued fallout
of subprime lending and the global liquidity crisis. A multitude of government initiatives along with interest rate cuts by the Federal Reserve have been designed to improve liquidity for the distressed financial markets and stabilize the
banking system. The relationship



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between declining interest-earning asset yields and more slowly declining interest-bearing liability costs has caused, and may continue to cause, net interest margin compression. Net interest
margin compression may also continue to be impacted by continued deterioration of assets resulting in further interest income adjustments.

Net interest income totaled $10.3 million for the three months ended March 31, 2011 compared with $10.8 million for the three months ended
March 31, 2010. Overall, interest income for the three months ended March 31, 2011 was negatively impacted by the following:



| |  |  | Reduction in interest rates by the Federal Reserve by 500 to 525 basis points throughout 2007 and 2008 and a continuation of this low rate environment
into 2011. In response, taking into consideration the yields earned and rates paid, we have refined the type of loan and deposit products we prefer to pursue and are exercising more discipline in our loan and deposit interest rate levels. We have
also implemented interest rate floors on loans. At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Foregone interest on nonaccrual loans for the three months ended March 31, 2011 totaled $500 thousand.
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | Maintaining historically high levels of cash as a result of loan and security repayments, deposit growth and funds received in the Private Placement
and related follow-on offerings. Maintaining this cash balance has reduced our interest income by $860 thousand for the three months ended March 31, 2011 when compared with investing these funds at the average yield of 2.29% on our investment
securities, since we are retaining a higher level of cash instead of reinvesting this cash in higher yielding assets. Given the consummation of our Private Placement in October 2010, we have begun redeploying this cash balance into investment
securities and also prepaid $91 million of FHLB advances in December 2010 and January 2011 that were scheduled to mature in January through April 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reduction of $35.0 million in gross loans and commercial loans held for sale during the three months ended March 31, 2011 as repayments, sales and
charge-offs outpaced new loan originations given limited loan demand from credit-worthy borrowers.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|---------------------------------------------------------- |  | ------------------------------------ | --------- | - | -------------- | - | ------ | ---------- |  |  | -------------- | - |  | -------------- | --------- | - | ---------- | - | ------ |  |  |  | ---- | -
|                                                           |  | For the three months ended March 31, |          
|                                                           |  | 2011                                 |           |   | 2010           |  
|                                                           |  | Averagebalance                       |           |   | Income/expense |   |        | Yield/rate |  |  | Averagebalance |   |  | Income/expense |           |   | Yield/rate |  
|Assets                                                     |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Interest-earning assets                                    |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Cash and cash equivalents                                  |  | $                                    | 184,437   |   |                | $ | 105    |            |  |  | 0.23           | % |  | $              | 126,593   |   |            | $ | 67     |  |  |  | 0.21 | %
|FHLB stock                                                 |  |                                      | 6,785     |   |                |   | 14     |            |  |  | 0.84           |   |  |                | 7,010     |   |            |   | 4      |  |  |  | 0.23 |  
|Investment securities available for sale, taxable (1)      |  |                                      | 165,664   |   |                |   | 761    |            |  |  | 1.86           |   |  |                | 71,718    |   |            |   | 818    |  |  |  | 4.63 |  
|Investment securities available for sale, nontaxable (1)   |  |                                      | 65,512    |   |                |   | 545    |            |  |  | 3.37           |   |  |                | 45,984    |   |            |   | 385    |  |  |  | 3.40 |  
|Loans (2)                                                  |  |                                      | 846,823   |   |                |   | 11,569 |            |  |  | 5.54           |   |  |                | 1,031,740 |   |            |   | 13,605 |  |  |  | 5.35 |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Total interest-earning assets                              |  |                                      | 1,269,221 |   |                |   | 12,994 |            |  |  | 4.15           |   |  |                | 1,283,045 |   |            |   | 14,879 |  |  |  | 4.70 |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Noninterest-earning assets                                 |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Cash and cash equivalents                                  |  |                                      | 13,135    |   |                |   |        |            |  |  |                |   |  |                | 11,711    |   |            |   |        |  |  |  |      |  
|Allowance for loan losses                                  |  |                                      | (26,301   | ) |                |   |        |            |  |  |                |   |  |                | (23,646   | ) |            |   |        |  |  |  |      |  
|Premises and equipment, net                                |  |                                      | 28,267    |   |                |   |        |            |  |  |                |   |  |                | 29,909    |   |            |   |        |  |  |  |      |  
|Goodwill                                                   |  |                                      |          |   |                |   |        |            |  |  |                |   |  |                | 3,688     |   |            |   |        |  |  |  |      |  
|Accrued interest receivable                                |  |                                      | 4,555     |   |                |   |        |            |  |  |                |   |  |                | 4,436     |   |            |   |        |  |  |  |      |  
|Foreclosed real estate                                     |  |                                      | 17,804    |   |                |   |        |            |  |  |                |   |  |                | 28,864    |   |            |   |        |  |  |  |      |  
|Income tax refund receivable                               |  |                                      | 7,435     |   |                |   |        |            |  |  |                |   |  |                | 15,928    |   |            |   |        |  |  |  |      |  
|Deferred tax asset, net                                    |  |                                      |          |   |                |   |        |            |  |  |                |   |  |                | 5,358     |   |            |   |        |  |  |  |      |  
|Other                                                      |  |                                      | 8,574     |   |                |   |        |            |  |  |                |   |  |                | 8,689     |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Total noninterest-earning assets                           |  |                                      | 53,469    |   |                |   |        |            |  |  |                |   |  |                | 84,937    |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Total assets                                               |  | $                                    | 1,322,690 |   |                |   |        |            |  |  |                |   |  | $              | 1,367,982 |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Liabilities and Shareholders Equity                       |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Liabilities                                                |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Interest-bearing liabilities                               |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Transaction deposit accounts                               |  | $                                    | 295,779   |   |                | $ | 49     |            |  |  | 0.07           | % |  | $              | 299,329   |   |            | $ | 61     |  |  |  | 0.08 | %
|Money market deposit accounts                              |  |                                      | 142,040   |   |                |   | 81     |            |  |  | 0.23           |   |  |                | 123,741   |   |            |   | 161    |  |  |  | 0.53 |  
|Savings deposit accounts                                   |  |                                      | 51,776    |   |                |   | 16     |            |  |  | 0.13           |   |  |                | 41,803    |   |            |   | 32     |  |  |  | 0.31 |  
|Time deposit accounts                                      |  |                                      | 525,052   |   |                |   | 2,530  |            |  |  | 1.95           |   |  |                | 536,876   |   |            |   | 3,309  |  |  |  | 2.50 |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Total interest-bearing deposits                            |  |                                      | 1,014,647 |   |                |   | 2,676  |            |  |  | 1.07           |   |  |                | 1,001,749 |   |            |   | 3,563  |  |  |  | 1.44 |  
|                                                           |  |                                      |           |   |                |  
|Retail repurchase agreements                               |  |                                      | 23,311    |   |                |   | 11     |            |  |  | 0.19           |   |  |                | 22,319    |   |            |   | 14     |  |  |  | 0.25 |  
|Commercial paper (Master notes)                            |  |                                      |          |   |                |   |       |            |  |  |               |   |  |                | 16,671    |   |            |   | 10     |  |  |  | 0.24 |  
|Other short-term borrowings                                |  |                                      | 1         |   |                |   |       |            |  |  |               |   |  |                | 2         |   |            |   |       |  |  |  |     |  
|FHLB borrowings                                            |  |                                      | 5,666     |   |                |   | 49     |            |  |  | 3.51           |   |  |                | 99,666    |   |            |   | 493    |  |  |  | 2.01 |  
|Convertible debt                                           |  |                                      |          |   |                |   |       |            |  |  |               |   |  |                | 4         |   |            |   |       |  |  |  |     |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Total interest-bearing liabilities                         |  |                                      | 1,043,625 |   |                |   | 2,736  |            |  |  | 1.06           |   |  |                | 1,140,411 |   |            |   | 4,080  |  |  |  | 1.45 |  
|                                                           |  |                                      |           |   |                |  
|Noninterest-bearing liabilities                            |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Noninterest-bearing deposits                               |  |                                      | 146,666   |   |                |   |        |            |  |  |                |   |  |                | 140,753   |   |            |   |        |  |  |  |      |  
|Accrued interest payable                                   |  |                                      | 1,204     |   |                |   |        |            |  |  |                |   |  |                | 1,727     |   |            |   |        |  |  |  |      |  
|Other                                                      |  |                                      | 11,153    |   |                |   |        |            |  |  |                |   |  |                | 8,443     |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|Total noninterest-bearing liabilities                      |  |                                      | 159,023   |   |                |   |        |            |  |  |                |   |  |                | 150,923   |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Total liabilities                                          |  |                                      | 1,202,648 |   |                |   |        |            |  |  |                |   |  |                | 1,291,334 |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Shareholders equity                                       |  |                                      | 120,042   |   |                |   |        |            |  |  |                |   |  |                | 76,648    |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|Total liabilities and shareholders equity                 |  | $                                    | 1,322,690 |   |                |   |        |            |  |  |                |   |  | $              | 1,367,982 |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  
|                                                           |  |                                      |           |   |                |  
|NET INTEREST INCOME / NET YIELD ON INTEREST-EARNING ASSETS |  |                                      |           |   |                | $ | 10,258 |            |  |  | 3.28           | % |  |                |           |   |            | $ | 10,799 |  |  |  | 3.41 | %
|                                                           |  |                                      |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |  |  |  |      |  



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

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



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

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



|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|---------------------------------------- |  | -------------------------------------------------------------------------------------------- | ------ | - | ------------- | - | ----- | ----------- |  | - | ------ | -
|                                         |  | For the three months ended March 31, 2011compared with 
the three months endedMarch 31, 2010 |       
|                                         |  | Change involume                                                                              |        |   | Change inrate |   |       | Totalchange | 
|Assets                                   |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Interest-earning assets                  |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Cash and cash equivalents                |  | $                                                                                            | 33     |   |               | $ | 5     |             |  | $ | 38     |  
|FHLB stock                               |  |                                                                                              |       |   |               |   | 10    |             |  |   | 10     |  
|Investment securities available for sale |  |                                                                                              | 192    |   |               |   | (89   | )           |  |   | 103    |  
|Loans                                    |  |                                                                                              | (2,548 | ) |               |   | 512   |             |  |   | (2,036 | )
|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Total interest income                    |  | $                                                                                            | (2,323 | ) |               | $ | 438   |             |  | $ | (1,885 | )
|                                         |  |                                                                                              |       
|Liabilities and Shareholders Equity     |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Interest-bearing liabilities             |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Transaction deposit accounts             |  | $                                                                                            | (1     | ) |               | $ | (11   | )           |  | $ | (12    | )
|Money market deposit accounts            |  |                                                                                              | 29     |   |               |   | (109  | )           |  |   | (80    | )
|Savings deposit accounts                 |  |                                                                                              | 12     |   |               |   | (28   | )           |  |   | (16    | )
|Time deposit accounts                    |  |                                                                                              | (72    | ) |               |   | (707  | )           |  |   | (779   | )
|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Total interest paid on deposits          |  |                                                                                              | (32    | ) |               |   | (855  | )           |  |   | (887   | )
|                                         |  |                                                                                              |       
|Retail repurchase agreements             |  |                                                                                              | 1      |   |               |   | (4    | )           |  |   | (3     | )
|Commercial paper (Master notes)          |  |                                                                                              | (5     | ) |               |   | (5    | )           |  |   | (10    | )
|FHLB borrowings                          |  |                                                                                              | (2,151 | ) |               |   | 1,707 |             |  |   | (444   | )
|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|Total interest expense                   |  | $                                                                                            | (2,187 | ) |               | $ | 843   |             |  | $ | (1,344 | )
|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  
|                                         |  |                                                                                              |       
|Net interest income                      |  | $                                                                                            | (136   | ) |               | $ | (405  | )           |  | $ | (541   | )
|                                         |  |                                                                                              |        |   |               |   |       |             |  |   |        |  

Absent the significant impact of nonaccrual loans during the three months ended March 31, 2011, the change in loans due
to volume and the change due to rate for the three month period ended March 31, 2011 compared with the three month period ended March 31, 2010 was ($5.0) million and $2.9 million, respectively.

Provision for Loan Losses

Provision for
loan losses decreased from $10.8 million during the three months ended March 31, 2010 to $5.5 million for the three months ended March 31, 2011. The decrease was due primarily to declining charge-offs resulting from lower levels of
nonperforming assets and declines in criticized and classified assets. See also Financial Condition  Lending Activities, included elsewhere in this item, for discussion regarding our accounting policies related to, factors impacting, and
methodology for analyzing the adequacy of our allowance for loan losses and, therefore, our provision for loan losses.

Noninterest Income

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



|                                                                |  |                                     |       |  |      |   |       | 
|--------------------------------------------------------------- |  | ----------------------------------- | ----- |  | ---- | - | ----- | 
|                                                                |  | For the three monthsended March 31, |      
|                                                                |  | 2011                                |       |  | 2010 |  
|Service charges on deposit accounts, net                        |  | $                                   | 1,762 |  |      | $ | 1,950 | 
|Fees for trust and investment management and brokerage services |  |                                     | 691   |  |      |   | 651   | 
|Mortgage-banking                                                |  |                                     | 376   |  |      |   | 429   | 
|Automatic teller machine                                        |  |                                     | 232   |  |      |   | 231   | 
|Merchant services                                               |  |                                     | 10    |  |      |   | 794   | 
|Bankcard services                                               |  |                                     | 76    |  |      |   | 156   | 
|Investments securities gains, net                               |  |                                     |      |  |      |   | 8     | 
|Other                                                           |  |                                     | 425   |  |      |   | 278   | 
|                                                                |  |                                     |       |  |      |   |       | 
|Total noninterest income                                        |  | $                                   | 3,572 |  |      | $ | 4,497 | 
|                                                                |  |                                     |       |  |      |   |       | 



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Service Charges on Deposit Accounts, Net. Net service charges on deposit accounts comprise a
significant component of noninterest income totaling 2.4% of average transaction deposit accounts for the three months ended March 31, 2011 compared with 2.6% of average transaction deposit accounts for the three month period ended
March 31, 2010. The decrease in service charges on deposit accounts of $188 thousand, or 9.6%, is attributed primarily to a decrease in NSF fees resulting from a $100 courtesy overdraft line included with the MyPal checking account we began
offering in March 2010, changes in customer behavior that have resulted in a reduction in the number of transactions that would otherwise result in overdrafts, and the customers with historical overdraft transactions who did not opt-in to overdraft
protection in accordance with Regulation E which went into effect during the third quarter 2010.

In response to competition to retain
deposits, institutions in the financial services industry have increasingly been providing services for free in an effort to lure deposits away from competitors and retain existing balances. Services that were initially developed as fee income
opportunities, such as Internet banking and bill payment service, are now provided to customers free of charge. Consequently, opportunities to earn additional income from service charges for such services have been more limited. In addition, recent
focus on the level of deposit service charges within the banking industry by the media and the U.S. Government may result in future legislation limiting the amount and type of services charges within the banking industry.

The November 2009 amendment to Regulation E of the Electronic Fund Transfer Act, which was effective July 1, 2010 for new customers and
August 15, 2010 for existing customers, prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions unless a consumer consents to the overdraft service for
those types of transactions. Some industry experts estimated that the impact of the change from Regulation E would result in a reduction of 30% to 40% of such overdraft fees. To continue to have overdraft services available to those customers who
desired to have this service, we were proactive in encouraging our deposit customers to opt-in to overdraft protection; however, not all of our customers who have previously utilized overdraft features have opted-in to overdraft protection. In
addition, in December 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would
result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community
banks, which could be pressured by the marketplace to lower their own interchange rates. We are still evaluating the guidance and at this time we do not yet know if the guidance and the implementation of Regulation E will result in a sustained
reduction in our services charges.

Fees for Trust and Investment Management and Brokerage Services. Fees for trust and investment
management and brokerage services represent income associated with wealth management and advisory services provided by the Company. The increase in this category was due to a $27 thousand increase in trust fees while brokerage services increased $13
thousand. The growth in income was due to an increase in assets under management, both from new accounts and the general increase in fair values of the underlying assets against which the fees are calculated.

Mortgage-Banking. Most of the residential mortgage loans that we originate are sold in the secondary market. Normally we retain the servicing
rights to maintain the customer relationships related to servicing the loans. Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at March 31, 2011 and December 31, 2010, respectively, and are
not included in our Consolidated Balance Sheets.

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



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|                                                                                                     |  |                                      |      |   |      |   |      |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ---- | - | ---- | - | ---- | -
|                                                                                                     |  | For the three months ended March 31, |     
|                                                                                                     |  | 2011                                 |      |   | 2010 |  
|Mortgage-servicing fees                                                                              |  | $                                    | 258  |   |      | $ | 256  |  
|Gain on sale of mortgage loans held for sale                                                         |  |                                      | 300  |   |      |   | 343  |  
|Mortgage-servicing rights portfolio amortization and impairment                                      |  |                                      | (212 | ) |      |   | (191 | )
|Derivative loan commitment income                                                                    |  |                                      | 59   |   |      |   | 51   |  
|Forward sales commitment loss                                                                        |  |                                      | (75  | ) |      |   | (76  | )
|Other                                                                                                |  |                                      | 46   |   |      |   | 46   |  
|                                                                                                     |  |                                      |      |   |      |   |      |  
|Total mortgage-banking income                                                                        |  | $                                    | 376  |   |      | $ | 429  |  
|                                                                                                     |  |                                      |      |   |      |   |      |  
|                                                                                                     |  |                                     
|Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others |  |                                      | 0.25 | % |      |   | 0.24 | %

Mortgage-banking income decreased $53
thousand (12.4%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. Gains on sales of mortgage loans declined approximately $43 thousand (12.5%) while the expense associated with amortization and
impairment of mortgage-servicing rights increased $21 thousand (11.0%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. The decline in gain on sale of mortgage loans was the result of a decline in
the volume of loans originated and sold over the periods. Mortgage loans held for sale originated during the three months ended March 31, 2011 and 2010 totaled $11.4 million and $15.0 million, respectively, while sales over the same periods
were $16.2 million and $18.1 million, respectively. In March 2011, we completed a review of our mortgage origination and servicing business with the assistance of a third party consultant to identify opportunities to improve the profitability of
this business. We are still evaluating the results of this review.

Merchant Services. Merchant services income decreased $784 thousand
(98.7%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. As previously described in the Executive Summary of First Quarter 2011 Financial Results, Strategic Project Plan, we are critically
evaluating each of our product lines to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation, on March 31, 2010 we sold this product line and entered into a referral
and services agreement with Global Direct related to our merchant services business which resulted in a gross payment to the Company of $786 thousand, which is included in Merchant services income in the amount of $559 thousand, net of transaction
fees, for the three months ended March 31, 2010. Under the agreement, Global Direct provides services including merchant sales through a dedicated sales person, marketing and advertising within our geographic footprint, credit review and
approval and activating new merchant accounts, equipment sales and customer service, transaction authorization service, risk mitigation services, and compliance with applicable laws and card association and payment network rules. Under the terms of
the agreement, we now receive referral income when we refer customers that are accepted by Global Direct and a percentage of the ongoing revenues related to merchant services accounts sold to Global Direct.

Bankcard Services. Bankcard services income decreased $80 thousand (51.3%) from the three months ended March 31, 2010 to the three
months ended March 31, 2011. In connection with our on-going strategic review of our business, we sold our credit card portfolio and entered into a joint marketing agreement in December 2010 with Elan Financial Services, Inc., resulting in a
net gain of $1.2 million. We also entered into an interim servicing agreement to cover the period through the date the accounts are transferred to the third partys system, a period expected not to exceed nine months from the date of the sale.
In connection with the interim servicing agreement, we receive a set servicing fee per active account per month for providing servicing related functions such as payment processing, collections, customer service and billing. Based on the structure
of the interim servicing agreement, the servicing fee to be received is considered adequate compensation for the services to be performed and, therefore, no servicing asset or liability was recognized in connection with the sale.

Other. Other noninterest income increased $147 thousand (52.9%) from the three months ended March 31, 2010 to the three months ended
March 31, 2011. The increase was primarily due to increased debit card fees resulting primarily from the MyPal checking account ($35 thousand).

Noninterest Expense

General. The earnings component of our Strategic Project Plan
includes keen focus on expense management. As part of our earnings plan to improve our overall financial performance, we identified specific noninterest expense reductions realized in 2009 and 2010 and are continuing to review other expense areas
for additional reductions. Examples include:



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| |  |  | Freezing most employee salaries effective May 1, 2009 to February 28, 2011 and eliminating the remaining officer cash incentive plan awards
under the corporate incentive plan for 2009 and 2010,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing our Saturday banking hours from 2:00 p.m. to noon in September 2009 and converting some branch office hours on Saturdays to drive thru only in
October 2010,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing marketing expenses and corporate contributions to not-for-profit organizations, and
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | Reducing officer perquisites, including elimination in 2010 of all bank-owned automobiles, reduction in coverage for annual physical examinations,
elimination in 2010 of Company paid life insurance premiums for certain officers, and termination of officer participation in the Supplemental Executive Retirement Plan.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

With the assistance from a third party consulting firm, we also reviewed our Retail Banking network from March through June 2010 and are implementing process improvements and other recommendations that we
believe will result in reduced expenses. In September 2010 through January 2011, with assistance from the same consulting firm, we performed a comprehensive review of our lending process that we believe will similarly result in efficiency
improvements and cost savings. Savings have also been realized resulting from more fully leveraging existing technology, implementing more advanced technology, and other process improvements. These expense reductions are partially offset by the
higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming assets. We continue to review other expense areas for additional reduction opportunities.

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



|                                               |  |                                     |        |  |      |   |        | 
|---------------------------------------------- |  | ----------------------------------- | ------ |  | ---- | - | ------ | 
|                                               |  | For the three monthsended March 31, |       
|                                               |  | 2011                                |        |  | 2010 |  
|Salaries and other personnel                   |  | $                                   | 6,551  |  |      | $ | 6,137  | 
|Occupancy                                      |  |                                     | 1,183  |  |      |   | 1,171  | 
|Furniture and equipment                        |  |                                     | 985    |  |      |   | 967    | 
|Professional services                          |  |                                     | 510    |  |      |   | 547    | 
|FDIC deposit insurance assessment              |  |                                     | 958    |  |      |   | 715    | 
|Marketing                                      |  |                                     | 414    |  |      |   | 295    | 
|Foreclosed real estate writedowns and expenses |  |                                     | 833    |  |      |   | 1,012  | 
|Loss on commercial loans held for sale         |  |                                     | 1,151  |  |      |   |       | 
|Other                                          |  |                                     | 1,773  |  |      |   | 2,036  | 
|                                               |  |                                     |        |  |      |   |        | 
|Total noninterest expense                      |  | $                                   | 14,358 |  |      | $ | 12,880 | 
|                                               |  |                                     |        |  |      |   |        | 

Salaries and Other Personnel. Salaries and other personnel expense increased $414 thousand (6.7%) for the three
months ended March 31, 2011 as compared to the three months ended March 31, 2010 as a result of increased use of contract labor, employee raises generally effective February 28, 2011 after a two year salary freeze, and increased
incentive compensation accruals paid for new product sales and referrals. Total full-time equivalent employees (FTE) at March 31, 2011 and 2010 were 385 and 409, respectively. While total FTEs declined, certain positions that became
open were replaced with higher paid employees as part of our plan to recruit personnel with specific industry expertise and experience. In the first quarter 2011, additions to headcount were primarily focused in revenue generating roles such as
commercial lending, trust, and retail banking. In connection with the execution of our strategic plan, we have been evaluating the proper alignment of roles and responsibilities within the Company and working to ensure our overall compensation
structure remains competitive with the industry as we continue to compete for talent.

Occupancy. Occupancy costs increased slightly
($12 thousand, or 1.0%) for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010. Decreases in maintenance costs were offset by higher repairs expense. During the first quarter 2010, as part of our
strategic evaluation of proper alignment of resources, we engaged a property management firm to handle property management functions for all of our facilities. This initiative has resulted in increased efficiencies through a reduction in facilities
related vendors, execution of standardized contracts, and volume based pricing.

Furniture and Equipment. Furniture and equipment
expense increased $18 thousand, or 1.9%, from the three months ended March 31, 2010 to the three months ended March 31, 2011. The increase was due to increased property taxes on leased equipment that were partially offset by lower
depreciation and maintenance costs on bank-owned automobiles resulting from the sale of all Company-provided automobiles in April 2010.



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Professional Services. Professional services expense decreased $37 thousand, or 6.8%, from the three
months ended March 31, 2010. The decline is attributable to lower consulting expenses and accounting fees. To date, and primarily in 2010, we executed nine process improvement engagements across the Company that were facilitated by third party
consultants. We expect our consulting expense to decline in 2011 as the last such planned engagement is currently in process.

FDIC Deposit
Insurance Assessment. FDIC insurance premiums increased $243 thousand (34.0%) from the three months ended March 31, 2010 to the same period of 2011. The increase in FDIC insurance premiums is attributable to a higher assessment rate in
2011 based on our overall regulatory rating as well as an increase in transaction deposit balances.

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

With the consummation of the Private Placement in October 2010 and the resulting change in the Banks capital classification to well-capitalized, as well as the changes to the deposit insurance
assessment regulations, we project that our FDIC insurance premiums will be reduced by approximately $1.8 million in 2011 when compared with 2010, based on our 2011 budgeted level of deposits and assets.

Marketing. Marketing expense increased $119 thousand (40.3%) from the three month period ended March 31, 2010 to the same period of
2011, primarily due to increased television and radio advertising campaigns designed to increase brand awareness and to promote certain consumer lending programs. Marketing expense in the first quarter 2010 was primarily impacted by promotional
efforts related to our new MyPal checking and Smart Savings deposit accounts and increased marketing related to mortgage and small business.

Foreclosed Real Estate Writedowns and Expenses. Foreclosed real estate writedowns and expenses decreased $179 thousand from the three months ended
March 31, 2010 to the same period of 2011. The carrying value of these assets is written down to their fair value less estimated selling costs, based on currently available valuation information primarily from third party appraisals. Writedowns
on 19 such properties during the first quarter of 2011 resulted in a provision charged to expense of $596 thousand. The continued high level of writedowns is due to receipts of contracts for sale and updated appraisals which continued to show
declining values based on lack of property sales activity. The continued high level of expenses is due to payment of legal fees, taxes, insurance, utilities, property management company fees, and other carrying costs on our elevated level of
foreclosed properties.

Loss on Commercial Loans Held for Sale. In September 2010, we began marketing for sale a pool of specifically
identified commercial loans. Our marketing efforts continued through the first quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan basis and are balancing the desire to reduce problem loans
with preservation of capital. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general, and our Company in particular, to deleverage commercial real estate assets. We
believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the first quarter 2011, such prices continue to reflect heavy
discounting. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets
and concentration in commercial real estate as required by the Consent Order.



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Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to
fair value, which was based on updated appraisals received during the first quarter, less estimated costs to sell, or internal valuations, as applicable.

During the first quarter 2011, we closed five loans, representing two relationships, with a gross book value of $2.0 million. At March 31, 2011, we had commercial loans held for sale aggregating
$60.3 million.

Other. Other noninterest expense decreased $263 thousand (12.9%) during the three months ended March 31, 2011
over the same period of 2010. Included in this financial statement line item and positively impacting this decline were the following:



| |  |  | Merchant expenses eliminated during 2010 in conjunction with the sale of the merchant services product line to Global Direct resulting in a decline of
$192 thousand over the periods.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Branch closure expense associated with banking offices previously consolidated or relocated for which leases had not yet expired or properties had not
yet been subleased or sold. Two operating leases expired during 2010 resulting in a reduction in branch facilities during the three months ended March 31, 2011 over the same period of 2010 ($89 thousand).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Offsetting these positive impacts was the following:



| |  |  | During the first quarter of 2011, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing
cost, we prepaid $30.0 million of FHLB advances resulting in a prepayment penalty of $136 thousand for the three months ended March 31, 2011. We did not prepay any advances during the three months ended March 31, 2010.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Provision (Benefit) for Income Taxes

Provision for income taxes was $52 thousand in the first quarter 2011 compared to an income tax benefit of $3.0 million in the first quarter 2010. The provision for income taxes in the first quarter 2011
reflects the additional valuation allowance necessary to fully offset the net deferred tax asset of $22.9 million at March 31, 2011. As discussed in Part I  Financial Information, Item 1. Financial Statements, Note 12 and Financial
Condition  Deferred Tax Asset, we determined that based on projections of future taxable income, available tax planning strategies and limitations on our ability to utilize net operating loss carryforwards, a valuation allowance on our net
deferred tax asset was necessary. Based on projections for the remainder of 2011, we expect to maintain a full allowance against the net deferred tax asset. Additional provisions or benefits may result to the extent of changes in deferred tax
liabilities which require adjustments to the valuation allowance to maintain a full allowance against the net deferred tax asset. The first quarter 2010 benefit is related to our ability to utilize operating losses as a carryback to offset income
taxes paid in 2008.

Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently
subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at March 31, 2011 and
December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to
utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and therefore
how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.

Recently Issued / Adopted Authoritative Pronouncements

See Item 1. Financial
Statements, Note 1, for a discussion regarding recently issued and recently adopted authoritative pronouncements and their expected impact on our business, financial condition, results of operations, and cash flows.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As of March 31, 2011, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and
downward movements in interest rates of 100, 200 and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical
interest rate cycles and other factors



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deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements.
Therefore, managements assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying
assumptions.



|                           |  |                                                 |      |  
|-------------------------- |  | ----------------------------------------------- | ---- | -
|Interest rate scenario (1) |  | Percentagechange in netinterest incomefrom base |     
|Up 300 basis points        |  |                                                 | 8.27 | %
|Up 200 basis points        |  |                                                 | 6.09 |  
|Up 100 basis points        |  |                                                 | 3.48 |  
|Base                       |  |                                                 |      |  
|Down 100 basis points      |  |                                                 | 0.87 |  
|Down 200 basis points      |  |                                                 | 0.56 |  
|Down 300 basis points      |  |                                                 | 0.36 |  



| | (1) | The rising and falling 100, 200 and 300 basis point interest rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve.
Beginning with the March 31, 2011 analysis, the Company revised certain assumptions with respect to the interest rate sensitivity of its transaction account deposits to be more representative of the long-term nature of these balances and better
reflect the interest rate profile of these funding sources.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

There are material limitations with the model presented above,
which include, but are not limited to:



| |  |  | It presents the balance sheet in a static position. When assets and liabilities mature or reprice, they do not necessarily keep the same
characteristics.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The computation of prospective impacts of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as
indicative of actual results.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The computations do not contemplate any additional actions we could undertake in response to changes in interest rates.
| | - |  | -----------------------------------------------------------------------------------------------------------------------

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation of our disclosure controls
and procedures (as defined in Sections 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of the Companys Chief Executive Officer and Chief Financial Officer and
several other members of senior management as of March 31, 2011, the last day of the period covered by this Quarterly Report. The Companys Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of March 31, 2011 in ensuring that the information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 is (i) accumulated and communicated to management
(including the Companys Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms.

First Quarter Internal Control Changes

During the first quarter of 2011, we did not make any changes in our internal controls over financial reporting that have materially affected or are
reasonably likely to materially affect those controls.



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PART II  OTHER INFORMATION

Item 1. Legal Proceedings

See Part I  Financial Information, Item 1. Financial Statements, Note 16 contained herein for disclosures required by this item.

Item 1A. Risk Factors

In addition to the other information
set forth in this Quarterly Report, you should carefully consider the factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 which could materially affect our business, financial condition,
results of operations, or cash flows. The risks described in the Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known or currently deemed to be immaterial also may materially and adversely
affect our business, financial condition, results of operations or cash flows.

Item 2. Unregistered Sales of
Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

None

Item 4. (Removed and Reserved)

Item 5. Other Information

None

Item 6. Exhibits



|      |  |                                                                                                                                                                                                                                                                                     
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1  |  | Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Samuel L. Erwin dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
|      | 
|10.2  |  | Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Lee S. Dixon dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011   
|      | 
|10.3  |  | Form of Subscription Agreement: Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on
February 3, 2011                                                                                        
|      | 
|31.1^ |  | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                           
|      | 
|31.2^ |  | Roy D. Jones Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                               
|      | 
|32^   |  | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                            



|^ | Filed with this Quarterly Report on Form 10-Q
|- | ---------------------------------------------

Copies of exhibits are available upon written request to Corporate Secretary, Palmetto Bancshares, Inc., 306 East North Street, Greenville, South
Carolina 20601



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



|                         
|-------------------------
|PALMETTO BANCSHARES, INC.
|                         
|By:                      
|                         
|/s/ Samuel L. Erwin      
|Samuel L. Erwin          
|Chief Executive Officer  
|Palmetto Bancshares, Inc.
|                         
|/s/ Roy D. Jones         
|Roy D. Jones             
|Chief Financial Officer  
|Palmetto Bancshares, Inc.

Date: May 2, 2011



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EXHIBIT INDEX



|           |  |                                                                                                                                                                                                                                                                                     
|---------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Description                                                                                                                                                                                                                                                                         
|           | 
|10.1       |  | Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Samuel L. Erwin dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
|           | 
|10.2       |  | Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Lee S. Dixon dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011   
|           | 
|10.3       |  | Form of Subscription Agreement: Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on
February 3, 2011                                                                                        
|           | 
|31.1       |  | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                           
|           | 
|31.2       |  | Roy D. Jones Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                               
|           | 
|32         |  | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                            



84