##### 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 June 30, 2010

OR



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

For the transition period from
 to

Commission file number 0-26016

PALMETTO BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|South Carolina                                                 |  | 74-2235055                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)
|                                                               | 
|306 East North Street, Greenville, South Carolina              |  | 29601                            
|(Address of principal executive offices)                       |  | (Zip Code)                       

(800)
7252265

(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  x |  | Non-accelerated filer   ̈ |  | Smaller reporting company   ̈

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

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



|                              |  |                             
|----------------------------- |  | ----------------------------
|Class                         |  | Outstanding at July 30, 2010
|Common stock, $5.00 par value |  | 6,495,130                   









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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Table of Contents



|                               |  |          |  |                                                                                       |  |     
|------------------------------ |  | -------- |  | ------------------------------------------------------------------------------------- |  | ----
|                               |  |          |  |                                                                                       |  | Page
|                               | 
|PART I - FINANCIAL INFORMATION |  | 1       
|                               |  | Item 1.  |  | Financial Statements                                                                  |  | 1   
|                               |  | Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations |  | 27  
|                               |  | Item 3.  |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 71  
|                               |  | Item 4.  |  | Controls and Procedures                                                               |  | 71  
|                               | 
|PART II - OTHER INFORMATION    |  | 73      
|                               |  | Item 1.  |  | Legal Proceedings                                                                     |  | 73  
|                               |  | Item 1A. |  | Risk Factors                                                                          |  | 73  
|                               |  | Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 73  
|                               |  | Item 3.  |  | Defaults Upon Senior Securities                                                       |  | 74  
|                               |  | Item 4.  |  | (Removed and Reserved)                                                                |  | 74  
|                               |  | Item 5.  |  | Other Information                                                                     |  | 74  
|                               |  | Item 6.  |  | Exhibits                                                                              |  | 74  
|                               | 
|SIGNATURES                     |  | 75      



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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)



|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                                                 |  | June 30,2010 |           |   | December 31,2009 |  
|                                                                                                                                                                                                 |  | (unaudited)  |           |   |                  |  
|Assets                                                                                                                                                                                           |  |              |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                                                        |  |              |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                                                          |  | $            | 236,029   |   |                  | $ | 188,084   |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total cash and cash equivalents                                                                                                                                                                  |  |              | 236,029   |   |                  |   | 188,084   |  
|Federal Home Loan Bank (FHLB) stock, at cost                                                                                                                                                   |  |              | 7,010     |   |                  |   | 7,010     |  
|Investment securities available for sale, at fair value                                                                                                                                          |  |              | 112,316   |   |                  |   | 119,986   |  
|Mortgage loans held for sale                                                                                                                                                                     |  |              | 1,898     |   |                  |   | 3,884     |  
|Loans, gross                                                                                                                                                                                     |  |              | 967,244   |   |                  |   | 1,040,312 |  
|Less: allowance for loan losses                                                                                                                                                                  |  |              | (28,383   | ) |                  |   | (24,079   | )
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Loans, net                                                                                                                                                                                       |  |              | 938,861   |   |                  |   | 1,016,233 |  
|Premises and equipment, net                                                                                                                                                                      |  |              | 29,344    |   |                  |   | 29,605    |  
|Goodwill, net                                                                                                                                                                                    |  |              | 3,691     |   |                  |   | 3,691     |  
|Accrued interest receivable                                                                                                                                                                      |  |              | 4,222     |   |                  |   | 4,322     |  
|Real estate acquired in settlement of loans                                                                                                                                                      |  |              | 26,521    |   |                  |   | 27,826    |  
|Income tax refund receivable                                                                                                                                                                     |  |              | 4,721     |   |                  |   | 20,869    |  
|Other                                                                                                                                                                                            |  |              | 23,308    |   |                  |   | 14,440    |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total assets                                                                                                                                                                                     |  | $            | 1,387,921 |   |                  | $ | 1,435,950 |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Liabilities and shareholders equity                                                                                                                                                             |  |              |           |   |                  |   |           |  
|Liabilities                                                                                                                                                                                      |  |              |           |   |                  |   |           |  
|Deposits                                                                                                                                                                                         |  |              |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                                                                              |  | $            | 143,223   |   |                  | $ | 142,609   |  
|Interest-bearing                                                                                                                                                                                 |  |              | 1,048,152 |   |                  |   | 1,072,305 |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total deposits                                                                                                                                                                                   |  |              | 1,191,375 |   |                  |   | 1,214,914 |  
|Retail repurchase agreements                                                                                                                                                                     |  |              | 24,674    |   |                  |   | 15,545    |  
|Commercial paper (Master notes)                                                                                                                                                                  |  |              |          |   |                  |   | 19,061    |  
|FHLB borrowings                                                                                                                                                                                  |  |              | 96,000    |   |                  |   | 101,000   |  
|Convertible debt                                                                                                                                                                                 |  |              | 380       |   |                  |   |          |  
|Accrued interest payable                                                                                                                                                                         |  |              | 1,695     |   |                  |   | 2,020     |  
|Other                                                                                                                                                                                            |  |              | 11,154    |   |                  |   | 8,395     |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                                                |  |              | 1,325,278 |   |                  |   | 1,360,935 |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Shareholders equity                                                                                                                                                                             |  |              |           |   |                  |   |           |  
|Preferred stock - par value $0.01 per share; authorized 2,500,000 at both June 30, 2010 and December 31, 2009; none
issued and outstanding at both June 30, 2010 and December 31, 2009           |  |              |          |   |                  |   |          |  
|Common stock - par value $5.00 per share; authorized 25,000,000 shares at both June 30, 2010 and December 31, 2009; 6,495,130
issued and outstanding at both June 30, 2010 and December 31, 2009 |  |              | 32,309    |   |                  |   | 32,282    |  
|Capital surplus                                                                                                                                                                                  |  |              | 2,758     |   |                  |   | 2,599     |  
|Retained earnings                                                                                                                                                                                |  |              | 33,269    |   |                  |   | 47,094    |  
|Accumulated other comprehensive loss, net of tax                                                                                                                                                 |  |              | (5,693    | ) |                  |   | (6,960    | )
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                                                       |  |              | 62,643    |   |                  |   | 75,015    |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total liabilities and shareholders equity                                                                                                                                                       |  | $            | 1,387,921 |   |                  | $ | 1,435,950 |  
|                                                                                                                                                                                                 |  |              |           |   |                  |   |           |  

See Notes to Consolidated Financial Statements



1



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

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



|                                                                            |  |                                            |           |   |      |   |           |  
|--------------------------------------------------------------------------- |  | ------------------------------------------ | --------- | - | ---- | - | --------- | -
|                                                                            |  | For the three month 
periodsended June 30, |          
|                                                                            |  | 2010                                       |           |   | 2009 |  
|Interest income                                                             |  |                                            |           |   |      |   |           |  
|Interest earned on cash and cash equivalents                                |  | $                                          | 88        |   |      | $ | 32        |  
|Dividends paid on FHLB stock                                                |  |                                            | 5         |   |      |   |          |  
|Interest earned on investment securities available for sale                 |  |                                            |           |   |      |   |           |  
|U.S. Treasury and federal agencies (taxable)                                |  |                                            | 7         |   |      |   |          |  
|State and municipal (nontaxable)                                            |  |                                            | 364       |   |      |   | 410       |  
|Collateralized mortgage obligations (taxable)                               |  |                                            | 276       |   |      |   | 823       |  
|Other mortgage-backed (taxable)                                             |  |                                            | 139       |   |      |   | 248       |  
|Interest and fees earned on loans                                           |  |                                            | 13,571    |   |      |   | 14,377    |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Total interest income                                                       |  |                                            | 14,450    |   |      |   | 15,890    |  
|Interest expense                                                            |  |                                            |           |   |      |   |           |  
|Interest paid on deposits                                                   |  |                                            | 3,274     |   |      |   | 5,203     |  
|Interest paid on retail repurchase agreements                               |  |                                            | 13        |   |      |   | 14        |  
|Interest paid on commercial paper                                           |  |                                            | 11        |   |      |   | 14        |  
|Interest paid on other short-term borrowings                                |  |                                            |          |   |      |   | 11        |  
|Interest paid on FHLB borrowings                                            |  |                                            | 408       |   |      |   | 380       |  
|Other                                                                       |  |                                            | 10        |   |      |   |          |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Total interest expense                                                      |  |                                            | 3,716     |   |      |   | 5,622     |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Net interest income                                                         |  |                                            | 10,734    |   |      |   | 10,268    |  
|Provision for loan losses                                                   |  |                                            | 12,750    |   |      |   | 30,000    |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Net interest expense after provision for loan losses                        |  |                                            | (2,016    | ) |      |   | (19,732   | )
|                                                                            |  |                                            |           |   |      |   |           |  
|Noninterest income                                                          |  |                                            |           |   |      |   |           |  
|Service charges on deposit accounts, net                                    |  |                                            | 2,027     |   |      |   | 2,073     |  
|Fees for trust and investment management and brokerage services             |  |                                            | 735       |   |      |   | 576       |  
|Mortgage-banking                                                            |  |                                            | 377       |   |      |   | 1,244     |  
|Automatic teller machine                                                    |  |                                            | 321       |   |      |   | 335       |  
|Merchant services                                                           |  |                                            | 101       |   |      |   | 273       |  
|Other                                                                       |  |                                            | 500       |   |      |   | 602       |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Total noninterest income                                                    |  |                                            | 4,061     |   |      |   | 5,103     |  
|Noninterest expense                                                         |  |                                            |           |   |      |   |           |  
|Salaries and other personnel                                                |  |                                            | 6,302     |   |      |   | 6,215     |  
|Occupancy                                                                   |  |                                            | 1,148     |   |      |   | 1,155     |  
|Furniture and equipment                                                     |  |                                            | 927       |   |      |   | 892       |  
|Loss on disposition of premises and equipment                               |  |                                            | 3         |   |      |   | 21        |  
|Federal Deposit Insurance Corporation (FDIC) deposit insurance assessment |  |                                            | 981       |   |      |   | 1,372     |  
|Mortgage-servicing rights portfolio amortization and impairment             |  |                                            | 197       |   |      |   | 336       |  
|Marketing                                                                   |  |                                            | 450       |   |      |   | 316       |  
|Real estate acquired in settlement of loans writedowns and expenses         |  |                                            | 2,550     |   |      |   | 45        |  
|Other                                                                       |  |                                            | 2,813     |   |      |   | 2,791     |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Total noninterest expense                                                   |  |                                            | 15,371    |   |      |   | 13,143    |  
|                                                                            |  |                                            |           |   |      |   |           |  
|Net loss before benefit for income taxes                                    |  |                                            | (13,326   | ) |      |   | (27,772   | )
|Benefit for income taxes                                                    |  |                                            | (4,793    | ) |      |   | (9,921    | )
|                                                                            |  |                                            |           |   |      |   |           |  
|Net loss                                                                    |  | $                                          | (8,533    | ) |      | $ | (17,851   | )
|                                                                            |  |                                            |           |   |      |   |           |  
|Common and per share data                                                   |  |                                            |           |   |      |   |           |  
|Net loss - basic                                                            |  | $                                          | (1.32     | ) |      | $ | (2.77     | )
|Net loss - diluted                                                          |  |                                            | (1.32     | ) |      |   | (2.77     | )
|Cash dividends                                                              |  |                                            |          |   |      |   |          |  
|Book value                                                                  |  |                                            | 9.64      |   |      |   | 15.45     |  
|Weighted average common shares outstanding - basic                          |  |                                            | 6,455,598 |   |      |   | 6,450,090 |  
|Weighted average common shares outstanding - diluted                        |  |                                            | 6,455,598 |   |      |   | 6,450,090 |  

See Notes to
Consolidated Financial Statements



2



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

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



|                                                                    |  |                                         |           |   |      |   |           |  
|------------------------------------------------------------------- |  | --------------------------------------- | --------- | - | ---- | - | --------- | -
|                                                                    |  | For the six month periodsended
June 30, |          
|                                                                    |  | 2010                                    |           |   | 2009 |  
|Interest income                                                     |  |                                         |           |   |      |   |           |  
|Interest earned on cash and cash equivalents                        |  | $                                       | 155       |   |      | $ | 38        |  
|Dividends paid on FHLB stock                                        |  |                                         | 9         |   |      |   |          |  
|Interest earned on investment securities available for sale         |  |                                         |           |   |      |   |           |  
|U.S. Treasury and federal agencies (taxable)                        |  |                                         | 14        |   |      |   |          |  
|State and municipal (nontaxable)                                    |  |                                         | 749       |   |      |   | 839       |  
|Collateralized mortgage obligations (taxable)                       |  |                                         | 889       |   |      |   | 1,664     |  
|Other mortgage-backed (taxable)                                     |  |                                         | 337       |   |      |   | 511       |  
|Interest and fees earned on loans                                   |  |                                         | 27,176    |   |      |   | 30,404    |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Total interest income                                               |  |                                         | 29,329    |   |      |   | 33,456    |  
|Interest expense                                                    |  |                                         |           |   |      |   |           |  
|Interest paid on deposits                                           |  |                                         | 6,837     |   |      |   | 9,915     |  
|Interest paid on retail repurchase agreements                       |  |                                         | 27        |   |      |   | 27        |  
|Interest paid on commercial paper                                   |  |                                         | 21        |   |      |   | 29        |  
|Interest paid on other short-term borrowings                        |  |                                         |          |   |      |   | 30        |  
|Interest paid on FHLB borrowings                                    |  |                                         | 901       |   |      |   | 809       |  
|Other                                                               |  |                                         | 10        |   |      |   |          |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Total interest expense                                              |  |                                         | 7,796     |   |      |   | 10,810    |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Net interest income                                                 |  |                                         | 21,533    |   |      |   | 22,646    |  
|Provision for loan losses                                           |  |                                         | 23,500    |   |      |   | 32,175    |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Net interest expense after provision for loan losses                |  |                                         | (1,967    | ) |      |   | (9,529    | )
|                                                                    |  |                                         |           |   |      |   |           |  
|Noninterest income                                                  |  |                                         |           |   |      |   |           |  
|Service charges on deposit accounts, net                            |  |                                         | 3,977     |   |      |   | 3,956     |  
|Fees for trust and investment management and brokerage services     |  |                                         | 1,386     |   |      |   | 1,110     |  
|Mortgage-banking                                                    |  |                                         | 997       |   |      |   | 2,110     |  
|Automatic teller machine                                            |  |                                         | 624       |   |      |   | 635       |  
|Merchant services                                                   |  |                                         | 895       |   |      |   | 551       |  
|Investment securities gains                                         |  |                                         | 8         |   |      |   | 2         |  
|Other                                                               |  |                                         | 1,114     |   |      |   | 1,170     |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Total noninterest income                                            |  |                                         | 9,001     |   |      |   | 9,534     |  
|Noninterest expense                                                 |  |                                         |           |   |      |   |           |  
|Salaries and other personnel                                        |  |                                         | 12,439    |   |      |   | 12,134    |  
|Occupancy                                                           |  |                                         | 2,319     |   |      |   | 2,071     |  
|Furniture and equipment                                             |  |                                         | 1,894     |   |      |   | 1,775     |  
|Loss on disposition of premises and equipment                       |  |                                         | 8         |   |      |   | 76        |  
|FDIC deposit insurance assessment                                   |  |                                         | 1,696     |   |      |   | 1,826     |  
|Mortgage-servicing rights portfolio amortization and impairment     |  |                                         | 388       |   |      |   | 750       |  
|Marketing                                                           |  |                                         | 745       |   |      |   | 685       |  
|Real estate acquired in settlement of loans writedowns and expenses |  |                                         | 3,562     |   |      |   | 74        |  
|Other                                                               |  |                                         | 5,643     |   |      |   | 5,269     |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Total noninterest expense                                           |  |                                         | 28,694    |   |      |   | 24,660    |  
|                                                                    |  |                                         |           |   |      |   |           |  
|Net loss before benefit for income taxes                            |  |                                         | (21,660   | ) |      |   | (24,655   | )
|Benefit for income taxes                                            |  |                                         | (7,835    | ) |      |   | (8,798    | )
|                                                                    |  |                                         |           |   |      |   |           |  
|Net loss                                                            |  | $                                       | (13,825   | ) |      | $ | (15,857   | )
|                                                                    |  |                                         |           |   |      |   |           |  
|Common and per share data                                           |  |                                         |           |   |      |   |           |  
|Net loss - basic                                                    |  | $                                       | (2.14     | ) |      | $ | (2.46     | )
|Net loss - diluted                                                  |  |                                         | (2.14     | ) |      |   | (2.46     | )
|Cash dividends                                                      |  |                                         |          |   |      |   | 0.06      |  
|Book value                                                          |  |                                         | 9.64      |   |      |   | 15.45     |  
|Weighted average common shares outstanding - basic                  |  |                                         | 6,455,598 |   |      |   | 6,449,383 |  
|Weighted average common shares outstanding - diluted                |  |                                         | 6,455,598 |   |      |   | 6,449,383 |  

See Notes to
Consolidated Financial Statements



3



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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 |  |   | Accumulatedothercomprehensiveincome (loss), net |   |  | Total |       
|Balance at December 31, 2008                                                |  | 6,446,090            |  | $           | 32,230 |                | $ | 2,095            |  | $ | 87,568                                          |   |  | $     | (6,117 | ) |  | $ | 115,776 |  
|Net loss                                                                    |  |                      |  |             |        |                |   |                  |  |   | (15,857                                         | ) |  |       |        |   |  |   | (15,857 | )
|Other comprehensive income (loss), net of tax                               |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Investment securities available for sale                                    |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $122  |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       | 199    |   |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $1 |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       | (1     | ) |  |   |         |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Net unrealized gain on investment securities available for sale             |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   | 198     |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Comprehensive loss                                                          |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   | (15,659 | )
|Cash dividend declared and paid ($0.06 per share)                           |  |                      |  |             |        |                |   |                  |  |   | (389                                            | ) |  |       |        |   |  |   | (389    | )
|Compensation expense related to stock option plan                           |  |                      |  |             |        |                |   | 31               |  |   |                                                 |   |  |       |        |   |  |   | 31      |  
|Excess tax benefit from equity-based awards                                 |  |                      |  |             |        |                |   | 107              |  |   |                                                 |   |  |       |        |   |  |   | 107     |  
|Common stock issued pursuant to stock option plan                           |  | 4,000                |  |             | 20     |                |   | 86               |  |   |                                                 |   |  |       |        |   |  |   | 106     |  
|Common stock issued pursuant to restricted stock plan                       |  | 27,540               |  |             | 14     |                |   | 102              |  |   |                                                 |   |  |       |        |   |  |   | 116     |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Balance at June 30, 2009                                                    |  | 6,477,630            |  | $           | 32,264 |                | $ | 2,421            |  | $ | 71,322                                          |   |  | $     | (5,919 | ) |  | $ | 100,088 |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Balance at December 31, 2009                                                |  | 6,495,130            |  | $           | 32,282 |                | $ | 2,599            |  | $ | 47,094                                          |   |  | $     | (6,960 | ) |  | $ | 75,015  |  
|Net loss                                                                    |  |                      |  |             |        |                |   |                  |  |   | (13,825                                         | ) |  |       |        |   |  |   | (13,825 | )
|Other comprehensive income (loss), net of tax                               |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Investment securities available for sale                                    |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $778  |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       | 1,272  |   |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $3 |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       | (5     | ) |  |   |         |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Net unrealized gain on investment securities available for sale             |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   | 1,267   |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Comprehensive loss                                                          |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   | (12,558 | )
|Cash dividend declared and paid ($0.00 per share)                           |  |                      |  |             |        |                |   |                  |  |   |                                                |   |  |       |        |   |  |   |        |  
|Compensation expense related to stock option plan                           |  |                      |  |             |        |                |   | 15               |  |   |                                                 |   |  |       |        |   |  |   | 15      |  
|Common stock issued pursuant to restricted stock plan                       |  |                     |  |             | 27     |                |   | 144              |  |   |                                                 |   |  |       |        |   |  |   | 171     |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  
|Balance at June 30, 2010                                                    |  | 6,495,130            |  | $           | 32,309 |                | $ | 2,758            |  | $ | 33,269                                          |   |  | $     | (5,693 | ) |  | $ | 62,643  |  
|                                                                            |  |                      |  |             |        |                |   |                  |  |   |                                                 |   |  |       |        |   |  |   |         |  

See Notes to Consolidated Financial Statements



4



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)



|                                                                                                         |  |                                         |         |   |      |   |          |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                                         |  | For the six monthperiods ended
June 30, |        
|                                                                                                         |  | 2010                                    |         |   | 2009 |  
|OPERATING ACTIVITIES                                                                                     |  |                                         |         |   |      |   |          |  
|Net loss                                                                                                 |  | $                                       | (13,825 | ) |      | $ | (15,857  | )
|Adjustments to reconcile net loss to net cash provided by operating activities                           |  |                                         |         |   |      |   |          |  
|Depreciation                                                                                             |  |                                         | 1,067   |   |      |   | 1,093    |  
|Amortization of unearned discounts / premiums on investment securities available for sale, net           |  |                                         | 367     |   |      |   | 11       |  
|Provision for loan losses                                                                                |  |                                         | 23,500  |   |      |   | 32,175   |  
|Gains on sales of mortgage loans held for sale, net                                                      |  |                                         | (501    | ) |      |   | (1,075   | )
|Loss on disposition of premises and equipment                                                            |  |                                         | 8       |   |      |   | 76       |  
|Writedowns, gains, and losses on real estate acquired in settlement of loans                             |  |                                         | 3,101   |   |      |   | 42       |  
|Investment securities gains                                                                              |  |                                         | (8      | ) |      |   | (2       | )
|Originations of mortgage loans held for sale                                                             |  |                                         | (25,051 | ) |      |   | (100,862 | )
|Proceeds from sale of mortgage loans held for sale                                                       |  |                                         | 27,538  |   |      |   | 97,032   |  
|Compensation expense related to stock options granted                                                    |  |                                         | 15      |   |      |   | 31       |  
|Income tax benefits from exercises of nonqualified stock options in excess of amount previously provided |  |                                         |        |   |      |   | 107      |  
|Decrease (increase) in other assets, net                                                                 |  |                                         | 7,380   |   |      |   | (6,561   | )
|Increase (decrease) in other liabilities, net                                                            |  |                                         | 2,039   |   |      |   | (4,588   | )
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Net cash provided by operating activities                                                                |  |                                         | 25,630  |   |      |   | 1,622    |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|INVESTING ACTIVITIES                                                                                     |  |                                         |         |   |      |   |          |  
|Proceeds from sales of securities available for sale                                                     |  |                                         | 40,191  |   |      |   | 2        |  
|Proceeds from maturities of investment securities available for sale                                     |  |                                         | 27,284  |   |      |   | 3,308    |  
|Purchases of investment securities available for sale                                                    |  |                                         | (64,555 | ) |      |   | (1,494   | )
|Repayments on investment securities available for sale                                                   |  |                                         | 6,433   |   |      |   | 10,743   |  
|Purchases of FHLB stock                                                                                  |  |                                         |        |   |      |   | (1,592   | )
|Redemptions of FHLB stock                                                                                |  |                                         |        |   |      |   | 2,003    |  
|Decrease (increase) in loans, net                                                                        |  |                                         | 45,775  |   |      |   | (229     | )
|Proceeds on sale of real estate acquired in settlement of loans                                          |  |                                         | 6,301   |   |      |   | 288      |  
|Proceeds on sale of premises and equipment held for sale                                                 |  |                                         | 308     |   |      |   | 1,643    |  
|Purchases of premises and equipment, net                                                                 |  |                                         | (1,122  | ) |      |   | (4,416   | )
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Net cash provided by investing activities                                                                |  |                                         | 60,615  |   |      |   | 10,256   |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|CASH FLOW FROM FINANCING ACTIVITIES                                                                      |  |                                         |         |   |      |   |          |  
|Increase (decrease) in transaction, money market, and savings deposit accounts, net                      |  |                                         | 18,585  |   |      |   | (19,630  | )
|Increase (decrease) in time deposit accounts, net                                                        |  |                                         | (42,124 | ) |      |   | 178,152  |  
|Increase in retail repurchase agreements, net                                                            |  |                                         | 9,129   |   |      |   | 7,563    |  
|Decrease in commercial paper, net                                                                        |  |                                         | (19,061 | ) |      |   | (6,149   | )
|Decrease in other short-term borrowings                                                                  |  |                                         |        |   |      |   | (79,785  | )
|Proceeds from FHLB borrowings                                                                            |  |                                         |        |   |      |   | 30,000   |  
|Repayment of FHLB borrowings                                                                             |  |                                         | (5,000  | ) |      |   |         |  
|Other common stock activity                                                                              |  |                                         | 171     |   |      |   | 222      |  
|Cash dividends paid on common stock                                                                      |  |                                         |        |   |      |   | (389     | )
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Net cash provided by (used in) financing activities                                                      |  |                                         | (38,300 | ) |      |   | 109,984  |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Net change in cash and cash equivalents                                                                  |  |                                         | 47,945  |   |      |   | 121,862  |  
|Cash and cash equivalents, beginning of period                                                           |  |                                         | 188,084 |   |      |   | 29,305   |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Cash and cash equivalents, end of period                                                                 |  | $                                       | 236,029 |   |      | $ | 151,167  |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Supplemental cash flow disclosures                                                                       |  |                                         |         |   |      |   |          |  
|Cash paid (received) during the period for:                                                              |  |                                         |         |   |      |   |          |  
|Interest expense                                                                                         |  | $                                       | 8,121   |   |      | $ | 10,612   |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Income taxes paid (refunds received, net)                                                                |  |                                         | (20,272 | ) |      |   | 2,880    |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Significant noncash activities                                                                           |  |                                         |         |   |      |   |          |  
|Net unrealized gain on investment securities available for sale, net of tax                              |  | $                                       | 1,267   |   |      | $ | 198      |  
|                                                                                                         |  |                                         |         |   |      |   |          |  
|Loans transferred to real estate acquired in settlement of loans, at fair value                          |  |                                         | 8,097   |   |      |   | 10,987   |  
|                                                                                                         |  |                                         |         |   |      |   |          |  

See Notes to Consolidated Financial Statements



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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 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 and six month periods ended June 30, 2010 and 2009 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 accounting principles generally accepted in the United States
for complete financial statements and should be read in conjunction with the Consolidated Financial Statements, and notes thereto, for the year ended December 31, 2009, included in our Annual Report on Form 10-K.

Subsequent Events

We have evaluated the
effects of subsequent events that have occurred subsequent to the period ended June 30, 2010. All material events that require recognition in the accompanying Consolidated Financial Statements or disclosure in the Notes to Consolidated
Financial Statements have been included herein.

Business Segments

Operating segments are components of an enterprise about which separate financial information is available that are evaluated regularly by the chief
operating decision makers in deciding how to allocate resources and assess performance. As of and since June 30, 2010, we have made no changes to our determination in the Annual Report on Form 10-K for the year ended December 31, 2009 that
we had one reportable operating segment, banking.

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 years presented. Actual results could differ from these estimates and assumptions. Therefore, the results
of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results of operations that may be expected in future periods.



6



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##### Table of Contents

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 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 that results from borrowers inability or unwillingness to make contractually required payments. Market risk includes primarily interest rate risk. The Company is exposed to interest rate risk to the degree
that our interest-bearing liabilities mature or reprice at different speeds, or different bases, than our interest-earning assets. Market risk also reflects the risk of declines in the valuation of assets and liabilities and in the value of the
collateral underlying loans and the value of real estate held by the Company. Concentration of credit risk refers to the risk that, if the Company extends a significant portion of our 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 defaults and losses if those borrowers, or the value of such type of collateral, are 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 Bank is subject to the regulations of various government agencies. These regulations may change significantly from period to period. The Bank also
undergoes periodic examinations by regulatory agencies, which may subject the Bank to changes with respect to asset valuations, amount of required allowance for loan losses, lending requirements, capital levels, or operating restrictions.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.

Recently Adopted / Issued Accounting Pronouncements

Certain accounting standards required additional disclosures for the three and six month periods ended June 30, 2010, and such disclosures are
included herein. The following is a summary of other applicable accounting pronouncements adopted by the Company during the three month period ended June 30, 2010 that required accounting changes beyond mere disclosures.

In March 2010, guidance related to derivatives and hedging was amended to exempt embedded credit derivative features related to the transfer of credit
risk from potential bifurcation and separate accounting. Embedded features related to other types of risk and other embedded credit derivative features were not exempt from potential bifurcation and separate accounting. The amendments were effective
for the Company on July 1, 2010. The Company does not expect these amendments to have a material impact on our financial position, results of operations, or cash flows.

Other accounting standards that have been 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)

We report comprehensive income (loss) in accordance with GAAP, which establishes standards for the reporting and presentation of comprehensive income
(loss) and its components in financial statements. In accordance with this guidance, we elected to disclose changes in comprehensive income in our 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.



7



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##### Table of Contents

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



|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|----------------------------------------------------------------------------------------- |  | --------------------- | ------ | - | -------------------- | - | ----------------------------------------- |  | - | ----------------------------------------------- | - |  | ----- | ------ | - |  | - | ------ | -
|                                                                                          |  | Impact of FASBASC 715 |        |   | Impact ofcurtailment |   | Total impactof definedbenefitpension plan |  |   | Impact ofinvestmentsecuritiesavailable 
forsale |   |  | Total |       
|Accumulated other comprehensive income (loss), after income tax impact, December 31, 2008 |  | $                     | (6,126 | ) |                      | $ | 1,630                                     |  | $ | (4,496                                          | ) |  | $     | (1,621 | ) |  | $ | (6,117 | )
|Accumulated other comprehensive income, before income tax impact                          |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | 321    |   |  |   | 321    |  
|Income tax expense                                                                        |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | (123   | ) |  |   | (123   | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income, after income tax impact                           |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | 198    |   |  |   | 198    |  
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, June 30, 2009     |  | $                     | (6,126 | ) |                      | $ | 1,630                                     |  | $ | (4,496                                          | ) |  | $     | (1,423 | ) |  | $ | (5,919 | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, December 31, 2009 |  | $                     | (8,896 | ) |                      | $ | 1,630                                     |  | $ | (7,266                                          | ) |  | $     | 306    |   |  | $ | (6,960 | )
|Accumulated other comprehensive income, before income tax impact                          |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | 2,042  |   |  |   | 2,042  |  
|Income tax expense                                                                        |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | (775   | ) |  |   | (775   | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income, after income tax impact                           |  |                       |       |   |                      |   |                                          |  |   |                                                |   |  |       | 1,267  |   |  |   | 1,267  |  
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, June 30, 2010     |  | $                     | (8,896 | ) |                      | $ | 1,630                                     |  | $ | (7,266                                          | ) |  | $     | 1,573  |   |  | $ | (5,693 | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                 |   |  |       |        |   |  |   |        |  

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



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

Required Reserve Balances

The Federal
Reserve Act requires each depository institution to maintain reserves against its reservable liabilities as prescribed by regulations of the Board of Governors of the Federal Reserve (the Federal Reserve). The Bank reports our reservable
liabilities to the Federal Reserve on a weekly basis. Weekly reporting institutions maintain reserves on their reservable liabilities with a 30-day lag. For the maintenance period ended on July 14, 2010, based on reservable liabilities from
June 1, 2010 through June 14, 2010, the Federal Reserve required the Bank to maintain reserves of $11.4 million. After taking into consideration our levels of vault cash, reserves of $3.0 million were required to be maintained with the
Federal Reserve.

Concentrations and Restrictions

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

Cash and cash equivalents restricted to secure a letter of credit totaled $250 thousand (0.1%) and $512 thousand (0.3%) as of
June 30, 2010 and December 31, 2009, respectively. In addition, $836 thousand (0.4%) of the balance of cash and cash equivalents was restricted as of June 30, 2010 and December 31, 2009 under our merchant credit card agreement.



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

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



8



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##### Table of Contents

|                                               |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|---------------------------------------------- |  | ----------------- | ------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -------
|                                               |  | June 30, 2010    
|                                               |  | Amortizedcost     |         | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Fair value
|U.S. Treasury and federal agencies             |  | $                 | 16,320  |                      | $ | 2                     |  | $ |           |   |  | $ | 16,322 
|State and municipal                            |  |                   | 40,486  |                      |   | 1,869                 |  |   |           |   |  |   | 42,355 
|Collateralized mortgage obligations            |  |                   | 42,187  |                      |   | 186                   |  |   | (362       | ) |  |   | 42,011 
|Other mortgage-backed (federal agencies)       |  |                   | 10,788  |                      |   | 840                   |  |   |           |   |  |   | 11,628 
|                                               |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Total investment securities available for sale |  | $                 | 109,781 |                      | $ | 2,897                 |  | $ | (362       | ) |  | $ | 112,316
|                                               |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|                                               | 
|                                               |  | December 31, 2009
|                                               |  | Amortizedcost     |         | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Fair value
|U.S. Treasury and federal agencies             |  | $                 | 16,294  |                      | $ | 3                     |  | $ |           |   |  | $ | 16,297 
|State and municipal                            |  |                   | 44,908  |                      |   | 1,880                 |  |   | (3         | ) |  |   | 46,785 
|Collateralized mortgage obligations            |  |                   | 42,508  |                      |   | 168                   |  |   | (2,358     | ) |  |   | 40,318 
|Other mortgage-backed (federal agencies)       |  |                   | 15,783  |                      |   | 838                   |  |   | (35        | ) |  |   | 16,586 
|                                               |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Total investment securities available for sale |  | $                 | 119,493 |                      | $ | 2,889                 |  | $ | (2,396     | ) |  | $ | 119,986
|                                               |  |                   |         |                      |   |                       |  |   |            |   |  |   |        

We use prices from third party pricing services and, to a lesser
extent, indicative (non-binding) quotes from third party brokers, to measure fair value of our investment securities. For securities priced by third party pricing services, management determines the most appropriate and relevant pricing service for
each security class and has that pricing service provide the price for each security in the class. We record the unadjusted value provided by the third party pricing service / broker in our Consolidated Financial Statements, subject to our internal
price verification procedures.

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).



|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|---------------------------------------------- |  | ------------------- |  | ------------------- | ------ | --------------------- | - | --- |  | ---------- |  | --------------------- | ------ | - | - | ---------- |  | --------------------- |  | - | ------ |  | - | -----
|                                               |  | June 30, 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             |  |                    |  | $                   |       |                       | $ |    |  |           |  | $                     |       |   | $ |           |  |                      |  | $ |       |  | $ |     
|State and municipal                            |  |                    |  |                     |       |                       |   |    |  |           |  |                       |       |   |   |           |  |                      |  |   |       |  |   |     
|Collateralized mortgage obligations            |  | 8                   |  |                     | 32,058 |                       |   | 362 |  |           |  |                       |       |   |   |           |  | 8                     |  |   | 32,058 |  |   | 362  
|Other mortgage-backed (federal agencies)       |  |                    |  |                     |       |                       |   |    |  |           |  |                       |       |   |   |           |  |                      |  |   |       |  |   |     
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|Total investment securities available for sale |  | 8                   |  | $                   | 32,058 |                       | $ | 362 |  |           |  | $                     |       |   | $ |           |  | 8                     |  | $ | 32,058 |  | $ | 362  
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|                                               | 
|                                               |  | December 31, 2009  
|                                               |  | Less than 12 months |  | 12 months or longer |        | Total                
|                                               |  | #                   |  | Fair value          |        | Grossunrealizedlosses |   | #   |  | Fair value |  | Grossunrealizedlosses |        | # |   | Fair value |  | Grossunrealizedlosses
|U.S. Treasury and federal agencies             |  | 1                   |  | $                   | 300    |                       | $ |    |  |           |  | $                     |       |   | $ |           |  | 1                     |  | $ | 300    |  | $ |     
|State and municipal                            |  | 2                   |  |                     | 662    |                       |   | 3   |  |           |  |                       |       |   |   |           |  | 2                     |  |   | 662    |  |   | 3    
|Collateralized mortgage obligations            |  | 3                   |  |                     | 10,323 |                       |   | 412 |  | 6          |  |                       | 16,624 |   |   | 1,946      |  | 9                     |  |   | 26,947 |  |   | 2,358
|Other mortgage-backed (federal agencies)       |  | 2                   |  |                     | 1,444  |                       |   | 35  |  |           |  |                       |       |   |   |           |  | 2                     |  |   | 1,444  |  |   | 35   
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|Total investment securities available for sale |  | 8                   |  | $                   | 12,729 |                       | $ | 450 |  | 6          |  | $                     | 16,624 |   | $ | 1,946      |  | 14                    |  | $ | 29,353 |  | $ | 2,396
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      

Based on our other-than-temporary impairment analysis as of
June 30, 2010, we 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 June 30, 2010. An AAA rating is based not only on the credit of the issuer, but may also include consideration of the structure of the
securities and the credit quality of the collateral.



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##### Table of Contents

|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                        |  
|----------------------------- |  | -------------------------------- | - |  | ----------------- | - |  | --------------------------------- | - |  | -------------------------------------- | -
|                              |  | U.S. Treasuryand federalagencies |   |  | Stateandmunicipal |   |  | Collateralizedmortgageobligations |   |  | Othermortgage-backed(federal agencies) |  
|Aaa                           |  | 100                              | % |  | 3                 | % |  | 100                               | % |  | 100                                    | %
|Aa1-A3                        |  |                                 |   |  | 75                |   |  |                                  |   |  |                                       |  
|Baa1                          |  |                                 |   |  | 13                |   |  |                                  |   |  |                                       |  
|Not rated or withdrawn rating |  |                                 |   |  | 9                 |   |  |                                  |   |  |                                       |  
|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                        |  
|Total                         |  | 100                              | % |  | 100               | % |  | 100                               | % |  | 100                                    | %
|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                        |  

Of the state and municipal investment securities not rated or with withdrawn ratings by Moodys at June 30, 2010,
15% were rated AA+ by Standard and Poors ratings, 52% were rated AA, 19% were rated AA-, and 14%, or $565 thousand, were not rated by Standard and Poors ratings.

Maturities

The following table
summarizes the amortized cost and estimated fair value of investment securities available for sale at June 30, 2010 by contractual maturity (in thousands). Expected maturities may differ from contractual maturities because issuers may have the
right to call or prepay obligations. Collateralized mortgage obligations and other mortgage-backed securities are shown separately since they are not due at a single maturity date.



|                                                    |  |                |         |            |   |        
|--------------------------------------------------- |  | -------------- | ------- | ---------- | - | -------
|                                                    |  | Amortized cost |         | Fair value
|Due in one year or less                             |  | $              | 20,784  |            | $ | 20,838 
|Due after one year through five years               |  |                | 26,358  |            |   | 27,657 
|Due after five year through ten years               |  |                | 9,139   |            |   | 9,600  
|Due after ten years                                 |  |                | 525     |            |   | 582    
|Collateralized mortgage obligations                 |  |                | 42,187  |            |   | 42,011 
|Other mortgage-backed securities (federal agencies) |  |                | 10,788  |            |   | 11,628 
|                                                    |  |                |         |            |   |        
|Total investment securities available for sale      |  | $              | 109,781 |            | $ | 112,316
|                                                    |  |                |         |            |   |        

The weighted average contractual life of investment securities
available for sale was 3.7 years at June 30, 2010. Since 48%, based on amortized cost, of the portfolio 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.

Pledged

At June 30, 2010 and December 31, 2009, 61% of the portfolio was pledged to secure public deposits, including retail repurchase agreements, and
trust assets. Of the $69.0 million and $73.2 million pledged at June 30, 2010 and December 31, 2009, respectively, $47.9 million and $56.3 million, respectively, of the portfolio was securing public deposits and trust assets.

At June 30, 2010 and December 31, 2009, $6.3 million (6%) and $6.3 million (5%), respectively, of the portfolio was pledged to secure
federal funds funding from a correspondent bank.

At June 30, 2010 and December 31, 2009, $24.8 million (22%) and $29.8 million
(25%), respectively, of the portfolio was pledged to collateralize FHLB advances and letters of credit, of which $23.9 million and $26.8 million, respectively, was available as lendable collateral.

On July 1, 2010, investment securities with a market value of $21.5 million were purchased and pledged to collateralize FHLB advances and letters of
credit.

Concentrations

Four
state and municipal security issuers issued securities with fair values ranging from 2.0% to 3.6% of total shareholders equity at June 30, 2010. Twenty state and municipal security issuers issued securities with fair values ranging from
1.0% to 1.9% of total shareholders equity at June 30, 2010.

Two collateralized mortgage obligation issuers issued securities with
fair values of 1.3 and 4.1%, respectively, of total shareholders equity at June 30, 2010. Nine collateralized mortgage obligations, issued by the Government National Mortgage Association (GNMA), had an aggregate fair value of
$38.6 million (61.7% of shareholders equity) and an amortized cost of $38.8 million at June 30, 2010.



10



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##### Table of Contents

The following table summarizes issuer concentrations of other mortgage-backed investment securities at fair
value at June 30, 2010 (dollars in thousands).



|                                         |  |                                            |       |   |                                               |   |       |                                               |  |   |       |   |  |   |        |  
|---------------------------------------- |  | ------------------------------------------ | ----- | - | --------------------------------------------- | - | ----- | --------------------------------------------- |  | - | ----- | - |  | - | ------ | -
|                                         |  | FederalNationalMortgageAssociation(FNMA) |       |   | Federal HomeLoan MortgageCorporation(FHLMC) |   |       | GovernmentNationalMortgageAssociation(GNMA) |  |   | Total |  
|Other mortgage-backed (federal agencies) |  | $                                          | 8,384 |   |                                               | $ | 1,762 |                                               |  | $ | 1,482 |   |  | $ | 11,628 |  
|As a percentage of shareholders equity  |  |                                            | 13.4  | % |                                               |   | 2.8   | %                                             |  |   | 2.4   | % |  |   | 18.6   | %

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 month periodsended June 30, |   | For the six month periodsended June 30,
|                   |  | 2010                                      |   | 2009                                    |   | 2010 |  |   | 2009  
|Realized gains     |  | $                                         |  |                                         | $ |     |  | $ | 1,147  |   |  | $ | 2
|Realized losses    |  |                                           |  |                                         |   |     |  |   | (1,139 | ) |  |   | 
|                   |  |                                           |   |                                         |   |      |  |   |        |   |  |   |  
|Net realized gains |  | $                                         |  |                                         | $ |     |  | $ | 8      |   |  | $ | 2
|                   |  |                                           |   |                                         |   |      |  |   |        |   |  |   |  



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

Composition

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



|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  
|------------------------------------------------------------ |  | ------------- | ------- | ---------- | ----------------- | - | ----- | - | ---------- |  | ----- | -
|                                                             |  | June 30, 2010 |         |            | December 31, 2009 |  
|                                                             |  | Total         |         | % of total |                   |   | Total |   | % of total | 
|Secured by real estate                                       |  |               |         |            |                   |   |       |   |            |  |       |  
|Construction, land development, and other land loans         |  | $             | 178,297 |            | 18.4              | % |       | $ | 205,465    |  | 19.8  | %
|Farmland                                                     |  |               | 2,891   |            | 0.3               |   |       |   | 466        |  |      |  
|Single-family residential                                    |  |               | 194,808 |            | 20.1              |   |       |   | 203,330    |  | 19.6  |  
|Multifamily residential                                      |  |               | 28,927  |            | 3.0               |   |       |   | 30,668     |  | 3.0   |  
|Nonfarm nonresidential                                       |  |               | 432,085 |            | 44.7              |   |       |   | 459,130    |  | 44.1  |  
|Commercial and industrial                                    |  |               | 55,581  |            | 5.8               |   |       |   | 61,788     |  | 5.9   |  
|Obligations of states and political subdivisions of the U.S. |  |               | 1,059   |            | 0.1               |   |       |   | 1,418      |  | 0.1   |  
|General consumer                                             |  |               | 52,461  |            | 5.4               |   |       |   | 57,581     |  | 5.5   |  
|Credit line                                                  |  |               | 4,739   |            | 0.5               |   |       |   | 5,501      |  | 0.5   |  
|Bankcards                                                    |  |               | 12,433  |            | 1.3               |   |       |   | 13,214     |  | 1.3   |  
|Others                                                       |  |               | 3,963   |            | 0.4               |   |       |   | 1,751      |  | 0.2   |  
|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  
|Loans, gross                                                 |  | $             | 967,244 |            | 100.0             | % |       | $ | 1,040,312  |  | 100.0 | %
|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  

Loans included in the preceding loan composition table are net of participations sold. Participations sold totaled $12.5
million at June 30, 2010 and December 31, 2009.

Mortgage loans serviced for the benefit of others amounted to $426.7 million and
$426.6 million at June 30, 2010 and December 31, 2009, respectively, and are not included in our Consolidated Balance Sheets.

Pledged

To borrow from the FHLB,
members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. $339.5
million and $407.0 million of gross loans were pledged to collateralize FHLB advances and letters of credit at June 30, 2010 and December 31, 2009, respectively, of which $145.3 million and $162.0 million, respectively, was available as
lendable collateral.

On June 30, 2010, $15.8 million of loans was pledged as collateral for potential borrowings from the Federal
Reserve Discount Window.



11



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##### Table of Contents

Concentrations

The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at June 30, 2010 (dollars in thousands).



|                                                     |  |       |         |                 |      |   |                                    |       |  
|---------------------------------------------------- |  | ----- | ------- | --------------- | ---- | - | ---------------------------------- | ----- | -
|                                                     |  | Total |         | % of grossloans |      |   | % of Bankstotal regulatorycapital |      
|Secured by commercial real estate                    |  |       |         |                 |      |   |                                    |       |  
|Construction, land development, and other land loans |  | $     | 178,297 |                 | 18.4 | % |                                    | 244.5 | %
|Multifamily residential                              |  |       | 28,927  |                 | 3.0  |   |                                    | 39.7  |  
|Nonfarm nonresidential                               |  |       | 432,085 |                 | 44.7 |   |                                    | 592.4 |  
|                                                     |  |       |         |                 |      |   |                                    |       |  
|Total loans secured by commercial real estate        |  | $     | 639,309 |                 | 66.1 | % |                                    | 876.6 | %
|                                                     |  |       |         |                 |      |   |                                    |       |  

The following table further categorizes loans secured by commercial real estate, categorized by FDIC code, at June 30,
2010 (dollars in thousands).



|                                                                  |  |       |         |                 |      |   |                                    |       |  
|----------------------------------------------------------------- |  | ----- | ------- | --------------- | ---- | - | ---------------------------------- | ----- | -
|                                                                  |  | Total |         | % of grossloans |      |   | % of Bankstotal regulatorycapital |      
|Development commercial real estate loans                          |  |       |         |                 |      |   |                                    |       |  
|Secured by:                                                       |  |       |         |                 |      |   |                                    |       |  
|Land - unimproved (commercial or residential)                     |  | $     | 61,395  |                 | 6.4  | % |                                    | 84.2  | %
|Land development - commercial                                     |  |       | 16,925  |                 | 1.8  |   |                                    | 23.2  |  
|Land development - residential                                    |  |       | 59,876  |                 | 6.2  |   |                                    | 82.1  |  
|Commercial construction:                                          |  |       |         |                 |      |   |                                    |       |  
|Hotel / motel                                                     |  |       | 189     |                 |     |   |                                    | 0.3   |  
|Retail                                                            |  |       | 4,448   |                 | 0.5  |   |                                    | 6.1   |  
|Office                                                            |  |       | 244     |                 |     |   |                                    | 0.3   |  
|Multifamily                                                       |  |       | 2,617   |                 | 0.3  |   |                                    | 3.6   |  
|Industrial and warehouse                                          |  |       | 7,140   |                 | 0.7  |   |                                    | 9.8   |  
|Healthcare                                                        |  |       | 4,916   |                 | 0.5  |   |                                    | 6.7   |  
|Miscellaneous commercial                                          |  |       | 3,362   |                 | 0.3  |   |                                    | 4.6   |  
|                                                                  |  |       |         |                 |      |   |                                    |       |  
|Total development commercial real estate loans                    |  |       | 161,112 |                 | 16.7 |   |                                    | 220.9 |  
|Existing and other commercial real estate loans                   |  |       |         |                 |      |   |                                    |       |  
|Secured by:                                                       |  |       |         |                 |      |   |                                    |       |  
|Hotel / motel                                                     |  |       | 104,155 |                 | 10.8 |   |                                    | 142.8 |  
|Retail                                                            |  |       | 27,070  |                 | 2.8  |   |                                    | 37.1  |  
|Office                                                            |  |       | 27,428  |                 | 2.8  |   |                                    | 37.6  |  
|Multifamily                                                       |  |       | 28,927  |                 | 3.0  |   |                                    | 39.7  |  
|Industrial and warehouse                                          |  |       | 17,302  |                 | 1.8  |   |                                    | 23.7  |  
|Healthcare                                                        |  |       | 11,232  |                 | 1.1  |   |                                    | 15.4  |  
|Miscellaneous commercial                                          |  |       | 127,493 |                 | 13.2 |   |                                    | 174.8 |  
|Residential construction - speculative                            |  |       | 7,059   |                 | 0.7  |   |                                    | 9.7   |  
|                                                                  |  |       |         |                 |      |   |                                    |       |  
|Total existing and other commercial real estate loans             |  |       | 350,666 |                 | 36.2 |   |                                    | 480.8 |  
|Commercial real estate owner occupied and residential loans       |  |       |         |                 |      |   |                                    |       |  
|Secured by:                                                       |  |       |         |                 |      |   |                                    |       |  
|Commercial - owner occupied                                       |  |       | 117,199 |                 | 12.1 |   |                                    | 160.7 |  
|Commercial construction - owner occupied                          |  |       | 5,064   |                 | 0.5  |   |                                    | 7.0   |  
|Residential construction - contract                               |  |       | 5,268   |                 | 0.6  |   |                                    | 7.2   |  
|                                                                  |  |       |         |                 |      |   |                                    |       |  
|Total commercial real estate owner occupied and residential loans |  |       | 127,531 |                 | 13.2 |   |                                    | 174.9 |  
|                                                                  |  |       |         |                 |      |   |                                    |       |  
|Total loans secured by commercial real estate                     |  | $     | 639,309 |                 | 66.1 | % |                                    | 876.6 | %
|                                                                  |  |       |         |                 |      |   |                                    |       |  

Asset Quality

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



|                                          |  |              |        |                  |   |       
|----------------------------------------- |  | ------------ | ------ | ---------------- | - | ------
|                                          |  | June 30,2010 |        | December 31,2009
|Nonaccrual loans                          |  | $            | 91,653 |                  | $ | 96,936
|Loans past due 90 days and still accruing |  |              | 20     |                  |   |      
|                                          |  |              |        |                  |   |       
|                                          |  | $            | 91,673 |                  | $ | 96,936
|                                          |  |              |        |                  |   |       

No interest income was recorded during the three and six month periods
ended June 30, 2010 on loans classified as nonaccrual, as payments collected on nonaccrual loans are applied to the principal balance of the loan. Additional interest income of $999 thousand and $1.8 million would have been reported during the
three and six month periods, respectively, ended June 30, 2010 had these loans performed in accordance with their contractual terms. As a result, our earnings did not include this interest income.



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##### Table of Contents

Troubled Debt Restructurings. At June 30, 2010 and December 31, 2009, the principal balance
of troubled debt restructurings totaled $27.8 million and $14.6 million, respectively.

Allowance for Loan Losses

The following table summarizes the activity impacting the allowance for loan losses at the dates and for the periods indicated (in thousands).



|                                               |  |                                                   |         |   |                                                 |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | ------------------------------------------------- | ------- | - | ----------------------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                               |  | At and for the three month 
periodsended June 30, |         |   | At and for the six month 
periodsended June 30, |  
|                                               |  | 2010                                              |         |   | 2009                                            |   |         | 2010 |  |   | 2009    |  
|Allowance for loan losses, beginning of period |  | $                                                 | 28,426  |   |                                                 | $ | 12,606  |      |  | $ | 24,079  |   |  | $ | 11,000  |  
|Provision for loan losses                      |  |                                                   | 12,750  |   |                                                 |   | 30,000  |      |  |   | 23,500  |   |  |   | 32,175  |  
|Loans charged-off                              |  |                                                   | (13,078 | ) |                                                 |   | (20,686 | )    |  |   | (20,320 | ) |  |   | (21,301 | )
|Loan recoveries                                |  |                                                   | 285     |   |                                                 |   | 45      |      |  |   | 1,124   |   |  |   | 91      |  
|                                               |  |                                                   |         |   |                                                 |   |         |      |  |   |         |   |  |   |         |  
|Net loans charged-off                          |  |                                                   | (12,793 | ) |                                                 |   | (20,641 | )    |  |   | (19,196 | ) |  |   | (21,210 | )
|                                               |  |                                                   |         |   |                                                 |   |         |      |  |   |         |   |  |   |         |  
|Allowance for loan losses, end of period       |  | $                                                 | 28,383  |   |                                                 | $ | 21,965  |      |  | $ | 28,383  |   |  | $ | 21,965  |  
|                                               |  |                                                   |         |   |                                                 |   |         |      |  |   |         |   |  |   |         |  

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



|                                                                                                                 |  |              |         |                  |   |       
|---------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---------------- | - | ------
|                                                                                                                 |  | June 30,2010 |         | December 31,2009
|Impaired loans for which there is a related allowance for loan losses determined in accordance with FASB ASC 310 |  | $            | 30,353  |                  | $ | 11,253
|Other impaired loans                                                                                             |  |              | 68,354  |                  |   | 85,583
|                                                                                                                 |  |              |         |                  |   |       
|Total impaired loans                                                                                             |  | $            | 98,707  |                  | $ | 96,836
|                                                                                                                 |  |              |         |                  |   |       
|Average impaired loans calculated using a simple average                                                         |  | $            | 100,981 |                  | $ | 82,471
|Related allowance for loan losses                                                                                |  |              | 6,825   |                  |   | 5,250 



|5. | Premises and Equipment, Net
|-- | ---------------------------

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



|                              |  |              |         |   |                  |   |         |  
|----------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                              |  | June 30,2010 |         |   | December 31,2009 |  
|Land                          |  | $            | 6,534   |   |                  | $ | 6,534   |  
|Buildings                     |  |              | 19,772  |   |                  |   | 19,904  |  
|Leasehold improvements        |  |              | 5,245   |   |                  |   | 5,313   |  
|Furniture and equipment       |  |              | 20,741  |   |                  |   | 20,908  |  
|Software                      |  |              | 4,037   |   |                  |   | 3,719   |  
|Bank automobiles              |  |              | 137     |   |                  |   | 820     |  
|Capital lease asset           |  |              | 1,244   |   |                  |   | 420     |  
|                              |  |              |         |   |                  |   |         |  
|Premises and equipment, gross |  |              | 57,710  |   |                  |   | 57,618  |  
|Accumulated depreciation      |  |              | (28,366 | ) |                  |   | (28,013 | )
|                              |  |              |         |   |                  |   |         |  
|Premises and equipment, net   |  | $            | 29,344  |   |                  | $ | 29,605  |  
|                              |  |              |         |   |                  |   |         |  



|6. | Goodwill, net
|-- | -------------

Goodwill of $3.7
million at June 30, 2010 and December 31, 2009 resulted from past business combinations from 1988 through 1999. We perform our annual impairment testing as of June 30. Due to the overall adverse economic environment and the negative
impact on the banking industry as a whole, including the impact to the Company resulting in net losses and a decline in market capitalization based on our common stock price, we also performed an impairment test of our goodwill at December 31,
2009. No impairment loss was recognized during the three or six month periods ended June 30, 2010 or 2009 or at December 31, 2009.



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##### Table of Contents

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

Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009,
respectively, and are excluded from our Consolidated Balance Sheets.

The book value of mortgage-servicing rights at June 30, 2010 and
December 31, 2009 was $2.9 million and $3.0 million, respectively. Mortgage-servicing rights are included within the Other assets financial statement line item of the Consolidated Balance Sheets. The fair value of mortgage-servicing rights at
June 30, 2010 and December 31, 2009 was $3.4 million and $3.6 million, respectively.

Mortgage-Servicing Rights Activity

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



|                                                                                     |  |                                                  |       |   |                                                |   |       |      |  |   |       |   |  |   |       |  
|------------------------------------------------------------------------------------ |  | ------------------------------------------------ | ----- | - | ---------------------------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                     |  | At and for the three monthperiods ended June 30, |       |   | At and for the six monthperiods ended June 30, |  
|                                                                                     |  | 2010                                             |       |   | 2009                                           |   |       | 2010 |  |   | 2009  |  
|Mortgage-servicing rights portfolio, net of valuation allowance, beginning of period |  | $                                                | 3,014 |   |                                                | $ | 2,993 |      |  | $ | 3,039 |   |  | $ | 2,932 |  
|Capitalized mortgage-servicing rights                                                |  |                                                  | 107   |   |                                                |   | 408   |      |  |   | 273   |   |  |   | 883   |  
|Mortgage-servicing rights portfolio amortization and impairment                      |  |                                                  | (197  | ) |                                                |   | (336  | )    |  |   | (388  | ) |  |   | (750  | )
|                                                                                     |  |                                                  |       |   |                                                |   |       |      |  |   |       |   |  |   |       |  
|Mortgage-servicing rights portfolio, net of valuation allowance, end of period       |  | $                                                | 2,924 |   |                                                | $ | 3,065 |      |  | $ | 2,924 |   |  | $ | 3,065 |  
|                                                                                     |  |                                                  |       |   |                                                |   |       |      |  |   |       |   |  |   |       |  

Valuation Allowance

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



|                                                               |  |                                           |    |      |                                         |    |      |  |      |    |  |   |   
|-------------------------------------------------------------- |  | ----------------------------------------- | -- | ---- | --------------------------------------- | -- | ---- |  | ---- | -- |  | - | --
|                                                               |  | For the three monthperiods ended June 30, |    |      | For the six monthperiods ended June 30,
|                                                               |  | 2010                                      |    | 2009 |                                         |    | 2010 |  | 2009
|Valuation allowance, beginning of period                       |  | $                                         | 38 |      | $                                       | 39 |      |  | $    | 40 |  | $ | 30
|Additions charged to and (reductions credited from) operations |  |                                           | 3  |      |                                         | (1 | )    |  |      | 1  |  |   | 8 
|                                                               |  |                                           |    |      |                                         |    |      |  |      |    |  |   |   
|Valuation allowance, end of period                             |  | $                                         | 41 |      | $                                       | 38 |      |  | $    | 41 |  | $ | 38
|                                                               |  |                                           |    |      |                                         |    |      |  |      |    |  |   |   



|8. | Real Estate and Personal Property Acquired in Settlement of Loans
|-- | -----------------------------------------------------------------

Composition

The following table
summarizes real estate acquired in settlement of loans and personal property acquired in settlement of loans, the latter of which is included within the Other assets financial statement line item on the Consolidated Balance Sheets at the dates
indicated (in thousands).



|                                                  |  |              |        |                  |   |       
|------------------------------------------------- |  | ------------ | ------ | ---------------- | - | ------
|                                                  |  | June 30,2010 |        | December 31,2009
|Real estate acquired in settlement of loans       |  | $            | 26,521 |                  | $ | 27,826
|Personal property acquired in settlement of loans |  |              | 106    |                  |   | 188   
|                                                  |  |              |        |                  |   |       
|Total property acquired in settlement of loans    |  | $            | 26,627 |                  | $ | 28,014
|                                                  |  |              |        |                  |   |       

Real Estate Acquired in Settlement of Loans Activity

The following table summarizes the changes in real estate acquired in settlement of loans at the dates and for the periods indicated (in
thousands).



14



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##### Table of Contents

|                                                                           |  |                                                       |        |   |                                                     |   |        |  
|-------------------------------------------------------------------------- |  | ----------------------------------------------------- | ------ | - | --------------------------------------------------- | - | ------ | -
|                                                                           |  | At and for the three 
monthperiod ended June 30, 2010 |        |   | At and for the six monthperiod ended June 30, 
2010 |  
|Real estate acquired in settlement of loans, beginning of period           |  | $                                                     | 28,867 |   |                                                     | $ | 27,826 |  
|Plus: New real estate acquired in settlement of loans                      |  |                                                       | 4,204  |   |                                                     |   | 8,097  |  
|Less: Proceeds from sale of real estate acquired in settlement of loans    |  |                                                       | (4,248 | ) |                                                     |   | (6,301 | )
|Less: Gain / (loss) on sale on real estate acquired in settlement of loans |  |                                                       | 14     |   |                                                     |   | 285    |  
|Less: Provision charged to expense                                         |  |                                                       | (2,316 | ) |                                                     |   | (3,386 | )
|                                                                           |  |                                                       |        |   |                                                     |   |        |  
|Real estate acquired in settlement of loans, end of period                 |  | $                                                     | 26,521 |   |                                                     | $ | 26,521 |  
|                                                                           |  |                                                       |        |   |                                                     |   |        |  

Subsequent to June 30, 2010, three properties with an aggregate net carrying amount of $4.7 million were sold at a gain
of $282 thousand. At July 28, 2010, nine additional assets with an aggregate net carrying amount of $1.3 million were under contract for sale scheduled to close in the third quarter of 2010.



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

Composition

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



|                                           |  |              |           |                  |   |          
|------------------------------------------ |  | ------------ | --------- | ---------------- | - | ---------
|                                           |  | June 30,2010 |           | December 31,2009
|Transaction deposit accounts               |  | $            | 431,040   |                  | $ | 449,867  
|Money market deposit accounts              |  |              | 150,053   |                  |   | 119,082  
|Savings deposit accounts                   |  |              | 46,776    |                  |   | 40,335   
|Time deposit accounts $100,000 and greater |  |              | 238,299   |                  |   | 263,664  
|Time deposit accounts less than $100,000   |  |              | 325,207   |                  |   | 341,966  
|                                           |  |              |           |                  |   |          
|Total traditional deposit accounts         |  | $            | 1,191,375 |                  | $ | 1,214,914
|                                           |  |              |           |                  |   |          

At June 30, 2010 and December 31, 2009, $810 thousand and
$542 thousand, respectively, of overdrawn transaction deposit accounts were reclassified to loans.

Interest Expense on Deposit Accounts

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



|                                                       |  |                                           |       |                                         |   |       |  |      |       |  |   |      
|------------------------------------------------------ |  | ----------------------------------------- | ----- | --------------------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                                                       |  | For the three monthperiods ended June 30, |       | For the six monthperiods ended June 30,
|                                                       |  | 2010                                      |       | 2009                                    |   | 2010  |  | 2009
|Transaction deposit accounts                           |  | $                                         | 67    |                                         | $ | 141   |  | $    | 128   |  | $ | 386  
|Money market deposit accounts                          |  |                                           | 174   |                                         |   | 139   |  |      | 334   |  |   | 307  
|Savings deposit accounts                               |  |                                           | 37    |                                         |   | 35    |  |      | 69    |  |   | 66   
|Time deposit accounts                                  |  |                                           | 2,996 |                                         |   | 4,888 |  |      | 6,306 |  |   | 9,156
|                                                       |  |                                           |       |                                         |   |       |  |      |       |  |   |      
|Total interest expense on traditional deposit accounts |  | $                                         | 3,274 |                                         | $ | 5,203 |  | $    | 6,837 |  | $ | 9,915
|                                                       |  |                                           |       |                                         |   |       |  |      |       |  |   |      



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

Federal Funds
Accommodations

At June 30, 2010, we had access to federal funds funding, secured by U.S. Treasury and federal agency securities, from
a correspondent bank. The following table summarizes our federal funds funding utilization and availability at the dates indicated (in thousands).



|                                               |  |              |       |                  |   |      
|---------------------------------------------- |  | ------------ | ----- | ---------------- | - | -----
|                                               |  | June 30,2010 |       | December 31,2009
|Authorized federal funds funding accomodations |  | $            | 5,000 |                  | $ | 5,000
|Utilized federal funds funding accomodations   |  |              |      |                  |   |     
|                                               |  |              |       |                  |   |      
|Available federal funds funding accomodations  |  | $            | 5,000 |                  | $ | 5,000
|                                               |  |              |       |                  |   |      

This federal funds funding source may be canceled at any time at the
correspondent banks discretion.

FHLB Borrowings



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##### Table of Contents

As disclosed in Notes 3 and 4, we pledge investment securities and loans to collateralize FHLB advances and
letters of credit. Additionally, we may pledge cash and cash equivalents. In order to compute lendable collateral amounts, the market value of pledged securities and loans balances is reduced by a collateral discount factor. This amount is then
adjusted by the institution assigned collateral maintenance level factor. Among other things, the collateral maintenance level factor takes into account our collateral credit score determined by the FHLB. Cash and cash equivalents, if pledged, are
not subject to the collateralization maintenance level.

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



|                                                                                                             |  |              |         |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | ------------ | ------- | - | ---------------- | - | -------- | -
|                                                                                                             |  | June 30,2010 |         |   | December 31,2009 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $            | 145,302 |   |                  | $ | 162,014  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |              | 23,909  |   |                  |   | 26,791   |  
|Advances and letters of credit                                                                               |  |              |         |   |                  |   |          |  
|FHLB advances                                                                                                |  | $            | (96,000 | ) |                  | $ | (101,000 | )
|Letters of credit                                                                                            |  |              | (50,000 | ) |                  |   | (50,000  | )
|Excess / (deficiency)                                                                                        |  | $            | (9,015  | ) |                  | $ | 55       |  

On July 1, 2010, investment
securities with a market value of $21.5 million were pledged to cover the deficiency at June 30, 2010.

The following table summarizes
FHLB borrowings at June 30, 2010 (dollars in thousands). Our FHLB advances do not have embedded call options.



|                  |  |   |          |   |  |   |           |   |  |   |          |   |  |   |          |   |       |   |          |   |  |   |        |  
|----------------- |  | - | -------- | - |  | - | --------- | - |  | - | -------- | - |  | - | -------- | - | ----- | - | -------- | - |  | - | ------ | -
|                  |  |   |          |   |  |   |           |   |  |   |          |   |  |   |          |   | Total |  
|Borrowing balance |  | $ | 19,000   |   |  | $ | 30,000    |   |  | $ | 30,000   |   |  | $ | 5,000    |   |       | $ | 12,000   |   |  | $ | 96,000 |  
|Interest rate     |  |   | 0.63     | % |  |   | 1.34      | % |  |   | 2.89     | % |  |   | 3.61     | % |       |   | 0.43     | % |  |   | 1.69   | %
|Maturity date     |  |   | 1/7/2011 |   |  |   | 1/18/2011 |   |  |   | 3/7/2011 |   |  |   | 4/2/2013 |   |       |   | 4/4/2011 |   |  |   |        |  

In January 2010, we were notified by the FHLB that it will not allow incremental borrowings until our financial
condition improves.

Federal Reserve Discount Window

On June 30, 2010, $15.8 million of loans were pledged as collateral to cover the various Federal Reserve System services that are being utilized by
the Company. The maximum maturity for borrowings is overnight. Any future potential borrowings from the Federal Reserve Discount Window are at the secondary credit rate and must be used for operational issues, and the Federal Reserve has the
discretion to deny approval of borrowing requests.

We had no outstanding borrowings from the Federal Reserve at June 30, 2010 or
December 31, 2009.

Convertible Debt

The Company has outstanding unsecured convertible promissory notes in an aggregate principal amount of $380 thousand to members of the Companys
Board of Directors. The notes bear interest at 10% per year payable quarterly, have a stated maturity of March 31, 2015, may be prepaid by the Company at any time, and are mandatorily convertible into stock of the Company at the same terms
and conditions as other investors that participate in the Companys next stock offering. The proceeds from the issuance of the notes were contributed to the Bank as a capital contribution. As of June 30, 2010, interest of $10 thousand has
been accrued but not paid.



|11. | Employee Benefit Plans
|--- | ----------------------

401(k)
Plan

During the three month periods ended June 30, 2010 and 2009, matching contributions made in conjunction with our employee 401(k)
plan totaled $101 thousand and $94 thousand, respectively. During the six month periods ended June 30, 2010 and 2009, matching contributions made in conjunction with our employee 401(k) plan totaled $199 thousand and $203 thousand,
respectively.



16



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##### Table of Contents

Defined Benefit Pension Plan

Historically, we have offered a noncontributory, defined benefit pension plan that covered all full-time employees having at least twelve months of
continuous service and having attained age 21. The plan was frozen on December 31, 2007; accordingly, effective January 1, 2008, we ceased accruing pension benefits under the 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 our defined benefit
postretirement plan in our Consolidated Balance Sheet. 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 recognized an accrued pension liability, net at June 30, 2010 and December 31, 2009, which was included in the Other liabilities financial statement line item on the Consolidated Balance Sheets, of $4.0 million and $3.7 million,
respectively.

The fair value of plan assets totaled $12.7 million and $13.2 million at June 30, 2010 and December 31, 2009,
respectively.

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



|                                   |  |                                               |      |   |                                             |   |      |  
|---------------------------------- |  | --------------------------------------------- | ---- | - | ------------------------------------------- | - | ---- | -
|                                   |  | For the three monthperiod ended June 30, 2010 |      |   | For the six monthperiod ended June 30, 2010 |  
|Interest cost                      |  | $                                             | 256  |   |                                             | $ | 482  |  
|Expected return on plan assets     |  |                                               | (258 | ) |                                             |   | (485 | )
|Amortization of net actuarial loss |  |                                               | 178  |   |                                             |   | 337  |  
|                                   |  |                                               |      |   |                                             |   |      |  
|Net periodic pension expense       |  | $                                             | 176  |   |                                             | $ | 334  |  
|                                   |  |                                               |      |   |                                             |   |      |  

No expense was recorded during the three and six month periods ended June 30, 2009.

Contributions.Employer contributions in the amount of at least $78 thousand will be made during 2010. Additional contributions may be made
depending on the funded status of the plan.



|12. | Equity Based Compensation
|--- | -------------------------

Stock Option Plan

Stock option awards
have been granted under the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan with various expiration dates through December 31, 2016. Of these, 132,810 stock option awards remained outstanding at June 30, 2010 with exercise prices
ranging from $13.50 to $30.40. All stock option awards granted have a vesting term of five years and an exercise period of ten years.

The
compensation cost that was charged against pretax net income (loss) for previously granted stock option awards that vested during the three month periods ended June 30, 2010 and 2009 was $8 thousand and $16 thousand, respectively. During the
six month periods ended June 30, 2010 and 2009, such compensation expense was $15 and $31 thousand, respectively.

At June 30, 2010,
based on stock option awards outstanding at that time, the total pretax compensation cost related to nonvested stock option awards granted under the stock option plan but not yet recognized was $16 thousand. Stock option compensation expense is
recognized on a straight-line basis over the stock option award vesting period. Remaining stock option compensation expense is expected to be recognized through 2011.

The following table summarizes stock option activity for the 1997 Stock Compensation Plan at the dates and for the periods indicated.



17



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##### Table of Contents

|                                 |  |                          |   |  |                                |      
|-------------------------------- |  | ------------------------ | - |  | ------------------------------ | -----
|                                 |  | Stock optionsoutstanding |   |  | Weighted-averageexercise price
|Outstanding at December 31, 2008 |  | 169,330                  |   |  | $                              | 20.98
|Exercised                        |  | (4,000                   | ) |  |                                | 26.60
|                                 |  |                          |   |  |                                |      
|Outstanding at June 30, 2009     |  | 165,330                  |   |  | $                              | 20.84
|                                 |  |                          |   |  |                                |      
|                                 |  |                         
|Outstanding at December 31, 2009 |  | 147,210                  |   |  | $                              | 21.80
|Forfeited                        |  | (14,400                  | ) |  |                                | 15.00
|                                 |  |                          |   |  |                                |      
|Outstanding at June 30, 2010     |  | 132,810                  |   |  | $                              | 22.54
|                                 |  |                          |   |  |                                |      

The following table summarizes information regarding stock option
awards outstanding and exercisable at June 30, 2010.



|                                          |  |                                             |  |                                                  |  |                                |  |                                             |  |                                |       |  |         |  |   |      
|----------------------------------------- |  | ------------------------------------------- |  | ------------------------------------------------ |  | ------------------------------ |  | ------------------------------------------- |  | ------------------------------ | ----- |  | ------- |  | - | -----
|                                          |  | Options outstanding                         |  | Options exercisable                             
|Exercise price or range
ofexercise prices |  | Number of stockoptionsoutstanding at6/30/10 |  | Weighted-averageremainingcontractual life(years) |  | Weighted-average exerciseprice |  | Number of stockoptionsexercisable at6/30/10 |  | Weighted-average exerciseprice
|$13.50                                    |  |                                             |  |                                                  |  | 7,800                          |  | 0.50                                        |  | $                              | 13.50 |  | 7,800   |  | $ | 13.50
|$15.00                                    |  | to                                          |  | $20.00                                           |  | 40,010                         |  | 2.06                                        |  |                                | 17.75 |  | 40,010  |  |   | 17.75
|$23.30                                    |  | to                                          |  | $26.60                                           |  | 51,200                         |  | 3.87                                        |  |                                | 24.47 |  | 51,200  |  |   | 24.47
|$27.30                                    |  | to                                          |  | $30.40                                           |  | 33,800                         |  | 5.53                                        |  |                                | 27.37 |  | 26,480  |  |   | 27.36
|                                          |  |                                             |  |                                                  |  |                                |  |                                             |  |                                |       |  |         |  |   |      
|Total                                     |  |                                             |  |                                                  |  | 132,810                        |  | 3.55                                        |  |                                | 22.54 |  | 125,490 |  |   | 22.26
|                                          |  |                                             |  |                                                  |  |                                |  |                                             |  |                                |       |  |         |  |   |      

At June 30, 2010, we determined the fair value of our common stock based on the average of the last five
trades reported through our Private Trading System. At June 30, 2010, the fair value of our common stock did not exceed the exercise price of any options outstanding and exercisable. Cash received from stock option exercises under the stock
option plan during the three and six month periods ended June 30, 2009 was $106 thousand. The total intrinsic value of stock options exercised during the three and six month period ended June 30, 2009 was $62 thousand. There were no stock
options exercised during the three and six month periods ended June 30, 2010.

Restricted Stock Plan

250,000 shares of common stock have been reserved for issuance under the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan, which provides for the
grant of common stock awards to the Companys employees, officers, and directors. The first awards were granted under the Plan during 2009. The following table summarizes restricted stock activity at the dates and for the periods indicated.



|                                 |  |                             |   |  |                             |      
|-------------------------------- |  | --------------------------- | - |  | --------------------------- | -----
|                                 |  | Restricted stockoutstanding |   |  | Weighted-average grantprice
|Outstanding at December 31, 2008 |  |                            |   |  | $                           |     
|                                 |  |                             |   |  |                             |      
|Granted                          |  | 37,540                      |   |  |                             | 42.00
|Forfeited                        |  | (10,000                     | ) |  |                             | 42.00
|                                 |  |                             |   |  |                             |      
|Outstanding at June 30, 2009     |  | 27,540                      |   |  |                             | 42.00
|                                 |  |                             |   |  |                             |      
|Granted                          |  | 17,500                      |   |  |                             | 21.95
|Vested                           |  | (5,508                      | ) |  |                             | 42.00
|                                 |  |                             |   |  |                             |      
|Outstanding at December 31, 2009 |  | 39,532                      |   |  |                             | 33.12
|                                 |  |                             |   |  |                             |      
|Granted                          |  |                            |   |  |                             |     
|                                 |  |                             |   |  |                             |      
|Outstanding at June 30, 2010     |  | 39,532                      |   |  | $                           | 33.12
|                                 |  |                             |   |  |                             |      

The value of the restricted stock awarded is established as the fair
value of the stock at the time of the grant. We measure compensation cost for restricted stock awards at fair value and recognize compensation expense over the service period. As such, expense relative to 2009 grants is recognized ratably over
the five year vesting period of the stock award grants. Of the restricted stock shares outstanding at June 30, 2010, 39% perform their annual vesting on July 1 and 61% perform their annual vesting on December 31. The compensation
cost that was charged against pretax income during the three month periods ended June 30, 2010 and June 30, 2009 for restricted stock awards was $85 thousand and $37 thousand, respectively. The total income tax benefit recognized in the
Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation cost was $30 thousand and $13 thousand, for the same periods, respectively. The compensation cost that was charged against pretax income during the
six month periods ended June 30, 2010 and June 30, 2009 for restricted stock awards was $170 thousand and $116 thousand, respectively. The total income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to
the deductible portion of this compensation cost was $60 thousand and $41 thousand, for the same periods, respectively. Forfeitures are accounted for by eliminating compensation expense for unvested shares as forfeitures occur. At June 30,
2010, based on restricted stock awards outstanding at that time, the total pretax compensation cost related to nonvested restricted stock awards granted under the restricted stock plan but not yet recognized was $1.1 million. This cost is
expected to be recognized over a remaining period through 2014. The estimation of restricted stock awards that will ultimately vest requires judgment and, to the extent actual results or updated estimates differ from current estimates, such
amounts will be recorded as a cumulative adjustment in the period estimates are revised.



18



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##### Table of Contents

At June 30, 2010, there was no intrinsic value associated with the restricted stock as the fair value
did not exceed the fair value on the date of grant. At June 30, 2010, 204,960 shares were available for issuance under the plan.

Shares
of restricted stock granted to employees under the 2008 Restricted Stock Plan are subject to prorata restrictions as to continuous employment for a specified time period following the date of grant, currently five years. During this period, the
holder is entitled to full voting rights and dividends.



|13. | Shareholders Equity and Average Share Information
|--- | --------------------------------------------------

Private Placement

On May 25, 2010,
as amended on June 8, 2010, the Company entered into a Stock Purchase Agreement and Registration Rights Agreement and Amendment No. 1 to Stock Purchase Agreement and Registration Rights Agreement (Amendment No. 1 and
together with the Stock Purchase Agreement and the Registration Rights Agreement, the Investment Agreements) with institutional investors pursuant to which the investors committed to purchase approximately $103 million of shares of the
Companys common stock at $2.60 per share (the Private Placement).

Pursuant to the Investment Agreements, the Company has
agreed to, among other things, nominate and appoint three designees of the investors to the Companys and the Banks Board of Directors. In addition, the investors will 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 current shareholders.

The Private Placement is conditioned upon, among other things, the Companys
shareholders approval of an amendment to the Companys Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock from 25,000,000 shares to 75,000,000 shares and reduce the par value of the
common stock from $5.00 per share to $0.01 per share, the Companys representations and warranties contained in the Investment Agreements being true and correct in all material respects on the closing date, and the investors receiving all
required regulatory approvals and determinations. The Investment Agreements may be terminated by the Company or an investor under certain circumstances, including that the Company or an investor, with respect to its investment, may terminate if the
closing of the Private Placement has not occurred by December 31, 2010.

The Companys annual shareholder meeting, at which time the
shareholders will vote on the proposals described above, is scheduled for August 6, 2010.

Cash Dividends

The Board of Directors has not declared or paid a dividend on our common stock since the quarter ended March 31, 2009. The Company and the Bank are
subject to regulatory policies and requirements relating to the payment of dividends. Since our total risk-based capital ratio was below the well-capitalized regulatory minimum threshold at June 30, 2010, payment of a dividend on our common
stock would have required prior notification and non-objection from the FDIC.

Average Share Information



19



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##### Table of Contents

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



|                                                                |  |                                           |  |                                         |  |           |  |          
|--------------------------------------------------------------- |  | ----------------------------------------- |  | --------------------------------------- |  | --------- |  | ---------
|                                                                |  | For the three monthperiods ended June 30, |  | For the six monthperiods ended
June 30,
|                                                                |  | 2010                                      |  | 2009                                    |  | 2010      |  | 2009     
|Weighted average common shares outstanding - basic              |  | 6,455,598                                 |  | 6,450,090                               |  | 6,455,598 |  | 6,449,383
|Dilutive impact resulting from potential common share issuances |  |                                          |  |                                        |  |          |  |         
|                                                                |  |                                           |  |                                         |  |           |  |          
|Weighted average common shares outstanding - diluted            |  | 6,455,598                                 |  | 6,450,090                               |  | 6,455,598 |  | 6,449,383
|                                                                |  |                                           |  |                                         |  |           |  |          

Basic net income (loss) per share is computed by dividing net income
(loss) available to common shareholders by the weighted average number of shares of common stock outstanding during the period. For diluted net income per share, the denominator is increased to include the number of additional common shares that
would have been outstanding if dilutive potential common shares had been issued. If dilutive, common stock equivalents are calculated for stock options and restricted stock shares using the treasury stock method. No potential common shares were
included in the computation of the diluted per share amount for the three and six month periods ended June 30, 2010 and 2009 as inclusion would be antidilutive given our net loss during the periods.



|14. | Income Taxes
|--- | ------------

During 2009, the
U.S. Congress extended the net operating loss carryback period from two years to five years for qualifying institutions. As a result of our net operating loss in 2009, the Company filed income tax refund claims and recorded receivables related to
carrybacks from 2004 through 2007 and federal and state tax refund claims for estimated taxes paid in 2009 totaling $20.9 million, all of which were received during the three month period ended March 31, 2010, reduced by $661 thousand as a
result of the filing of an amended 2009 federal income tax return in June 2010.

Our income tax receivable of $4.7 million recorded at
June 30, 2010 was primarily the result of our taxable net operating loss for the six month period ended June 30, 2010 which was carried back to 2008. 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 June 30, 2010, the Company has additional carryback capacity in 2010 to recapture up to $3.2 million of taxes paid in 2008.

As of June 30, 2010, net deferred income tax assets totaling $8.7 million are recorded in the Companys Consolidated Balance Sheet. As of that
date, we determined that $3.2 million of our net deferred income tax assets are realizable based primarily on an available refund from net operating loss carryback against income taxes previously paid in 2008, and $5.5 million is supported by tax
planning strategies and projections of future taxable income. Accordingly, no valuation allowance is recorded against net deferred income tax assets as of June 30, 2010.



|15. | Commitments, Guarantees, and Other Contingencies
|--- | ------------------------------------------------

Lending Commitments and Standby Letters of Credit

Unused lending commitments to customers are not recorded in our 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 following table summarizes the contractual amounts of our unused lending commitments relating to extension of credit with off-balance
sheet risk at June 30, 2010 (in thousands).



20



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|                                                                                        |  |   |        
|--------------------------------------------------------------------------------------- |  | - | -------
|Commitments to extend credit:                                                           |  |   |        
|Revolving, open-end lines secured by single-family residential properties               |  | $ | 49,347 
|Bankcardlines                                                                           |  |   | 40,820 
|Commercial real estate, construction, and land development loans secured by real estate |  |   |        
|Single-family residential construction loan commitments                                 |  |   | 3,370  
|Commercial real estate, other construction loan, and land development loan commitments  |  |   | 14,727 
|Other                                                                                   |  |   | 51,013 
|                                                                                        |  |   |        
|Total commitments to extend credit                                                      |  | $ | 159,277
|                                                                                        |  |   |        

Commitments to fund other loans are comprised primarily of
overdraft protection lines and lines related to commercial and industrial loans.

Standby letters of credit are issued for customers in
connection with contracts between the customers and third parties. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The maximum potential amount of undiscounted future payments
related to letters of credit was $3.3 million and $4.6 million at June 30, 2010 and December 31, 2009, respectively.

The reserve
for unfunded commitments at June 30, 2010 and December 31, 2009 was $98 thousand and $128 thousand, respectively, and is recorded in the Other liabilities financial statement line item in the Consolidated Balance Sheet.

Loan Participations

With regard to
participations sold aggregating $23.0 million at June 30, 2010 ($12.5 million of which related to gross loan balances and $10.5 million of which related to the contractual loan balances of real estate acquired in settlement of loans), we serve
as the lead bank and are 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 our duties
to the participating banks.

Derivatives

See Note 16 for further discussion regarding our off-balance sheet arrangements and commitments related to our derivative loan commitments and
freestanding derivatives.

Real Property Operating Lease Obligations

We lease certain of our office facilities and real estate related to banking services under operating leases. There has been no significant change in
future minimum lease payments payable as reported in our Annual Report on Form 10-K for the year ended December 31, 2009.

Legal
Proceedings

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



|16. | Derivative Financial Instruments and Hedging Activities
|--- | -------------------------------------------------------

At June 30, 2010 and December 31, 2009, our only derivative instruments related to our residential mortgage lending activities. We are required
to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on
the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

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



21



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At June 30, 2010, commitments to originate conforming loans totaled $7.9 million. At June 30,
2010, these derivative loan commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets, totaling $250 thousand and no negative fair values. At December 31, 2009,
commitments to originate conforming loans totaled $7.0 million. At December 31, 2009, these derivative loan commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets,
totaling $52 thousand, and negative fair values, included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $11 thousand. The net change in derivative loan commitment fair values during the three
and six month periods ended June 30, 2010 resulted in net derivative loan commitment income of $157 thousand and $209 thousand, respectively. Net derivative loan commitment income was $95 thousand for the three and six month periods ended
June 30, 2009.

Forward sales commitments totaled $9.0 million at June 30, 2010. At June 30, 2010, forward sales commitments
had no positive fair values, and negative fair values, included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $240 thousand. At December 31, 2009, forward sales commitments totaled $10.0
million. At December 31, 2009, these forward sales commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets, totaling $92 thousand, and negative fair values,
included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $1 thousand. The net change in forward sales commitment fair values during the three and six month periods ended June 30, 2010
resulted in net forward sales commitment expense of $255 thousand and $331 thousand, respectively. Net forward sales commitment income was $245 thousand for the three and six month periods ended June 30, 2009.



|17. | Disclosures Regarding Fair Value
|--- | --------------------------------

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables summarize our 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).



|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|-------------------------------------------------------- |  | ----------------- | ------ | ------- | - | ------- |  | ----- | ------ |  | - | -------
|                                                         |  | June 30, 2010    
|                                                         |  | Level 1           |        | Level 2 |   | Level 3 |  | Total
|Assets                                                   |  |                   |        |         |   |         |  |       |        |  |   |        
|Investment securities available for sale                 |  | $                 | 16,322 |         | $ | 53,983  |  | $     | 42,011 |  | $ | 112,316
|Derivative financial instruments                         |  |                   |       |         |   | 250     |  |       |       |  |   | 250    
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|Total assets measured at fair value on a recurring basis |  | $                 | 16,322 |         | $ | 54,233  |  | $     | 42,011 |  | $ | 112,566
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|                                                         |  |                   |        |        
|Liabitites                                               |  |                   |        |         |   |         |  |       |        |  |   |        
|Derivative financial instruments                         |  | $                 |       |         | $ | 240     |  | $     |       |  | $ | 240    
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|                                                         | 
|                                                         |  | December 31, 2009
|                                                         |  | Level 1           |        | Level 2 |   | Level 3 |  | Total
|Assets                                                   |  |                   |        |         |   |         |  |       |        |  |   |        
|Investment securities available for sale                 |  | $                 | 16,297 |         | $ | 63,371  |  | $     | 40,318 |  | $ | 119,986
|Derivative financial instruments                         |  |                   |       |         |   | 144     |  |       |       |  |   | 144    
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|Total assets measured at fair value on a recurring basis |  | $                 | 16,297 |         | $ | 63,515  |  | $     | 40,318 |  | $ | 120,130
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        
|                                                         |  |                   |        |        
|Liabitites                                               |  |                   |        |         |   |         |  |       |        |  |   |        
|Derivative financial instruments                         |  | $                 |       |         | $ | 12      |  | $     |       |  | $ | 12     
|                                                         |  |                   |        |         |   |         |  |       |        |  |   |        

The following tables summarize the detail of investment securities
available for sale fair value measurements from brokers or third party pricing services by level at the dates indicated (in thousands).



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|                             |  |                   |        |         |   |         |  |       |        |  |   |        
|---------------------------- |  | ----------------- | ------ | ------- | - | ------- |  | ----- | ------ |  | - | -------
|                             |  | June 30, 2010    
|                             |  | Level 1           |        | Level 2 |   | Level 3 |  | Total
|Brokers                      |  | $                 |       |         | $ |        |  | $     | 42,011 |  | $ | 42,011 
|Third party pricing services |  |                   | 16,322 |         |   | 53,983  |  |       |       |  |   | 70,305 
|                             |  |                   |        |         |   |         |  |       |        |  |   |        
|Total                        |  | $                 | 16,322 |         | $ | 53,983  |  | $     | 42,011 |  | $ | 112,316
|                             |  |                   |        |         |   |         |  |       |        |  |   |        
|                             | 
|                             |  | December 31, 2009
|                             |  | Level 1           |        | Level 2 |   | Level 3 |  | Total
|Brokers                      |  | $                 |       |         | $ |        |  | $     | 40,318 |  | $ | 40,318 
|Third party pricing services |  |                   | 16,297 |         |   | 63,371  |  |       |       |  |   | 79,668 
|                             |  |                   |        |         |   |         |  |       |        |  |   |        
|Total                        |  | $                 | 16,297 |         | $ | 63,371  |  | $     | 40,318 |  | $ | 119,986
|                             |  |                   |        |         |   |         |  |       |        |  |   |        

The following table reconciles the beginning and ending balances of
investment securities available for sale fair value measurements using significant unobservable inputs on a recurring basis at the dates and for the period indicated (in thousands).



|                                                          |  |         |        |  
|--------------------------------------------------------- |  | ------- | ------ | -
|                                                          |  | Level 3 |       
|Balance, December 31, 2009                                |  | $       | 40,318 |  
|Total gains / losses (realized / unrealized) included in: |  |         |        |  
|Net income / loss                                         |  |         | (371   | )
|Accumulated other comprehensive income                    |  |         | 54     |  
|Purchases, sales, issuances, and settlements, net         |  |         | 2,010  |  
|Transfers in and (out) of level three                     |  |         |       |  
|                                                          |  |         |        |  
|Balance, June 30, 2010                                    |  | $       | 42,011 |  
|                                                          |  |         |        |  

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The following tables summarize our assets measured at fair value on a nonrecurring basis at the dates indicated, aggregated by the level in the fair value
hierarchy within which those measurements fall (in thousands).



|                                                                  |  |                   |   |         |   |         |  |       |        |  |   |        
|----------------------------------------------------------------- |  | ----------------- | - | ------- | - | ------- |  | ----- | ------ |  | - | -------
|                                                                  |  | June 30, 2010    
|                                                                  |  | Level 1           |   | Level 2 |   | Level 3 |  | Total
|Assets                                                            |  |                   |   |         |   |         |  |       |        |  |   |        
|Impaired loans, net                                               |  | $                 |  |         | $ | 65,398  |  | $     | 26,484 |  | $ | 91,882 
|Real estate and personal property acquired in settlement of loans |  |                   |  |         |   | 13,133  |  |       | 13,494 |  |   | 26,627 
|                                                                  |  |                   |   |         |   |         |  |       |        |  |   |        
|Total assets measured at fair value on a nonrecurring basis       |  | $                 |  |         | $ | 78,531  |  | $     | 39,978 |  | $ | 118,509
|                                                                  |  |                   |   |         |   |         |  |       |        |  |   |        
|                                                                  | 
|                                                                  |  | December 31, 2009
|                                                                  |  | Level 1           |   | Level 2 |   | Level 3 |  | Total
|Assets                                                            |  |                   |   |         |   |         |  |       |        |  |   |        
|Impaired loans, net                                               |  | $                 |  |         | $ | 75,209  |  | $     | 16,377 |  | $ | 91,586 
|Real estate and personal property acquired in settlement of loans |  |                   |  |         |   | 25,522  |  |       | 2,492  |  |   | 28,014 
|                                                                  |  |                   |   |         |   |         |  |       |        |  |   |        
|Total assets measured at fair value on a nonrecurring basis       |  | $                 |  |         | $ | 100,731 |  | $     | 18,869 |  | $ | 119,600
|                                                                  |  |                   |   |         |   |         |  |       |        |  |   |        

Carrying Amounts and Estimated Fair Value of Principal Financial
Assets and Liabilities

The following table summarizes the carrying amount and fair values for other financial instruments included in our
Consolidated Balance Sheets at the dates indicated (in thousands).



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|                  |  |                |           |                   |   |                |  |            |           |  |   |          
|----------------- |  | -------------- | --------- | ----------------- | - | -------------- |  | ---------- | --------- |  | - | ---------
|                  |  | June 30, 2010  |           | December 31, 2009
|                  |  | Carryingamount |           | Fair value        |   | Carryingamount |  | Fair value
|Assets            |  |                |           |                   |   |                |  |            |           |  |   |          
|Loans, gross      |  | $              | 868,537   |                   | $ | 846,979        |  | $          | 943,476   |  | $ | 924,647  
|                  |  |                |           |                   |   |                |  |            |           |  |   |          
|Total assets      |  | $              | 868,537   |                   | $ | 846,979        |  | $          | 943,476   |  | $ | 924,647  
|                  |  |                |           |                   |   |                |  |            |           |  |   |          
|                  |  |                |           |                  
|Liabilities       |  |                |           |                   |   |                |  |            |           |  |   |          
|Deposits          |  | $              | 1,191,375 |                   | $ | 1,183,474      |  | $          | 1,214,914 |  | $ | 1,206,857
|FHLB borrowings   |  |                | 96,000    |                   |   | 95,692         |  |            | 101,000   |  |   | 100,119  
|                  |  |                |           |                   |   |                |  |            |           |  |   |          
|Total liabilities |  | $              | 1,287,375 |                   | $ | 1,279,166      |  | $          | 1,315,914 |  | $ | 1,306,976
|                  |  |                |           |                   |   |                |  |            |           |  |   |          



|18. | Regulatory 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).
Although our Tier 1 leverage ratio and Tier 1 risk-based capital ratio were above the well-capitalized regulatory minimum threshold of 5% and 6%, respectively, at December 31, 2009, these ratios are in the adequately-capitalized category at
June 30, 2010. Our total risk-based capital ratio was below the well-capitalized regulatory minimum threshold of 10% at June 30, 2010 and December 31, 2009. As a result, we were classified in the undercapitalized category at
June 30, 2010 and the adequately-capitalized category at December 31, 2009.

Since June 30, 2010, no conditions or events have
occurred, of which we are aware, that have resulted in a material change in the Companys or the Banks category other than as reported in this Quarterly Report on Form 10-Q.



|                                       |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|-------------------------------------- |  | ------ | ------ | ----- | ---------------------------- | - | ------ | ----------------------------------------------------------------- | ------ |  | ---- | ------ |  | ----- | ------- |  | ----- | -
|                                       |  | Actual |        |       | For capital adequacypurposes |   |        | To be well capitalized 
underprompt corrective actionprovisions |       
|                                       |  | amount |        | ratio |                              |   | amount |                                                                   | ratio  |  |      | amount |  | ratio |        
|At June 30, 2010                       |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Total capital to risk-weighted assets  |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  | $      | 72,050 |       | 7.08                         | % |        | $                                                                 | 81,375 |  | 8.00 | %      |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 72,931 |       | 7.17                         |   |        |                                                                   | 81,420 |  | 8.00 |        |  | $     | 101,775 |  | 10.00 | %
|Tier 1 capital to risk-weighted assets |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  |        | 59,141 |       | 5.81                         |   |        |                                                                   | 40,687 |  | 4.00 |        |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 60,015 |       | 5.90                         |   |        |                                                                   | 40,710 |  | 4.00 |        |  |       | 61,065  |  | 6.00  |  
|Tier 1 leverage ratio                  |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  |        | 59,141 |       | 4.34                         |   |        |                                                                   | 54,505 |  | 4.00 |        |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 60,015 |       | 4.40                         |   |        |                                                                   | 54,597 |  | 4.00 |        |  |       | 68,246  |  | 5.00  |  
|At December 31, 2009                   |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Total capital to risk-weighted assets  |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  | $      | 93,298 |       | 8.25                         | % |        | $                                                                 | 90,426 |  | 8.00 | %      |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 93,013 |       | 8.22                         |   |        |                                                                   | 90,518 |  | 8.00 |        |  | $     | 113,147 |  | 10.00 | %
|Tier 1 capital to risk-weighted assets |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  |        | 79,046 |       | 6.99                         |   |        |                                                                   | 45,213 |  | 4.00 |        |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 78,745 |       | 6.96                         |   |        |                                                                   | 45,259 |  | 4.00 |        |  |       | 67,888  |  | 6.00  |  
|Tier 1 leverage ratio                  |  |        |        |       |                              |   |        |                                                                   |        |  |      |        |  |       |         |  |       |  
|Company                                |  |        | 79,046 |       | 5.55                         |   |        |                                                                   | 56,951 |  | 4.00 |        |  |       | n/a     |  | n/a   |  
|Bank                                   |  |        | 78,745 |       | 5.52                         |   |        |                                                                   | 57,042 |  | 4.00 |        |  |       | 71,302  |  | 5.00  |  

Private Placement

As disclosed in Note 13, on May 25, 2010, as amended on June 8, 2010, the Company entered into Investment Agreements with
institutional investors, pursuant to which the investors committed to purchase approximately $103 million of shares of the Companys common stock. The net proceeds of the Private Placement, after estimated direct expenses of $8.5 million,
are expected to be approximately $94.5 million of which approximately $1.5 million will be retained by the Company and approximately $93.0 million will be contributed to the Bank as a capital contribution. Successful completion of the
Private Placement will result in the Companys and the Banks capital levels being above the amounts necessary to be categorized as well-capitalized.



24



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Recent Regulatory Developments

The Company and the Bank are subject to periodic examination by various regulatory agencies. In November 2009, the FDIC and the South Carolina State Board
of Financial Institutions (the State Board) conducted their annual joint examination of the Bank. Beginning in October 2009, the Companys Board of Directors and the Regulatory Oversight Committee of the Board of Directors met
periodically with these regulatory agencies to receive status reports on their examination, and the Board received the final report of examination in April 2010. Effective June 10, 2010, the Bank agreed to the issuance of a Consent Order with
the FDIC and the State Board (the 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
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



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##### Table of Contents

| | Bank, the major areas in and means by which the Bank will seek to improve the Banks operating performance, realistic and comprehensive budgets, a budget review process to monitor income and
expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Banks loan,
investment, and operating policies and budget and profit planning with the funds management policy;
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | 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 we operate were considered high-rate areas. Accordingly, the Bank is able to offer
interest rates on deposits up to 75 basis points over the prevailing interest rates in our geographic areas; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

The Company intends to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof we
have 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 our compliance will be
made by the FDIC and the State Board. However, we believe we are currently in compliance with all provisions of the Consent Order except for the requirements to raise additional capital and to reduce our criticized assets by the specified
percentages by certain dates, with the first date being December 6, 2010. 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.



26



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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 factors impacting our financial condition as of June 30, 2010 and results of operations and cash flows
for the three and six month periods ended June 30, 2010. This discussion should be read in conjunction with our Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q and our Consolidated
Financial Statements and the notes thereto for the year ended December 31, 2009 included in our Annual Report on Form 10-K for that period. Results for the three and six month periods ended June 30, 2010 are not necessarily indicative of
the results for the year ending December 31, 2010 or any future period. Percentage calculations contained herein have been calculated based on actual not rounded results presented herein.

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 efforts to raise capital or otherwise increase our regulatory capital ratios,
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Risks and uncertainties associated with the closing of our private placement, including the risk that we are unable to consummate the private
placement,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Our ability to 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 the 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,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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,
| | - |  | ------------------------------------------------------------------------------



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



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



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



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



| |  |  | Changes in monetary and tax policies,
| | - |  | -------------------------------------



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



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



27



---

##### Table of Contents

| |  |  | Our reliance on available secondary funding sources such as FHLB advances, Federal Reserve Discount Window borrowings, sales of securities and loans,
and federal funds lines of credit from correspondent banks to meet our liquidity needs,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



| |  |  | Other risks and uncertainties detailed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, in Part II,
Item 1A of 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 recent developments in 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 continue to impact the Company in 2010. There can be no assurance that these unprecedented developments will not continue to materially and adversely impact our business, financial condition, and results of
operations, as well as our ability to raise 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.



28



---

##### Table of Contents

Selected Financial Data

The following consolidated 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).



|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|--------------------------------------------------------------------- |  | ---------------------------------------- | --------- | --- | ---------------------------------------- | - | --------- | --- |  |  |  | ------------------------------------------ |  | - | ------------------------------------------- | --- |  | ---------------------------------------------- | --------- | --- | ----------------------------------------------- | - | --------- | ------------------------------------------ |  | - | --------------------------------- | --- |  | - | --------- | --- |  | - | --------- | ---
|                                                                      |  | For the sixmonthperiod endedJune 30,2010 |           |     | For the sixmonthperiod endedJune 30,2009 |   |           |     |  |  |  | For the threemonthperiod endedJune 30,2010 |  |   | For the threemonthperiod endedMarch 31,2010 |     |  | For the
threemonthperiod endedDecember 31,2009 |           |     | For the
threemonthperiod endedSeptember 30,2009 |   |           | For the threemonthperiod endedJune 30,2009 |  |   | For the yearendedDecember 31,2009 |    
|STATEMENTS OF INCOME (LOSS)                                           |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Interest income                                                       |  | $                                        | 29,329    |     |                                          | $ | 33,456    |     |  |  |  |                                            |  | $ | 14,450                                      |     |  | $                                              | 14,879    |     |                                                 | $ | 15,708    |                                            |  | $ | 17,046                            |     |  | $ | 15,890    |     |  | $ | 66,210    |    
|Interest expense                                                      |  |                                          | 7,796     |     |                                          |   | 10,810    |     |  |  |  |                                            |  |   | 3,716                                       |     |  |                                                | 4,080     |     |                                                 |   | 5,099     |                                            |  |   | 5,530                             |     |  |   | 5,622     |     |  |   | 21,439    |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Net interest income                                                   |  |                                          | 21,533    |     |                                          |   | 22,646    |     |  |  |  |                                            |  |   | 10,734                                      |     |  |                                                | 10,799    |     |                                                 |   | 10,609    |                                            |  |   | 11,516                            |     |  |   | 10,268    |     |  |   | 44,771    |    
|Provision for loan losses                                             |  |                                          | 23,500    |     |                                          |   | 32,175    |     |  |  |  |                                            |  |   | 12,750                                      |     |  |                                                | 10,750    |     |                                                 |   | 17,225    |                                            |  |   | 24,000                            |     |  |   | 30,000    |     |  |   | 73,400    |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Net interest income (loss) after provision for loan losses            |  |                                          | (1,967    | )   |                                          |   | (9,529    | )   |  |  |  |                                            |  |   | (2,016                                      | )   |  |                                                | 49        |     |                                                 |   | (6,616    | )                                          |  |   | (12,484                           | )   |  |   | (19,732   | )   |  |   | (28,629   | )  
|Noninterest income                                                    |  |                                          | 9,001     |     |                                          |   | 9,534     |     |  |  |  |                                            |  |   | 4,061                                       |     |  |                                                | 4,940     |     |                                                 |   | 4,625     |                                            |  |   | 4,543                             |     |  |   | 5,103     |     |  |   | 18,702    |    
|Noninterest expense                                                   |  |                                          | 28,694    |     |                                          |   | 24,660    |     |  |  |  |                                            |  |   | 15,371                                      |     |  |                                                | 13,323    |     |                                                 |   | 13,628    |                                            |  |   | 13,998                            |     |  |   | 13,143    |     |  |   | 52,286    |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Net loss before benefit for income taxes                              |  |                                          | (21,660   | )   |                                          |   | (24,655   | )   |  |  |  |                                            |  |   | (13,326                                     | )   |  |                                                | (8,334    | )   |                                                 |   | (15,619   | )                                          |  |   | (21,939                           | )   |  |   | (27,772   | )   |  |   | (62,213   | )  
|Benefit for income taxes                                              |  |                                          | (7,835    | )   |                                          |   | (8,798    | )   |  |  |  |                                            |  |   | (4,793                                      | )   |  |                                                | (3,042    | )   |                                                 |   | (5,566    | )                                          |  |   | (7,764                            | )   |  |   | (9,921    | )   |  |   | (22,128   | )  
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Net loss                                                              |  | $                                        | (13,825   | )   |                                          | $ | (15,857   | )   |  |  |  |                                            |  | $ | (8,533                                      | )   |  | $                                              | (5,292    | )   |                                                 | $ | (10,053   | )                                          |  | $ | (14,175                           | )   |  | $ | (17,851   | )   |  | $ | (40,085   | )  
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|COMMON AND PER SHARE DATA                                             |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Net loss per common share:                                            |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Basic                                                                 |  | $                                        | (2.14     | )   |                                          | $ | (2.46     | )   |  |  |  |                                            |  | $ | (1.32                                       | )   |  | $                                              | (0.82     | )   |                                                 | $ | (1.55     | )                                          |  | $ | (2.20                             | )   |  | $ | (2.77     | )   |  | $ | (6.21     | )  
|Diluted                                                               |  |                                          | (2.14     | )   |                                          |   | (2.46     | )   |  |  |  |                                            |  |   | (1.32                                       | )   |  |                                                | (0.82     | )   |                                                 |   | (1.55     | )                                          |  |   | (2.20                             | )   |  |   | (2.77     | )   |  |   | (6.21     | )  
|Cash dividends per common share                                       |  |                                          |          |     |                                          |   |          |     |  |  |  |                                            |  |   |                                            |     |  |                                                |          |     |                                                 |   |          |                                            |  |   |                                  |     |  |   |          |     |  |   | 0.06      |    
|Book value per common share                                           |  |                                          | 9.64      |     |                                          |   | 15.45     |     |  |  |  |                                            |  |   | 9.64                                        |     |  |                                                | 10.93     |     |                                                 |   | 11.55     |                                            |  |   | 13.63                             |     |  |   | 15.45     |     |  |   | 11.55     |    
|Outstanding common shares                                             |  |                                          | 6,495,130 |     |                                          |   | 6,477,630 |     |  |  |  |                                            |  |   | 6,495,130                                   |     |  |                                                | 6,495,130 |     |                                                 |   | 6,495,130 |                                            |  |   | 6,477,630                         |     |  |   | 6,477,630 |     |  |   | 6,495,130 |    
|Weighted average common shares outstanding - basic                    |  |                                          | 6,455,598 |     |                                          |   | 6,449,383 |     |  |  |  |                                            |  |   | 6,455,598                                   |     |  |                                                | 6,455,598 |     |                                                 |   | 6,450,150 |                                            |  |   | 6,450,090                         |     |  |   | 6,450,090 |     |  |   | 6,449,754 |    
|Weighted average common shares outstanding - diluted                  |  |                                          | 6,455,598 |     |                                          |   | 6,449,383 |     |  |  |  |                                            |  |   | 6,455,598                                   |     |  |                                                | 6,455,598 |     |                                                 |   | 6,450,150 |                                            |  |   | 6,450,090                         |     |  |   | 6,450,090 |     |  |   | 6,449,754 |    
|Dividend payout ratio                                                 |  |                                          | n/a       | %   |                                          |   | (2.45     | ) % |  |  |  |                                            |  |   | n/a                                         | %   |  |                                                | n/a       | %   |                                                 |   | n/a       | %                                          |  |   | n/a                               | %   |  |   | n/a       | %   |  |   | n/a       | %  
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|PERIOD-END BALANCES                                                   |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Assets                                                                |  | $                                        | 1,387,921 |     |                                          | $ | 1,465,529 |     |  |  |  |                                            |  | $ | 1,387,921                                   |     |  | $                                              | 1,348,463 |     |                                                 | $ | 1,435,950 |                                            |  | $ | 1,425,455                         |     |  | $ | 1,465,529 |     |  | $ | 1,435,950 |    
|Investment securities available for sale, at fair value               |  |                                          | 112,316   |     |                                          |   | 113,347   |     |  |  |  |                                            |  |   | 112,316                                     |     |  |                                                | 115,893   |     |                                                 |   | 119,986   |                                            |  |   | 121,027                           |     |  |   | 113,347   |     |  |   | 119,986   |    
|Total loans                                                           |  |                                          | 969,142   |     |                                          |   | 1,138,832 |     |  |  |  |                                            |  |   | 969,142                                     |     |  |                                                | 1,011,368 |     |                                                 |   | 1,044,196 |                                            |  |   | 1,082,313                         |     |  |   | 1,138,832 |     |  |   | 1,044,196 |    
|Deposits (including traditional and nontraditional)                   |  |                                          | 1,216,049 |     |                                          |   | 1,275,744 |     |  |  |  |                                            |  |   | 1,216,049                                   |     |  |                                                | 1,168,978 |     |                                                 |   | 1,249,520 |                                            |  |   | 1,247,850                         |     |  |   | 1,275,744 |     |  |   | 1,249,520 |    
|FHLB borrowings                                                       |  |                                          | 96,000    |     |                                          |   | 82,000    |     |  |  |  |                                            |  |   | 96,000                                      |     |  |                                                | 96,000    |     |                                                 |   | 101,000   |                                            |  |   | 82,000                            |     |  |   | 82,000    |     |  |   | 101,000   |    
|Convertible debt                                                      |  |                                          | 380       |     |                                          |   |          |     |  |  |  |                                            |  |   | 380                                         |     |  |                                                | 380       |     |                                                 |   |          |                                            |  |   |                                  |     |  |   |          |     |  |   |          |    
|Shareholders equity                                                  |  |                                          | 62,643    |     |                                          |   | 100,088   |     |  |  |  |                                            |  |   | 62,643                                      |     |  |                                                | 70,978    |     |                                                 |   | 75,015    |                                            |  |   | 88,266                            |     |  |   | 100,088   |     |  |   | 75,015    |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|AVERAGE BALANCES                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Assets                                                                |  | $                                        | 1,370,438 |     |                                          | $ | 1,414,629 |     |  |  |  |                                            |  | $ | 1,372,608                                   |     |  | $                                              | 1,368,244 |     |                                                 | $ | 1,431,639 |                                            |  | $ | 1,462,846                         |     |  | $ | 1,441,610 |     |  | $ | 1,430,271 |    
|Interest-earning assets                                               |  |                                          | 1,293,718 |     |                                          |   | 1,356,912 |     |  |  |  |                                            |  |   | 1,304,274                                   |     |  |                                                | 1,283,045 |     |                                                 |   | 1,332,232 |                                            |  |   | 1,385,232                         |     |  |   | 1,386,300 |     |  |   | 1,352,956 |    
|Investment securities available for sale, at fair value               |  |                                          | 116,481   |     |                                          |   | 120,505   |     |  |  |  |                                            |  |   | 115,274                                     |     |  |                                                | 117,702   |     |                                                 |   | 120,606   |                                            |  |   | 115,377                           |     |  |   | 117,532   |     |  |   | 119,238   |    
|Total loans                                                           |  |                                          | 1,013,061 |     |                                          |   | 1,163,551 |     |  |  |  |                                            |  |   | 994,587                                     |     |  |                                                | 1,031,740 |     |                                                 |   | 1,070,390 |                                            |  |   | 1,126,812                         |     |  |   | 1,162,453 |     |  |   | 1,130,809 |    
|Deposits (including traditional and nontraditional)                   |  |                                          | 1,187,044 |     |                                          |   | 1,204,990 |     |  |  |  |                                            |  |   | 1,192,535                                   |     |  |                                                | 1,181,492 |     |                                                 |   | 1,248,568 |                                            |  |   | 1,270,659                         |     |  |   | 1,255,242 |     |  |   | 1,232,526 |    
|Other short-term borrowings                                           |  |                                          | 1         |     |                                          |   | 9,997     |     |  |  |  |                                            |  |   |                                            |     |  |                                                | 2         |     |                                                 |   | 112       |                                            |  |   | 1,386                             |     |  |   | 6,605     |     |  |   | 15,447    |    
|FHLB borrowings                                                       |  |                                          | 97,822    |     |                                          |   | 73,220    |     |  |  |  |                                            |  |   | 95,998                                      |     |  |                                                | 99,666    |     |                                                 |   | 84,063    |                                            |  |   | 82,000                            |     |  |   | 53,647    |     |  |   | 68,054    |    
|Convertible debt                                                      |  |                                          | 193       |     |                                          |   |          |     |  |  |  |                                            |  |   | 380                                         |     |  |                                                | 4         |     |                                                 |   |          |                                            |  |   |                                  |     |  |   |          |     |  |   |          |    
|Shareholders equity                                                  |  |                                          | 73,660    |     |                                          |   | 118,411   |     |  |  |  |                                            |  |   | 70,705                                      |     |  |                                                | 76,648    |     |                                                 |   | 88,879    |                                            |  |   | 102,298                           |     |  |   | 118,922   |     |  |   | 106,906   |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|SELECT PERFORMANCE RATIOS                                             |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Return on average assets                                              |  |                                          | (2.03     | ) % |                                          |   | (2.26     | ) % |  |  |  |                                            |  |   | (2.49                                       | ) % |  |                                                | (1.57     | ) % |                                                 |   | (2.79     | ) %                                        |  |   | (3.84                             | ) % |  |   | (4.97     | ) % |  |   | (2.80     | ) %
|Return on average shareholders equity                                |  |                                          | (37.85    | )   |                                          |   | (27.00    | )   |  |  |  |                                            |  |   | (48.41                                      | )   |  |                                                | (28.00    | )   |                                                 |   | (44.87    | )                                          |  |   | (54.97                            | )   |  |   | (60.21    | )   |  |   | (37.50    | )  
|Net interest margin                                                   |  |                                          | 3.36      |     |                                          |   | 3.37      |     |  |  |  |                                            |  |   | 3.30                                        |     |  |                                                | 3.41      |     |                                                 |   | 3.16      |                                            |  |   | 3.30                              |     |  |   | 2.97      |     |  |   | 3.31      |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|CAPITAL RATIOS                                                        |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Average shareholders equity as a percentage of average assets        |  |                                          | 5.37      | %   |                                          |   | 8.37      | %   |  |  |  |                                            |  |   | 5.15                                        | %   |  |                                                | 5.60      | %   |                                                 |   | 6.21      | %                                          |  |   | 6.99                              | %   |  |   | 8.25      | %   |  |   | 7.47      | %  
|Shareholders equity as a percentage of assets, at period end         |  |                                          | 4.51      |     |                                          |   | 6.83      |     |  |  |  |                                            |  |   | 4.51                                        |     |  |                                                | 5.26      |     |                                                 |   | 5.22      |                                            |  |   | 6.19                              |     |  |   | 6.83      |     |  |   | 5.22      |    
|Tier 1 risk-based capital                                             |  |                                          | 5.81      |     |                                          |   | 8.46      |     |  |  |  |                                            |  |   | 5.81                                        |     |  |                                                | 6.82      |     |                                                 |   | 6.99      |                                            |  |   | 7.50                              |     |  |   | 8.46      |     |  |   | 6.99      |    
|Total risk-based capital                                              |  |                                          | 7.08      |     |                                          |   | 9.71      |     |  |  |  |                                            |  |   | 7.08                                        |     |  |                                                | 8.09      |     |                                                 |   | 8.25      |                                            |  |   | 8.76                              |     |  |   | 9.71      |     |  |   | 8.25      |    
|Tier 1 leverage ratio                                                 |  |                                          | 4.34      |     |                                          |   | 7.17      |     |  |  |  |                                            |  |   | 4.34                                        |     |  |                                                | 5.30      |     |                                                 |   | 5.55      |                                            |  |   | 5.99                              |     |  |   | 7.17      |     |  |   | 5.55      |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|ASSET QUALITY INFORMATION                                             |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    
|Allowance for loan losses                                             |  | $                                        | 28,383    |     |                                          | $ | 21,965    |     |  |  |  |                                            |  | $ | 28,383                                      |     |  | $                                              | 28,426    |     |                                                 | $ | 24,079    |                                            |  | $ | 22,548                            |     |  | $ | 21,965    |     |  | $ | 24,079    |    
|Nonaccrual loans                                                      |  |                                          | 91,653    |     |                                          |   | 95,549    |     |  |  |  |                                            |  |   | 91,653                                      |     |  |                                                | 113,181   |     |                                                 |   | 96,936    |                                            |  |   | 92,532                            |     |  |   | 95,549    |     |  |   | 96,936    |    
|Nonperforming assets                                                  |  |                                          | 118,280   |     |                                          |   | 113,413   |     |  |  |  |                                            |  |   | 118,280                                     |     |  |                                                | 142,161   |     |                                                 |   | 124,950   |                                            |  |   | 120,297                           |     |  |   | 113,413   |     |  |   | 124,950   |    
|Net loans charged-off                                                 |  |                                          | 19,196    |     |                                          |   | 21,210    |     |  |  |  |                                            |  |   | 12,793                                      |     |  |                                                | 6,403     |     |                                                 |   | 15,694    |                                            |  |   | 23,417                            |     |  |   | 20,641    |     |  |   | 60,321    |    
|Allowance for loan losses as a percentage of gross loans              |  |                                          | 2.93      | %   |                                          |   | 1.95      | %   |  |  |  |                                            |  |   | 2.93                                        | %   |  |                                                | 2.81      | %   |                                                 |   | 2.31      | %                                          |  |   | 2.09                              | %   |  |   | 1.95      | %   |  |   | 2.31      | %  
|Nonaccrual loans as a percentage of gross loans and foreclosed assets |  |                                          | 9.22      |     |                                          |   | 8.35      |     |  |  |  |                                            |  |   | 9.22                                        |     |  |                                                | 10.89     |     |                                                 |   | 9.07      |                                            |  |   | 8.35                              |     |  |   | 8.35      |     |  |   | 9.07      |    
|Nonperforming assets as a percentage of assets                        |  |                                          | 8.52      |     |                                          |   | 7.74      |     |  |  |  |                                            |  |   | 8.52                                        |     |  |                                                | 10.54     |     |                                                 |   | 8.70      |                                            |  |   | 8.44                              |     |  |   | 7.74      |     |  |   | 8.70      |    
|Net loans charged-off as a percentage of average gross loans          |  |                                          | 3.83      |     |                                          |   | 3.70      |     |  |  |  |                                            |  |   | 5.17                                        |     |  |                                                | 2.53      |     |                                                 |   | 5.83      |                                            |  |   | 8.28                              |     |  |   | 7.18      |     |  |   | 5.36      |    
|                                                                      |  |                                          |           |     |                                          |   |           |     |  |  |  |                                            |  |   |                                             |     |  |                                                |           |     |                                                 |   |           |                                            |  |   |                                   |     |  |   |           |     |  |   |           |    



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Executive Summary of Second Quarter 2010 Financial Results

Context for the Three Month Period Ended June 30, 2010 and the Company

2009 was a very challenging year for the Company, the banking industry, and the U.S. economy in general, and these challenges have continued into 2010. In
relation to the Company, the overall economic context for our financial condition and results of operations include the following:



| |  |  | Ongoing financial crisis in the overall U.S. economy that generally started in August 2008 and continued in 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 with significant financial assistance to many financial institutions, extensive regulatory and congressional
scrutiny, and new regulatory rules and requirements.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 the government intervention in the financial markets, with current expectations of
rising interest rates although the timing is uncertain.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Additional context specific to the Company includes the following:



| |  |  | Fast growth from 2004 through the first quarter of 2009 growing total assets 57% during that period that 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 development of broader distribution channels for delivery of our products and services.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | In planning for the retirement of the former Chief Executive Officer of the Company and the Chief Executive Officer of the Bank (who also served as the
President, Chief Operating Officer, and Chief Accounting Officer of the Company), the Company hired Samuel L. Erwin in March 2009 and Lee. S. Dixon in May 2009 as senior executive vice presidents. Effective July 1, 2009, the Company named
Mr. Erwin as Chief Executive Officer and President of the Bank and Mr. 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, subject to regulatory approval, will also assume the role of Chief Financial Officer as of
July 1, 2010.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Messrs. Erwin and Dixon have proven bank turn around and operational capabilities and rapidly developed and implemented the Companys Strategic
Project Plan in June 2009 as summarized below.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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. We also incurred a net loss in the first and second quarters of 2010.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increased regulatory scrutiny given declining asset quality, financial results and capital position, which resulted in the Bank entering into a Consent
Order with the banking regulatory agencies in June 2010.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | 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 higher priced certificates of deposit accounts used to fund the loan growth during that period. Gross loans have decreased $189.1 million from
March 31, 2009 to June 30, 2010. Total traditional and nontraditional deposits increased $3.4 million over the same period through various certificate of deposit and transaction deposit campaigns designed to attract and retain lower
priced deposit accounts.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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                                             |  | June 2009  June 2010
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                           
|2010 Annual Strategic Plan |  |       Strategic planning at the corporate and department
level for calendar year 2010 in the context of the uncertain economic environment 
      Acceleration of overcoming the growth hump/life cycle stage of maturity
resulting from fast growth reaching a high of $1.5 billion in assets 
      Positioning the Bank to return to profitability in the post-recession
environment |  | Calendar year 2010   
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                           
|Bank of the Future         |  |       Reinventing the Bank to be the bank of the
future 
      Determining the customer of tomorrow and refining our
products, services, and distributions channels to meet their expectations 
      Adapting to the rapidly changing financial services
landscape 
      Potential listing on the NASDAQ stock exchange                                                          |  | Two to five years    

We believe it is critical to focus on all
three strategic initiatives simultaneously to optimize long-term shareholder value. As a result, management and the Board of Directors focused a tremendous amount of time and effort on addressing all three initiatives in 2009 and continuing into
2010 with the overall objectives being: 1) to aggressively deal with our credit quality and earnings 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 many believe the recession officially ended in 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.

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. Unemployment in
South Carolina rose significantly throughout 2009 and into 2010 and is higher than the national average, and residential and commercial real estate projects are depressed with significant deterioration in values. As a result, the impact in our
geographic area and to individual borrowers was severe. As a result of the extended recession, our financial results in the second quarters of 2009 and 2010 were significantly impacted by the following in comparison to our historical financial
results in the second quarter of 2008:



| |  |  | Provision for loan losses totaling $12.8 million and $30.0 million, respectively, in 2010 and 2009 compared to $687 thousand for 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Net loss from writedowns, expenses, operations, and sales of real estate acquired in settlement of loans totaling $2.6 million and $45 thousand in 2010
and 2009, respectively, compared to $38 thousand in 2008.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Foregone interest of $1.1 million and $940 thousand 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 2.74 and 5.05%, respectively.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Higher FDIC insurance premiums due to industry wide increases in general assessment rates, our voluntary participation in the FDICs Transaction
Account Guarantee Program, our capital classification below well-capitalized, and the 2009 special assessment totaling $981 thousand and $1.4 million, respectively, in 2010 and 2009, compared to $183 thousand in 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

In total, the above reduced our earnings by approximately $16.5 million and $31.4 million for the
three month periods ended June 30, 2010 and 2009, respectively, compared to the same period of 2008. Accordingly, management believes successful completion of the Strategic Project Plan will result in significant improvement to our earnings.

The credit-related costs for banks associated with the recession are significant. Beginning in the fourth quarter of 2008 and continuing into
2010, we recognized that construction, acquisition and development real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing. During 2009, 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 manifested itself in our borrowers in several ways: the cash flows from underlying properties supporting the
loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties), cash flows from the borrowers themselves and guarantors were under pressure due to illiquid and diminished
personal balance sheets resulting from investing additional personal capital in the projects, and fair values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers
were no longer willing to sell the assets at such deep discounts.

The result of the above was a significant increase in the level of
nonperforming assets through March 31, 2010, with a continued elevated level of such assets at June 30, 2010. In addition, many of these loans are collateral dependent real estate loans for which we are required to write down the loans to
fair value less estimated costs to sell with the fair values determined primarily based on third party appraisals. During 2009 and continuing into 2010, appraised values decreased significantly even in comparison to appraisals received within the
past 12 to 48 months. As a result, our evaluation of our loan portfolio and allowance for loan losses at June 30, 2010 resulted in net charge-offs of $12.8 million and a provision for loan losses of $12.8 million during the three month period
ended June 30, 2010.

Recent Regulatory Developments

As a result of the above and the examination of the Bank by the FDIC and the State Board (collectively, the Supervisory Authorities) in
November 2009, effective June 10, 2010, the Bank agreed to the issuance of a Consent Order with the Supervisory Authorities. Beginning in October 2009, the Board of Directors and a newly created committee of the Board of Directors, the
Regulatory Oversight Committee, met periodically with these regulatory agencies to receive status reports on their examination, and the Board received the final report of examination in April 2010 and the Consent Order in June 2010. A summary of the
requirements of the Consent Order and the Banks status on complying with the Consent Order is as follows:



|                                                                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                   |  | Banks Compliance
Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Achieve and maintain, within 120 days from the effective date of the Consent Order, Total
Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. |  | As disclosed in more detail in this report, on May 25, 2010 and amended on June 8,
2010, the Company entered into a Stock Purchase Agreement with institutional investors pursuant to which the investors agreed to purchase approximately $103 million of shares of the Companys common stock. Substantially all of the net proceeds
of the Private Placement will be contributed to the Bank as a capital contribution. Successful completion of the Private Placement will result in the Companys and the Banks capital levels being above the amounts necessary to be
categorized as well-capitalized.



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|                                                                                                                                                                                                                                                                                                                                             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Determine, within 30 days of the last day of the calendar quarter,its capital ratios. If any capital measure falls
below the establishedminimum, within 30 days provide a written plan to the supervisoryauthorities describing the means and timing by which the Bankshall increase such ratios to or in excess of the establishedminimums. |  | At June 30, 2010, the Banks capital ratios were
below theestablished minimum and we have submitted a written plan tothe Supervisory Authorities describing our capital plan,including the Private Placement summarized above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                             | 
|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 have prepared a written analysis and assessment of the Banks management and
staffing needs and have submitted the plan to the Supervisory Authorities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                             | 
|Notify the supervisory authorities in writing of the
resignation or termination of any of the Banks directors or senior executive officers.                                                                                                                                                                                                 |  | Effective June 30, 2010, Lauren S. Greer transitioned from her role as Chief Financial
Officer of the Bank to the Director of Finance and Accounting. We have notified the Supervisory Authorities, and subject to their approval, effective July 1, 2010, Lee S. Dixon, our current Chief Operating Officer and Chief Risk Officer, will assume
the responsibilities as the Chief Financial Officer. Mr. Dixon has substantial banking, regulatory, financial reporting, and risk management expertise from his 22 years of business experience, including as a partner in the Banking and Capital
Markets practice of PricewaterhouseCoopers LLP, and has worked with banking clients ranging from small community banks to some of the largest national banks.
|                                                                                                                                                                                                                                                                                                                                             | 
|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.                                                                                                                                       |  | At June 30, 2010, we have complied with this provision and no additional reductions were
required by 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.                                                  |  | As part of our Strategic Project Plan summarized below, in 2009 we reviewed and updated
our policy in June and October to ensure the adequacy of the allowance for loan losses, including a review of the allowance for loan losses each calendar quarter. We have continued to refine our policy in 2010. We have submitted the revised policy
to the Supervisory Authorities.                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                             | 
|Submit, within 60 days from the effective date of the
Consent Order, a written plan to reduce classified assets, which shall include, among other things, a reduction of the Banks risk exposure in relationships with assets in excess of $1,000,000 which are criticized as Substandard,
Doubtful, or Special Mention.              |  | As part of our Strategic Project Plan summarized below, we have developed written loan
workout plans to reduce classified assets, and we have submitted our plan to the Supervisory Authorities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                             | 
|Revise, within 60 days from the effective date of the
Consent Order, its policies and procedures for managing the Banks Adversely Classified Other Real Estate Owned.                                                                                                                                                                       |  | As part of our Strategic Project Plan summarized below, we have revised our policies and
procedures for managing our real estate acquired in foreclosure, and we have submitted our policies and procedures to the Supervisory Authorities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Not extend any additional credit to any borrower who has a loan orother extension of credit from the Bank that has been
charged offor classified, in whole or in part, Loss or Doubtful and isuncollected. In addition, the Bank may not extend any additionalcredit to any borrower who has a loan or other extension of creditfrom the
Bank that has been criticized, in whole or in part,Substandard or Special Mention and is uncollected, unless theBanks board of directors determines that failure to extend furthercredit to a particular
borrower would be detrimental to the bestinterests of the Bank.                                                                                                                                                                                                                                             |  | We believe we are in compliance with this provision of
theConsent 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.                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review, within 60 days from the effective date of the
Consent Order and annually thereafter, the Banks loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Banks lending functions and
ensure their implementation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed our
loan policies and procedures for adequacy and made appropriate revisions to enhance our lending and Credit Administration functions. We have continued to refine our policies and procedures in 2010. We have submitted the revised policy to the
Supervisory Authorities.                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Adopt, within 60 days from the effective date of the Consent
Order, an effective internal loan review and grading system to provide for the periodic review of the Banks loan portfolio in order to identify and categorize the Banks loans, and other extensions of credit which are carried on the
Banks books as loans, on the basis of credit quality.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed our
loan review and grading system to provide for the periodic review of our loan portfolio to review and categorize our loans. As described in more detail elsewhere in this report, we have conducted internal and external loan reviews in 2009 and 2010.
We have submitted the revised policy to the Supervisory Authorities.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|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. |  | In 2009 we prepared an annual 2010 budget that was approved by the Banks Board of
Directors. We have updated our 2010 budget based on actual results through June 30, 2010 and projections for the remainder of the year.                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review and update, within 60 days from the effective date of
the Consent Order, its written plan addressing liquidity, contingent funding, and asset liability management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed and
updated our written Asset Liability and Investments Plan, and we have submitted the plan to the Supervisory Authorities.                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Eliminate, within 30 days from the effective date
of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | At June 30, 2010, we had eliminated all matters set                                                                                                                                                                                                                                                                                                                                                                   



34



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##### Table of Contents

|                                                                                                                                                                                                                                                                                          |  |                                                                                                                                                                                                                                                                                                                                                                                   
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|the Consent Order, all violations of law and regulation orcontraventions of policy set forth in the FDICs safety
andsoundness examination of the Bank in November 2009.                                                                                                                  |  | forth in the FDICs safety and soundness examination of
theBank 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 June 30, 2010, the Bank did not have any brokered
deposits.                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                          | 
|Limit asset growth to 10% per annum.                                                                                                                                                                                                                                                      |  | We believe we are in compliance 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 are in compliance 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 are in compliance with this provision of the Consent Order. On April 1,
2010, we were notified by the FDIC that it had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, the Bank is able to offer interest rates on deposits up to 75 basis points over the prevailing
interest rates in our geographic areas.
|                                                                                                                                                                                                                                                                                          | 
|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 are in compliance with this provision of the Consent Order, and we have
submitted the required progress report to the Supervisory Authorities.                                                                                                                                                                                                                      

We intend to take all actions necessary to enable the
Bank to comply with the requirements of the Consent Order, and as of the date hereof we have submitted all documentation required 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 our compliance will be made by the Supervisor Authorities. However, we believe we are currently in compliance with all provisions of the Consent Order except for the requirements to raise
additional capital and to reduce our criticized assets by the specified percentages by certain dates, with the first date being December 6, 2010. 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.

Strategic Project Plan

In response to the challenging economic environment and our negative financial results and in preparation for a potential formal agreement from the
banking regulatory agencies, in June 2009 the Board of Directors and management adopted and began executing a proactive and aggressive Strategic Project Plan (the Plan) to address the issues related to credit quality, liquidity,
earnings, and capital. Execution of the Plan is being overseen by the special Regulatory Oversight Committee of the Board of Directors, and we have engaged external expertise to assist with its implementation. The Plan contemplated substantially all
of the requirements of the Consent Order and therefore we believe we have already made substantial progress towards complying with the requirements of the Consent Order. However, certain provision of the Consent Order require 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 yet can predict the ongoing impact of the recession given its length and severity. However, it is our expectation that our hard work, 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 into 2010, we have worked aggressively to identify and quantify potential losses and execute plans to reduce problem assets. The credit
quality plan includes, among other things:



35



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##### Table of Contents

| |  |  | Performing detailed loan reviews of our loan portfolio. In May and June 2009, we performed an expanded internal loan review of our nonconsumer loan
portfolio that covered 70% of these loans. In July and August 2009, an independent loan review firm also reviewed 35% of our nonconsumer loan portfolio. In February 2010, we performed another internal loan review of our nonconsumer loan
portfolio that covered $274.4 million, and in May 2010 the independent loan review firm reviewed $280.8 million of our nonconsumer loan portfolio.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For problem loans identified, we have 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 have 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 have 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 April 2010, we hired two 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 six individuals.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We are actively marketing problem assets for sale. Since June 30, 2009, we have sold real estate acquired in settlement of loans aggregating $6.5
million. Subsequent to June 30, 2010, three properties with an aggregate net carrying amount of $4.7 million were sold at a gain of $282 thousand. At July 28, 2010, nine additional assets with an aggregate net carrying amount of $1.3
million were under contract for sale scheduled to close in the third quarter of 2010.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In total, at June 30, 2010, our nonperforming assets declined $23.9 million (17%) from March 31, 2010, the first quarterly decline since
we adopted the Plan in June 2009.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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



| |  |  | Executing targeted deposit growth and retention campaigns which resulted in retained and new certificates of deposit aggregating $258.1 million from
January 1, 2010 through June 30, 2010.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Monitoring our correspondent bank lines of credit.
| | - |  | --------------------------------------------------



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



| |  |  | Maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in other earning assets.
Maintaining this cash balance has reduced our interest income by $1.1 million for the three month period ended June 30, 2010 when compared with investing these funds at the average yield of 2.74% on our investment securities, since we are
retaining a higher level of cash instead of reinvesting this cash in higher yielding assets. However, we expect to maintain this cash balance until successful completion of the Private Placement transaction.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

At July 28, 2010, funding sources included cash invested at the Federal Reserve totaling $214.0 million and our correspondent bank line of credit
totaling $5.0 million.

Capital. At June 30, 2010, our total risk-based capital ratio, Tier 1 leverage ratio, and Tier 1
risk-based capital ratio were below the well-capitalized regulatory minimum thresholds. To preserve our capital we have:



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



36



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##### Table of Contents



Reduced our loan portfolio by $189.1 million since March 31, 2009.  

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

Issued unsecured convertible debt from the Company in March 2010 of $380 thousand, the proceeds of which were contributed to the Bank as a capital
contribution.  

On May 25, 2010 and amended on June 8, 2010, the Company entered into Investment Agreements with certain institutional investors to purchase
approximately $103 million of shares of the Companys common stock at $2.60 per share in a Private Placement. The net proceeds of the Private Placement are expected to be approximately $94.5 million, substantially all of which will be
contributed to the Bank as a capital contribution. The capital contribution to the Bank will result in the Banks capital adequacy ratios exceeding the minimum capital levels required to be categorized as well capitalized. Earnings. We have developed 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 have implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain
criteria. At June 30, 2010, loans aggregating $217.8 million had interest rate floors, of which $196.9 million had floors greater than or equal to 5%. In June and July 2010, we began short-term loan specials intended to generate additional loan
volume for residential mortgage, auto, credit card, and consumer 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, we
have also borrowed longer-term advances from the FHLB to lock in the current low interest rates.  

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 have also evaluated the profitability of all of our pre-existing deposit accounts and in
the third quarter of 2010 will continue the migration of unprofitable accounts to these new accounts to generate additional noninterest income. We are also revising our existing fees and implementing new fees, with various implementation dates
targeted for December 2010 and March 2011.  

Regarding noninterest expenses, we have identified over $2.5 million of specific noninterest expense reductions to be realized in 2009 and into 2010,
and are continuing to review other expense areas for additional reductions with assistance from a consulting firm that specializes in process and efficiency reviews. These expense reductions 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.  

Lastly, we are critically evaluating each of our businesses to determine their contribution to our financial performance and their relative risk /
return relationship. Based on the evaluation to date, on March 31, 2010, we entered into a referral and services agreement with Global Direct Payments, Inc. (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 noninterest income in the amount of $550 thousand, net of transaction costs, for the six month period ended June 30, 2010. Summary In summary, during the three
month period ended June 30, 2010, we continued to be impacted by the negative financial conditions of our borrowers and the economy in general, but we have also made substantial progress on the execution of the Strategic Project Plan adopted in
June 2009. We believe that raising capital, combined with an improving economy, will accelerate our road to recovery and return to profitability in the post-recession environment. If we complete the Private Placement during the third quarter of
2010, then we believe that we may return to profitability, on a quarterly basis, at some point during 2011. However, as discussed in this Quarterly Report on Form 10-Q, our quarterly 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, regardless of whether the Private Placement is completed. Critical Accounting Policies and Estimates




37



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##### Table of Contents

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, mortgage-servicing rights portfolio, goodwill, real estate
acquired in settlement of loans, the realization of our deferred tax asset, defined benefit pension plan, the valuation of our common stock, and the determination of fair value of financial instruments were determined to be critical as reported in
the Annual Report on Form 10-K for the year ended December 31, 2009. 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 for the year ended December 31, 2009.

Financial Condition

Overview

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands)



|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -------------- |  | - | --------------- | - |  | ------ | --
|                                                        |  | June 30,2010 |           |   | December 31,2009 |   |           | Dollarvariance |  |   | Percentvariance |  
|                                                        |  | (unaudited)  |           |   |                  |   |           |                |  |   |                 |  
|Assets                                                  |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Cash and cash equivalents                               |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Cash and due from banks                                 |  | $            | 236,029   |   |                  | $ | 188,084   |                |  | $ | 47,945          |   |  | 25.5   | % 
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total cash and cash equivalents                         |  |              | 236,029   |   |                  |   | 188,084   |                |  |   | 47,945          |   |  | 25.5   |   
|FHLB stock, at cost                                     |  |              | 7,010     |   |                  |   | 7,010     |                |  |   |                |   |  |       |   
|Investment securities available for sale, at fair value |  |              | 112,316   |   |                  |   | 119,986   |                |  |   | (7,670          | ) |  | (6.4   | ) 
|Mortgage loans held for sale                            |  |              | 1,898     |   |                  |   | 3,884     |                |  |   | (1,986          | ) |  | (51.1  | ) 
|Loans, gross                                            |  |              | 967,244   |   |                  |   | 1,040,312 |                |  |   | (73,068         | ) |  | (7.0   | ) 
|Less: allowance for loan losses                         |  |              | (28,383   | ) |                  |   | (24,079   | )              |  |   | (4,304          | ) |  | 17.9   |   
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Loans, net                                              |  |              | 938,861   |   |                  |   | 1,016,233 |                |  |   | (77,372         | ) |  | (7.6   | ) 
|Premises and equipment, net                             |  |              | 29,344    |   |                  |   | 29,605    |                |  |   | (261            | ) |  | (0.9   | ) 
|Goodwill, net                                           |  |              | 3,691     |   |                  |   | 3,691     |                |  |   |                |   |  |       |   
|Accrued interest receivable                             |  |              | 4,222     |   |                  |   | 4,322     |                |  |   | (100            | ) |  | (2.3   | ) 
|Real estate acquired in settlement of loans             |  |              | 26,521    |   |                  |   | 27,826    |                |  |   | (1,305          | ) |  | (4.7   | ) 
|Income tax refund receivable                            |  |              | 4,721     |   |                  |   | 20,869    |                |  |   | (16,148         | ) |  | (77.4  | ) 
|Other                                                   |  |              | 23,308    |   |                  |   | 14,440    |                |  |   | 8,868           |   |  | 61.4   |   
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total assets                                            |  | $            | 1,387,921 |   |                  | $ | 1,435,950 |                |  | $ | (48,029         | ) |  | (3.3   | )%
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Liabilities and shareholders equity                    |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Liabilities                                             |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Deposits                                                |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Noninterest-bearing                                     |  | $            | 143,223   |   |                  | $ | 142,609   |                |  | $ | 614             |   |  | 0.4    | % 
|Interest-bearing                                        |  |              | 1,048,152 |   |                  |   | 1,072,305 |                |  |   | (24,153         | ) |  | (2.3   | ) 
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total deposits                                          |  |              | 1,191,375 |   |                  |   | 1,214,914 |                |  |   | (23,539         | ) |  | (1.9   | ) 
|Retail repurchase agreements                            |  |              | 24,674    |   |                  |   | 15,545    |                |  |   | 9,129           |   |  | 58.7   |   
|Commercial paper (Master notes)                         |  |              |          |   |                  |   | 19,061    |                |  |   | (19,061         | ) |  | (100.0 | ) 
|FHLB borrowings                                         |  |              | 96,000    |   |                  |   | 101,000   |                |  |   | (5,000          | ) |  | (5.0   | ) 
|Convertible debt                                        |  |              | 380       |   |                  |   |          |                |  |   | 380             |   |  | 100.0  |   
|Accrued interest payable                                |  |              | 1,695     |   |                  |   | 2,020     |                |  |   | (325            | ) |  | (16.1  | ) 
|Other                                                   |  |              | 11,154    |   |                  |   | 8,395     |                |  |   | 2,759           |   |  | 32.9   |   
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total liabilities                                       |  |              | 1,325,278 |   |                  |   | 1,360,935 |                |  |   | (35,657         | ) |  | (2.6   | ) 
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Shareholders equity                                    |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Preferred stock                                         |  |              |          |   |                  |   |          |                |  |   |                |   |  |       |   
|Common stock                                            |  |              | 32,309    |   |                  |   | 32,282    |                |  |   | 27              |   |  | 0.1    |   
|Capital surplus                                         |  |              | 2,758     |   |                  |   | 2,599     |                |  |   | 159             |   |  | 6.1    |   
|Retained earnings                                       |  |              | 33,269    |   |                  |   | 47,094    |                |  |   | (13,825         | ) |  | (29.4  | ) 
|Accumulated other comprehensive loss, net of tax        |  |              | (5,693    | ) |                  |   | (6,960    | )              |  |   | 1,267           |   |  | (18.2  | ) 
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total shareholders equity                              |  |              | 62,643    |   |                  |   | 75,015    |                |  |   | (12,372         | ) |  | (16.5  | ) 
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   
|Total liabilities and shareholders equity              |  | $            | 1,387,921 |   |                  | $ | 1,435,950 |                |  | $ | (48,029         | ) |  | (3.3   | )%
|                                                        |  |              |           |   |                  |   |           |                |  |   |                 |   |  |        |   

Cash and Cash Equivalents

Cash and cash equivalents increased $47.9 million (25.5%) at June 30, 2010 over December 31, 2009 primarily as a result of maintaining our
excess liquidity with the Federal Reserve. Until we complete the Private Placement, we are intentionally maintaining these higher cash balances to provide liquidity, notwithstanding the negative impact to our interest income since we only earn
25 basis points on our deposits with the Federal Reserve versus investing this cash in higher earning assets. For the three month period ended June 30, 2010, the difference between the interest earned on the cash at the Federal Reserve at 25
basis points and the interest that could have been earned by investing this cash in the securities portfolio at the average yield on the portfolio of 2.74% was $1.1 million. Once the banking industry returns to a more stable operating environment
and we raise additional capital, our plan is to reinvest these cash reserves into higher yielding assets which should significantly improve our net interest margin.



38



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##### Table of Contents

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

Cash and cash equivalents restricted to secure a
letter of credit totaled $250 thousand (0.1%) and $512 thousand (0.3%) as of June 30, 2010 and December 31, 2009, respectively. In addition, $836 thousand (0.4%) of the balance of cash and cash equivalents was restricted as of
June 30, 2010 and December 31, 2009 under our merchant credit card agreement.

Investment Activities

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

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



|                                               |  |               |         |            |                   |   |       |   |            |  |       |  
|---------------------------------------------- |  | ------------- | ------- | ---------- | ----------------- | - | ----- | - | ---------- |  | ----- | -
|                                               |  | June 30, 2010 |         |            | December 31, 2009 |  
|                                               |  | Total         |         | % of total |                   |   | Total |   | % of total | 
|U.S. Treasury and federal agencies             |  | $             | 16,322  |            | 14.5              | % |       | $ | 16,297     |  | 13.6  | %
|State and municipal                            |  |               | 42,355  |            | 37.7              |   |       |   | 46,785     |  | 39.0  |  
|Collateralized mortgage obligations            |  |               | 42,011  |            | 37.4              |   |       |   | 40,318     |  | 33.6  |  
|Other mortgage-backed (federal agencies)       |  |               | 11,628  |            | 10.4              |   |       |   | 16,586     |  | 13.8  |  
|                                               |  |               |         |            |                   |   |       |   |            |  |       |  
|Total investment securities available for sale |  | $             | 112,316 |            | 100.0             | % |       | $ | 119,986    |  | 100.0 | %
|                                               |  |               |         |            |                   |   |       |   |            |  |       |  

Average balances of investment securities available for sale decreased to $115.3 million during the three month period ended
June 30, 2010 from $117.5 million during the same period of 2009. During March 2010, we evaluated and executed several capital preservation transactions, one of which was a sale of investment securities available for sale. Eleven collateralized
mortgage obligations, three other mortgage-backed securities, and three state and municipal securities totaling $40.2 million were sold during March 2010 resulting in a net gain on sale totaling $8 thousand. The proceeds from the sales were
reinvested in GNMA collateralized mortgage obligations and U.S. Treasury and federal agencies with an expected duration of 2.0 years. These transactions were executed as part of our repositioning the investment securities portfolio in light of the
current interest rate environment, including expectation of rising interest rates over at least the next 18 months. In addition, the transactions resulted in an improved regulatory capital position as the securities sold were in higher risk weighted
asset categories compared to the securities purchased.

The fair value of the investment securities available for sale portfolio represented
8.1% of total assets at June 30, 2010 and 8.4% of total assets at December 31, 2009.

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 (in thousands).



|                                               |  |               |         |                   |   |               |  |           |         |  |   |        
|---------------------------------------------- |  | ------------- | ------- | ----------------- | - | ------------- |  | --------- | ------- |  | - | -------
|                                               |  | June 30, 2010 |         | December 31, 2009
|                                               |  | Amortizedcost |         | Fairvalue         |   | Amortizedcost |  | Fairvalue
|U.S. Treasury and federal agencies             |  | $             | 16,320  |                   | $ | 16,322        |  | $         | 16,294  |  | $ | 16,297 
|State and municipal                            |  |               | 40,486  |                   |   | 42,355        |  |           | 44,908  |  |   | 46,785 
|Collateralized mortgage obligations            |  |               | 42,187  |                   |   | 42,011        |  |           | 42,508  |  |   | 40,318 
|Other mortgage-backed (federal agencies)       |  |               | 10,788  |                   |   | 11,628        |  |           | 15,783  |  |   | 16,586 
|                                               |  |               |         |                   |   |               |  |           |         |  |   |        
|Total investment securities available for sale |  | $             | 109,781 |                   | $ | 112,316       |  | $         | 119,493 |  | $ | 119,986
|                                               |  |               |         |                   |   |               |  |           |         |  |   |        

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).



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|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|---------------------------------------------- |  | ------------------- |  | ------------------- | ------ | --------------------- | - | --- |  | ---------- |  | --------------------- | ------ | - | - | ---------- |  | --------------------- |  | - | ------ |  | - | -----
|                                               |  | June 30, 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             |  |                    |  | $                   |       |                       | $ |    |  |           |  | $                     |       |   | $ |           |  |                      |  | $ |       |  | $ |     
|State and municipal                            |  |                    |  |                     |       |                       |   |    |  |           |  |                       |       |   |   |           |  |                      |  |   |       |  |   |     
|Collateralized mortgage obligations            |  | 8                   |  |                     | 32,058 |                       |   | 362 |  |           |  |                       |       |   |   |           |  | 8                     |  |   | 32,058 |  |   | 362  
|Other mortgage-backed (federal agencies)       |  |                     |  |                     |        |                       |   |     |  |           |  |                       |       |   |   |           |  |                      |  |   |       |  |   |     
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|Total investment securities available for sale |  | 8                   |  | $                   | 32,058 |                       | $ | 362 |  |           |  | $                     |       |   | $ |           |  | 8                     |  | $ | 32,058 |  | $ | 362  
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|                                               | 
|                                               |  | December 31, 2009  
|                                               |  | Less than 12 months |  | 12 months or longer |        | Total                
|                                               |  | #                   |  | Fair value          |        | Grossunrealizedlosses |   | #   |  | Fair value |  | Grossunrealizedlosses |        | # |   | Fair value |  | Grossunrealizedlosses
|U.S. Treasury and federal agencies             |  | 1                   |  | $                   | 300    |                       | $ |    |  |           |  | $                     |       |   | $ |           |  | 1                     |  | $ | 300    |  | $ |     
|State and municipal                            |  | 2                   |  |                     | 662    |                       |   | 3   |  |           |  |                       |       |   |   |           |  | 2                     |  |   | 662    |  |   | 3    
|Collateralized mortgage obligations            |  | 3                   |  |                     | 10,323 |                       |   | 412 |  | 6          |  |                       | 16,624 |   |   | 1,946      |  | 9                     |  |   | 26,947 |  |   | 2,358
|Other mortgage-backed (federal agencies)       |  | 2                   |  |                     | 1,444  |                       |   | 35  |  |           |  |                       |       |   |   |           |  | 2                     |  |   | 1,444  |  |   | 35   
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      
|Total investment securities available for sale |  | 8                   |  | $                   | 12,729 |                       | $ | 450 |  | 6          |  | $                     | 16,624 |   | $ | 1,946      |  | 14                    |  | $ | 29,353 |  | $ | 2,396
|                                               |  |                     |  |                     |        |                       |   |     |  |            |  |                       |        |   |   |            |  |                       |  |   |        |  |   |      

Gross unrealized losses decreased $2.0 million from December 31,
2009 to June 30, 2010, primarily within the collateralized mortgage obligation sector of the investment securities portfolio. Eleven collateralized mortgage obligations were sold during the six month period ended June 30, 2010. The gross
unrealized losses on the sold collateralized mortgage obligations totaled $2.0 million at December 31, 2009.

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

Ratings. The following table summarizes Moodys ratings, by segment, of the investment securities available for sale based on fair value, at
June 30, 2010. An AAA rating is based not only on the credit of the issuer, but may also include consideration of the structure of the securities and the credit quality of the collateral.



|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                       |  
|----------------------------- |  | -------------------------------- | - |  | ----------------- | - |  | --------------------------------- | - |  | ------------------------------------- | -
|                              |  | U.S. Treasuryand federalagencies |   |  | Stateandmunicipal |   |  | Collateralizedmortgageobligations |   |  | Othermortgage-backed(federalagencies) |  
|Aaa                           |  | 100                              | % |  | 3                 | % |  | 100                               | % |  | 100                                   | %
|Aa1-A3                        |  |                                 |   |  | 75                |   |  |                                  |   |  |                                      |  
|Baa1                          |  |                                 |   |  | 13                |   |  |                                  |   |  |                                      |  
|Not rated or withdrawn rating |  |                                 |   |  | 9                 |   |  |                                  |   |  |                                      |  
|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                       |  
|Total                         |  | 100                              | % |  | 100               | % |  | 100                               | % |  | 100                                   | %
|                              |  |                                  |   |  |                   |   |  |                                   |   |  |                                       |  

Of the state and municipal investment securities not rated or with withdrawn ratings by Moodys at June 30, 2010,
15% were rated AA+ by Standard and Poors ratings, 52% were rated AA, 19% were rated AA-, and 14%, or $565 thousand, were not rated by Standard and Poors ratings.

Maturities. The weighted average contractual life of investment securities available for sale was 3.7 years at June 30, 2010. Since 48%,
based on amortized cost, of the portfolio 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.

Pledged. At June 30, 2010 and December 31, 2009, 61% of the portfolio
was pledged to secure public deposits, including retail repurchase agreements, and trust assets. Of the $69.0 million and $73.2 million pledged at June 30, 2010 and December 31, 2009, respectively, $47.9 million and $56.3 million,
respectively, of the portfolio was securing public deposits and trust assets.



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At June 30, 2010 and December 31, 2009, $6.3 million (6%) and $6.3 million (5%),
respectively, of the portfolio was pledged to secure federal funds funding from a correspondent bank.

At June 30, 2010 and
December 31, 2009, $24.8 million (22%) and $29.8 million (25%), respectively, of the portfolio was pledged to collateralize FHLB advances and letters of credit, of which $23.9 million and $26.8 million, respectively, was available as
lendable collateral.

On July 1, 2010, investment securities with a market value of $21.5 million were purchased and pledged to
collateralize FHLB advances and letters of credit.

Concentrations. Four state and municipal security issuers issued securities with
fair values ranging from 2.0 to 3.6% of total shareholders equity at June 30, 2010. Twenty state and municipal security issuers issued securities with fair values ranging from 1.0% to 1.9% of total shareholders equity at
June 30, 2010.

Two collateralized mortgage obligation issuers issued securities with fair values of 1.3 and 4.1%, respectively, of total
shareholders equity at June 30, 2010. Nine collateralized mortgage obligations, issued by GNMA, had an aggregate fair value of $38.6 million (61.7% of shareholders equity) and an amortized cost of $38.8 million at June 30,
2010.

The following table summarizes issuer concentrations of other mortgage-backed investment securities at fair value at June 30, 2010
(dollars in thousands).



|                                         |  |      |       |   |       |   |       |      |  |   |       |   |  |   |        |  
|---------------------------------------- |  | ---- | ----- | - | ----- | - | ----- | ---- |  | - | ----- | - |  | - | ------ | -
|                                         |  | FNMA |       |   | FHLMC |   |       | GNMA |  |   | Total |  
|Other mortgage-backed (federal agencies) |  | $    | 8,384 |   |       | $ | 1,762 |      |  | $ | 1,482 |   |  | $ | 11,628 |  
|As a percentage of shareholders equity  |  |      | 13.4  | % |       |   | 2.8   | %    |  |   | 2.4   | % |  |   | 18.6   | %

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 
monthperiods ended June 30, |   | For the six 
monthperiods ended June 30,
|                   |  | 2010                                       |   | 2009                                     |   | 2010 |  |   | 2009  
|Realized gains     |  | $                                          |  |                                          | $ |     |  | $ | 1,147  |   |  | $ | 2
|Realized losses    |  |                                            |  |                                          |   |     |  |   | (1,139 | ) |  |   | 
|                   |  |                                            |   |                                          |   |      |  |   |        |   |  |   |  
|Net realized gains |  | $                                          |  |                                          | $ |     |  | $ | 8      |   |  | $ | 2
|                   |  |                                            |   |                                          |   |      |  |   |        |   |  |   |  

Lending Activities

General. Loans continue to be the largest component of our assets. During the six month period ended June 30, 2010, gross loans declined $73.1
million (7.0%) as we actively sought to reduce our commercial real estate loan portfolio to preserve capital as part of our capital plan and to reduce concentrations in the commercial real estate related segments of the loan portfolio. Based on
our risk assessment of borrowers, we also implemented risk-based loan pricing and interest rate floors, or minimum interest rates, both at origination and renewal. In addition, we are proactively addressing the reduction of our nonperforming assets
through restructurings, charge-offs, and sales. During the three month period ended June 30, 2010, we charged-off $11.3 million, in gross loan charge-offs, related to loans evaluated individually for impairment and transferred $3.4 million
of loans evaluated individually for impairment to the real estate acquired in settlement of loans portfolio.

Composition. The
following table summarizes gross loans, categorized by FDIC code, at the dates indicated (dollars in thousands).



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|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  
|------------------------------------------------------------ |  | ------------- | ------- | ---------- | ----------------- | - | ----- | - | ---------- |  | ----- | -
|                                                             |  | June 30, 2010 |         |            | December 31, 2009 |  
|                                                             |  | Total         |         | % of total |                   |   | Total |   | % of total | 
|Secured by real estate                                       |  |               |         |            |                   |   |       |   |            |  |       |  
|Construction, land development, and other land loans         |  | $             | 178,297 |            | 18.4              | % |       | $ | 205,465    |  | 19.8  | %
|Farmland                                                     |  |               | 2,891   |            | 0.3               |   |       |   | 466        |  |      |  
|Single-family residential                                    |  |               | 194,808 |            | 20.1              |   |       |   | 203,330    |  | 19.6  |  
|Multifamily residential                                      |  |               | 28,927  |            | 3.0               |   |       |   | 30,668     |  | 3.0   |  
|Nonfarm nonresidential                                       |  |               | 432,085 |            | 44.7              |   |       |   | 459,130    |  | 44.1  |  
|Commercial and industrial                                    |  |               | 55,581  |            | 5.8               |   |       |   | 61,788     |  | 5.9   |  
|Obligations of states and political subdivisions of the U.S. |  |               | 1,059   |            | 0.1               |   |       |   | 1,418      |  | 0.1   |  
|General consumer                                             |  |               | 52,461  |            | 5.4               |   |       |   | 57,581     |  | 5.5   |  
|Credit line                                                  |  |               | 4,739   |            | 0.5               |   |       |   | 5,501      |  | 0.5   |  
|Bankcards                                                    |  |               | 12,433  |            | 1.3               |   |       |   | 13,214     |  | 1.3   |  
|Others                                                       |  |               | 3,963   |            | 0.4               |   |       |   | 1,751      |  | 0.2   |  
|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  
|Loans, gross                                                 |  | $             | 967,244 |            | 100.0             | % |       | $ | 1,040,312  |  | 100.0 | %
|                                                             |  |               |         |            |                   |   |       |   |            |  |       |  

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



|                              |  |               |         |            |                   |   |       |   |           |            |  |       |  
|----------------------------- |  | ------------- | ------- | ---------- | ----------------- | - | ----- | - | --------- | ---------- |  | ----- | -
|                              |  | June 30, 2010 |         |            | December 31, 2009 |  
|                              |  | Total         |         | % of total |                   |   | Total |   |           | % of total | 
|Commercial business           |  | $             | 110,833 |            | 11.5              | % |       | $ | 121,691   |            |  | 11.7  | %
|Commercial real estate        |  |               | 619,210 |            | 64.0              |   |       |   | 671,701   |            |  | 64.6  |  
|Installment                   |  |               | 16,796  |            | 1.7               |   |       |   | 20,845    |            |  | 2.0   |  
|Installment real estate       |  |               | 74,357  |            | 7.7               |   |       |   | 80,395    |            |  | 7.7   |  
|Indirect                      |  |               | 35,788  |            | 3.7               |   |       |   | 36,291    |            |  | 3.5   |  
|Credit line                   |  |               | 1,900   |            | 0.2               |   |       |   | 1,970     |            |  | 0.2   |  
|Prime access                  |  |               | 65,580  |            | 6.8               |   |       |   | 66,082    |            |  | 6.4   |  
|Residential mortgage          |  |               | 26,714  |            | 2.8               |   |       |   | 26,282    |            |  | 2.5   |  
|Bankcards                     |  |               | 12,457  |            | 1.3               |   |       |   | 13,236    |            |  | 1.3   |  
|Business manager              |  |               | 348     |            |                  |   |       |   | 319       |            |  |      |  
|Other loans                   |  |               | 1,323   |            | 0.1               |   |       |   | 1,081     |            |  | 0.1   |  
|Loans in process              |  |               | 1,560   |            | 0.2               |   |       |   | (33       | )          |  |      |  
|Deferred loans fees and costs |  |               | 378     |            |                  |   |       |   | 452       |            |  |      |  
|                              |  |               |         |            |                   |   |       |   |           |            |  |       |  
|Loans, gross                  |  | $             | 967,244 |            | 100.0             | % |       | $ | 1,040,312 |            |  | 100.0 | %
|                              |  |               |         |            |                   |   |       |   |           |            |  |       |  

Loans included in both of the preceding loan composition tables are net of participations sold. Participations sold totaled
$12.5 million (2 loans) at June 30, 2010 and December 31, 2009. With regard to participations sold, we serve as the lead bank and are therefore responsible for certain administration and other management functions as agent to the
participating banks. We are in active discussions with the participating banks to keep them informed of the status of these loans and determine loan workout plans.

Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009,
respectively, and are not included in our Consolidated Balance Sheets.

Pledged. To borrow from the FHLB, members must pledge
collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. $339.5 million and $407.0
million of gross loans were pledged to collateralize FHLB advances and letters of credit at June 30, 2010 and December 31, 2009, respectively, of which $145.3 million and $162.0 million, respectively, was available as lendable collateral.

On June 30, 2010, $15.8 million of loans were pledged as collateral to cover the various Federal Reserve System services that are being
utilized by the Company. The maximum maturity for potential borrowings is overnight. Any future potential borrowings from the 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. We would be required to pledge collateral for such secondary borrowing.

Concentrations. General. During 2009 and continuing into 2010, we increased our monitoring of borrower and industry sector concentrations and are
limiting additional credit exposure to these concentrations, in particular the segments of our loan portfolio secured by commercial real estate. In addition, we are proactively executing loan workout plans with a particular focus on reducing our
concentrations in these segments. In addition, we are evaluating the potential sale, individually or in bulk, of performing and nonperforming commercial real estate loans although no such loans are currently under contract for sale.



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Loan Type / Industry Concentration. The following table summarizes loans secured by commercial real estate,
categorized by FDIC code, at June 30, 2010 (dollars in thousands).



|                                                     |  |       |         |                 |      |   |                                    |       |  
|---------------------------------------------------- |  | ----- | ------- | --------------- | ---- | - | ---------------------------------- | ----- | -
|                                                     |  | Total |         | % of grossloans |      |   | % of Bankstotal regulatorycapital |      
|Secured by commercial real estate                    |  |       |         |                 |      |   |                                    |       |  
|Construction, land development, and other land loans |  | $     | 178,297 |                 | 18.4 | % |                                    | 244.5 | %
|Multifamily residential                              |  |       | 28,927  |                 | 3.0  |   |                                    | 39.7  |  
|Nonfarm nonresidential                               |  |       | 432,085 |                 | 44.7 |   |                                    | 592.4 |  
|                                                     |  |       |         |                 |      |   |                                    |       |  
|Total loans secured by commercial real estate        |  | $     | 639,309 |                 | 66.1 | % |                                    | 876.6 | %
|                                                     |  |       |         |                 |      |   |                                    |       |  

The following table further categorizes loans secured by commercial real estate, categorized by FDIC code, at June 30,
2010 (dollars in thousands).



|                                                                        |  |       |         |                 |      |   |                                    |       |  
|----------------------------------------------------------------------- |  | ----- | ------- | --------------- | ---- | - | ---------------------------------- | ----- | -
|                                                                        |  | Total |         | % of grossloans |      |   | % of Bank'stotal regulatorycapital |      
|Development commercial real estate loans Secured by:                    |  |       |         |                 |      |   |                                    |       |  
|Land - unimproved (commercial or residential)                           |  | $     | 61,395  |                 | 6.4  | % |                                    | 84.2  | %
|Land development - commercial                                           |  |       | 16,925  |                 | 1.8  |   |                                    | 23.2  |  
|Land development - residential                                          |  |       | 59,876  |                 | 6.2  |   |                                    | 82.1  |  
|Commercial construction:                                                |  |       |         |                 |      |   |                                    |       |  
|Hotel / motel                                                           |  |       | 189     |                 |     |   |                                    | 0.3   |  
|Retail                                                                  |  |       | 4,448   |                 | 0.5  |   |                                    | 6.1   |  
|Office                                                                  |  |       | 244     |                 |     |   |                                    | 0.3   |  
|Multifamily                                                             |  |       | 2,617   |                 | 0.3  |   |                                    | 3.6   |  
|Industrial and warehouse                                                |  |       | 7,140   |                 | 0.7  |   |                                    | 9.8   |  
|Healthcare                                                              |  |       | 4,916   |                 | 0.5  |   |                                    | 6.7   |  
|Miscellaneous commercial                                                |  |       | 3,362   |                 | 0.3  |   |                                    | 4.6   |  
|                                                                        |  |       |         |                 |      |   |                                    |       |  
|Total development commercial real estate loans                          |  |       | 161,112 |                 | 16.7 |   |                                    | 220.9 |  
|Existing and other commercial real estate loans Secured by:             |  |       |         |                 |      |   |                                    |       |  
|Hotel / motel                                                           |  |       | 104,155 |                 | 10.8 |   |                                    | 142.8 |  
|Retail                                                                  |  |       | 27,070  |                 | 2.8  |   |                                    | 37.1  |  
|Office                                                                  |  |       | 27,428  |                 | 2.8  |   |                                    | 37.6  |  
|Multifamily                                                             |  |       | 28,927  |                 | 3.0  |   |                                    | 39.7  |  
|Industrial and warehouse                                                |  |       | 17,302  |                 | 1.8  |   |                                    | 23.7  |  
|Healthcare                                                              |  |       | 11,232  |                 | 1.1  |   |                                    | 15.4  |  
|Miscellaneous commercial                                                |  |       | 127,493 |                 | 13.2 |   |                                    | 174.8 |  
|Residential construction - speculative                                  |  |       | 7,059   |                 | 0.7  |   |                                    | 9.7   |  
|                                                                        |  |       |         |                 |      |   |                                    |       |  
|Total existing and other commercial real estate loans                   |  |       | 350,666 |                 | 36.2 |   |                                    | 480.8 |  
|Commercial real estate owner occupied and residential loans Secured by: |  |       |         |                 |      |   |                                    |       |  
|Commercial - owner occupied                                             |  |       | 117,199 |                 | 12.1 |   |                                    | 160.7 |  
|Commercial construction - owner occupied                                |  |       | 5,064   |                 | 0.5  |   |                                    | 7.0   |  
|Residential construction - contract                                     |  |       | 5,268   |                 | 0.6  |   |                                    | 7.2   |  
|                                                                        |  |       |         |                 |      |   |                                    |       |  
|Total commercial real estate owner occupied and residential loans       |  |       | 127,531 |                 | 13.2 |   |                                    | 174.9 |  
|                                                                        |  |       |         |                 |      |   |                                    |       |  
|Total loans secured by commercial real estate                           |  | $     | 639,309 |                 | 66.1 | % |                                    | 876.6 | %
|                                                                        |  |       |         |                 |      |   |                                    |       |  

Asset Quality. Given the negative credit quality trends which began in 2008, accelerated during 2009, and have
continued into 2010, we have performed extensive analysis of our nonconsumer loan portfolio, with particular focus on commercial real estate loans. The analyses included internal and external loan reviews that required detailed, written analyses for
the loans reviewed and vetting of the risk rating, accrual status, and collateral valuation of the loans by the loan officers, our senior management team, external consultants, and an external loan review firm. Of particular significance is that
these reviews have identified 38 specifically identified borrower relationships (47 individual loans) aggregating $140.1 million in remaining unpaid principal balance at June 30, 2010 that have resulted in $51.7 million (60%) of the $85.4
million of net charge-offs and writedowns on foreclosed assets recorded in the past five quarters. In general, these loans, which in the aggregate were carried on our Consolidated Balance Sheet at $80.5 million at June 30, 2010, 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 historically originated
by the Company.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 of the Company for whom we generally had no pre-existing banking relationship.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Concentrated in commercial real estate with 67% of the remaining unpaid principal balance of these loans at June 30, 2010 originated by two loan
officers who are no longer employed by the Company.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

At June 30, 2010, the remaining unpaid principal balance for this
pool of loans comprises 64% of our total problem assets (all loans individually evaluated for impairment, and real estate acquired in settlement of loans greater than $1 million). In addition, the loss rate on this pool of loans for the five
quarters ended June 30, 2010 has been 37% of the unpaid principal balance, which is significantly higher than the loss rate on the remainder of the loan portfolio, which was 3.3% for the same period.

In general, our entire commercial real estate loan portfolio has been impacted by the challenging economic environment in 2008, 2009, and 2010. However,
this pool of loans is the primary contributor to our deteriorated asset quality, charge-offs, and resulting net loss over the past five 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 ongoing customers of the Company that were underwritten by loan officers of the Company 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 loss rate of 37% 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 to address the impact of the economic environment on our loan portfolio, we are continuing our detailed
review of the loan portfolio and are focused on executing detailed loan workout plans for all of our problem loans led by a team of seasoned commercial lenders and using external loan workout consulting expertise. It is clear that many of our
borrowers are continuing to face financial stress manifesting itself in the following ways:



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



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



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

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



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



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



| |  |  | Credit Administration: In July 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; in August 2009 we reassigned two commercial lenders to credit analysts in the Credit Administration department; and, in September 2009, we hired an additional Credit Administration executive.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Training: During the first six months of 2010, we conducted additional training using external specialists in the areas of problem loan workout and
negotiating skills, analysis of personal financial statements and business tax returns and cash flows.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All of these actions
were taken to improve our credit risk management approach and accelerate the resolution of our credit quality issues.



44



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##### Table of Contents

At June 30, 2010, nonperforming assets decreased $23.9 million (17%) from March 31, 2010,
which is the first quarterly decline since we adopted our Strategic Project Plan in June 2009. In addition, the number of loans placed on nonaccrual status the past two quarters has declined. 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 FDIC code, at the dates indicated (dollars in thousands).



|                                                     |  |              |           |   |               |   |           |                  |  |   |           |  
|---------------------------------------------------- |  | ------------ | --------- | - | ------------- | - | --------- | ---------------- |  | - | --------- | -
|                                                     |  | June 30,2010 |           |   | March 31,2010 |   |           | December 31,2009 | 
|Secured by real estate                               |  |              |           |   |               |   |           |                  |  |   |           |  
|Construction, land development, and other land loans |  | $            | 37,733    |   |               | $ | 54,347    |                  |  | $ | 47,901    |  
|Farmland                                             |  |              | 48        |   |               |   | 48        |                  |  |   | 50        |  
|Single-family residential                            |  |              | 9,159     |   |               |   | 8,472     |                  |  |   | 7,652     |  
|Multifamily residential                              |  |              | 9,352     |   |               |   | 9,827     |                  |  |   | 9,844     |  
|Nonfarm nonresidential                               |  |              | 28,200    |   |               |   | 31,910    |                  |  |   | 23,330    |  
|Commercial and industrial                            |  |              | 6,330     |   |               |   | 7,917     |                  |  |   | 7,475     |  
|General consumer                                     |  |              | 831       |   |               |   | 660       |                  |  |   | 684       |  
|                                                     |  |              |           |   |               |   |           |                  |  |   |           |  
|Total nonaccrual loans                               |  |              | 91,653    |   |               |   | 113,181   |                  |  |   | 96,936    |  
|Real estate acquired in settlement of loans          |  |              | 26,521    |   |               |   | 28,867    |                  |  |   | 27,826    |  
|Personal property acquired in settlement of loans    |  |              | 106       |   |               |   | 113       |                  |  |   | 188       |  
|                                                     |  |              |           |   |               |   |           |                  |  |   |           |  
|Total foreclosed assets                              |  |              | 26,627    |   |               |   | 28,980    |                  |  |   | 28,014    |  
|                                                     |  |              |           |   |               |   |           |                  |  |   |           |  
|Total nonperforming assets                           |  | $            | 118,280   |   |               | $ | 142,161   |                  |  | $ | 124,950   |  
|                                                     |  |              |           |   |               |   |           |                  |  |   |           |  
|Gross loans                                          |  | $            | 967,244   |   |               | $ | 1,010,247 |                  |  | $ | 1,040,312 |  
|Total assets                                         |  |              | 1,387,921 |   |               |   | 1,348,463 |                  |  |   | 1,435,950 |  
|Nonaccrual loans as a percentage of:                 |  |              |           |   |               |   |           |                  |  |   |           |  
|gross loans and foreclosed assets                    |  |              | 9.22      | % |               |   | 10.89     | %                |  |   | 9.07      | %
|total assets                                         |  |              | 6.60      |   |               |   | 8.39      |                  |  |   | 6.75      |  
|Nonperforming assets as a percentage of:             |  |              |           |   |               |   |           |                  |  |   |           |  
|gross loans and foreclosed assets                    |  |              | 11.90     | % |               |   | 13.68     | %                |  |   | 11.70     | %
|total assets                                         |  |              | 8.52      |   |               |   | 10.54     |                  |  |   | 8.70      |  

Loans placed in nonaccrual status
during 2010 resulted primarily from loans becoming delinquent on contractual payments due to deterioration in the financial condition of the borrowers or guarantors such that payment in full of principal or interest was not expected due to personal
cash flows from the borrowers and guarantors 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.

Twenty-five loans with a balance at June 30, 2010 greater than $1
million comprised 61% of our nonaccrual loans at June 30, 2010. The following table summarizes the composition of these loans by collateral type (dollars in thousands).



|                                                                      |  |                                    |        |                            |    |  
|--------------------------------------------------------------------- |  | ---------------------------------- | ------ | -------------------------- | -- | -
|                                                                      |  | Total nonaccrual loans >$1 million |        | %of total 
nonaccrualloans |   
|Residential lots / golf course development                            |  | $                                  | 26,248 |                            | 29 | %
|Multifamily residential                                               |  |                                    | 8,183  |                            | 9  |  
|Retirement center properties                                          |  |                                    | 2,674  |                            | 3  |  
|Real estate for commercial use                                        |  |                                    | 13,285 |                            | 14 |  
|Marina                                                                |  |                                    | 1,229  |                            | 1  |  
|Other business loans                                                  |  |                                    | 4,263  |                            | 5  |  
|                                                                      |  |                                    |        |                            |    |  
|Total nonaccrual loans > $1 million secured by commercial real estate |  | $                                  | 55,882 |                            | 61 | %
|                                                                      |  |                                    |        |                            |    |  

Additionally, four of these loans (18% based on the principal balance at June 30, 2010) were purchased participations
and seven of these loans (30% based on the principal balance at June 30, 2010) are out-of-market loans. In 2009, we amended our loan policy to preclude originating any new loans of these kinds.

While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest income of $999 thousand and $1.8 million
would have been reported during the three and six month periods ended June 30, 2010, respectively, 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.



45



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##### Table of Contents

The following table summarizes the changes in the real estate acquired in settlement of loans portfolio at
the dates and for the periods indicated (in thousands). Real estate acquired in settlement of loans is net of participations sold of $6.5 million (three properties) at June 30, 2010.



|                                                                           |  |                                                    |        |   |                                                  |   |        |  
|-------------------------------------------------------------------------- |  | -------------------------------------------------- | ------ | - | ------------------------------------------------ | - | ------ | -
|                                                                           |  | At and for thethree monthperiod endedJune 30, 2010 |        |   | At and for thesix monthperiod endedJune 30, 2010 |  
|Real estate acquired in settlement of loans, beginning of period           |  | $                                                  | 28,867 |   |                                                  | $ | 27,826 |  
|Plus: New real estate acquired in settlement of loans                      |  |                                                    | 4,204  |   |                                                  |   | 8,097  |  
|Less: Proceeds from sale of real estate acquired in settlement of loans    |  |                                                    | (4,248 | ) |                                                  |   | (6,301 | )
|Less: Gain / (loss) on sale on real estate acquired in settlement of loans |  |                                                    | 14     |   |                                                  |   | 285    |  
|Less: Provision charged to expense                                         |  |                                                    | (2,316 | ) |                                                  |   | (3,386 | )
|                                                                           |  |                                                    |        |   |                                                  |   |        |  
|Real estate acquired in settlement of loans, end of period                 |  | $                                                  | 26,521 |   |                                                  | $ | 26,521 |  
|                                                                           |  |                                                    |        |   |                                                  |   |        |  

The following table summarizes the Real estate acquired in settlement of loans portfolio, by FDIC code, at June 30,
2010 (in thousands).



|                                                     |  |   |       
|---------------------------------------------------- |  | - | ------
|Construction, land development, and other land loans |  | $ | 9,078 
|Single-family residential                            |  |   | 2,647 
|Nonfarm, nonresidential                              |  |   | 14,796
|                                                     |  |   |       
|Total real estate acquired in settlement of loans    |  | $ | 26,521
|                                                     |  |   |       

Five individual properties greater than $1 million comprised 58% of
our real estate acquired in settlement of loans portfolio at June 30, 2010. Of the balance of these properties, 27% were hotel properties, 10% were residential development properties, and 63% were retirement center properties. Additionally, 60%
of these properties were participations. Three of the six were the result of out-of-market loans.

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

During the quarter ended June 30, 2010, we sold 24 properties with an aggregate net carrying amount of $4.2 million in total
real estate acquired in settlement of loans sales at a net gain of $14 thousand.

Subsequent to June 30, 2010, three properties with an
aggregate net carrying amount of $4.7 million were sold at a gain of $282 thousand. At July 28, 2010, nine additional assets with an aggregate net carrying amount of $1.3 million were under contract for sale scheduled to close in the third
quarter of 2010.

We are actively addressing the issue of our increase in 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. 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. As necessary, carrying values of these assets may require
additional adjustment for further declines in estimated fair values.

Troubled Debt Restructurings. Troubled debt restructurings are loans
which have been restructured from their original contractual terms (for example, reduction in contractual interest rate). As part of the 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 June 30, 2010 and December 31, 2009, the principal balance of troubled debt restructurings totaled $27.8 million and $14.6 million,
respectively.



46



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##### Table of Contents

Historically, we have not split loans into two legally separate loans. However, at June 30, 2010, we
had two loans that had been legally split into separate loans (an A/B loan structure), with the B loans accounted for as troubled debt restructures. Restructuring these loans into legally separate loans did not result in any charge-offs and all of
the loans are currently performing in accordance with their terms. The aggregate balances of the A and B loans at June 30, 2010 were $4.3 million and $6.7 million, respectively.

Six individual loans greater than $1 million comprised 76% of our troubled debt restructurings at June 30, 2010. One of the loans experienced rate
concessions, one experienced a term concession, and four experienced rate and term concessions. At June 30, 2010, all are performing as expected under the new terms.

A troubled debt restructuring can be removed from this classification if the loan returns to market terms or once there is sufficient history, generally
six months, of demonstrating the borrower can service the credit under the modified terms. For the three month period ended June 30, 2010, one loan with a carrying value of $1.8 million was removed from this classification.

Potential Problem Loans. Potential problem loans consist of commercial loans not already classified as nonaccrual that are inadequately protected by the
current sound worth and paying capacity of the borrower(s) or of the collateral pledged, if any, have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt, and are characterized by the distinct possibility that we will
sustain some loss of the deficiencies are not corrected. Management monitors these loans closely and reviews performance on a regular basis. As of June 30, 2010, potential problem loans totaled $147.5 million.

Allowance for Loan Losses. The allowance for loan losses represents an amount that we believe will be adequate to absorb probable losses as of a
specific period of time inherent in our loan portfolio. 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.

Our allowance for loan losses totaled $28.4 million at June 30, 2010 and March 31, 2010 and $24.1 million at
December 31, 2009, representing 2.93%, 2.81%, and 2.31% of gross loans, respectively. The June 30, 2010 allowance for loan losses, and, therefore indirectly the provision for loan losses for the three and six month periods ended
June 30, 2010, was determined based on the following specific factors, though not intended to be an all inclusive list:



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



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



| |  |  | The asset quality trends in our loan portfolio, including a high level of nonaccrual loans at June 30, 2010. Nonaccrual loans decreased at
June 30, 2010, the first quarterly decrease since September 30, 2009,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | The results of our internal and external loan reviews during the first and second quarters of 2010, and
| | - |  | -------------------------------------------------------------------------------------------------------



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



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



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

The following table summarizes activity within our allowance for loan losses, by FDIC code, 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.



47



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##### Table of Contents

|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|--------------------------------------------------------------- |  | ------------------------------------------------ | ------- | - | ---------------------------------------------- | - | --------- | ------------------------ |  | - | --------- | - |  | ----------------- | --------- | - |  | - | --------- | -
|                                                                |  | At and for the three monthperiods ended June 30, |         |   | At and for the six monthperiods ended June 30, |   |           | At and for theyear ended | 
|                                                                |  | 2010                                             |         |   | 2009                                           |   |           | 2010                     |  |   | 2009      |   |  | December 31, 2009 |          
|Allowance for loan losses, beginning of period                  |  | $                                                | 28,426  |   |                                                | $ | 12,606    |                          |  | $ | 24,079    |   |  | $                 | 11,000    |   |  | $ | 11,000    |  
|Provision for loan losses                                       |  |                                                  | 12,750  |   |                                                |   | 30,000    |                          |  |   | 23,500    |   |  |                   | 32,175    |   |  |   | 73,400    |  
|Loans charged-off                                               |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Secured by real estate                                          |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Construction, land development, and other land loans            |  |                                                  | 9,074   |   |                                                |   | 14,349    |                          |  |   | 11,572    |   |  |                   | 14,433    |   |  |   | 33,873    |  
|Farmland                                                        |  |                                                  |        |   |                                                |   |          |                          |  |   |          |   |  |                   |          |   |  |   |          |  
|Single-family residential                                       |  |                                                  | 266     |   |                                                |   | 714       |                          |  |   | 1,442     |   |  |                   | 922       |   |  |   | 4,060     |  
|Multifamily residential                                         |  |                                                  | 26      |   |                                                |   | 2,720     |                          |  |   | 509       |   |  |                   | 2,720     |   |  |   | 5,096     |  
|Nonfarm nonresidential                                          |  |                                                  | 3,035   |   |                                                |   | 1,792     |                          |  |   | 5,324     |   |  |                   | 1,792     |   |  |   | 10,784    |  
|Commercial and industrial                                       |  |                                                  | 215     |   |                                                |   | 503       |                          |  |   | 497       |   |  |                   | 536       |   |  |   | 4,945     |  
|General consumer and other                                      |  |                                                  | 462     |   |                                                |   | 608       |                          |  |   | 976       |   |  |                   | 898       |   |  |   | 2,033     |  
|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Total loans charged-off                                         |  |                                                  | 13,078  |   |                                                |   | 20,686    |                          |  |   | 20,320    |   |  |                   | 21,301    |   |  |   | 60,791    |  
|Recoveries                                                      |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Secured by real estate                                          |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Construction, land development, and other land loans            |  |                                                  | 49      |   |                                                |   |          |                          |  |   | 283       |   |  |                   |          |   |  |   | 32        |  
|Farmland                                                        |  |                                                  |        |   |                                                |   |          |                          |  |   |          |   |  |                   |          |   |  |   |          |  
|Single-family residential                                       |  |                                                  | 14      |   |                                                |   | 2         |                          |  |   | 80        |   |  |                   | 4         |   |  |   | 5         |  
|Multifamily residential                                         |  |                                                  | 9       |   |                                                |   |          |                          |  |   | 9         |   |  |                   |          |   |  |   |          |  
|Nonfarm nonresidential                                          |  |                                                  | 70      |   |                                                |   | 5         |                          |  |   | 199       |   |  |                   | 15        |   |  |   | 79        |  
|Commercial and industrial                                       |  |                                                  | 5       |   |                                                |   | 5         |                          |  |   | 150       |   |  |                   | 8         |   |  |   | 88        |  
|General consumer and other                                      |  |                                                  | 138     |   |                                                |   | 33        |                          |  |   | 403       |   |  |                   | 64        |   |  |   | 266       |  
|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Total recoveries                                                |  |                                                  | 285     |   |                                                |   | 45        |                          |  |   | 1,124     |   |  |                   | 91        |   |  |   | 470       |  
|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Net loans charged-off                                           |  |                                                  | 12,793  |   |                                                |   | 20,641    |                          |  |   | 19,196    |   |  |                   | 21,210    |   |  |   | 60,321    |  
|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Allowance for loan losses, end of period                        |  | $                                                | 28,383  |   |                                                | $ | 21,965    |                          |  | $ | 28,383    |   |  | $                 | 21,965    |   |  | $ | 24,079    |  
|                                                                |  |                                                  |         |   |                                                |   |           |                          |  |   |           |   |  |                   |           |   |  |   |           |  
|Average gross loans                                             |  | $                                                | 992,999 |   |                                                | $ | 1,153,180 |                          |  | $ | 1,010,553 |   |  | $                 | 1,154,655 |   |  | $ | 1,124,599 |  
|Ending gross loans                                              |  |                                                  | 967,244 |   |                                                |   | 1,126,512 |                          |  |   | 967,244   |   |  |                   | 1,126,512 |   |  |   | 1,040,312 |  
|Nonaccrual loans                                                |  |                                                  | 91,653  |   |                                                |   | 95,549    |                          |  |   | 91,653    |   |  |                   | 95,549    |   |  |   | 96,936    |  
|Net loans charged-off as a percentage of average gross loans    |  |                                                  | 5.17    | % |                                                |   | 7.18      | %                        |  |   | 3.83      | % |  |                   | 3.70      | % |  |   | 5.36      | %
|Allowance for loan losses as a percentage of ending gross loans |  |                                                  | 2.93    |   |                                                |   | 1.95      |                          |  |   | 2.93      |   |  |                   | 1.95      |   |  |   | 2.31      |  
|Allowance for loan losses as a percentage of nonaccrual loans   |  |                                                  | 30.97   |   |                                                |   | 22.99     |                          |  |   | 30.97     |   |  |                   | 22.99     |   |  |   | 24.84     |  

In addition to loans charged-off in
the ordinary course of business, included within loans charged-off for the six month period ended June 30, 2010 were $17.1 million in gross loan charge-offs relating to loans individually evaluated for impairment. The determination was made to
take partial charge-offs on certain collateral dependent loans based on the status of the underlying real estate projects or our expectation that these loans would be foreclosed on and we would take possession of the collateral. The loan charge-offs
were recorded to writedown the loans to the fair value of the collateral less estimated costs to sell generally based on fair values from third party appraisals.

We analyze individual loans within the portfolio and make allocations to the allowance for loan losses based on each individual loans specific
factors and other circumstances that impact the collectability of the loan. The population of loans evaluated to be potential impaired loans includes all troubled debt restructures and loans with interest reserves, as well as significant
individual loans classified as doubtful or on nonaccrual status. At June 30, 2010, we had one loan totaling $1.6 million with interest reserves that, based on our analysis, was considered impaired. This loan was also a troubled debt
restructuring.

In situations where a loan is determined to be impaired (primarily because it is probable that all principal and interest due
according to the terms of the loan agreement will not be collected as scheduled), the loan is excluded from the general reserve calculation described below and is evaluated individually for impairment. The impairment analysis is based on the
determination of the most probable source of repayment which is typically liquidation of the underlying collateral but may also include discounted future cash flows or, in rare cases, the market value of the loan itself. At June 30, 2010, $85.6
million of our loans evaluated individually for impairment were valued based on liquidation of collateral while $13.1 million were valued based on discounted future cash flows.

Generally, for larger impaired loans valued based on liquidation of collateral, current appraisals performed by Company 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, management uses 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.



48



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##### Table of Contents

The following table summarizes the composition of impaired loans, by FDIC code, at the date indicated (in
thousands).



|                                                     |  |              |       
|---------------------------------------------------- |  | ------------ | ------
|                                                     |  | June 30,2010
|Secured by real estate                               |  |              |       
|Construction, land development, and other land loans |  | $            | 36,235
|Farmland                                             |  |              |      
|Single-family residential                            |  |              | 9,732 
|Multifamily residential                              |  |              | 9,294 
|Nonfarm nonresidential                               |  |              | 35,927
|Commercial and industrial                            |  |              | 7,519 
|                                                     |  |              |       
|Total impaired loans                                 |  | $            | 98,707
|                                                     |  |              |       

The following table summarizes information relative to impaired loans
at the dates and for the periods indicated (in thousands).



|                                                                                                                 |  |              |         |                  |   |       
|---------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---------------- | - | ------
|                                                                                                                 |  | June 30,2010 |         | December 31,2009
|Impaired loans for which there is a related allowance for loan losses determined in accordance with FASB ASC 310 |  | $            | 30,353  |                  | $ | 11,253
|Other impaired loans                                                                                             |  |              | 68,354  |                  |   | 85,583
|                                                                                                                 |  |              |         |                  |   |       
|Total impaired loans                                                                                             |  | $            | 98,707  |                  | $ | 96,836
|                                                                                                                 |  |              |         |                  |   |       
|Average impaired loans calculated using a simple average                                                         |  | $            | 100,981 |                  | $ | 82,471
|Related allowance for loan losses                                                                                |  |              | 6,825   |                  |   | 5,250 

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 lookback period when computing historical loss rates. However, given the increase in charge-offs
beginning in 2009, we also utilized a three-year lookback period at June 30, 2010 for computing historical loss rates as another reference point in determining the allowance for loan losses.

We adjust these historical loss percentages for qualitative environmental factors derived from macroeconomic indicators and other
factors. Qualitative factors we considered in the determination of the June 30, 2010 allowance for loan losses include pervasive factors that generally impact borrowers across the loan portfolio (such as unemployment and consumer price
index) and factors that have specific implications to particular loan portfolios (such as residential home sales or commercial development). Factors evaluated may include changes in delinquent, nonaccrual and troubled debt restructured loan trends,
trends in risk grades and net loans charged-off, concentrations of credit, competition and legal and regulatory requirements, trends in the nature and volume of the loan portfolio, national and local economic and business conditions, collateral
valuations, the experience and depth of lending management, lending policies and procedures, underwriting standards and practices, the quality of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other
external factors. The general reserve calculated using the historical loss rates and qualitative factors is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.

The following table summarizes the allocation of the allowance for loan losses at the dates indicated (in thousands).



|                                          |  |              |        |               |   |                  |  |   |       
|----------------------------------------- |  | ------------ | ------ | ------------- | - | ---------------- |  | - | ------
|                                          |  | June 30,2010 |        | March 31,2010 |   | December 31,2009
|Allowance for loan losses allocated to    |  |              |        |               |   |                  |  |   |       
|Homogenous loan pools                     |  | $            | 21,508 |               | $ | 21,373           |  | $ | 18,829
|Loan individually analyzed for impairment |  |              | 6,825  |               |   | 6,997            |  |   | 5,250 
|Unallocated                               |  |              | 50     |               |   | 56               |  |   |      
|                                          |  |              |        |               |   |                  |  |   |       
|Allowance for loan losses                 |  | $            | 28,383 |               | $ | 28,426           |  | $ | 24,079
|                                          |  |              |        |               |   |                  |  |   |       

The allowance for loan losses coverage ratio increased from 2.81% to
2.93% of gross loans from March 31, 2010 to June 30, 2010. Overall, the allowance for loan losses at June 30, 2010 is consistent with that at March 31, 2010. Based on the overall trends in our asset quality, loan portfolio, and
economic factors, some of which offset one another, we believed it was appropriate for the provision for loan losses to cover net charge-offs in the second quarter 2010, and therefore the allowance for loan losses to be substantially the same
quarter over quarter.



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The following table summarizes the allocation of the allowance for loan losses at June 30, 2010, by
FDIC code (dollars in thousands).



|                                                             |  |                     |        |                     |       |   |                          |       |  
|------------------------------------------------------------ |  | ------------------- | ------ | ------------------- | ----- | - | ------------------------ | ----- | -
|                                                             |  | Allowanceallocation |        | Allowanceallocation |       |   | % of loans togross loans |      
|Secured by real estate                                       |  |                     |        |                     |       |   |                          |       |  
|Construction, land development, and other land loans         |  | $                   | 7,845  |                     | 27.6  | % |                          | 18.4  | %
|Farmland                                                     |  |                     | 4      |                     |      |   |                          | 0.3   |  
|Single-family residential                                    |  |                     | 4,362  |                     | 15.4  |   |                          | 20.1  |  
|Multifamily residential                                      |  |                     | 857    |                     | 3.0   |   |                          | 3.0   |  
|Nonfarm nonresidential                                       |  |                     | 8,905  |                     | 31.4  |   |                          | 44.7  |  
|Commercial and industrial                                    |  |                     | 4,286  |                     | 15.1  |   |                          | 5.8   |  
|Obligations of states and political subdivisions of the U.S. |  |                     |       |                     |      |   |                          | 0.1   |  
|General consumer                                             |  |                     | 1,236  |                     | 4.4   |   |                          | 5.4   |  
|Credit line                                                  |  |                     | 248    |                     | 0.9   |   |                          | 0.5   |  
|Bankcards                                                    |  |                     | 630    |                     | 2.2   |   |                          | 1.3   |  
|Others                                                       |  |                     | 10     |                     |      |   |                          | 0.4   |  
|                                                             |  |                     |        |                     |       |   |                          |       |  
|Total                                                        |  | $                   | 28,383 |                     | 100.0 | % |                          | 100.0 | %
|                                                             |  |                     |        |                     |       |   |                          |       |  

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 managements judgment, should be charged-off. While management utilizes the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses
depends on a variety of factors beyond the Companys control, including the performance of the Companys loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications.

In addition to the Companys portfolio review process, various regulatory agencies periodically review the Companys allowance for
loan losses. These agencies may require the Company 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 the Company uses 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 June 30, 2010 is appropriate and adequate to cover probable inherent losses in the loan portfolio.
However, underlying assumptions may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers which was not known to management at the time of
the issuance of the Companys Consolidated Financial Statements. Therefore, managements assumptions may or may not prove valid. Thus, there can be no assurance that loan losses in future periods 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 managements ongoing evaluation of the loan portfolio, in light of changing economic conditions and
other relevant factors, will not require significant future additions to the allowance for loan losses, thus adversely impacting the Companys business, financial condition, results of operations, and cash flows.

Premises and equipment, net

Premises
and equipment, net decreased by $261 thousand (0.9%) during the six month period ended June 30, 2010. As part of our earnings plan to improve our overall financial performance, we reduced several perquisites, including elimination in 2010 of
all bank-owned automobiles provided to officers. Bank automobiles with a net book value of $270 thousand were sold at a loss of $21 thousand during the six month period ended June 30, 2010.

In June 2010, we sold one vacant bank owned branch with a net book value of $46 thousand at a gain of $14 thousand and are currently evaluating the
potential sale of one other vacant branch facility.

Goodwill

Goodwill arose from our acquisition of various branches from 1988 through 1999 and represents the excess of the cost of businesses acquired over the fair
value of the net assets acquired. We perform our annual impairment testing as of June 30. Our impairment testing at June 30, 2010 indicated that no impairment charge was required. Due to the overall adverse economic
environment and the negative impact on the banking industry as a whole, including the impact to the Company resulting in net losses and a decline in market capitalization based on our common stock price, we also performed an impairment test of our
goodwill at December 31, 2009 and March 31, 2010. Based on our impairment testing as of these dates, we determined that our goodwill was not impaired.



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Due to the current economic environment and other uncertainties, it is possible that our estimates and
assumptions may adversely change in the future. If our market capitalization further decreases or the Private Placement transaction is not consummated, we may be required to record goodwill impairment losses in future periods, whether in connection
with our next annual impairment testing or prior to that, if any changes constitute a triggering event. It is not possible at this time to determine if any such future impairment loss would result; however, any such potential impairment loss would
be limited to the balance of goodwill, which was $3.7 million at June 30, 2010.

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 traditional deposit composition at the dates indicated (dollars in thousands).



|                                                 |  |               |           |            |                   |   |       |   |            |  |       |  
|------------------------------------------------ |  | ------------- | --------- | ---------- | ----------------- | - | ----- | - | ---------- |  | ----- | -
|                                                 |  | June 30, 2010 |           |            | December 31, 2009 |  
|                                                 |  | Total         |           | % of total |                   |   | Total |   | % of total | 
|Noninterest-bearing transaction deposit accounts |  | $             | 143,223   |            | 12.0              | % |       | $ | 142,609    |  | 11.7  | %
|Interest-bearing transaction deposit accounts    |  |               | 287,817   |            | 24.2              |   |       |   | 307,258    |  | 25.3  |  
|                                                 |  |               |           |            |                   |   |       |   |            |  |       |  
|Transaction deposit accounts                     |  |               | 431,040   |            | 36.2              |   |       |   | 449,867    |  | 37.0  |  
|Money market deposit accounts                    |  |               | 150,053   |            | 12.6              |   |       |   | 119,082    |  | 9.8   |  
|Savings deposit accounts                         |  |               | 46,776    |            | 3.9               |   |       |   | 40,335     |  | 3.3   |  
|Time deposit accounts                            |  |               | 563,506   |            | 47.3              |   |       |   | 605,630    |  | 49.9  |  
|                                                 |  |               |           |            |                   |   |       |   |            |  |       |  
|Total traditional deposit accounts               |  | $             | 1,191,375 |            | 100.0             | % |       | $ | 1,214,914  |  | 100.0 | %
|                                                 |  |               |           |            |                   |   |       |   |            |  |       |  

In March 2010, we introduced a new checking accounting, 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 account holders uses their debit card. Thus, ten debit card
transactions per month results in no monthly fee to the account holders. 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. As of June 30, 2010, the aggregate current balance of new and converted MyPal checking accounts totaled $7.5 million.

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 holders use their debit cards. The Company matches each $1 transfer with $1 for the first six months and then $0.10 thereafter, up to $250 per year. The Smart Savings account is also
interest-bearing. As of June 30, 2010, the aggregate current balance of Smart Savings accounts totaled $2.8 million.

During the first
and second quarters of 2010, we conducted targeted deposit growth and retention campaigns related to maturing certificates of deposit and to attract new deposits. The certificate of deposit (CD) campaigns included CDs with various
maturities ranging from 6 months to 60 months, as well as 15, 20, and 36 month step-up add-on CDs that allow holders to reset their interest rate up to one, two and three times, respectively, over the life of the CD and to add to the CDs over their
lives. These CD campaigns ended on June 30, 2010. From January 1, 2010 through June 30, 2010, these campaigns resulted in the retention of existing CDs and generation of new CDs totaling $258.1 million. However, due primarily to
maturing CDs that were not retained, through July 28, 2010 total traditional deposit accounts, and as a result our cash, decreased $19.2 million from December 31, 2009. In general, this CD runoff was expected as part of our balance sheet
management efforts to attract and retain lower priced transaction deposit accounts and shrinking our higher priced deposit base given the decline in the loan portfolio.



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At June 30, 2010, traditional deposit accounts as a percentage of liabilities were 89.9% compared with
89.3% at December 31, 2009. Interest-bearing deposits decreased $24.2 million during the six month period ended June 30, 2010, primarily due to higher priced time deposit accounts not being retained at maturity as part of our balance sheet
management efforts. Noninterest-bearing deposits increased $614 thousand during the same period. Traditional deposit accounts continue to be our primary source of funding, and, as part of our liquidity plan, we are proactively pursuing deposit
retention initiatives with our deposit customers. We are also pursuing strategies to increase our transaction deposit accounts as a proportion of our total deposits.

In October 2008, the Emergency Economic Stabilization Act (EESA) was enacted. Among other things, the EESA increased FDIC deposit insurance
on most accounts from $100,000 to $250,000. The increased coverage is currently available through December 31, 2013. In addition, we are voluntarily participating in the FDICs Transaction Account Guarantee Program. Under this program, all
noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount of the account. On April 13, 2010, the FDIC approved an interim rule that extends the Transaction Account Guarantee Program to December 31,
2010. We have elected to continue our voluntary participation in the program. Coverage under the program is in addition to and separate from the basic coverage available under the FDICs general deposit insurance rules. We believe participation
in the program is enhancing our ability to retain customer deposits.

On July 16, 2010, the FDIC announced that First National Bank of
the South in Spartanburg, South Carolina, was closed by the Office of the Comptroller of the Currency, which appointed the FDIC as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with another financial
institution to assume all of the deposits of First National Bank of the South. This was the third South Carolina bank, but the first in our geographic market, to be taken into receivership by the FDIC in 2010; accordingly, we are monitoring closely
its potential impact to the banking industry in South Carolina.

Borrowing Activities

During the six month period ended June 30, 2010, borrowings as a percentage of total liabilities decreased from 10.0% at December 31, 2009 to
9.1% at June 30, 2010.

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



|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|------------------------------------- |  | ------------- | ------- | --------- | ----------------- | - | ----- | - | --------- |  | ----- | -
|                                      |  | June 30, 2010 |         |           | December 31, 2009 |  
|                                      |  | Total         |         | % oftotal |                   |   | Total |   | % oftotal | 
|Retail repurchase agreements          |  | $             | 24,674  |           | 20.4              | % |       | $ | 15,545    |  | 11.5  | %
|Commercial paper                      |  |               |        |           |                  |   |       |   | 19,061    |  | 14.0  |  
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|Total nontraditional deposit accounts |  |               | 24,674  |           | 20.4              |   |       |   | 34,606    |  | 25.5  |  
|                                      |  |               |         |          
|FHLB borrowings                       |  |               | 96,000  |           | 79.3              |   |       |   | 101,000   |  | 74.5  |  
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|Total wholesale funding               |  |               | 96,000  |           | 79.3              |   |       |   | 101,000   |  | 74.5  |  
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|                                      |  |               |         |          
|Convertible debt                      |  |               | 380     |           | 0.3               |   |       |   |          |  |      |  
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|Total convertible debt                |  |               | 380     |           | 0.3               |   |       |   |          |  |      |  
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  
|Total borrowed funds                  |  | $             | 121,054 |           | 100.0             | % |       | $ | 135,606   |  | 100.0 | %
|                                      |  |               |         |           |                   |   |       |   |           |  |       |  

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

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



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Effective July 1, 2010, as part of our efforts to provide enhanced services to our customers, we no
longer offer the commercial paper program, and all commercial paper accounts were converted to a new money market sweep account by June 30, 2010. The money market sweep account is an FDIC insured deposit and includes interest paid on excess
balances and automatic transfers between various different accounts of our customers.

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



|                                                                                                             |  |              |         |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | ------------ | ------- | - | ---------------- | - | -------- | -
|                                                                                                             |  | June 30,2010 |         |   | December 31,2009 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $            | 145,302 |   |                  | $ | 162,014  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |              | 23,909  |   |                  |   | 26,791   |  
|Advances and letters of credit                                                                               |  |              |         |   |                  |   |          |  
|FHLB advances                                                                                                |  | $            | (96,000 | ) |                  | $ | (101,000 | )
|Letters of credit                                                                                            |  |              | (50,000 | ) |                  |   | (50,000  | )
|Excess / (deficiency)                                                                                        |  | $            | (9,015  | ) |                  | $ | 55       |  

On July 1, 2010, investment
securities with a market value of $21.5 million were pledged to cover the deficiency at June 30, 2010.

The following table summarizes
FHLB borrowings at June 30, 2010 (dollars in thousands). Our FHLB advances do not have embedded call options.



|                  |  |   |          |   |  |   |           |   |  |   |          |   |  |   |          |   |       |   |          |   |  |   |        |  
|----------------- |  | - | -------- | - |  | - | --------- | - |  | - | -------- | - |  | - | -------- | - | ----- | - | -------- | - |  | - | ------ | -
|                  |  |   |          |   |  |   |           |   |  |   |          |   |  |   |          |   | Total |  
|Borrowing balance |  | $ | 19,000   |   |  | $ | 30,000    |   |  | $ | 30,000   |   |  | $ | 5,000    |   |       | $ | 12,000   |   |  | $ | 96,000 |  
|Interest rate     |  |   | 0.63     | % |  |   | 1.34      | % |  |   | 2.89     | % |  |   | 3.61     | % |       |   | 0.43     | % |  |   | 1.69   | %
|Maturity date     |  |   | 1/7/2011 |   |  |   | 1/18/2011 |   |  |   | 3/7/2011 |   |  |   | 4/2/2013 |   |       |   | 4/4/2011 |   |  |   |        |  

In January 2010, we were notified by the FHLB that it will not allow incremental borrowings until our financial
condition improves.

Federal Reserve Discount Window. The maximum maturity for potential borrowings is overnight. Any potential
borrowings from the 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. We had no outstanding borrowings from the Federal
Reserve at December 31, 2009 or June 30, 2010.

Federal Funds Accommodations. At June 30, 2010, we had access to federal
funds funding from a correspondent bank. Our federal funds accommodation line is secured by U.S. Treasury and federal agencies securities. The following table summarizes our federal funds funding utilization and availability at the dates indicated
(in thousands).



|                                               |  |              |       |                  |   |      
|---------------------------------------------- |  | ------------ | ----- | ---------------- | - | -----
|                                               |  | June 30,2010 |       | December 31,2009
|Authorized federal funds funding accomodations |  | $            | 5,000 |                  | $ | 5,000
|Utilized federal funds funding accomodations   |  |              |      |                  |   |     
|                                               |  |              |       |                  |   |      
|Available federal funds funding accomodations  |  | $            | 5,000 |                  | $ | 5,000
|                                               |  |              |       |                  |   |      

This federal funds funding source may be canceled at any time at the
correspondent banks discretion.

Convertible Debt. In March 2010, the Company issued unsecured convertible promissory notes in an
aggregate principal amount of $380 thousand to members of the Board of Directors. The notes bear interest at 10% per year payable quarterly, have a stated maturity of March 31, 2015, may be prepaid by the Company at any time at the
discretion of the Board of Directors, and are mandatorily convertible into stock of the Company at the same terms and conditions as other investors that participate in the Companys next stock offering. The proceeds from the issuance of the
notes were contributed to the Bank as a capital contribution. As of June 30, 2010, interest of $10 thousand has been accrued but not paid.

Capital

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



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|                                                               |  |                                                   |        |   |                                                 |   |         |      |  |   |        |   |  |   |         |   
|-------------------------------------------------------------- |  | ------------------------------------------------- | ------ | - | ----------------------------------------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------- | --
|                                                               |  | At and for the three 
monthperiods ended June 30, |        |   | At and for the six 
monthperiods ended June 30, |  
|                                                               |  | 2010                                              |        |   | 2009                                            |   |         | 2010 |  |   | 2009   |  
|Total shareholders equity                                     |  | $                                                 | 62,643 |   |                                                 | $ | 100,088 |      |  | $ | 62,643 |   |  | $ | 100,088 |   
|Average shareholders equity                                   |  |                                                   | 70,705 |   |                                                 |   | 118,922 |      |  |   | 73,660 |   |  |   | 118,411 |   
|Shareholders equity as a percentage of assets                 |  |                                                   | 4.51   | % |                                                 |   | 6.83    | %    |  |   | 4.51   | % |  |   | 6.83    | % 
|Average shareholders equity as a percentage of average assets |  |                                                   | 5.15   |   |                                                 |   | 8.25    |      |  |   | 5.37   |   |  |   | 8.37    |   
|Cash dividends per common share                                |  | $                                                 |       |   |                                                 | $ |        |      |  | $ |       |   |  | $ | 0.06    |   
|Dividend payout ratio                                          |  |                                                   | n/a    | % |                                                 |   | n/a     | %    |  |   | n/a    | % |  |   | (2.45   | )%

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



|                                                                                               |  |                                                     |         |  
|---------------------------------------------------------------------------------------------- |  | --------------------------------------------------- | ------- | -
|                                                                                               |  | At and for the six 
monthperiod ended June 30, 2010 |        
|Total shareholders equity, beginning of period                                                |  | $                                                   | 75,015  |  
|Additions to shareholders equity during period                                                |  |                                                     |         |  
|Change in accumulated other comprehensive loss due to investment securities available for sale |  |                                                     | 1,267   |  
|Common stock issued pursuant to restricted stock plan                                          |  |                                                     | 171     |  
|Compensation expense related to stock option plan                                              |  |                                                     | 15      |  
|                                                                                               |  |                                                     |         |  
|Total additions to shareholders equity during period                                          |  |                                                     | 1,453   |  
|Reductions in shareholders equity during period                                               |  |                                                     |         |  
|Net loss                                                                                       |  |                                                     | (13,825 | )
|                                                                                               |  |                                                     |         |  
|Total reductions in shareholders equity during period                                         |  |                                                     | (13,825 | )
|                                                                                               |  |                                                     |         |  
|Total shareholders equity, end of period                                                      |  | $                                                   | 62,643  |  
|                                                                                               |  |                                                     |         |  

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



|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|----------------------------------------------------------------------------------------- |  | --------------------- | ------ | - | -------------------- | - | ----------------------------------------- |  | - | ---------------------------------------------- | - |  | ----- | ------ | - |  | - | ------ | -
|                                                                                          |  | Impact of FASBASC 715 |        |   | Impact ofcurtailment |   | Total impactof definedbenefitpension plan |  |   | Impact ofinvestmentsecuritiesavailable forsale |   |  | Total |       
|Accumulated other comprehensive income (loss), after income tax impact, December 31, 2008 |  | $                     | (6,126 | ) |                      | $ | 1,630                                     |  | $ | (4,496                                         | ) |  | $     | (1,621 | ) |  | $ | (6,117 | )
|Accumulated other comprehensive income, before income tax impact                          |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | 321    |   |  |   | 321    |  
|Income tax expense                                                                        |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | (123   | ) |  |   | (123   | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income, after income tax impact                           |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | 198    |   |  |   | 198    |  
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, June 30, 2009     |  | $                     | (6,126 | ) |                      | $ | 1,630                                     |  | $ | (4,496                                         | ) |  | $     | (1,423 | ) |  | $ | (5,919 | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, December 31, 2009 |  | $                     | (8,896 | ) |                      | $ | 1,630                                     |  | $ | (7,266                                         | ) |  | $     | 306    |   |  | $ | (6,960 | )
|Accumulated other comprehensive income, before income tax impact                          |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | 2,042  |   |  |   | 2,042  |  
|Income tax expense                                                                        |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | (775   | ) |  |   | (775   | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income, after income tax impact                           |  |                       |       |   |                      |   |                                          |  |   |                                               |   |  |       | 1,267  |   |  |   | 1,267  |  
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  
|Accumulated other comprehensive income (loss), after income tax impact, June 30, 2010     |  | $                     | (8,896 | ) |                      | $ | 1,630                                     |  | $ | (7,266                                         | ) |  | $     | 1,573  |   |  | $ | (5,693 | )
|                                                                                          |  |                       |        |   |                      |   |                                           |  |   |                                                |   |  |       |        |   |  |   |        |  

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

Private Placement

As previously described, the Bank agreed to the issuance of a Consent Order with the Supervisory Authorities effective June 10, 2010. One of the
requirements of the Consent Order is to raise additional capital to meet the regulatory minimum capital requirements.

On May 25, 2010
and amended June 8, 2010, the Company entered into Investment Agreements with institutional investors, pursuant to which the investors agreed to purchase approximately $103 million of shares of the Companys common stock at $2.60 per
share. Pursuant to the Investment Agreements, the Company has agreed to, among other things, nominate and appoint three designees of the investors to the Companys and the Banks Board of Directors. In addition, the investors will 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 current shareholders.



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The Private Placement is conditioned upon, among other things, the Companys shareholders
approval of an amendment to the Companys Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock from 25,000,000 shares to 75,000,000 shares and reduce the par value of the common stock from
$5.00 per share to $0.01 per share, the Companys representations and warranties contained in the Investment Agreements being true and correct in all material respects on the closing date, and the Investors receiving all required regulatory
approvals and determinations. The Investment Agreements may be terminated by the Company or an Investor under certain circumstances, including that the Company or an Investor, with respect to its investment, may terminate if the closing of the
Private Placement has not occurred by December 31, 2010. The Companys annual shareholder meeting, at which time the shareholders will vote on the proposals described above, will be held on August 6, 2010.

The net proceeds of the Private Placement, after estimated direct expenses of $8.5 million, are expected to be approximately $94.5 million of
which approximately $1.5 million will be retained by the Company and approximately $93.0 million will be contributed to the Bank as a capital contribution. The capital contribution to the Bank will result in the Banks capital adequacy
ratios exceeding the minimum capital levels required to be categorized as well capitalized.

Dividends. The following table summarizes
key dividend information at the dates and for the periods indicated (dollars in thousands, except per share data).



|                                 |  |                                                   |     |   |                                                 |   |     |      |  |   |      |   |  |   |       |   
|-------------------------------- |  | ------------------------------------------------- | --- | - | ----------------------------------------------- | - | --- | ---- |  | - | ---- | - |  | - | ----- | --
|                                 |  | At and for the three 
monthperiods ended June 30, |     |   | At and for the six 
monthperiods ended June 30, |  
|                                 |  | 2010                                              |     |   | 2009                                            |   |     | 2010 |  |   | 2009 |  
|Cash dividends per common share  |  | $                                                 |    |   |                                                 | $ |    |      |  | $ |     |   |  | $ | 0.06  |   
|Cash dividends declared and paid |  |                                                   |    |   |                                                 |   |    |      |  |   |     |   |  |   | 389   |   
|Dividend payout ratio            |  |                                                   | n/a | % |                                                 |   | n/a | %    |  |   | n/a  | % |  |   | (2.45 | )%

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, since our total risk-based capital ratio at June 30, 2010
was below the well-capitalized regulatory minimum threshold, payment of a dividend on the common stock of the Bank requires prior notification and non-objection from the FDIC. 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.

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

As previously described, in March 2010, the Company issued unsecured
convertible promissory notes in an aggregate principal amount of $380 thousand. The proceeds from this issuance, along with other cash of the Company, were contributed to the Bank as a capital contribution. At the closing of the Private Placement,
the outstanding convertible promissory notes will be converted into shares of the Companys common stock on the same terms as the Private Placement.

Our total risk-based capital ratio, Tier 1 leverage ratio, and Tier 1 risk-based capital ratio were below the well-capitalized regulatory minimum
threshold of 10%, 5%, and 6%, respectively, at June 30, 2010. As a result, although we had none at or since June 30, 2010, we may not accept brokered deposits unless a waiver is granted by the FDIC. Additionally, we would normally be
restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website. However, on April 1, 2010 we were notified by the FDIC that they had determined that the
geographic areas in which we operate were considered high-rate areas. Accordingly, we are able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in our geographic areas.



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The balance of net deferred income tax assets at June 30, 2010 represented tax assets and liabilities
arising from temporary differences between the financial reporting and income tax bases of various items as of that date. As of June 30, 2010, we evaluated whether it was more likely than not that the net deferred tax assets could be supported
as realizable, given the financial results for the year. Based on this evaluation, no valuation allowance was required for financial reporting purposes at June 30, 2010. However, our deferred tax asset of approximately $5.5 million that was not
realizable through the carryback period as of June 30, 2010 was disallowed in its entirety for regulatory capital purposes due to a regulatory limitation on the period for which future taxable income estimates may be considered.

See Part I. Financial Information, Item 1. Financial Statements, Note 18, contained herein for additional disclosures regarding the Companys
and the Banks actual and required regulatory capital requirements and ratios. Since June 30, 2010, no conditions or events have occurred of which we are aware, that have resulted in a material change in the Companys or the
Banks category other than as reported in this Quarterly Report on Form 10-Q.

Outstanding Equity. We currently have authorized
common stock and preferred stock of 25 million and 2.5 million shares, respectively. As part of the Private Placement, the Board of Directors has recommended to our shareholders to increase our authorized common stock to 75 million
shares, 39,734,709 of which would be issued to the investors in the Private Placement. The annual meeting of shareholders is scheduled on August 6, 2010 to vote on this proposal, as well as a proposal to reduce the par value of the
Companys commons stock from $5.00 per share to $.01 per share. Approval of both proposals by the shareholders is a closing condition for the Private Placement.

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. With respect to any 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 at that time, the
cost to the Company of alternative capital at that time, and the Companys strategy at that time 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 become listed on the NASDAQ within nine months of closing the Private Placement.

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

Prior to the closing of the Private Placement, the Company has agreed to appoint, subject to the closing, three designees from two specific institutional
investors to serve on the Boards of Directors of each of the Company and the Bank. Based on terms of the Private Placement, after the shareholder meeting scheduled for August 6, 2010 and assuming the Private Placement transaction is
consummated, the Board of Directors will be comprised of 16 directors and is to be reduced to 11 directors immediately following the consummation of the Private Placement transaction. Accordingly, the current Board of Directors is currently
evaluating the expected composition of the Board in preparation for the required reduction in size to 11 directors.



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Commitments, Guarantees, and Other Contingencies

See Part I  Financial Information, Item 1. Financial Statements, Note 15 contained herein for disclosures regarding our commitments,
guarantees, and other contingencies.

Derivative Activities

See Part I  Financial Information, Item 1. Financial Statements, Note 16 for disclosures regarding our derivative financial instruments and
hedging activities.



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Second Quarter 2010 Earnings Review

Overview

PALMETTO
BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

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



|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|------------------------------------------------------------------- |  | ------------------------------------------ | --------- | - | -------------- | - | --------- | --------------- |  | - | ------- | - |  | ------- | --
|                                                                    |  | For the three 
monthperiods ended June 30, |           |   | Dollarvariance |   |           | Percentvariance | 
|                                                                    |  | 2010                                       |           |   | 2009           |   |           |                
|Interest income                                                     |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Interest earned on cash and cash equivalents                        |  | $                                          | 88        |   |                | $ | 32        |                 |  | $ | 56      |   |  | 175.0   | % 
|Dividends paid on FHLB stock                                        |  |                                            | 5         |   |                |   |          |                 |  |   | 5       |   |  | 100.0   |   
|Interest earned on investment securities available for sale         |  |                                            | 786       |   |                |   | 1,481     |                 |  |   | (695    | ) |  | (46.9   | ) 
|Interest and fees earned on loans                                   |  |                                            | 13,571    |   |                |   | 14,377    |                 |  |   | (806    | ) |  | (5.6    | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Total interest income                                               |  |                                            | 14,450    |   |                |   | 15,890    |                 |  |   | (1,440  | ) |  | (9.1    | ) 
|Interest expense                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Interest paid on deposits                                           |  |                                            | 3,274     |   |                |   | 5,203     |                 |  |   | (1,929  | ) |  | (37.1   | ) 
|Interest paid on retail repurchase agreements                       |  |                                            | 13        |   |                |   | 14        |                 |  |   | (1      | ) |  | (7.1    | ) 
|Interest paid on commercial paper                                   |  |                                            | 11        |   |                |   | 14        |                 |  |   | (3      | ) |  | (21.4   | ) 
|Interest paid on other short-term borrowings                        |  |                                            |          |   |                |   | 11        |                 |  |   | (11     | ) |  | (100.0  | ) 
|Interest paid on FHLB borrowings                                    |  |                                            | 408       |   |                |   | 380       |                 |  |   | 28      |   |  | 7.4     |   
|Other                                                               |  |                                            | 10        |   |                |   |          |                 |  |   | 10      |   |  | 100.0   |   
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Total interest expense                                              |  |                                            | 3,716     |   |                |   | 5,622     |                 |  |   | (1,906  | ) |  | (33.9   | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Net interest income                                                 |  |                                            | 10,734    |   |                |   | 10,268    |                 |  |   | 466     |   |  | 4.5     |   
|Provision for loan losses                                           |  |                                            | 12,750    |   |                |   | 30,000    |                 |  |   | (17,250 | ) |  | (57.5   | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Net interest expense after provision for loan losses                |  |                                            | (2,016    | ) |                |   | (19,732   | )               |  |   | 17,716  |   |  | (89.8   | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Noninterest income                                                  |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Service charges on deposit accounts, net                            |  |                                            | 2,027     |   |                |   | 2,073     |                 |  |   | (46     | ) |  | (2.2    | ) 
|Fees for trust and investment management and brokerage services     |  |                                            | 735       |   |                |   | 576       |                 |  |   | 159     |   |  | 27.6    |   
|Mortgage-banking                                                    |  |                                            | 377       |   |                |   | 1,244     |                 |  |   | (867    | ) |  | (69.7   | ) 
|Automatic teller machine                                            |  |                                            | 321       |   |                |   | 335       |                 |  |   | (14     | ) |  | (4.2    | ) 
|Merchant services                                                   |  |                                            | 101       |   |                |   | 273       |                 |  |   | (172    | ) |  | (63.0   | ) 
|Other                                                               |  |                                            | 500       |   |                |   | 602       |                 |  |   | (102    | ) |  | (16.9   | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Total noninterest income                                            |  |                                            | 4,061     |   |                |   | 5,103     |                 |  |   | (1,042  | ) |  | (20.4   | ) 
|Noninterest expense                                                 |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Salaries and other personnel                                        |  |                                            | 6,302     |   |                |   | 6,215     |                 |  |   | 87      |   |  | 1.4     |   
|Occupancy                                                           |  |                                            | 1,148     |   |                |   | 1,155     |                 |  |   | (7      | ) |  | (0.6    | ) 
|Furniture and equipment                                             |  |                                            | 927       |   |                |   | 892       |                 |  |   | 35      |   |  | 3.9     |   
|Loss on disposition of premises and equipment                       |  |                                            | 3         |   |                |   | 21        |                 |  |   | (18     | ) |  | (85.7   | ) 
|FDIC deposit insurance assessment                                   |  |                                            | 981       |   |                |   | 1,372     |                 |  |   | (391    | ) |  | (28.5   | ) 
|Mortgage-servicing rights portfolio amortization and impairment     |  |                                            | 197       |   |                |   | 336       |                 |  |   | (139    | ) |  | (41.4   | ) 
|Marketing                                                           |  |                                            | 450       |   |                |   | 316       |                 |  |   | 134     |   |  | 42.4    |   
|Real estate acquired in settlement of loans writedowns and expenses |  |                                            | 2,550     |   |                |   | 45        |                 |  |   | 2,505   |   |  | 5,566.7 |   
|Other                                                               |  |                                            | 2,813     |   |                |   | 2,791     |                 |  |   | 22      |   |  | 0.8     |   
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Total noninterest expense                                           |  |                                            | 15,371    |   |                |   | 13,143    |                 |  |   | 2,228   |   |  | 17.0    |   
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Net loss before benefit for income taxes                            |  |                                            | (13,326   | ) |                |   | (27,772   | )               |  |   | 14,446  |   |  | (52.0   | ) 
|Benefit for income taxes                                            |  |                                            | (4,793    | ) |                |   | (9,921    | )               |  |   | 5,128   |   |  | (51.7   | ) 
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Net loss                                                            |  | $                                          | (8,533    | ) |                | $ | (17,851   | )               |  | $ | 9,318   |   |  | (52.2   | )%
|                                                                    |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Common and per share data                                           |  |                                            |           |   |                |   |           |                 |  |   |         |   |  |         |   
|Net loss - basic                                                    |  | $                                          | (1.32     | ) |                | $ | (2.77     | )               |  | $ | 1.45    |   |  |         |   
|Net loss - diluted                                                  |  |                                            | (1.32     | ) |                |   | (2.77     | )               |  |   | 1.45    |   |  |         |   
|Cash dividends                                                      |  |                                            |          |   |                |   |          |                 |  |   |        |   |  |         |   
|Book value                                                          |  |                                            | 9.64      |   |                |   | 15.45     |                 |  |   | (5.81   | ) |  |         |   
|Weighted average common shares outstanding - basic                  |  |                                            | 6,455,598 |   |                |   | 6,450,090 |                 |  |   |         |   |  |         |   
|Weighted average common shares outstanding - diluted                |  |                                            | 6,455,598 |   |                |   | 6,450,090 |                 |  |   |         |   |  |         |   

Summary

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

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



| |  |  | With respect to net interest income, we have implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain
criteria. At June 30, 2010, loans aggregating $217.8 million had interest rate floors, of which $196.9 million had floors greater than or equal to 5%. In June and July 2010, we began short-term loan specials intended to generate additional loan
volume for residential mortgage, auto, credit card, and consumer 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, we
have also borrowed longer-term advances from the FHLB to lock in the current low interest rates.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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 debit card transactions. We have also evaluated the profitability of all of our pre-existing deposit accounts and in the third quarter
of 2010 will continue the migration of unprofitable accounts to these new accounts to generate additional noninterest income. We are also revising our existing fees and implementing new fees, with various implementation dates between December 2010
and March 2011.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regarding noninterest expenses, we have identified over $2.5 million of specific noninterest expense reductions to be realized in 2009 and into 2010
and are continuing to review other expense areas for additional reductions, including with assistance from a consulting firm that specializes in process and efficiency reviews. These expense reductions 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.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Lastly, we are critically evaluating each of our businesses to determine their contribution to our financial performance and their relative risk /
return relationship. Based on the evaluation to date, on March 31, 2010 we 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 $550 thousand, net of transaction fees, for the six month period ended June 30, 2010.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Net interest income totaled $10.7 million for the three month period ended June 30, 2010 compared with $10.3 million for the three month period
ended June 30, 2009. Overall, interest income has been negatively impacted by the following:



| |  |  | Reduction in interest rates by the Federal Reserve by 500 to 525 basis points throughout 2007 and 2008. In response, we have refined the type of loan
and deposit products we prefer to pursue taking into consideration the yields earned and rates paid and are exercising more discipline in our loan and deposit interest rate levels. We have also implemented interest rate floors on loans. At
June 30, 2010, loans aggregating $217.8 million had interest rate floors, of which $196.9 million had floors greater than or equal to 5%.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Higher level of loans placed in nonaccrual status during the period; foregone interest on nonaccrual loans for the three month period ended
June 30, 2010 totaled $999 thousand.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Retaining a higher level of cash at the Federal Reserve, primarily from loan and security repayments, for which we earn a 25 basis points yield.
Maintaining this liquidity position has reduced our interest income by $1.1 million for the three month period ended June 30, 2010, when compared with investing these funds at the average yield of 2.74% on our investment securities because we
are retaining a higher level of cash instead of reinvesting this cash in higher yielding assets. However, we expect to maintain this level of cash until we close the Private Placement, notwithstanding the negative impact to our interest income. Once
the banking industry returns to a more stable operating environment and we raise additional capital, our plan is to reinvest these cash reserves into higher yielding assets which should significantly improve our net interest margin.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|---------------------------------------------------------- |  | ------------------------------------------ | --------- | - | -------------- | - | ---------- |  | ----- | -------------- |  | - | -------------- | - | ---------- | - | ------ |  | ---- | -
|                                                           |  | For the three month periods ended June 30, |          
|                                                           |  | 2010                                       |           |   | 2009           |  
|                                                           |  | Averagebalance                             |           |   | Income/expense |   | Yield/rate |  |       | Averagebalance |  |   | Income/expense |   | Yield/rate |  
|Assets                                                     |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Interest-earnings assets                                   |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Cash and cash equivalents                                  |  | $                                          | 187,403   |   |                | $ | 88         |  | 0.19  | %              |  | $ | 100,341        |   |            | $ | 32     |  | 0.13 | %
|FHLB stock                                                 |  |                                            | 7,010     |   |                |   | 5          |  | 0.29  |                |  |   | 5,974          |   |            |   |       |  |     |  
|Investment securities available for sale, taxable (1)      |  |                                            | 72,152    |   |                |   | 422        |  | 2.35  |                |  |   | 68,810         |   |            |   | 1,071  |  | 6.24 |  
|Investment securities available for sale, nontaxable (1)   |  |                                            | 43,122    |   |                |   | 364        |  | 3.39  |                |  |   | 48,722         |   |            |   | 410    |  | 3.38 |  
|Loans (2)                                                  |  |                                            | 994,587   |   |                |   | 13,571     |  | 5.47  |                |  |   | 1,162,453      |   |            |   | 14,377 |  | 4.96 |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-earning assets                              |  |                                            | 1,304,274 |   |                |   | 14,450     |  | 4.44  |                |  |   | 1,386,300      |   |            |   | 15,890 |  | 4.60 |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Noninterest-earning assets                                 |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Cash and cash equivalents                                  |  |                                            | 10,428    |   |                |   |            |  |       |                |  |   | 12,589         |   |            |   |        |  |      |  
|Allowance for loan losses                                  |  |                                            | (27,361   | ) |                |   |            |  |       |                |  |   | (13,046        | ) |            |   |        |  |      |  
|Premises and equipment, net                                |  |                                            | 29,842    |   |                |   |            |  |       |                |  |   | 29,257         |   |            |   |        |  |      |  
|Premises held for sale                                     |  |                                            | 33        |   |                |   |            |  |       |                |  |   |               |   |            |   |        |  |      |  
|Goodwill, net                                              |  |                                            | 3,688     |   |                |   |            |  |       |                |  |   | 3,688          |   |            |   |        |  |      |  
|Accrued interest receivable                                |  |                                            | 4,082     |   |                |   |            |  |       |                |  |   | 5,260          |   |            |   |        |  |      |  
|Real estate acquired in settlement of loans                |  |                                            | 29,045    |   |                |   |            |  |       |                |  |   | 7,085          |   |            |   |        |  |      |  
|Income tax refund receivable                               |  |                                            | 782       |   |                |   |            |  |       |                |  |   |               |   |            |   |        |  |      |  
|Other                                                      |  |                                            | 17,795    |   |                |   |            |  |       |                |  |   | 10,477         |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total noninterest-earning assets                           |  |                                            | 68,334    |   |                |   |            |  |       |                |  |   | 55,310         |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total assets                                               |  | $                                          | 1,372,608 |   |                |   |            |  |       |                |  | $ | 1,441,610      |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Liabilities and Shareholders Equity                       |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Liabilities                                                |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Interest-bearing liabilities                               |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Transaction deposit accounts                               |  | $                                          | 297,394   |   |                | $ | 67         |  | 0.09  | %              |  | $ | 333,340        |   |            | $ | 141    |  | 0.17 | %
|Money market deposit accounts                              |  |                                            | 134,181   |   |                |   | 174        |  | 0.52  |                |  |   | 103,670        |   |            |   | 139    |  | 0.54 |  
|Savings deposit accounts                                   |  |                                            | 46,030    |   |                |   | 37         |  | 0.32  |                |  |   | 41,671         |   |            |   | 35     |  | 0.34 |  
|Time deposit accounts                                      |  |                                            | 531,828   |   |                |   | 2,996      |  | 2.26  |                |  |   | 598,703        |   |            |   | 4,888  |  | 3.27 |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-bearing deposits                            |  |                                            | 1,009,433 |   |                |   | 3,274      |  | 1.30  |                |  |   | 1,077,383      |   |            |   | 5,203  |  | 1.94 |  
|Retail repurchase agreements                               |  |                                            | 21,861    |   |                |   | 13         |  | 0.24  |                |  |   | 22,565         |   |            |   | 14     |  | 0.25 |  
|Commercial paper (Master notes)                            |  |                                            | 17,347    |   |                |   | 11         |  | 0.25  |                |  |   | 22,342         |   |            |   | 14     |  | 0.25 |  
|Other short-term borrowings                                |  |                                            |          |   |                |   |           |  |      |                |  |   | 6,605          |   |            |   | 11     |  | 0.67 |  
|FHLB borrowings                                            |  |                                            | 95,998    |   |                |   | 408        |  | 1.70  |                |  |   | 53,647         |   |            |   | 380    |  | 2.84 |  
|Convertible debt                                           |  |                                            | 380       |   |                |   | 10         |  | 10.56 |                |  |   |               |   |            |   |       |  |     |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-bearing liabilities                         |  |                                            | 1,145,019 |   |                |   | 3,716      |  | 1.30  |                |  |   | 1,182,543      |   |            |   | 5,622  |  | 1.91 |  
|Noninterest-bearing liabilities                            |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Noninterest-bearing deposits                               |  |                                            | 143,894   |   |                |   |            |  |       |                |  |   | 132,952        |   |            |   |        |  |      |  
|Accrued interest payable                                   |  |                                            | 1,508     |   |                |   |            |  |       |                |  |   | 2,309          |   |            |   |        |  |      |  
|Other                                                      |  |                                            | 11,482    |   |                |   |            |  |       |                |  |   | 4,884          |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total noninterest-bearing liabilities                      |  |                                            | 156,884   |   |                |   |            |  |       |                |  |   | 140,145        |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total liabilities                                          |  |                                            | 1,301,903 |   |                |   |            |  |       |                |  |   | 1,322,688      |   |            |   |        |  |      |  
|Shareholders equity                                       |  |                                            | 70,705    |   |                |   |            |  |       |                |  |   | 118,922        |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total liabilities and shareholders equity                 |  | $                                          | 1,372,608 |   |                |   |            |  |       |                |  | $ | 1,441,610      |   |            |   |        |  |      |  
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|NET INTEREST INCOME / NET YIELD ON INTEREST-EARNING ASSETS |  |                                            |           |   |                | $ | 10,734     |  | 3.30  | %              |  |   |                |   |            | $ | 10,268 |  | 2.97 | %
|                                                           |  |                                            |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  



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



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



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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 prime interest rate and the federal funds interest rate from December 31, 2008
through June 30, 2010.

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



|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|---------------------------------------- |  | ------------------------------------------------------------------------------------------------------ | ------ | - | ------------- | - | ------ | ----------- |  | - | ------ | -
|                                         |  | For the three month period ended June 30, 
2010compared with the three month period endedJune 30, 2009 |       
|                                         |  | Change involume                                                                                        |        |   | Change inrate |   |        | Totalchange | 
|Assets                                   |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Interest-earnings assets                 |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Cash and cash equivalents                |  | $                                                                                                      | 36     |   |               | $ | 20     |             |  | $ | 56     |  
|FHLB stock                               |  |                                                                                                        |       |   |               |   | 5      |             |  |   | 5      |  
|Investment securities available for sale |  |                                                                                                        | (27    | ) |               |   | (668   | )           |  |   | (695   | )
|Loans*                                   |  |                                                                                                        | (2,828 | ) |               |   | 2,022  |             |  |   | (806   | )
|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Total interest income                    |  | $                                                                                                      | (2,819 | ) |               | $ | 1,379  |             |  | $ | (1,440 | )
|Liabilities and Shareholders Equity     |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Interest-bearing liabilities             |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Transaction deposit accounts             |  | $                                                                                                      | (14    | ) |               | $ | (60    | )           |  | $ | (74    | )
|Money market deposit accounts            |  |                                                                                                        | 40     |   |               |   | (5     | )           |  |   | 35     |  
|Savings deposit accounts                 |  |                                                                                                        | 4      |   |               |   | (2     | )           |  |   | 2      |  
|Time deposit accounts                    |  |                                                                                                        | (501   | ) |               |   | (1,391 | )           |  |   | (1,892 | )
|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Total interest paid on deposits          |  |                                                                                                        | (471   | ) |               |   | (1,458 | )           |  |   | (1,929 | )
|Retail repurchase agreements             |  |                                                                                                        |       |   |               |   | (1     | )           |  |   | (1     | )
|Commercial paper                         |  |                                                                                                        | (3     | ) |               |   |       |             |  |   | (3     | )
|Other short-term borrowings              |  |                                                                                                        | (11    | ) |               |   |       |             |  |   | (11    | )
|FHLB borrowings                          |  |                                                                                                        | 57     |   |               |   | (29    | )           |  |   | 28     |  
|Convertible debt                         |  |                                                                                                        | 10     |   |               |   |       |             |  |   | 10     |  
|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Total interest expense                   |  | $                                                                                                      | (418   | ) |               | $ | (1,488 | )           |  | $ | (1,906 | )
|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  
|Net interest income                      |  | $                                                                                                      | (2,401 | ) |               | $ | 2,867  |             |  | $ | 466    |  
|                                         |  |                                                                                                        |        |   |               |   |        |             |  |   |        |  



|* | Absent the significant impact of impaired loans during the three month period ended June 30, 2010, the change due to volume and the change due to rate for the
three month period ended June 30, 2010 compared with the three month period ended June 30, 2009 was -$5.2 million and $4.4 million, respectively.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Provision for Loan Losses

Provision for
loan losses decreased from $30.0 million during the three month period ended June 30, 2009 to $12.8 million for the three month period ended June 30, 2010. See Part I.  Financial Information, Item 2. 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
monthperiods ended June 30,
|                                                                |  | 2010                                      |       | 2009
|Service charges on deposit accounts, net                        |  | $                                         | 2,027 |      | $ | 2,073
|Fees for trust and investment management and brokerage services |  |                                           | 735   |      |   | 576  
|Mortgage-banking                                                |  |                                           | 377   |      |   | 1,244
|Automatic teller machine                                        |  |                                           | 321   |      |   | 335  
|Merchant services                                               |  |                                           | 101   |      |   | 273  
|Other                                                           |  |                                           | 500   |      |   | 602  
|                                                                |  |                                           |       |      |   |      
|Total noninterest income                                        |  | $                                         | 4,061 |      | $ | 5,103
|                                                                |  |                                           |       |      |   |      

Service Charges on Deposit Accounts, Net. Net service charges,
annualized, on deposit accounts comprise a significant component of noninterest income totaling 1.8% of average transaction deposit accounts for the three month periods ended June 30, 2010 and June 30, 2009.



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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 is 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 have estimated that the impact of the change from Regulation E would result in a reduction of 30% to 40% of such overdraft fees. We have evaluated the potential impact of Regulation E on our
services charges with the assistance of a specialized consulting firm and developed alternatives to mitigate the potential impact. At this time, we do not yet know if the implementation of Regulation E will result in a reduction in our services
charges.

Fees for Trust and Investment Management and Brokerage Services.The following table summarizes the composition of fees for
trust and investment management and brokerage services for the periods indicated (in thousands).



|                                                                      |  |                                            |     |      |   |    
|--------------------------------------------------------------------- |  | ------------------------------------------ | --- | ---- | - | ---
|                                                                      |  | For the three 
monthperiods ended June 30,
|                                                                      |  | 2010                                       |     | 2009
|Fees for trust and investment management services                     |  | $                                          | 575 |      | $ | 454
|Fees for brokerage services                                           |  |                                            | 160 |      |   | 122
|                                                                      |  |                                            |     |      |   |    
|Total fees for trust and investment management and brokerage services |  | $                                          | 735 |      | $ | 576
|                                                                      |  |                                            |     |      |   |    

Fees for trust and investment management and brokerage services for
the three month period ended June 30, 2010 increased $159 thousand (27.6%) to $735 thousand from $576 thousand for the three month period ended June 30, 2009, primarily as a result of the overall increase in the average market values
of securities held in trust accounts upon which trust fees are calculated. Fees for brokerage services are primarily transaction-based. As such, the increase in these fees was primarily due to the increase in brokerage transaction activity over the
periods presented.

Mortgage-Banking. Most of the residential mortgage loans that we originate are sold in the secondary market.
Normally we retain the servicing rights. Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009, respectively, and are not included in our Consolidated Balance
Sheets.

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



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|                                                                                                     |  |                                            |      |   |      |   |       |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ---- | - | ---- | - | ----- | -
|                                                                                                     |  | For the three 
monthperiods ended June 30, |     
|                                                                                                     |  | 2010                                       |      |   | 2009 |  
|Mortgage-servicing fees                                                                              |  | $                                          | 285  |   |      | $ | 247   |  
|Gain on sale of mortgage loans held for sale                                                         |  |                                            | 158  |   |      |   | 553   |  
|Derivative loan commitment income                                                                    |  |                                            | 157  |   |      |   | 245   |  
|Forward sales commitment income                                                                      |  |                                            | (255 | ) |      |   | 95    |  
|Other                                                                                                |  |                                            | 32   |   |      |   | 104   |  
|                                                                                                     |  |                                            |      |   |      |   |       |  
|Total mortgage-banking income                                                                        |  | $                                          | 377  |   |      | $ | 1,244 |  
|                                                                                                     |  |                                            |      |   |      |   |       |  
|Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others |  |                                            | 0.27 | % |      |   | 0.25  | %

Mortgage-banking income decreased $867
thousand (69.7%) from the three month period ended June 30, 2009 to the three month period ended June 30, 2010. Gains on sales of mortgage loans and related processing fees, included in Other, declined approximately $545 thousand for
the three month period ended June 30, 2010 compared to the three month period ended June 30, 2009. In 2009, the low interest rate environment contributed to an increase in refinancings which has declined to normal levels in 2010.
Derivative loan commitment income and forward sales commitment income also decreased $438 thousand over the same periods. Derivative loan commitment income and forward sales commitment income fluctuates based on the change in interest rates between
the time we enter into the commitment to originate / sell the loans and the valuation date.

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 over $2.5 million of specific noninterest expense reductions to be realized in 2009 and into 2010 and are continuing to review other expense areas for additional reductions. Examples include freezing
most employee salaries effective May 1, 2009, eliminating the remaining officer cash incentive plan awards under the corporate incentive plan for 2009, reducing our Saturday banking hours from 2:00 p.m. to noon effective September 5, 2009,
reducing marketing expenses, reducing corporate contributions to not-for-profit organizations, reducing perquisites, including reduction in the number of club memberships, elimination in 2010 of all bank-owned automobiles provided to officers,
reduction in coverage for annual physical examinations for officers, elimination in 2010 of Company paid life insurance premiums for certain officers, and termination of officer participation in the Supplemental Executive Retirement Plan. Savings
have also been realized resulting from implementing more advanced technology and other process improvements. These expense reductions 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 review other expense areas for additional reduction opportunities, including assistance in the first half of 2010 from a consulting firm that specializes in
efficiency reviews and expense reductions.

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



|                                                                    |  |                                            |        |      |   |       
|------------------------------------------------------------------- |  | ------------------------------------------ | ------ | ---- | - | ------
|                                                                    |  | For the three 
monthperiods ended June 30,
|                                                                    |  | 2010                                       |        | 2009
|Salaries and other personnel                                        |  | $                                          | 6,302  |      | $ | 6,215 
|Occupancy                                                           |  |                                            | 1,148  |      |   | 1,155 
|Furniture and equipment                                             |  |                                            | 927    |      |   | 892   
|Loss (gain) on disposition of premises, furniture, and equipment    |  |                                            | 3      |      |   | 21    
|FDIC deposit insurance assessment                                   |  |                                            | 981    |      |   | 1,372 
|Mortgage-servicing rights portfolio amortization and impairment     |  |                                            | 197    |      |   | 336   
|Marketing                                                           |  |                                            | 450    |      |   | 316   
|Real estate acquired in settlement of loans writedowns and expenses |  |                                            | 2,550  |      |   | 45    
|Other                                                               |  |                                            | 2,813  |      |   | 2,791 
|                                                                    |  |                                            |        |      |   |       
|Total noninterest expense                                           |  | $                                          | 15,371 |      | $ | 13,143
|                                                                    |  |                                            |        |      |   |       

Salaries and Other Personnel. Comprising 41.0% of total
noninterest expense during the three month period ended June 30, 2010 and 47.3% of total noninterest expense during the three month period ended June 30, 2009, salaries and other personnel expense increased $87 thousand (1.4%) over
the same periods.

FDIC Deposit Insurance Assessment. FDIC insurance premiums decreased $391 thousand (28.5%) from the three month
period ended June 30, 2009 to the same period of 2010. During the second quarter of 2009, we accrued an incremental $680 thousand of increased FDIC premiums due to the industry-wide special assessment by the FDIC to bolster the FDIC insurance
fund. The FDIC imposed a 5 basis point special assessment on assets less tier 1 capital with a cap of 10-basis points times deposits. This incremental special assessment was paid to the FDIC at the end of the third quarter of 2009. For the three
month period ended June 30, 2010, the FDICs general assessment rates increased compared to the same period of 2010. The increase in the general assessment was the result of our voluntary participation in the FDICs Transaction
Account Guarantee Program and our capital classification below well-capitalized.



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Mortgage-Servicing Rights Portfolio Amortization and Impairment. Amortization and impairment of the
mortgage-servicing rights portfolio decreased $139 thousand (41.4%) from the three month period ended June 30, 2009 to the same period of 2010. During 2007 and 2008, the Federal Reserve decreased rates by 500 to 525 basis points. During
the three month period ended June 30, 2009, this decline in interest rates resulted in an increase in loan prepayments and, therefore, increased amortization within the mortgage-servicing rights portfolio. Loan prepayments were significantly
lower in the quarter ended June 30, 2010.

Marketing. Marketing expense increased $134 thousand (42.4%) from the three month
period ended June 30, 2009 to the same period of 2010, primarily due to promotional efforts related to our new deposit accounts introduced in March 2010 and our CD campaigns that ran through June 30, 2010.

Real Estate Acquired in Settlement of Loans Writedowns and Expenses. Real estate acquired in settlement of loans writedowns and expenses increased
$2.5 million from the three month period ended June 30, 2009 to the same period of 2010. Based on currently available valuation information, the carrying value of these assets is written down to their fair value less estimated costs. Writedowns
on four such properties resulted in a provision charged to expense of $1.9 million. Of the total writedowns recorded during the three month period ended June 30, 2010, 82% related to these four properties.

Other. Other noninterest expense remained relatively unchanged over the three month periods ended June 30, 2009 and 2010.

Included as branch closure expense within this financial statement line item are the expenses associated with banking offices previously consolidated or
relocated that have not yet been subleased or sold. In June 2010, we sold one vacant bank owned branch with a net book value of $46 thousand at a slight gain and are currently evaluating the potential sale of one other vacant branch facility.

Also included within this financial statement line item for the three month period ended June 30, 2010 was the provision for loss on
unfunded commitments. Due to the change in the reserve for unfunded commitments during the period, we reduced the reserve by $116 thousand for the three month period ended June 30, 2010. Commitments have fixed expiration dates and most of our
commitments to extend credit have adverse change clauses that allow the Bank to cancel the commitments based on various factors, including deterioration in the creditworthiness of the borrower. Accordingly, many of our loan commitments are expected
to expire without being drawn upon and therefore the total commitment amounts do not necessarily represent potential credit exposure. In general the methodology to determine the reserve for unfunded commitments is inherently similar to that used to
determine the general reserve component of the allowance for loan losses.

Provision (Benefit) for Income Taxes

As a result of our pretax net loss of $13.3 million for the three month period ended June 30, 2010, we recognized an income tax benefit of $4.8
million for the period. During the three month period ended June 30, 2009, we recognized an income tax benefit of $9.9 million on pretax net loss of $27.8 million. Our effective tax rate was 36.0% for the three month period ended June 30,
2010 and 35.7% for the three month period ended June 30, 2009.

Year-to-Date Earnings Review

Overview



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

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



|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|------------------------------------------------------------------- |  | ---------------------------------------- | --------- | - | -------------- | - | --------- | --------------- |  | - | ------ | - |  | ------- | --
|                                                                    |  | For the six 
monthperiods ended June 30, |           |   | Dollarvariance |   |           | Percentvariance | 
|                                                                    |  | 2010                                     |           |   | 2009           |   |           |                
|Interest income                                                     |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Interest earned on cash and cash equivalents                        |  | $                                        | 155       |   |                | $ | 38        |                 |  | $ | 117    |   |  | 307.9   | % 
|Dividends paid on FHLB stock                                        |  |                                          | 9         |   |                |   |          |                 |  |   | 9      |   |  | 100.0   |   
|Interest earned on investment securities available for sale         |  |                                          | 1,989     |   |                |   | 3,014     |                 |  |   | (1,025 | ) |  | (34.0   | ) 
|Interest and fees earned on loans                                   |  |                                          | 27,176    |   |                |   | 30,404    |                 |  |   | (3,228 | ) |  | (10.6   | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Total interest income                                               |  |                                          | 29,329    |   |                |   | 33,456    |                 |  |   | (4,127 | ) |  | (12.3   | ) 
|Interest expense                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Interest paid on deposits                                           |  |                                          | 6,837     |   |                |   | 9,915     |                 |  |   | (3,078 | ) |  | (31.0   | ) 
|Interest paid on retail repurchase agreements                       |  |                                          | 27        |   |                |   | 27        |                 |  |   |       |   |  |        |   
|Interest paid on commercial paper                                   |  |                                          | 21        |   |                |   | 29        |                 |  |   | (8     | ) |  | (27.6   | ) 
|Interest paid on other short-term borrowings                        |  |                                          |          |   |                |   | 30        |                 |  |   | (30    | ) |  | (100.0  | ) 
|Interest paid on FHLB borrowings                                    |  |                                          | 901       |   |                |   | 809       |                 |  |   | 92     |   |  | 11.4    |   
|Other                                                               |  |                                          | 10        |   |                |   |          |                 |  |   | 10     |   |  | 100.0   |   
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Total interest expense                                              |  |                                          | 7,796     |   |                |   | 10,810    |                 |  |   | (3,014 | ) |  | (27.9   | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Net interest income                                                 |  |                                          | 21,533    |   |                |   | 22,646    |                 |  |   | (1,113 | ) |  | (4.9    | ) 
|Provision for loan losses                                           |  |                                          | 23,500    |   |                |   | 32,175    |                 |  |   | (8,675 | ) |  | (27.0   | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Net interest expense after provision for loan losses                |  |                                          | (1,967    | ) |                |   | (9,529    | )               |  |   | 7,562  |   |  | (79.4   | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Noninterest income                                                  |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Service charges on deposit accounts, net                            |  |                                          | 3,977     |   |                |   | 3,956     |                 |  |   | 21     |   |  | 0.5     |   
|Fees for trust and investment management and brokerage services     |  |                                          | 1,386     |   |                |   | 1,110     |                 |  |   | 276    |   |  | 24.9    |   
|Mortgage-banking                                                    |  |                                          | 997       |   |                |   | 2,110     |                 |  |   | (1,113 | ) |  | (52.7   | ) 
|Automatic teller machine                                            |  |                                          | 624       |   |                |   | 635       |                 |  |   | (11    | ) |  | (1.7    | ) 
|Merchant services                                                   |  |                                          | 895       |   |                |   | 551       |                 |  |   | 344    |   |  | 62.4    |   
|Investment securities gains                                         |  |                                          | 8         |   |                |   | 2         |                 |  |   | 6      |   |  | 300.0   |   
|Other                                                               |  |                                          | 1,114     |   |                |   | 1,170     |                 |  |   | (56    | ) |  | (4.8    | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Total noninterest income                                            |  |                                          | 9,001     |   |                |   | 9,534     |                 |  |   | (533   | ) |  | (5.6    | ) 
|Noninterest expense                                                 |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Salaries and other personnel                                        |  |                                          | 12,439    |   |                |   | 12,134    |                 |  |   | 305    |   |  | 2.5     |   
|Occupancy                                                           |  |                                          | 2,319     |   |                |   | 2,071     |                 |  |   | 248    |   |  | 12.0    |   
|Furniture and equipment                                             |  |                                          | 1,894     |   |                |   | 1,775     |                 |  |   | 119    |   |  | 6.7     |   
|Loss on disposition of premises and equipment                       |  |                                          | 8         |   |                |   | 76        |                 |  |   | (68    | ) |  | (89.5   | ) 
|FDIC deposit insurance assessment                                   |  |                                          | 1,696     |   |                |   | 1,826     |                 |  |   | (130   | ) |  | (7.1    | ) 
|Mortgage-servicing rights portfolio amortization and impairment     |  |                                          | 388       |   |                |   | 750       |                 |  |   | (362   | ) |  | (48.3   | ) 
|Marketing                                                           |  |                                          | 745       |   |                |   | 685       |                 |  |   | 60     |   |  | 8.8     |   
|Real estate acquired in settlement of loans writedowns and expenses |  |                                          | 3,562     |   |                |   | 74        |                 |  |   | 3,488  |   |  | 4,713.5 |   
|Other                                                               |  |                                          | 5,643     |   |                |   | 5,269     |                 |  |   | 374    |   |  | 7.1     |   
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Total noninterest expense                                           |  |                                          | 28,694    |   |                |   | 24,660    |                 |  |   | 4,034  |   |  | 16.4    |   
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Net loss before benefit for income taxes                            |  |                                          | (21,660   | ) |                |   | (24,655   | )               |  |   | 2,995  |   |  | (12.1   | ) 
|Benefit for income taxes                                            |  |                                          | (7,835    | ) |                |   | (8,798    | )               |  |   | 963    |   |  | (10.9   | ) 
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Net loss                                                            |  | $                                        | (13,825   | ) |                | $ | (15,857   | )               |  | $ | 2,032  |   |  | (12.8   | )%
|                                                                    |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Common and per share data                                           |  |                                          |           |   |                |   |           |                 |  |   |        |   |  |         |   
|Net loss - basic                                                    |  | $                                        | (2.14     | ) |                | $ | (2.46     | )               |  | $ | 0.32   |   |  |         |   
|Net loss - diluted                                                  |  |                                          | (2.14     | ) |                |   | (2.46     | )               |  |   | 0.32   |   |  |         |   
|Cash dividends                                                      |  |                                          |          |   |                |   | 0.06      |                 |  |   | (0.06  | ) |  |         |   
|Book value                                                          |  |                                          | 9.64      |   |                |   | 15.45     |                 |  |   | (5.81  | ) |  |         |   
|Weighted average common shares outstanding - basic                  |  |                                          | 6,455,598 |   |                |   | 6,449,383 |                 |  |   |        |   |  |         |   
|Weighted average common shares outstanding - diluted                |  |                                          | 6,455,598 |   |                |   | 6,449,383 |                 |  |   |        |   |  |         |   

Net Interest Income

Net interest income totaled $21.5 million for the six month period ended June 30, 2010 compared with $22.6 million for the six month period ended
June 30, 2009. In addition to the impact of changes due to volume and rate as summarized below in Rate / Volume Analysis, net interest income for the period was negatively impacted by the impact of loans placed in nonaccrual status during the
period. Foregone interest on nonaccrual loans for the six month period ended June 30, 2010 totaled $1.8 million. The net interest margin was also negatively impacted by retaining at the Federal Reserve a higher level of cash, primarily from
loan and security repayments, for which we earn a 25 basis points yield. The net interest margin remained relatively unchanged at 3.37% during the six month period ended June 30, 2009 and 3.36% during the same period of 2010.

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



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|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|---------------------------------------------------------- |  | ---------------------------------------- | --------- | - | -------------- | - | ---------- |  | ----- | -------------- |  | - | -------------- | - | ---------- | - | ------ |  | ---- | -
|                                                           |  | For the six month periods ended June 30, |          
|                                                           |  | 2010                                     |           |   | 2009           |  
|                                                           |  | Averagebalance                           |           |   | Income/expense |   | Yield/rate |  |       | Averagebalance |  |   | Income/expense |   | Yield/rate |  
|Assets                                                     |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Interest-earnings assets                                   |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Cash and cash equivalents                                  |  | $                                        | 157,166   |   |                | $ | 155        |  | 0.20  | %              |  | $ | 66,301         |   |            | $ | 38     |  | 0.12 | %
|FHLB stock                                                 |  |                                          | 7,010     |   |                |   | 9          |  | 0.26  |                |  |   | 6,555          |   |            |   |       |  |     |  
|Investment securities available for sale, taxable (1)      |  |                                          | 71,936    |   |                |   | 1,240      |  | 3.48  |                |  |   | 70,830         |   |            |   | 2,175  |  | 6.19 |  
|Investment securities available for sale, nontaxable (1)   |  |                                          | 44,545    |   |                |   | 749        |  | 3.39  |                |  |   | 49,675         |   |            |   | 839    |  | 3.41 |  
|Loans (2)                                                  |  |                                          | 1,013,061 |   |                |   | 27,176     |  | 5.41  |                |  |   | 1,163,551      |   |            |   | 30,404 |  | 5.27 |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-earning assets                              |  |                                          | 1,293,718 |   |                |   | 29,329     |  | 4.57  |                |  |   | 1,356,912      |   |            |   | 33,456 |  | 4.97 |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Noninterest-earning assets                                 |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Cash and cash equivalents                                  |  |                                          | 11,066    |   |                |   |            |  |       |                |  |   | 13,689         |   |            |   |        |  |      |  
|Allowance for loan losses                                  |  |                                          | (25,514   | ) |                |   |            |  |       |                |  |   | (12,177        | ) |            |   |        |  |      |  
|Premises and equipment, net                                |  |                                          | 29,875    |   |                |   |            |  |       |                |  |   | 28,241         |   |            |   |        |  |      |  
|Premises held for sale                                     |  |                                          | 17        |   |                |   |            |  |       |                |  |   | 684            |   |            |   |        |  |      |  
|Goodwill, net                                              |  |                                          | 3,688     |   |                |   |            |  |       |                |  |   | 3,688          |   |            |   |        |  |      |  
|Accrued interest receivable                                |  |                                          | 4,258     |   |                |   |            |  |       |                |  |   | 5,290          |   |            |   |        |  |      |  
|Real estate acquired in settlement of loans                |  |                                          | 28,955    |   |                |   |            |  |       |                |  |   | 6,833          |   |            |   |        |  |      |  
|Income tax refund receivable                               |  |                                          | 8,313     |   |                |   |            |  |       |                |  |   |               |   |            |   |        |  |      |  
|Other                                                      |  |                                          | 16,062    |   |                |   |            |  |       |                |  |   | 11,469         |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total noninterest-earning assets                           |  |                                          | 76,720    |   |                |   |            |  |       |                |  |   | 57,717         |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total assets                                               |  | $                                        | 1,370,438 |   |                |   |            |  |       |                |  | $ | 1,414,629      |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Liabilities and Shareholders Equity                       |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Liabilities                                                |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Interest-bearing liabilities                               |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Transaction deposit accounts                               |  | $                                        | 298,356   |   |                | $ | 128        |  | 0.09  | %              |  | $ | 343,804        |   |            | $ | 386    |  | 0.23 | %
|Money market deposit accounts                              |  |                                          | 128,990   |   |                |   | 334        |  | 0.52  |                |  |   | 99,067         |   |            |   | 307    |  | 0.62 |  
|Savings deposit accounts                                   |  |                                          | 43,928    |   |                |   | 69         |  | 0.32  |                |  |   | 39,933         |   |            |   | 66     |  | 0.33 |  
|Time deposit accounts                                      |  |                                          | 534,338   |   |                |   | 6,306      |  | 2.38  |                |  |   | 544,494        |   |            |   | 9,156  |  | 3.39 |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-bearing deposits                            |  |                                          | 1,005,612 |   |                |   | 6,837      |  | 1.37  |                |  |   | 1,027,298      |   |            |   | 9,915  |  | 1.95 |  
|Retail repurchase agreements                               |  |                                          | 22,089    |   |                |   | 27         |  | 0.25  |                |  |   | 22,131         |   |            |   | 27     |  | 0.25 |  
|Commercial paper (Master notes)                            |  |                                          | 17,011    |   |                |   | 21         |  | 0.25  |                |  |   | 23,370         |   |            |   | 29     |  | 0.25 |  
|Other short-term borrowings                                |  |                                          | 1         |   |                |   |           |  |      |                |  |   | 9,997          |   |            |   | 30     |  | 0.61 |  
|FHLB borrowings                                            |  |                                          | 97,822    |   |                |   | 901        |  | 1.86  |                |  |   | 73,220         |   |            |   | 809    |  | 2.23 |  
|Convertible debt                                           |  |                                          | 193       |   |                |   | 10         |  | 10.45 |                |  |   |               |   |            |   |       |  |     |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total interest-bearing liabilities                         |  |                                          | 1,142,728 |   |                |   | 7,796      |  | 1.38  |                |  |   | 1,156,016      |   |            |   | 10,810 |  | 1.89 |  
|Noninterest-bearing liabilities                            |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Noninterest-bearing deposits                               |  |                                          | 142,332   |   |                |   |            |  |       |                |  |   | 132,191        |   |            |   |        |  |      |  
|Accrued interest payable                                   |  |                                          | 1,617     |   |                |   |            |  |       |                |  |   | 2,177          |   |            |   |        |  |      |  
|Other                                                      |  |                                          | 10,101    |   |                |   |            |  |       |                |  |   | 5,834          |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total noninterest-bearing liabilities                      |  |                                          | 154,050   |   |                |   |            |  |       |                |  |   | 140,202        |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total liabilities                                          |  |                                          | 1,296,778 |   |                |   |            |  |       |                |  |   | 1,296,218      |   |            |   |        |  |      |  
|Shareholders equity                                       |  |                                          | 73,660    |   |                |   |            |  |       |                |  |   | 118,411        |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|Total liabilities and shareholders equity                 |  | $                                        | 1,370,438 |   |                |   |            |  |       |                |  | $ | 1,414,629      |   |            |   |        |  |      |  
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  
|NET INTEREST INCOME / NET YIELD ON INTEREST-EARNING ASSETS |  |                                          |           |   |                | $ | 21,533     |  | 3.36  | %              |  |   |                |   |            | $ | 22,646 |  | 3.37 | %
|                                                           |  |                                          |           |   |                |   |            |  |       |                |  |   |                |   |            |   |        |  |      |  



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



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



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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 prime interest rate and the federal funds interest rate from December 31, 2008
through June 30, 2010.

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



|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|---------------------------------------- |  | -------------------------------------------------------------------------------------------------- | ------ | - | ------------- | - | ------ | ----------- |  | - | ------ | -
|                                         |  | For the six month period ended June 30, 
2010compared with the six month period endedJune 30, 2009 |       
|                                         |  | Change involume                                                                                    |        |   | Change inrate |   |        | Totalchange | 
|Assets                                   |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Interest-earnings assets                 |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Cash and cash equivalents                |  | $                                                                                                  | 77     |   |               | $ | 40     |             |  | $ | 117    |  
|FHLB stock                               |  |                                                                                                    |       |   |               |   | 9      |             |  |   | 9      |  
|Investment securities available for sale |  |                                                                                                    | (98    | ) |               |   | (927   | )           |  |   | (1,025 | )
|Loans*                                   |  |                                                                                                    | (4,064 | ) |               |   | 836    |             |  |   | (3,228 | )
|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Total interest income                    |  | $                                                                                                  | (4,085 | ) |               | $ | (42    | )           |  | $ | (4,127 | )
|Liabilities and Shareholders Equity     |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Interest-bearing liabilities             |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Transaction deposit accounts             |  | $                                                                                                  | (45    | ) |               | $ | (213   | )           |  | $ | (258   | )
|Money market deposit accounts            |  |                                                                                                    | 61     |   |               |   | (34    | )           |  |   | 27     |  
|Savings deposit accounts                 |  |                                                                                                    | 7      |   |               |   | (4     | )           |  |   | 3      |  
|Time deposit accounts                    |  |                                                                                                    | (168   | ) |               |   | (2,682 | )           |  |   | (2,850 | )
|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Total interest paid on deposits          |  |                                                                                                    | (145   | ) |               |   | (2,933 | )           |  |   | (3,078 | )
|Retail repurchase agreements             |  |                                                                                                    |       |   |               |   |       |             |  |   |       |  
|Commercial paper                         |  |                                                                                                    | (8     | ) |               |   |       |             |  |   | (8     | )
|Other short-term borrowings              |  |                                                                                                    | (15    | ) |               |   | (15    | )           |  |   | (30    | )
|FHLB borrowings                          |  |                                                                                                    | 183    |   |               |   | (91    | )           |  |   | 92     |  
|Convertible debt                         |  |                                                                                                    | 10     |   |               |   |       |             |  |   | 10     |  
|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Total interest expense                   |  | $                                                                                                  | 25     |   |               | $ | (3,039 | )           |  | $ | (3,014 | )
|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  
|Net interest income                      |  | $                                                                                                  | (4,110 | ) |               | $ | 2,997  |             |  | $ | (1,113 | )
|                                         |  |                                                                                                    |        |   |               |   |        |             |  |   |        |  



|* | Absent the significant impact of impaired loans during the six month period ended June 30, 2010, the change due to volume and the change due to rate for the
six month period ended June 30, 2010 compared with the six month period ended June 30, 2009 was -$6.0 million and $2.8 million, respectively.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Provision for Loan Losses

Provision for
loan losses decreased from $32.2 million during the six month period ended June 30, 2009 to $23.5 million for the six month period ended June 30, 2010. See Part I.  Financial Information, Item 2. 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 six 
monthperiods ended June 30,
|                                                                |  | 2010                                     |       | 2009
|Service charges on deposit accounts, net                        |  | $                                        | 3,977 |      | $ | 3,956
|Fees for trust and investment management and brokerage services |  |                                          | 1,386 |      |   | 1,110
|Mortgage-banking                                                |  |                                          | 997   |      |   | 2,110
|Automatic teller machine                                        |  |                                          | 624   |      |   | 635  
|Merchant services                                               |  |                                          | 895   |      |   | 551  
|Investment securities gains                                     |  |                                          | 8     |      |   | 2    
|Other                                                           |  |                                          | 1,114 |      |   | 1,170
|                                                                |  |                                          |       |      |   |      
|Total noninterest income                                        |  | $                                        | 9,001 |      | $ | 9,534
|                                                                |  |                                          |       |      |   |      

Service Charges on Deposit Accounts, Net. Net service charges,
annualized, on deposit accounts comprise a significant component of noninterest income totaling 1.8% of average transaction deposit accounts for the six month period ended June 30, 2010 compared with 1.7% of average transaction deposit accounts
for the six month period ended June 30, 2009. See Second Quarter 2010 Earnings Review, Noninterest Income, Service Charges on Deposit Accounts, Net for additional disclosures.



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Fees for Trust and Investment Management and Brokerage Services. The following table summarizes the
composition of fees for trust and investment management and brokerage services for the periods indicated (in thousands).



|                                                                      |  |                                          |       |      |   |      
|--------------------------------------------------------------------- |  | ---------------------------------------- | ----- | ---- | - | -----
|                                                                      |  | For the six 
monthperiods ended June 30,
|                                                                      |  | 2010                                     |       | 2009
|Fees for trust and investment management services                     |  | $                                        | 1,073 |      | $ | 861  
|Fees for brokerage services                                           |  |                                          | 313   |      |   | 249  
|                                                                      |  |                                          |       |      |   |      
|Total fees for trust and investment management and brokerage services |  | $                                        | 1,386 |      | $ | 1,110
|                                                                      |  |                                          |       |      |   |      

Fees for trust and investment management and brokerage services for
the six month period ended June 30, 2010 increased $276 thousand (24.9%) to $1.4 million from $1.1 million for the six month period ended June 30, 2009. See Second Quarter 2010 Earnings Review, Noninterest Income, Fees for Trust and
Investment Management and Brokerage Services for additional disclosures.

Mortgage-Banking. Most of the residential mortgage loans that
we originate are sold in the secondary market. Normally we retain the servicing rights. Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009, respectively,
and are not included in our Consolidated Balance Sheets.

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



|                                                                                                     |  |                                          |      |   |      |   |       |  
|---------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ---- | - | ---- | - | ----- | -
|                                                                                                     |  | For the six 
monthperiods ended June 30, |     
|                                                                                                     |  | 2010                                     |      |   | 2009 |  
|Mortgage-servicing fees                                                                              |  | $                                        | 541  |   |      | $ | 487   |  
|Gain on sale of mortgage loans held for sale                                                         |  |                                          | 501  |   |      |   | 1,075 |  
|Derivative loan commitment income                                                                    |  |                                          | 209  |   |      |   | 245   |  
|Forward sales commitment income                                                                      |  |                                          | (331 | ) |      |   | 95    |  
|Other                                                                                                |  |                                          | 77   |   |      |   | 208   |  
|                                                                                                     |  |                                          |      |   |      |   |       |  
|Total mortgage-banking income                                                                        |  | $                                        | 997  |   |      | $ | 2,110 |  
|                                                                                                     |  |                                          |      |   |      |   |       |  
|Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others |  |                                          | 0.26 | % |      |   | 0.25  | %

Mortgage-banking income decreased $1.1
million (52.7%) from the six month period ended June 30, 2009 to the six month period ended June 30, 2010. See Second Quarter 2010 Earnings Review, Noninterest Income, Mortgage-Banking for additional disclosures.

Merchant Services. Merchant services income increased $344 thousand (62.4%) from the six month period ended June 30, 2009 to the same
period 2010. As previously described, we are critically evaluating each of our businesses to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation to date, on March 31,
2010 we 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
$550 thousand, net of transaction fees, for the six month period ended June 30, 2010. Under the agreement, Global Direct will provide services including merchant sales through a dedicated sales person, marketing and advertising within our
geographic footprint, credit review and approval and activating new merchant accounts, equipment sales and customer service, transaction authorization service, risk mitigation services, and compliance with applicable laws and card association and
payment network rules.

Noninterest Expense

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



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|                                                                    |  |                                          |        |      |   |       
|------------------------------------------------------------------- |  | ---------------------------------------- | ------ | ---- | - | ------
|                                                                    |  | For the six 
monthperiods ended June 30,
|                                                                    |  | 2010                                     |        | 2009
|Salaries and other personnel                                        |  | $                                        | 12,439 |      | $ | 12,134
|Occupancy                                                           |  |                                          | 2,319  |      |   | 2,071 
|Furniture and equipment                                             |  |                                          | 1,894  |      |   | 1,775 
|Loss (gain) on disposition of premises, furniture, and equipment    |  |                                          | 8      |      |   | 76    
|FDIC deposit insurance assessment                                   |  |                                          | 1,696  |      |   | 1,826 
|Mortgage-servicing rights portfolio amortization and impairment     |  |                                          | 388    |      |   | 750   
|Marketing                                                           |  |                                          | 745    |      |   | 685   
|Real estate acquired in settlement of loans writedowns and expenses |  |                                          | 3,562  |      |   | 74    
|Other                                                               |  |                                          | 5,643  |      |   | 5,269 
|                                                                    |  |                                          |        |      |   |       
|Total noninterest expense                                           |  | $                                        | 28,694 |      | $ | 24,660
|                                                                    |  |                                          |        |      |   |       

Salaries and Other Personnel. Comprising 43.4% of total
noninterest expense during the six month period ended June 30, 2010 and 49.2% of total noninterest expense during the six month period ended June 30, 2009, salaries and other personnel expense increased by $305 thousand (2.5%) over
the same periods.

Occupancy. Occupancy expense increased $248 thousand (12.0%) for the six month period ended June 30, 2010
over the same period of 2009, primarily as a result of the impact of the new corporate headquarters. Occupancy expense for the six month period ended June 30, 2010 included six monthly payments under the lease agreement for the new headquarters
and only three and one-half monthly payments for the six month period ended June 30, 2009. This increase was offset by the impact of expenses associated with banking offices previously consolidated or relocated that have not yet been subleased
or sold no longer being recorded within this financial statement line item but rather being recorded as a branch closure expense within the Other noninterest expense financial statement line item of the Consolidated Statements of Income (Loss).

FDIC Deposit Insurance Assessment. FDIC insurance premiums decreased $130 thousand (7.1%) for the six month period ended
June 30, 2010 over the same period of 2009. During the second quarter of 2009, we accrued an incremental $680 thousand of increased FDIC premiums due to the industry-wide special assessment by the FDIC to bolster the FDIC insurance fund. The
FDIC imposed a 5 basis point special assessment on assets less tier 1 capital with a cap of 10-basis points times deposits. This incremental special assessment was paid to the FDIC at the end of the third quarter 2009. For the six month period ended
June 30, 2010, the FDICs general assessment rates increased compared to the same period of 2009. The increase in the general assessment was the result of our voluntary participation in the FDICs Transaction Account Guarantee Program
and our capital classification below well-capitalized.

Mortgage-Servicing Rights Portfolio Amortization and Impairment. Amortization
and impairment of the mortgage-servicing rights portfolio decreased $362 thousand (48.3%) from the six month period ended June 30, 2009 to the same period of 2009. See Second Quarter 2010 Earnings Review, Noninterest Income,
Mortgage-Servicing Rights Portfolio Amortization and Impairment for additional disclosures.

Marketing. Marketing expense increased $60
thousand (8.8%) from the six month period ended June 30, 2009 to the same period of 2010, primarily due to promotional efforts related to our new deposit accounts introduced in March 2010 and our CD campaigns that ran through June 30,
2010.

Real Estate Acquired in Settlement of Loans Writedowns and Expenses. Real estate acquired in settlement of loans writedowns and
expenses increased $3.5 million from the six month period ended June 30, 2009 to the same period of 2010. Based on currently available valuation information, the carrying value of these assets is written down to their fair value less estimated
costs. Writedowns on seven such properties resulted in a provision charged to expense of $2.8 million. Of the total writedowns recorded during the six month period ended June 30, 2010, 81% related to these seven properties.

Other. Other noninterest expense increased by $374 thousand (7.1%) from the six month period ended June 30, 2009 to the same period of
2010. In large part, this increase was the result of increased credit-related costs and expenses associated with the execution of the Strategic Project Plan and problem loan resolution consulting assistance.

Included as branch closure expense within this financial statement line item are the expenses associated with banking offices previously consolidated or
relocated that have not yet been subleased or sold. In June 2010, we sold one vacant bank owned branch with a net book value of $46 thousand at a slight gain and are currently evaluating the potential sale of one other vacant branch facility.



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Also included within this financial statement line item for the six month period ended June 30, 2010
was the provision for loss on unfunded commitments. Due to the change in the reserve for unfunded commitments during the period, we reduced the reserve by $29 thousand for the six month period ended June 30, 2010.

Provision (Benefit) for Income Taxes

As
a result of our pretax net loss of $21.7 million for the six month period ended June 30, 2010, we recognized an income tax benefit of $7.8 million for the period. During the six month period ended June 30, 2009, we recognized an income tax
benefit of $8.8 million on pretax net loss of $24.7 million. Our effective tax rate was 36.2% for the six month period ended June 30, 2010 and 35.7% for the six month period ended June 30, 2009.

Recently Issued Applicable Accounting Pronouncements

See Item 1. Financial Statements, Note 1 contained herein for disclosures regarding accounting pronouncements recently issued, if applicable, and
their expected impact on our business, financial condition, results of operations, or cash flows.



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

As of June 30, 2010, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward
movements in interest rates of 100, 200 and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates (based upon current economic conditions and past interest rate cycles).
Estimates are based on historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated
Financial Statements. Therefore, managements assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to
differ from underlying assumptions.



|                           |  |                                                 |   
|-------------------------- |  | ----------------------------------------------- | --
|Interest rate scenario (1) |  | Percentagechange in netinterest incomefrom base |   
|Up 300 basis points        |  | (5.46                                           | )%
|Up 200 basis points        |  | (3.21                                           | ) 
|Up 100 basis points        |  | (1.43                                           | ) 
|Base                       |  |                                                 |   
|Down 100 basis points      |  | 4.61                                            |   
|Down 200 basis points      |  | 4.24                                            |   
|Down 300 basis points      |  | 3.57                                            |   



|(1) | The rising and falling 100, 200 and 300 basis point interest rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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



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



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



|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
June 30, 2010, 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 June 30, 2010 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.



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Second Quarter Internal Control Changes

During the second quarter of 2010, 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 15 contained herein for disclosures required by this item.



|Item 1A. | Risk Factors
|-------- | ------------

Certain risks described
below update the risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition, results of operations, or cash flows. The risks
described below and 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.

Capital Adequacy Risk

The Company and the Bank are subject to periodic examination by various regulatory agencies. As previously disclosed, effective June 10, 2010 the
Bank agreed to the issuance of a Consent Order with the FDIC and the State Board. The Consent Order includes requirements regarding the Banks capital position including a requirement that we increase our capital ratios prior to October 7,
2010. Given this requirement, it is critical that we raise capital immediately. If we fail to meet the capital or other requirements in the Consent Order in a timely manner, then this would result in additional regulatory requirements, which could
ultimately lead to the Bank being taken into receivership by the FDIC.

Private Placement Risk

We need additional capital to increase our capital ratios above the regulatory minimums and more effectively pursue our strategic objectives. After
considering numerous potential financing and strategic alternatives, we determined that the Private Placement was the best available alternative and would provide the greatest potential value for the Companys shareholders, as well as provide
the necessary capital to increase our capital ratios to meet the minimum requirements of a well-capitalized bank and to pursue our long-term strategic goals. In our review of the Private Placement, we also considered a number of
potentially negative factors, including the following factors:



| |  |  | There are risks and uncertainties in our ability to execute our strategic plan and to enhance shareholder value;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | The private placement will have a highly dilutive effect on our current shareholders;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | The interests of the investors may conflict with current shareholder interests. The investors will control approximately 85% of the Companys
outstanding shares of common stock, based on the number of shares of common stock to be outstanding after closing of the Private Placement;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Sale of the shares of common stock sold in the Private Placement to the investors in the public market pursuant to registration statements that we
would be obligated to file and maintain effective under the Registration Rights Agreement could have a material adverse affect on the market price of our common stock;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The completion of the Private Placement is subject to the satisfaction or waiver of a number of conditions, including, without limitation, shareholder
approval of amendments to our Articles of Incorporation and the investors receipt of necessary regulatory approvals which could delay or prevent the completion of the Private Placement; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Private Placement will likely delay the timing of the Companys use of our net operating loss carryforwards for income tax purposes.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

There can be no assurance that the Private Placement will be completed or, if it is completed, that we will be able to
achieve all or significantly all of the benefits that we expect to result from the Private Placement.



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

None



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##### Table of Contents

|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None



|Item 4. | (Removed and Reserved).
|------- | -----------------------



|Item 5. | Other Information
|------- | -----------------

None



|Item 6. | Exhibits
|------- | --------



|      |  |                                                                                                                                                                                                                                                                                                                                                                                
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1  |  | Stock Purchase Agreement by and among Palmetto Bancshares, Inc. and the investors named therein, dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 1, 2010                                                                                            
|      | 
|10.2  |  | Registration Rights Agreement by and among Palmetto Bancshares, Inc. and the investors named therein, dated as of May 25, 2010: Incorporated by reference to Exhibit 10.2 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 1, 2010                                                                                       
|      | 
|10.3  |  | Amendment No. 1 dated June 8, 2010 to Stock Purchase Agreement and Registration Rights Agreement by and among Palmetto Bancshares, Inc. and each of the other investors named
therein, each dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 11, 2010
|      | 
|10.4  |  | Consent Order, effective June 10, 2010, between the FDIC, the South Carolina State Board of Financial Institutions, and The Palmetto Bank: Incorporated by reference to Exhibit 10.2
to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 11, 2010                                                                           
|      | 
|31.1^ |  | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                      
|      | 
|31.2^ |  | Lee S. Dixons 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 the SEC in conjunction with this Quarterly Report on Form 10-Q.
|- | --------------------------------------------------------------------------

Copies of these exhibits are available upon written request to Lauren S. Greer, The Palmetto Bank, 306 East North Street, Greenville,
South Carolina 29601.



74



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.



|                                  
|----------------------------------
|PALMETTO BANCSHARES, INC.         
|                                  
|By:                               
|                                  
|/s/ Samuel L. Erwin               
|Samuel L. Erwin                   
|Chief Executive Officer           
|Palmetto Bancshares, Inc.         
|                                  
|/s/ Lee S. Dixon                  
|Lee S. Dixon                      
|Acting Principal Financial Officer
|Palmetto Bancshares, Inc.         
|                                  
|Date: August 2, 2010              



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##### Table of Contents

EXHIBIT INDEX



|            |  |                                                                                                                                                                                                                                                                                                                                                                                
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                    
|            | 
|10.1        |  | Stock Purchase Agreement by and among Palmetto Bancshares, Inc. and the investors named therein, dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 1, 2010                                                                                            
|            | 
|10.2        |  | Registration Rights Agreement by and among Palmetto Bancshares, Inc. and the investors named therein, dated as of May 25, 2010: Incorporated by reference to Exhibit 10.2 to the
Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 1, 2010                                                                                       
|            | 
|10.3        |  | Amendment No. 1 dated June 8, 2010 to Stock Purchase Agreement and Registration Rights Agreement by and among Palmetto Bancshares, Inc. and each of the other investors named
therein, each dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 11, 2010
|            | 
|10.4        |  | Consent Order, effective June 10, 2010, between the FDIC, the South Carolina State Board of Financial Institutions, and The Palmetto Bank: Incorporated by reference to Exhibit 10.2
to the Companys Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 11, 2010                                                                           
|            | 
|31.1        |  | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                      
|            | 
|31.2        |  | Lee S. Dixons 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                                                                                                                                                                                                                                                                                                       



76