<PAGE>

                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-Q

     __X__QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
                                       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                        (I.R.S. Employer
    of incorporation or organization)                  Identification No.)



                               301 Hillcrest Drive
                             Laurens, South Carolina
                                      29360
                          _____________________________

                    (Address of principal executive offices)
                                   (Zip Code)

                                 (864) 984-4551
                        _________________________________

              ( Registrant's telephone number, including area code)


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

                    Class                        Outstanding at November 1, 2001
               ---------------                         -----------------
        Common stock, $5.00 par value                      6,264,734

<PAGE>

                            PALMETTO BANCSHARES, INC.

                          Quarterly Report on Form 10-Q
                    For the Quarter Ended September 30, 2001

<TABLE>
<CAPTION>

INDEX                                                                               Page No.
-----                                                                               --------

PART I - FINANCIAL INFORMATION
------------------------------
<S>                                                                                 <C>
Item 1.  Financial Statements

         Consolidated Balance Sheets at September 30, 2001 and December 31, 2000          1

         Consolidated Income Statements for the Three Months
         Ended September 30, 2001 and 2000                                                2

         Consolidated Income Statements for the Nine Months
         Ended September 30, 2001 and 2000                                                3

         Consolidated Statements of Changes in Shareholders' Equity and
         Comprehensive Income for the Nine Months Ended
         September 30, 2001 and 2000                                                      4

         Consolidated Statements of Cash Flows for the Nine Months
         Ended September 30, 2001 and 2000                                                5

         Notes to the Consolidated Interim Financial Statements                           6

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations                                              7-14

Item 3.  Quantitative and Qualitative Disclosures About Market Risk                       14-15

PART II - OTHER INFORMATION
---------------------------

Item 1.  Legal Proceedings                                                                16

Item 2.  Changes in Securities and Use of Proceeds                                        16

Item 3.  Defaults Upon Senior Securities                                                  16

Item 4.  Submission of Matters to a Vote of Security Holders                              16

Item 5.  Other Information                                                                16

Item 6.  Exhibits and Reports on Form 8-K                                                 16

SIGNATURES                                                                                17
----------
</TABLE>

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                           Consolidated Balance Sheets
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                     September 30, 2001         December 31, 2000
                                                                                     ------------------         -----------------
Assets                                                                                   (unaudited)
<S>                                                                                  <C>                        <C>
Cash and due from banks                                                                       $  31,985                 $  36,305
Federal funds sold                                                                                1,760                     1,879
Federal Home Loan Bank stock, at cost                                                             1,733                     1,733
Investment securities available for sale (amortized cost of $95,350
   and $99,030, in 2001 and 2000, respectively)                                                  97,266                    98,601
Loans held for sale                                                                               5,346                       611
Loans                                                                                           546,626                   498,242
   Less allowance for loan losses                                                                (5,611)                   (5,446)
                                                                                              ---------                 ---------
               Loans, net                                                                       541,015                   492,796

Premises and equipment, net                                                                      18,551                    16,481
Accrued interest                                                                                  5,043                     5,229
Other assets                                                                                     11,257                     9,755
                                                                                              ---------                 ---------
               Total assets                                                                   $ 713,956                 $ 663,390
                                                                                              =========                 =========
Liabilities and Shareholders' Equity

Liabilities:
Deposits:
   Non-interest-bearing                                                                         100,606                    96,097
   Interest-bearing                                                                             522,850                   476,569
                                                                                              ---------                 ---------
               Total deposits                                                                   623,456                   572,666

Securities sold under agreements to repurchase                                                   14,605                    19,923
Commercial paper (Master note)                                                                   12,907                    15,359
Other liabilities                                                                                 4,812                     2,849
                                                                                              ---------                 ---------
               Total liabilities                                                                655,780                   610,797
                                                                                              ---------                 ---------
Shareholders' Equity:
Common stock-$5.00 par value.  Authorized 10,000,000 shares;
 6,264,734 issued and outstanding in 2001; and
 6,255,734 issued and outstanding in 2000                                                        31,324                    31,279
Capital surplus                                                                                      47                        23
Retained earnings                                                                                25,628                    21,555
Accumulated other comprehensive income (loss)                                                     1,177                      (264)
                                                                                              ---------                 ---------
               Total shareholders' equity                                                        58,176                    52,593
                                                                                              ---------                 ---------

               Total liabilities and shareholders' equity                                     $ 713,956                 $ 663,390
                                                                                              =========                 =========

</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       1

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                   Consolidated Income Statements (Unaudited)
             For the three months ended September 30, 2001 and 2000
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                                     2001                  2000
                                                                                                  ---------             ----------
<S>                                                                                               <C>                   <C>
Interest income:
 Interest and fees on loans                                                                       $  11,126             $   10,334
 Interest and dividends on investment securities available for sale:
   U.S. Treasury and U.S. Government agencies                                                           146                    391
   State and municipal                                                                                  674                    789
   Mortgage-backed securities                                                                           284                    398
 Interest on federal funds sold                                                                          82                     30
 Dividends on FHLB stock                                                                                 29                     35
                                                                                                  ---------             ----------
                              Total interest income                                                  12,341                 11,977
                                                                                                  ---------             ----------
Interest expense:
 Interest on deposits                                                                                 4,600                  4,623
 Interest on securities sold under agreements to repurchase                                              82                    292
 Interest on federal funds purchased                                                                      5                    228
 Interest on commercial paper (Master note)                                                              80                    218
                                                                                                  ---------             ----------
                              Total interest expense                                                  4,767                  5,361
                                                                                                  ---------             ----------

                              Net interest income                                                     7,574                  6,616
Provision for loan losses                                                                               900                    800
                                                                                                  ---------             ----------

                              Net interest income after provision for loan losses                     6,674                  5,816
Non-interest income:
 Service charges on deposit accounts                                                                  1,911                  1,244
 Fees for trust services                                                                                427                    386
 Gains on sales of loans                                                                                204                     34
 Other income                                                                                           690                    650
                                                                                                  ---------             ----------
                              Total non-interest income                                               3,232                  2,314

Non-interest expense:
 Salaries and other personnel                                                                         3,562                  2,691
 Net occupancy                                                                                          523                    511
 Furniture and equipment                                                                                614                    551
 FDIC assessment                                                                                         28                     28
 Postage and supplies                                                                                   293                    270
 Marketing and advertising                                                                              201                    134
 Telephone                                                                                              196                    194
 Cardholder processing expense                                                                          135                    158
 Sales finance losses                                                                                     2                    137
 Other expense                                                                                        1,278                  1,045
                                                                                                  ---------             ----------
                              Total non-interest expense                                              6,832                  5,719
                                                                                                  ---------             ----------
                              Income before income taxes                                              3,074                  2,411
                                                                                                  ---------             ----------
Income tax provision                                                                                    882                    608
                                                                                                  ---------             ----------

                              Net income                                                          $   2,192             $    1,803
                                                                                                  =========             ==========
                              Net income per share-basic                                          $    0.35             $     0.29
                              Net income per share-dilutive                                       $    0.34             $     0.28
                              Cash dividends declared per share                                   $    0.10             $     0.09

</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       2

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                   Consolidated Income Statements (Unaudited)
              For the nine months ended September 30, 2001 and 2000
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                            2001         2000
                                                                          --------       ------
<S>                                                                       <C>          <C>
Interest income:
  Interest and fees on loans                                              $ 33,135     $ 29,719
  Interest and dividends on investment securities available for sale:
     U.S. Treasury and U.S. Government agencies                                569        1,001
     State and municipal                                                     2,039        2,392
     Mortgage-backed securities                                                939        1,255
  Interest on federal funds sold                                               299          164
  Dividends on FHLB stock                                                       96          104
                                                                          --------     --------
         Total interest income                                              37,077       34,635
                                                                          --------     --------

Interest expense:
  Interest on deposits                                                      14,532       12,994
  Interest on securities sold under agreements to repurchase                   502          750
  Interest on federal funds purchased                                           48          442
  Interest on commercial paper (Master note)                                   314          567
                                                                          --------     --------
         Total interest expense                                             15,396       14,753
                                                                          --------     --------

         Net interest income                                                21,681       19,882
Provision for loan losses                                                    3,138        2,935
                                                                          --------     --------

         Net interest income after provision for loan losses                18,543       16,947
Non-interest income:
  Service charges on deposit accounts                                        5,422        3,392
  Fees for trust services                                                    1,372        1,495
  Gains on sales of loans                                                      403           54
  Other income                                                               2,114        1,957
                                                                          --------     --------
         Total non-interest income                                           9,311        6,898

Non-interest expense:
  Salaries and other personnel                                               9,797        8,020
  Net occupancy                                                              1,552        1,478
  Furniture and equipment                                                    1,768        1,665
  FDIC assessment                                                               82           84
  Postage and supplies                                                         986          864
  Marketing and advertising                                                    714          540
  Telephone                                                                    567          577
  Cardholder processing expense                                                410          416
  Sales finance losses                                                          16          137
  Other expense                                                              3,542        2,869
                                                                          --------     --------
         Total non-interest expense                                         19,434       16,650
                                                                          --------     --------
         Income before income taxes                                          8,420        7,195
                                                                          --------     --------
Income tax provision                                                         2,468        1,956
                                                                          --------     --------

         Net income                                                       $  5,952      $ 5,239
                                                                          ========     ========
         Net income per share-basic                                       $   0.95      $  0.84
         Net income per share-dilutive                                    $   0.92      $  0.82
         Cash dividends declared per share                                $   0.30      $  0.27
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       3

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
  Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
    Income (Unaudited) For the nine months ended September 30, 2001 and 2000
                 (Dollars in thousands except number of shares)

<TABLE>
<CAPTION>
                                                                                                               Accumulated
                                                                                      Capital                     Other
                                                                         Common       Surplus      Retained   Comprehensive
                                                                          Stock      (Deficit)     Earnings     Loss, Net    Total
                                                                       ------------------------------------------------------------
<S>                                                                    <C>          <C>         <C>           <C>          <C>
Balance at December 31, 1999                                           $ 31,134     $     -     $ 16,890      $ (2,397)    $ 45,627
Net income                                                                                         5,239                      5,239
Other comprehensive income, net of tax:
  Unrealized holding gains arising during period, net
    of tax effect of $670                                                                                                     1,071
  Less: reclassification adjustment for gains included
    in net income, net of tax effect of $1                                                                                       (2)
  Net unrealized losses on securities                                                                            1,069
                                                                                                                         -----------
Comprehensive income                                                                                                          6,308
                                                                                                                         -----------
Cash dividend declared                                                                            (1,685)                    (1,685)
Issuance of 20,200 shares in connection with stock options                  101          22                                     123
                                                                       -------------------------------------------------------------
Balance at September 30, 2000                                            31,235          22       20,444        (1,328)      50,373
                                                                       =============================================================
Balance at December 31, 2000                                             31,279          23       21,555          (264)      52,593
Net income                                                                                         5,952                      5,952
Other comprehensive income, net of tax:
  Unrealized holding gains arising during period, net
    of tax effect of $902                                                                                        1,441        1,441
                                                                                                                         -----------
Comprehensive income                                                                                                          7,393
                                                                                                                         -----------
Cash dividend declared                                                                            (1,879)                    (1,879)
Issuance of 9,000 shares in connection with stock options                    45          24                                      69
                                                                       -------------------------------------------------------------
Balance at September 30, 2001                                          $ 31,324     $    47     $ 25,628      $  1,177     $ 58,176
                                                                       =============================================================
</TABLE>

See accompanying notes to consolidated interim financial statements.

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                Consolidated Statements of Cash Flows (Unaudited)
              For the nine months ended September 30, 2001 and 2000
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                      2001        2000
                                                                                    --------    --------
<S>                                                                                 <C>         <C>
Cash flows from operating activities:

  Net income                                                                        $  5,952    $  3,436
  Adjustments to reconcile net income to net cash
     provided by operating activities:
              Depreciation and amortization                                            1,981       1,087
              Provision for loan losses                                                3,138       2,135
              Origination of loans held for sale                                     (64,875)     (3,440)
              Sale of loans held for sale                                             60,543       3,136
              Gain on sale of loans                                                     (403)        (20)
              Change in accrued interest receivable                                      186        (197)
              Change in other assets                                                  (1,247)       (603)
              Change in other liabilities, net                                         1,061        (538)
                                                                                    --------    --------

                          Net cash provided by operating activities                    6,336       4,996

Cash flows from investing activities:
  Purchase of investment securities available for sale                               (18,432)    (10,000)
  Proceeds from maturities of investment securities available for sale                16,239       1,579
  Principal paydowns on mortgage-backed securities available for sale                  5,822       2,457
  Net increase in loans outstanding                                                  (52,369)    (25,822)
  Purchases of premises and equipment, net                                            (3,245)     (1,217)
                                                                                    --------    --------

                          Net cash used in investing activities                      (51,985)    (33,003)

Cash flows from financing activities:
  Net increase in deposit accounts                                                    50,790       7,055
  Net decrease in securities sold under agreements
     to repurchase                                                                    (5,318)     (2,967)
  Net increase in commercial paper                                                    (2,452)      1,716
  Net increase in federal funds purchased                                                 --      13,000
  Proceeds from issuance of common stock                                                  69         108
  Dividends paid                                                                      (1,879)     (1,123)
                                                                                    --------    --------

                          Net cash provided by financing activities                   41,210      17,789
                                                                                    --------    --------

Net decrease in cash and cash equivalents                                             (4,439)    (10,218)
                                                                                    --------    --------
Cash and cash equivalents at beginning of the period                                  38,184      43,817
                                                                                    --------    --------
Cash and cash equivalents at end of the period                                      $ 33,745    $ 33,599
                                                                                    ========    ========

Supplemental Information:
Cash paid during the period for:
     Interest expense                                                               $ 15,692    $ 14,637
                                                                                    ========    ========
     Income taxes                                                                      2,328       1,514
                                                                                    ========    ========

Supplemental schedule of non-cash investing and financing transactions:
    Change in unrealized gain (loss) on investment securities available for sale,
          before tax                                                                   2,343       1,738
                                                                                    ========    ========
    Loans transferred to other real estate owned                                       1,012           6
                                                                                    ========    ========
    Loans charged -off                                                                 3,125       3,803
                                                                                    ========    ========
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       5

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
               Notes To Consolidated Interim Financial Statements

1.  Basis of Presentation
    ---------------------
     The accompanying unaudited consolidated interim financial statements have
been prepared pursuant to the rules and regulations for reporting on Form 10-Q.
Accordingly, certain information and footnotes required by generally accepted
accounting principles for complete financial statements are not included herein.
The interim statements should be read in conjunction with the financial
statements and notes thereto included in Palmetto Bancshares, Inc.'s (the
"Company's") Annual Report on Form 10-K for the year ended December 31, 2000.
     In the Company's opinion, all adjustments necessary for a fair presentation
of these interim statements have been included and are of a normal and recurring
nature. The results of operations for the three and nine month periods ended
September 30, 2001 are not necessarily indicative of the results that may be
expected for the entire year.
     Certain amounts from 2000 have been reclassified to conform to the 2001
presentation. These reclassifications have no effect on shareholders' equity or
on net income as previously reported.

2.  Principles of Consolidation
    ---------------------------
     The consolidated financial statements include the accounts of the Company,
its wholly owned subsidiary, The Palmetto Bank (the "Bank"), and Palmetto
Capital, Inc., the Bank's wholly owned subsidiary. The Bank provides a full
range of banking services, including taking deposits and making loans. Palmetto
Capital, Inc. offers the brokerage of stocks, bonds, mutual funds and unit
investment trusts. Palmetto Capital, Inc. also offers advisory services and
variable rate annuities. In consolidation, all significant intercompany accounts
and transactions have been eliminated.

3.  Summary of Significant Accounting Policies
    ------------------------------------------
     The significant accounting policies used by the Company are described in
Note 1 to the Company's December 2000 Annual Report on Form 10-K. There have
been no changes in these policies subsequent to the year ended December 31,
2000.


                                       6

<PAGE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

DISCUSSION OF FINANCIAL CONDITION CHANGES FROM DECEMBER 31, 2000 TO SEPTEMBER
30, 2001

Forward-Looking Statements
--------------------------
     This document may contain certain "forward-looking statements," within the
meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. Such
forward-looking statements are about matters that are inherently subject to
certain risks, uncertainties, and assumptions. Factors that could influence the
matters discussed in certain forward-looking statements include the relative
levels of market interest rates, loan prepayments and rates of change in deposit
balances, the timing and amount of revenues that may be recognized by the
Company, continuation of current revenue, expense and charge-off trends, legal
and regulatory changes, and general changes in the economy. Should one or more
of these risks or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those expected or
projected. These forward-looking statements speak only as of the date of this
document. The Company assumes no obligation to update any forward-looking
statements. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them.

Assets
------
     Total assets increased $50.6 million, or 8%, for the nine month period
ended September 30, 2001, primarily as a result of an increase in loans
receivable and loans held for sale. Liquid assets, which include cash, federal
funds sold, and investments available for sale, decreased by $5.8 million, or
4%, for the nine-month period. The decrease in liquid assets was attributable to
the $4.3 million decrease in cash and due from banks, the $1.3 million decrease
in investment securities available for sale, and the $120,000 decrease in
federal funds sold. During the first nine months of 2001, the Bank purchased
$18.4 million of investment securities (available for sale), $16.2 million of
the investment portfolio matured, and $5.8 million was paid down on mortgage
backed securities held for sale. The Bank had a $2.3 million change in pre-tax
unrealized gains in its investment portfolio at September 30, 2001.

     Loans, net, increased by $48.2 million, or 10%, during the nine-month
period as a result of growth sparked by a favorable interest rate environment
and increased efforts by lenders. The allowance for loan losses as a percentage
of total loans decreased to 1.03% from 1.09% at September 30, 2001 and 2000,
respectively. Management feels the allowance is adequate at September 30, 2001
because the Bank uses an allowance model that takes into account the risk grades
of loans, delinquency trends, charge-off ratios and loan growth. The Bank has
been making efforts to improve its underwriting standards, shift its emphasis
toward higher-dollar, higher-quality loans, and charge off significant amounts
of lower-quality loans.

     At September 30, 2001, the Company had $5.3 million in loans held for sale
with commitments to sell these loans in October and November 2001. Because the
interest rate environment has been favorable for mortgage loans and refinances,
the Bank has been able to make approximately $77.9 million in mortgage loans
during the first nine months of 2001, with over 65% being sold in the secondary
market. The mortgage servicing rights related to the mortgage servicing
department's activities were $1.5 million at September 30, 2001, which
approximates their fair value. Loans serviced for the benefit of others amounted
to $169.0 million at September 30, 2001.


                                       7

<PAGE>

     Other assets increased by $1.5 million, or 15%, from December 31, 2000 to
September 30, 2001. Because of the increased sales of mortgage loans, mortgage
servicing rights increased approximately $817,000, while $429,000 of those
rights were amortized. Other real estate increased by $1.1 million and prepaid
expenses increased $330,000, while repossessed assets were reduced by $204,000.
During the first nine months of 2001, the investment portfolio accumulated
unrealized gains, thus eliminating the deferred tax benefit that was recorded at
December 31, 2000. At September 30, 2001, there was a deferred tax liability of
$737,000 related to those unrealized gains.

Liabilities and Shareholders' Equity
------------------------------------
     Deposit balances increased by 9% during the nine-month period, from $572.7
million to $623.5 million. The Bank has made an effort to attract depositors
through special rate certificates of deposit and new deposit products.
Securities sold under agreements to repurchase decreased by $5.3 million, or
27%, and commercial paper associated with the alternative commercial sweep
accounts (master note program) decreased by $2.5 million, or 16%. These changes
are the result of normal fluctuations in the accounts.

     Total shareholders' equity increased by $5.5 million, or 11%, for the
nine-month period as a result of comprehensive income of $7.4 million, less
dividends paid of $1.9 million. The Company also added $69,000 to equity as the
result of stock option exercises.

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2001 AND 2000

Net Income
----------
     Net income for the three months ended September 30, 2001 and 2000 was $2.2
million and $1.8 million, respectively. Net income per common share-basic for
the three months ended September 30, 2001 and 2000 was $0.35 and $0.29,
respectively. Net income per common share-dilutive for the same periods was
$0.34 and $0.28, respectively.

Net Interest Income
-------------------
     The largest component of the Company's net income is the Bank's net
interest income, defined as the difference between gross interest and fees on
earning assets, primarily loans and investment securities, and interest paid on
deposits and borrowed funds. Net interest income is affected by the interest
rates earned or paid and by volume changes in loans, securities, deposits and
borrowed funds.

     For the three-month periods ended September 30, 2001 and 2000, net interest
income was $7.6 million and $6.6 million, respectively. This increase in net
interest income was the result of a $55.9 million increase in average earning
assets. Earning assets averaged $650.2 million and $594.2 million during the
second quarters of 2001 and 2000, respectively. The increases in volume were
primarily due to the growth of loans. The average tax-equivalent net interest
margin for the 2001 period was 4.78%, compared to 4.60% for the same period in
2000.

     Interest and fees on loans increased 8%, from $10.3 million to $11.1
million, for the 2000 three-month period compared to the corresponding period in
2001. This increase is due to increased loan volume, offset by a decrease in the
average loan yield from 8.57% to 8.00% for the three-month periods ended
September 30, 2000 and 2001, respectively. Interest on investment securities
decreased $474,000 for the 2001 three-month period compared to the corresponding
period in 2000 due to a lower balance


                                       8

<PAGE>

in the investment portfolio during the period ended September 30, 2001. Interest
income on federal funds sold increased $52,000 due to an increase in average
volume of federal funds sold for the quarter compared to the same period last
year. The yield on average earning assets, which includes loans, federal funds
sold and investment securities, decreased from 8.00% to 7.53% for the three
months ended September 30, 2000 and 2001, respectively.

     Total interest expense increased by 11%, from $5.4 million to $4.8 million.
Comparing the quarter ended September 30, 2001 to the same period in the prior
year, total interest-bearing liabilities increased 9% from $502.3 million to
$545.3 million. The total cost of average interest-bearing liabilities for the
quarter ended September 30, 2001 was 3.47%, compared to 4.25% for the same
quarter last year.

Provision for Loan Losses
-------------------------
     The provision for loan losses increased to $900,000 from $800,000 for the
three months ended September 30, 2001 and 2000, respectively. The provision is
adjusted each month to reflect loan volume growth and allow for loan
charge-offs, recoveries and other factors which impact management's assessment
of the adequacy of the allowance for loan losses. Management's objective is to
maintain the allowance for loan losses at an adequate level to cover probable
losses in the portfolio. Additions to the allowance for loan losses are based on
management's evaluation of the loan portfolio under current economic conditions,
past loan loss experience, and such other factors, which in management's
judgment deserve recognition in estimating loan losses.

     Loans are charged off when, in the opinion of management, they are deemed
to be uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance. Loans over 90 days delinquent
and on non-accrual amounted to approximately $2.5 million and $3.2 million at
September 30, 2001 and 2000, respectively. The annualized net charge-off ratio
has decreased from .31% for the quarter ended September 30, 2000 to .25% for the
quarter ended September 30, 2001. The Bank has been focusing its efforts on
improving loan quality, particularly in the sales finance area. As a result of
this refocused effort, the Bank has experienced higher than normal losses in
this area during the past 12 to 18 months. However, the sales finance portfolio
has shown improvement as past due loans over 30 days have decreased from 14.6%
at December 31, 2000 to 7.3% at September 30, 2001.

     While management uses the best information available to make evaluations,
future adjustments to the allowance in the form of provisions through the income
statement may be necessary if economic conditions differ substantially from the
assumptions used in making the evaluation. The allowance for loan losses is
subject to periodic evaluation by various regulatory authorities and may be
subject to adjustment, based upon information that is available to them at the
time of their examination.

Non-interest Income
-------------------
     Total non-interest income increased by $918,000, or 40%, for the three
months ended September 30, 2001, as compared to the same period in 2000. The
largest portion of this increase, $667,000, or 73%, can be attributed to service
charges on customer deposit accounts. The increases are primarily related to a
new automatic overdraft privilege offered to deposit customers that was
implemented earlier in 2001.

Non-interest Expense
--------------------
     Total non-interest expense increased by $1.1 million, or 19%, during the
2001 three-month period compared to the same period in 2000. The largest
contributor to this increase was salaries and other personnel expense, which
increased $871,000, or 32%, due to normal raises, new employees related to


                                       9

<PAGE>

growth, and increased medical insurance premiums paid on behalf of employees. At
September 30, 2001, the Bank had 354 full-time equivalent employees compared to
336 full-time equivalent employees at September 30, 2000.

Income Taxes
------------
     The Company incurred income tax expense of $882,000 for the 2001
three-month period compared to $608,000 for the same period in 2000 due to an
increase in taxable income. This expense is based on an expected annual
effective tax rate of approximately 29.3%. The effective tax rate for the same
period in 2000 was 27.2% and the effective tax rate for the year ended December
31, 2000 was 27.4%.

Net Income Per Share
--------------------
     The following table illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net income for
the three months ended September 30, 2001 and 2000 (dollars in thousands except
per share numbers):

<TABLE>
<CAPTION>
                                                                  Income             Shares           Per-Share
   2001                                                         (Numerator)       (Denominator)        Amount
   ----                                                         --------------------------------------------------
   <S>                                                          <C>               <C>                 <C>
   Basic EPS:
   ---------
   Net income                                                    $2,192             6,263,125           $0.35
   Effect of dilutive securities: stock options                      --               174,206              --
                                                                --------------------------------------------------
   Diluted EPS:
   -----------
   Net income plus assumed exercises of stock options            $2,192             6,437,331           $0.34
                                                                ==================================================

<CAPTION>
                                                                  Income             Shares           Per-Share
   2000                                                         (Numerator)       (Denominator)        Amount
   ----                                                         --------------------------------------------------
   <S>                                                          <C>               <C>                 <C>
   Basic EPS:
   ---------
   Net income                                                    $1,803             6,244,686           $0.29
   Effect of dilutive securities: stock options                      --               183,903              --
                                                                --------------------------------------------------
   Diluted EPS:
   -----------
   Net income plus assumed exercises of stock options            $1,803             6,428,589           $0.28
                                                                ==================================================
</TABLE>

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2001 AND 2000

Net Income
----------
       Net income for the nine months ended September 30, 2001 and 2000 was $5.9
million and $5.2 million, respectively. Net income per common share-basic for
the nine months ended September 30, 2001 and 2000 was $0.95 and $0.84,
respectively. Net income per common share-dilutive for the same periods was
$0.92 and $0.82, respectively.

Net Interest Income
-------------------
     For the nine-month periods ended September 30, 2001 and 2000, net interest
income was $21.7 million and $19.9 million, respectively. This increase in net
interest income was the result of a $56.1 million increase in average earning
assets. Earning assets averaged $634.3 million and $578.2 million during the
first nine months of 2001 and 2000, respectively. The increases in volume were
primarily due to the growth of loans. The average tax-equivalent net interest
margin for the nine months ended September 30, 2001 was 4.72%, compared to 4.79%
for the same period in 2000.

                                       10

<PAGE>

     Interest and fees on loans increased 11%, from $29.7 million to $33.1
million, for the 2000 nine-month period compared to the corresponding period in
2001. This increase is due to increased loan volume, offset by a decrease in the
average loan yield from 8.57% to 8.31% for the nine-month period ended September
30, 2000 and 2001, respectively. Interest on investment securities decreased
$1.1 million for the 2001 nine-month period compared to the corresponding period
in 2000 due to a lower balance in the investment portfolio during the period
ended September 30, 2001. Interest income on federal funds sold increased
$135,000 due to an increase in average volume of federal funds during the nine
months ended September 30, 2001 compared to the same period last year. The yield
on average earning assets, which includes loans, federal funds sold and
investment securities, decreased from 8.00% to 7.81% for the nine months ended
September 30, 2000 and 2001, respectively.

     Total interest expense increased by 4%, from $14.7 million to $15.9
million. For the nine months ended September 30, 2001, total interest-bearing
liabilities were $533.3 million compared to $491.2 million at September 30,
2000. The total cost of average interest-bearing liabilities for the nine months
ended September 30, 2001 was 3.86%, compared to 4.01% for the same period last
year.

Provision for Loan Losses
-------------------------
       The provision for loan losses increased to $3.1 million from $2.9 million
for the nine months ended September 30, 2001 and 2000, respectively. The
provision is adjusted each month to reflect loan volume growth and allow for
loan charge-offs, recoveries and other factors which impact management's
assessment of the adequacy of the allowance for loan losses. Management's
objective is to maintain the allowance for loan losses at an adequate level to
cover probable losses in the portfolio. Additions to the allowance for loan
losses are based on management's evaluation of the loan portfolio under current
economic conditions, past loan loss experience, and such other factors, which in
management's judgment deserve recognition in estimating loan losses.

       Loans are charged off when, in the opinion of management, they are deemed
to be uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance. The annualized net charge-off
ratio has decreased from 1.05% for the nine months ended September 30, 2000 to
 .75% for the six months ended June 30, 2001. As previously discussed in the
three-month comparison, the Bank has been improving credit quality, particularly
in the sales finance area. During 2000, the Bank incurred above normal losses as
management charged-off lower quality loans.

Non-interest Income
-------------------
       Total non-interest income increased by $2.4 million, or 35%, for the nine
months ended September 30, 2001, as compared to the same period in 2000. The
largest portion of this increase, $2.0 million, can be attributed to service
charges on customer deposit accounts. The increases are primarily related to a
new automatic overdraft privilege offered to deposit customers and the increased
collection of insufficient funds charges associated with debit card transactions
during the 2001 period compared to the same period in 2000.

Non-interest Expense
--------------------
       Total non-interest expense increased by $2.8 million, or 17%, during the
2001 nine-month period compared to the same period in 2000. The largest
contributor to this increase was salaries and other personnel expense, which
increased $1.8 million, or 22%, due to normal raises, new employees related to
growth, and increased medical insurance premiums paid on behalf of employees.

                                       11

<PAGE>

Income Taxes
------------

       The Company incurred income tax expense of $2.5 million for the 2001
nine-month period compared to $2.0 million for the same period in 2000 due to an
increase in taxable income. This expense is based on an expected annual
effective tax rate of approximately 29.3%. The effective tax rate for the same
period in 2000 was 27.2% and the effective tax rate for the year ended December
31, 2000 was 27.4%.

Net Income Per Share
--------------------

        The following table illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net income for
the nine-months ended September 30, 2001 and 2000 (dollars in thousands except
per share numbers):

<TABLE>
<CAPTION>
                                                                  Income             Shares           Per-Share
   2001                                                         (Numerator)       (Denominator)        Amount
   ----                                                         --------------------------------------------------
   <S>                                                          <C>               <C>                 <C>
   Basic EPS:
   ---------
   Net income                                                    $5,952             6,261,335           $0.95
   Effect of dilutive securities: stock options                      --               173,564              --
                                                                --------------------------------------------------
   Diluted EPS:
   -----------
   Net income plus assumed exercises of stock options            $5,952             6,434,899           $0.92
                                                                ==================================================

<CAPTION>
                                                                  Income             Shares           Per-Share
   2000                                                         (Numerator)       (Denominator)        Amount
   ----                                                         --------------------------------------------------
   <S>                                                          <C>               <C>                 <C>
   Basic EPS:
   ---------
   Net income                                                    $5,239             6,239,438           $0.84
   Effect of dilutive securities: stock options                      --               181,498              --
                                                                --------------------------------------------------
   Diluted EPS:
   -----------
   Net income plus assumed exercises of stock options            $5,239             6,420,936,          $0.82
                                                                ==================================================
</TABLE>

Liquidity
---------

     The liquidity ratio is an indication of a company's ability to meet its
short-term funding obligations. The Company's policy is to maintain a liquidity
ratio between 10% and 25%. At September 30, 2001, the Company's liquidity ratio
was 14.83%.

     At September 30, 2001, the Bank had unused short-term lines of credit
totaling approximately $42 million (which are withdrawable at the lender's
option). At September 30, 2001, unused borrowing capacity from the Federal Home
Loan Bank ("FHLB") totaled $48 million. The Bank has pledged assets to be used
as collateral if the Bank takes advantage of the FHLB line of credit. Management
believes that these sources are adequate to meet its liquidity needs and to
maintain the liquidity ratio within policy guidelines.

     The Company has certain cash needs, including general operating expenses
and the payment of dividends and interest on borrowings. The Company currently
has no debt outstanding and has declared and paid $0.30 per share in dividends
so far in 2001. Although there can be no guarantee that any additional dividends
will be paid in 2001, the Company plans to continue its quarterly dividend
payments. Liquidity is provided from the Company's subsidiary, the Bank. The
Company and the Bank are subject to certain regulatory restrictions on the
amount of dividends they are permitted to pay. The Bank's current total
risk-based capital ratio is 10.60%. At September 30, 2001, the Bank had $3.3
million of excess retained earnings available to pay out dividends and still be
considered "well-capitalized."

                                       12

<PAGE>

     The Bank is on schedule to open its newest offices in Upstate South
Carolina, located in Travelers Rest and Seneca, during the first quarter of
2002.

Capital Resources
-----------------

     As of September 30, 2001, the Company and the Bank were in compliance with
each of the applicable regulatory capital requirements and met or exceeded the
"well-capitalized" regulatory guidelines. The table below sets forth various
capital ratios for the Company and the Bank:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
                                                     Adequately
                                        As of       Capitalized      Well-Capitalized
                                       9/30/01      Requirement         Requirement
--------------------------------------------------------------------------------------
<S>                                    <C>          <C>              <C>
Company:
-------

   Total Risk-based Capital            10.68%           8.00%             10.00%

   Tier 1 Risk-based Capital            9.65            4.00               6.00

   Tier 1 Leverage Ratio                7.52            4.00               5.00

Bank:
----

   Total Risk-based Capital            10.60            8.00              10.00

   Tier 1 Risk-based Capital            9.57            4.00               6.00

   Tier 1 Leverage Ratio                7.45            4.00               5.00
</TABLE>

Accounting and Reporting Matters
--------------------------------

     In September 2000, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 140 "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities - a replacement of FASB Statement No. 125". This statement became
effective for transfers occurring after March 31, 2001 and for disclosures
relating to securitizations and collateral for fiscal years ending after
December 15, 2000. In addition to replacing SFAS No. 125, this statement
rescinded SFAS No. 127 "Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125". SFAS No. 140 revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but carries over most of the provisions of
Statement 125 without reconsideration. Adoption of the standard did not have a
material effect on the Company.

     In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations" and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets". These standards will be adopted in 2002. The Company is currently
evaluating the impact that these standards will have on its financial
statements.

     Other accounting standards that have been issued or proposed by the
Financial Accounting Standards Board that do not require adoption until a
further date are not expected to have a material impact on the consolidated
financial statements upon adoption.

                                       13

<PAGE>

     On July 2, 2001, The Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 102 "Selected Loan Loss Allowance
Methodology and Documentation Issues". SAB 102 expresses the SEC's views on the
development, documentation and application of a systematic methodology for
determining the allowance for loan and lease losses in accordance with Generally
Accepted Accounting Principles. The Company believes that it is currently in
compliance with the requirements of SAB 102.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises principally from interest rate risk
inherent in its lending, deposit, borrowing and investing activities. Management
actively monitors and manages its inherent rate risk exposure. Although the
Company manages other risks, such as credit quality and liquidity risk, in the
normal course of business, management considers interest rate risk to be its
most significant market risk. This risk could potentially have the largest
material effect on the Company's financial condition and results of operations.
Other types of market risks, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.

     The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings. A sudden and substantial increase or
decrease in interest rates may adversely impact the Company's earnings to the
extent that the interest rates on interest-earning assets and interest-bearing
liabilities do not change at the same speed, to the same extent or on the same
basis. The Company monitors the impact of changes in interest rates on its net
interest income using several tools.

       The Bank's goal is to minimize interest rate risk between interest
bearing assets and liabilities at various maturities through its Asset-Liability
Management ("ALM"). ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic
outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be controlled
by management. Understanding the current position and implications of past
decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.

       Interest sensitivity management is part of the asset-liability management
process. Interest sensitivity gap ("GAP") is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period. The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year. Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction accounts, time
deposits and borrowings. The profitability of the Company is influenced
significantly by management's ability to manage the relationship between rate
sensitive assets and liabilities.

       The Company's current GAP analysis reflects that in periods of increasing
or decreasing interest rates, rate sensitive assets will reprice slower than
rate sensitive liabilities. The Company's GAP analysis also shows that at the
interest repricing of one year, the Company's net interest margin would be
adversely impacted by an increase in market interest rates. This analysis,
however, does not take into account the

                                       14

<PAGE>

dynamics of the marketplace. GAP is a static measurement that assumes that if
the prime rate increases by 100 basis points, all assets and liabilities that
are due to reprice will increase by 100 basis points at the next opportunity.
During the first nine months of 2001, market interest rates have steadily
declined. Because the Bank's rate sensitive assets have been repricing slower
than its rate sensitive liabilities during this period, the Bank has been able
to maintain a strong net interest margin of 4.57%.

     Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset/liability
strategies which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point change over twelve months. The
asset/liability committee meets weekly to address interest pricing issues, and
this model is reviewed monthly. Management will continue to monitor its
liability sensitive position in times of increasing interest rates, which might
adversely affect its net interest margin. The Company does not feel that the
market risk to the Company has changed significantly since December 31, 2000.

                                       15

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                           PART II - OTHER INFORMATION

Item 1. Legal Proceedings
        -----------------
        On January 19, 2001, M. Snyder's, Inc., an automobile dealership that
has sold and assigned sales finance contracts to the Bank, filed suit against
the Bank and Richard O. Lollis, a former employee of the Bank who was the
manager of the sales finance department. The suit was filed in the Court of
Common Pleas for Greenville County, South Carolina. M. Snyder's claims arise
from the sales finance contracts and its business relationship with the Bank,
including causes of action for alleged breach of contract, breach of fiduciary
duty, fraud, negligent representation, breach of contract accompanied by
fraudulent acts, unfair trade practices, negligence and negligent supervision;
M. Snyder's seeks actual and consequential damages. The Bank has filed
counterclaims against M. Snyder's based on, among other things, alleged breach
of contract with fraudulent intent, fraud, misrepresentations, unfair trade
practices, bad faith, procurement of breach of contracts by customers and
conversion of assets properly belonging to the Bank. The Bank does not believe
that M. Snyder's claims are well-founded and is vigorously pursuing its
counterclaims and its defenses against the claims. In connection with the above
lawsuit, the Bank has also filed a third party complaint against an employee of
M. Snyder's, Inc. arising from his actions in dealing with sales finance
contracts, including causes of action for fraud, misrepresentation and
conversion.

        The Company is not currently engaged in legal proceedings. In addition
to the matter described above, from time to time the Bank is involved in legal
proceedings incidental to its normal course of business as a bank. Management
believes that none of these proceedings is likely to have a materially adverse
effect on the business of the Company or the Bank.

Item 2. Changes in Securities and Use of Proceeds
        -----------------------------------------
None

Item 3. Defaults Upon Senior Securities
        -------------------------------
None

Item 4. Submission of Matters to a Vote of Securities Holders
        -----------------------------------------------------
None

Item 5. Other Information
        -----------------
None

Item 6. Exhibits and Reports on Form 8-K
        --------------------------------
(a) Exhibits:
None

(b) Reports on Form 8-K:
None

                                       16

<PAGE>

                                   SIGNATURES

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

PALMETTO BANCSHARES, INC.



By:

/s/ L. Leon Patterson
---------------------------------------
L. Leon Patterson
Chairman and Chief Executive Officer



/s/ Paul W. Stringer
---------------------------------------
Paul W. Stringer

President and Chief Operating Officer
(Chief Accounting Officer)

Date: November 2, 2001

                                       17