U. S. SECURITIES AND EXCHANGE
  COMMISSION
			WASHINGTON, D.C. 20549FORM 10-Q(X)
			QUARTERLY
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT
			OF 1934For the quarterly period ended
  June 30, 2004(  )
			TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
			OF 1934For the transition period from __________ to
  __________Commission file number  0-26016PALMETTO BANCSHARES, INC.(Exact name of registrant as specified in its
  charter)South Carolina
			
			74-2235055(State or other jurisdiction of
  incorporation or organization)
			
			(IRS Employer Identification No.)301 Hillcrest Drive, Laurens,
  South Carolina
			
			29360(Address of principal executive
  offices)
			
			(Zip Code)(864) 984-4551
			
			palmettobank.com(Registrant's telephone number)
			
			(Registrant's web site)Indicate
  by check mark whether the registrant (1) has filed all reports required to be
  filed by Section 
			13 or
  15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
  (or for such shorter period that the
  registrant was required to file such reports), and (2) has been subject to
  such filing requirements for the
  past 90 days. Yes X   No __Indicate
  by check mark whether the registrant is an accelerated filer (as defined in
  Rule 12b-2 of the Exchange
  Act).  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 August 2, 2004-----------------------------
			
			-------------------------------Common stock, $5.00 par value
			
			6,269,585






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PALMETTO BANCSHARES, INC.Table of ContentsPage
			No.PART I.   FINANCIAL INFORMATION
			3Item 1.
			Financial StatementsItem 2.
			Management's Discussion and Analysis of
			Financial Condition and 
			Results of Operations
			316Item 3.
			Quantitative and Qualitative Disclosures about
			Market Risk
			51Item 4.
			Controls and Procedures
			53PART II.  OTHER INFORMATION
			54Item 1.
			Legal Proceedings
			54Item 2.
			Changes in Securities and Use of Proceeds
			54Item 3.
			Defaults Upon Senior Securities
			54Item 4.
			Submission of Matters to a Vote of Security
			Holders
			54Item 5.
			Other Information
			54Item 6.
			Exhibits and Reports on Form 8-K
			54SIGNATURES
			55






2

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PART I.  FINANCIAL INFORMATION

|Item 1. | Financial Statements
|------- | --------------------
|        |                     

PALMETTO BANCSHARES, INC.Consolidated Balance Sheets(in thousands, except share data)June 30,
			
			December 31,2004
			
			2003
			
			2003(unaudited)ASSETSCash and due from banks
			
			
			$        25,802
			
			28,387
			
			32,309Federal funds sold
			
			
			1,338
			
			1,880
			
			930Cash and cash equivalents
			
			27,140
			
			30,267
			
			33,239Federal Home Loan Bank (FHLB) stock, at cost
			2,122
			
			1,868
			
			1,868Investment securities available for sale, at fair market value
			152,209
			
			115,380
			
			128,930Loans held for sale
			
			
			4,033
			
			12,963
			
			6,399Loans
			
			
			
			
			719,043
			
			666,627
			
			693,213Less allowance for loan losses
			
			(7,983)
			
			(7,022)
			
			(7,463)Loans, net
			
			
			711,060
			
			659,605
			
			685,750Premises and equipment, net
			
			
			22,488
			
			19,934
			
			21,724Accrued interest receivable
			
			
			4,105
			
			4,002
			
			4,083Other assets
			
			
			
			18,337
			
			15,937
			
			16,086Total assets
			
			
			$      941,494
			
			859,956
			
			898,079LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
			
			
			$      122,463
			
			120,343
			
			115,982Interest-bearing
			
			
			662,395
			
			624,062
			
			655,766Total deposits
			
			
			784,858
			
			744,405
			
			771,748Retail repurchase agreements
			
			
			18,790
			
			12,750
			
			13,525Commercial paper (Master notes)
			
			
			15,197
			
			19,676
			
			16,170Federal funds purchased
			
			
			13,286
			
			5,900
			
			18,000FHLB Advances
			
			
			30,000
			
			-
			
			-Other liabilities
			
			
			4,808
			
			5,119
			
			6,647Total liabilities
			
			
			866,939
			
			787,850
			
			826,090Shareholders' equityCommon stock - par value $5.00 per share;  authorized 10,000,000shares; issued and outstanding 6,269,535, 6,351,339 and 6,263,210at June 30, 2004 and 2003 and December 31, 2003, respectively.
			31,348
			
			31,757
			
			31,316Capital surplus
			
			
			298
			
			225
			
			250Retained earnings
			
			
			43,525
			
			38,260
			
			39,454Accumulated other comprehensive income (loss), net of tax
			(616)
			
			1,864
			
			969Total shareholders' equity
			
			74,555
			
			72,106
			
			71,989Total liabilities and shareholders' equity
			$      941,494
			
			859,956
			
			898,079


3

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PALMETTO BANCSHARES, INC.Consolidated Statements of Income(in thousands, except share data)For the three months ended June 30,2004
			
			2003(unaudited)Interest incomeInterest and fees on loans
			
			$      11,232
			
			11,629Interest and dividends on investment securities available for saleU.S. Treasury and U.S. Government agencies
			52
			
			299State and municipal
			
			
			570
			
			392Mortgage-backed securities
			
			391
			
			181Interest on federal funds sold
			
			14
			
			28Dividends on FHLB stock
			
			20
			
			19Total interest income
			
			12,279
			
			12,548Interest expenseInterest on deposits, including retail repurchase agreements
			2,413
			
			2,688Interest on securities sold under agreements to repurchase andreverse repurchase agreements
			
			32
			
			-Interest on federal funds purchased
			
			12
			
			8Interest on FHLB Advances
			
			45
			
			-Interest on commercial paper (Master notes)
			22
			
			29Total interest expense
			
			2,524
			
			2,725Net interest income
			
			9,755
			
			9,823Provision for loan losses
			
			
			750
			
			900Net interest income after provision for loan losses
			9,005
			
			8,923Noninterest incomeService charges on deposit accounts
			2,197
			
			2,217Net fees for trust and brokerage services
			768
			
			672Mortgage banking income
			
			161
			
			(14)Investment securities gains
			
			-
			
			186Other
			
			
			
			
			725
			
			687Total noninterest income
			
			3,851
			
			3,748Noninterest expenseSalaries and other personnel
			
			5,049
			
			4,989Occupancy
			
			
			
			598
			
			541Furniture and equipment
			
			
			855
			
			839Postage and supplies
			
			
			273
			
			409Marketing and advertising
			
			372
			
			253Telephone
			
			
			
			187
			
			188Professional services
			
			
			226
			
			127Other
			
			
			
			
			1,194
			
			1,329Total noninterest expense
			
			8,754
			
			8,675Income before income taxes
			4,102
			
			3,996Provision for income taxes
			
			
			1,306
			
			1,288Net income
			
			$        2,796
			
			2,708Share Data:Net income - basic
			
			
			$           0.45
			
			0.43Net income - diluted
			
			
			0.44
			
			0.42Book value
			
			
			
			11.89
			
			11.35Weighted average common shares outstanding - basic
			6,266,931
			
			6,346,105Weighted average common shares outstanding - diluted
			6,381,267
			
			6,498,919See accompanying notes to consolidated interim financial statements.


4

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PALMETTO BANCSHARES, INC.Consolidated Statements of Income(in thousands, except share data)For the six months ended June 30,2004
			
			2003(unaudited)Interest incomeInterest and fees on loans
			
			$      22,503
			
			23,172Interest and dividends on investment securities available for saleU.S. Treasury and U.S. Government agencies
			160
			
			714State and municipal
			
			
			1,080
			
			774Mortgage-backed securities
			
			729
			
			390Interest on federal funds sold
			
			29
			
			63Dividends on FHLB stock
			
			39
			
			42Total interest income
			
			24,540
			
			25,155Interest expenseInterest on deposits, including retail repurchase agreements
			4,893
			
			5,492Interest on securities sold under agreements to repurchase andreverse repurchase agreements
			
			32
			
			-Interest on federal funds purchased
			
			31
			
			12Interest on FHLB Advances
			
			45
			
			-Interest on commercial paper (Master notes)
			45
			
			52Total interest expense
			
			5,046
			
			5,556Net interest income
			
			19,494
			
			19,599Provision for loan losses
			
			
			1,500
			
			1,800Net interest income after provision for loan losses
			17,994
			
			17,799Noninterest incomeService charges on deposit accounts
			4,280
			
			4,221Net fees for trust and brokerage services
			1,438
			
			1,270Mortgage banking income
			
			326
			
			86Investment securities gains
			
			108
			
			281Other
			
			
			
			
			1,421
			
			1,324Total noninterest income
			
			7,573
			
			7,182Noninterest expenseSalaries and other personnel
			
			9,685
			
			9,480Occupancy
			
			
			
			1,189
			
			1,108Furniture and equipment
			
			
			1,738
			
			1,652Postage and supplies
			
			
			594
			
			805Marketing and advertising
			
			586
			
			437Telephone
			
			
			
			369
			
			372Professional services
			
			
			412
			
			284Other
			
			
			
			
			2,427
			
			2,547Total noninterest expense
			
			17,000
			
			16,685Income before income taxes
			8,567
			
			8,296Provision for income taxes
			
			
			2,741
			
			2,686Net income
			
			$        5,826
			
			5,610Share Data:Net income - basic
			
			
			$           0.93
			
			0.89Net income - diluted
			
			
			0.91
			
			0.87Book value
			
			
			
			11.89
			
			11.35Weighted average common shares outstanding - basic
			6,265,500
			
			6,336,455Weighted average common shares outstanding - diluted
			6,379,006
			
			6,483,582See accompanying notes to consolidated interim financial statements.


5

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PALMETTO BANCSHARES, INC.Consolidated Statements of Cash Flows(in thousands)For the six months ended June 30,2004
			
			2003(unaudited)Cash flows from operating activitiesNet income
			
			
			$       5,826
			
			5,610Adjustments to reconcile net income to net cashprovided by (used in) operating activitiesDepreciation and amortization
			2,066
			
			2,616Gain on sale of investment securities
			(108)
			
			(281)Provision for loan losses
			1,500
			
			1,800Origination of loans held for sale
			(20,537)
			
			(78,032)Proceeds from sale of loans held for sale
			23,229
			
			77,594Gain on sale of loans
			(326)
			
			(674)Change in accrued interest receivable
			(22)
			
			144Change in other assets
			(1,524)
			
			(1,264)Change in other liabilities, net
			(846)
			
			(2,809)Net cash provided by operating activities
			9,258
			
			4,704Cash flows from investing activitiesPurchase of investment securities available for sale
			(60,920)
			
			(44,453)Proceeds from maturities of investment securities available for sale
			6,287
			
			12,278Proceeds from sale and calls of investment securities available for sale
			15,335
			
			20,545Principal paydowns on mortgage-backed securities available for sale
			12,926
			
			11,331Purchase of Federal Home Loan Bank stock
			(254)
			
			(135)Net increase in loans outstanding
			(28,048)
			
			(42,873)Purchases of premises and equipment, net
			(1,696)
			
			(1,079)Net cash used in investing activities
			(56,370)
			
			(44,386)Cash flows from financing activitiesNet increase in deposit accounts
			13,110
			
			22,414Net increase (decrease) in securities sold under agreements to repurchase
			5,265
			
			(81)Net increase (decrease) in commercial paper
			(973)
			
			4,837Net increase (decrease) in federal funds purchased
			(4,714)
			
			5,900Net increase (decrease) in FHLB advances
			30,000
			
			-Proceeds from stock option activity
			80
			
			309Dividends paid
			
			(1,755)
			
			(1,523)Net cash provided by financing activities
			41,013
			
			31,856Net decrease in cash and cash equivalents
			(6,099)
			
			(7,826)Cash and cash equivalents at beginning of period
			33,239
			
			38,093Cash and cash equivalents at end of period
			$     27,140
			
			30,267Supplemental InformationCash paid during the period for:Interest expense
			
			$       5,114
			
			5,675Income taxes
			
			
			2,192
			
			2,637Supplemental schedule of non-cash investing and financing transactionsChange in unrealized gain on investment securities availablefor sale, pre-tax
			$     (2,578)
			
			307Loans transferred to other real estate owned
			1,238
			
			608Loans charged-off
			
			1,046
			
			1,262See accompanying notes to consolidated interim financial statements.


6

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PALMETTO BANCSHARES, INC.Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income(in thousands, except share data) (unaudited)AccumulatedShares of
			
			
			
			othercommon
			Common
			Capital
			Retained
			comprehensivestock
			stock
			surplus
			earnings
			income (loss), net
			TotalBalance at December 31, 2002
			6,324,659
			$   31,623
			50
			34,173
			1,675
			67,521Net income
			
			
			
			
			5,610
			
			5,610Other comprehensive income, net of tax:Net unrealized holding gains (losses) arising during period, netof tax effect of $227
			
			
			
			
			
			362Less:  reclassification adjustment for gains includedin net income, net of tax effect of $108
			
			
			
			
			(173)Net unrealized gains on securities
			
			
			
			
			
			189Comprehensive income
			
			
			
			
			
			
			5,799Cash dividend declared and paid ($0.24 per share)
			
			
			
			(1,523)
			
			(1,523)Stock option activity
			
			26,680
			134
			175
			
			
			309Balance at June 30, 2003
			
			6,351,339
			$   31,757
			225
			38,260
			1,864
			72,106Balance at December 31, 2003
			6,263,210
			$   31,316
			250
			39,454
			969
			71,989Net income
			
			
			
			
			5,826
			
			5,826Other comprehensive income, net of tax:Net unrealized holding gains (losses) arising during period, netof tax effect of $951
			
			
			
			
			
			(1,519)Less:  reclassification adjustment for gains includedin net income, net of tax effect of $42
			
			
			
			
			(66)Net unrealized losses on securities
			
			
			
			
			
			(1,585)Comprehensive income
			
			
			
			
			
			
			4,241Cash dividend declared and paid ($0.28 per share)
			
			
			
			(1,755)
			
			(1,755)Stock option activity
			
			6,325
			32
			48
			
			
			80Balance at June 30, 2004
			
			6,269,535
			$   31,348
			298
			43,525
			(616)
			74,555


7

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PALMETTO BANCSHARES, INC.Notes To Consolidated Financial
Statements

1.  GENERAL

Nature of OperationsPalmetto Bancshares is a bank holding company headquartered in Laurens,
South Carolina and organized in 1982 under the laws of South Carolina. Through
its wholly-owned subsidiary, The Palmetto Bank (the "Bank"), and the Bank's
wholly-owned subsidiary, Palmetto Capital, Inc. ("Palmetto Capital"), Bancshares
engages in the general banking business through 30 retail branch offices in the
Upstate South Carolina markets of Laurens, Greenville, Spartanburg, Greenwood,
Anderson, Cherokee, Abbeville, and Oconee counties (the "Upstate"). Throughout
this report, "Bancshares" shall refer to Palmetto Bancshares and subsidiaries,
except where the context requires otherwise. The Bank was organized and
chartered under South Carolina law in 1906.  Bancshares primarily operates
through its wholly-owned subsidiary bank, the Bank, which represents its only
reportable segment.

The
industry in which the Bank operates exists primarily to provide an intermediary
service to the general public with funds to deposit and, by using these funds,
to originate loans in the markets served. The Bank provides a full range of
banking activities, including, but not limited to, checking, savings, money
market, and other time deposits for a wide range of consumer and commercial
depositors, loans for business, real estate, and personal uses, safe deposit box
rental, various electronic funds transfer services, telephone banking, and bank
card services. The Bank's indirect lending department establishes relationships
with Upstate automobile dealers to provide customer financing on qualifying
automobile purchases, and its mortgage banking operation meets a range of
customers' financial service needs by originating, selling, and servicing
mortgage loans. The Bank also offers both individual and commercial trust
services through an active trust department. Palmetto Capital offers customers
stocks, treasury and municipal bonds, mutual funds, and insurance annuities, as
well as college and retirement planning.

Principles of
Consolidation and Basis of PresentationThe accompanying consolidated financial statements include the accounts of
Bancshares.  In management's opinion, all significant intercompany accounts
and transactions have been eliminated, and all adjustments necessary for a fair
presentation of the results for periods presented have been included.  Any
such adjustments are of a normal and recurring nature. Assets held by the Bank
in a fiduciary or agency capacity for customers are not included in the
consolidated financial statements as such assets do not represent assets of the
Bank.

The foregoing
consolidated financial statements and related notes are prepared in accordance
with the Securities and Exchange Commission's instructions for Quarterly Reports
on Form 10-Q. Accordingly, certain information and footnotes required by
generally accepted accounting principles for complete financial statements are
not included.  These statements should be read in conjunction with the
financial statements and footnotes thereto included in Bancshares' Annual Report
on Form 10-K for the year ended December 31, 2003.

ReclassificationsCertain amounts previously presented in consolidated financial statements
for prior periods have been reclassified to conform to current classifications.
All such reclassifications have no impact on the prior years' net income or
shareholders' equity as previously reported.

Accounting Estimates
and Assumptions
The accounting and reporting policies of Bancshares conform to accounting
principles generally accepted in the United States of America and to general
practices within the banking industry. In preparing its consolidated financial
statements, 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 dates of the consolidated balance sheets for the periods
presented. In addition, such estimates and assumptions also impact the reporting
amounts of income and expense during the reporting period as of the dates of the
consolidated statements of income for the periods presented. Actual results
could differ from these estimates and assumptions.  As such, the results of
operations for the three and six month periods ended June 30, 2004 are not
necessarily indicative of the results of operations that may be expected in
future periods.

8

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Summary of
Significant Accounting PoliciesThe significant accounting policies used by Bancshares for reporting within
this quarterly report are consistent with the accounting policies followed for
annual financial reporting as described in Note 1 of Notes to Consolidated
Financial Statements included in Bancshares' Annual Report on Form 10-K for the
year ended December 31, 2003 with the following exception.  During the
second quarter of 2004, Bancshares utilized advances from the Federal Home Loan
Bank ("FHLB").  The related policy, which could significantly impact the
determination of financial position, results of operations and cash flows, is
summarized below.

FHLB Advances

FHLB advances are a source of
funding which Bancshares uses depending on the current level of deposits,
management's willingness to raise deposits through market promotions, the Bank's
unused FHLB borrowing capacity, and the availability of collateral to secure
FHLB borrowings. Bancshares' short-term borrowings are defined as borrowings
with maturities of one year or less when made. Long-term borrowings have
maturities greater than one year when made. FHLB advances are used to fund a
portion of loan demand and increases in investment securities in times of
decreased funding provided by deposits. Both short-term and long-term borrowings
to fund growth of earning assets in excess of deposit growth. During the three
month and six month periods ended June 30, 2004, the increase in borrowed funds
was attributable to an increased reliance on short-term and long-term FHLB
advances to support earning asset growth, including increases in investment
securities.

2.   MORTGAGE SERVICING RIGHTS

The Bank originates
both fixed rate and adjustable rate mortgage loans with terms generally ranging
from 10 to 30 years.  The Bank's mortgage banking strategy is to sell most
of the loans it originates in the secondary market with servicing rights
retained. Real estate lending is generally considered to be collateral-based
lending with loan amounts based on predetermined loan to collateral values, and
liquidation of the underlying real estate collateral is viewed as the primary
source of repayment in the event of borrower default.

Effective in the third quarter 2003, the Bank began utilizing the expertise of a
third party to determine the value of mortgage servicing rights ("MSRs") as well
as the related amortization and impairment of such rights. The external
valuation utilizes estimates for the amount and timing of mortgage loan
repayments, estimated prepayment rates, credit loss experience, costs to service
loans, and discount rates to determine an estimate of the fair value of the
Bank's mortgage servicing rights. In regard to the valuation obtained at June
30, 2004, management believes that the modeling techniques and assumptions used
in conjunction with the valuation are reasonable.

In
accordance with Statement of Financial Accounting Standards ("SFAS") No. 140,
the third party evaluator stratifies mortgage servicing assets based on
predominant risk factors in order to evaluate impairment. The Bank recognizes
impairment as reported by the third party evaluator through a valuation
allowance. Impairment calculated by the third party evaluator is the difference
between the period end book value and the market value at the same point in
time.

9

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Amortization expense is calculated based on current
available information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and other environmental factors.

The
tables set forth below summarize the changes in gross mortgage servicing rights
during the three and six month periods ended June 30 (in thousands).



For the three months ended June 30,2004
			2003Mortgage
			servicing rights, beginning of period
			$   2,568
			2,128Capitalized mortgage servicing rights
			113
			504Amortization
			(131)
			(516)Total
			mortgage servicing rights, end of period
			$   2,550
			2,116


For the six months ended June 30,2004
			2003Mortgage
			servicing rights, beginning of period
			$   2,607
			2,070Capitalized mortgage servicing rights
			263
			983Amortization
			(320)
			(937)Total
			mortgage servicing rights, end of period
			$   2,550
			2,116


Amortization expense for MSRs for the twelve months ended December 31, 2003
totaled $1.1 million.

The
tables set forth below summarize the activity impacting the valuation allowance
for impairment of mortgage servicing rights during the three and six month
periods ended June 30 (in thousands).



For the three months ended June 30,2004
			2003Valuation
			allowance, beginning of period
			$   90
			159Aggregate
			additions charged and reductions credited to   
			operations
			69
			87Valuation
			allowance, end of period
			$   159
			246


For the six months ended June 30,2004
			2003Valuation
			allowance, beginning of period
			$   40
			113Aggregate
			additions charged and reductions credited to operations
			119
			133Valuation
			allowance, end of period
			$   159
			246


As management projected
in its Annual Report on Form 10-K for the year ended December 31, 2003, due to
the interest rate environment, residential mortgage production during the first
six months of 2004 has declined compared with recent years, resulting in reduced
loan sales.  As a result, mortgage servicing rights capitalized during the
first six months of 2004 have also declined when compared with the same period
of 2003. Mortgage loans originated totaled $7.0 million during the second
quarter of 2004 compared with $41.3 million during the same quarter of 2003.
Sales during the same periods totaled $9.5 million and $39.7 million,
respectively.  The Bank expects lower origination and sales figures to
continue due to higher mortgage loan rates. Although existing mortgage servicing
rights continued to be amortized and evaluated for impairment, changes in
current available market information regarding such facets of the portfolio as
loan payments and prepayments have caused a decline in amortization and
impairment during the six months ended June 30, 2004 when compared with the same
period of 2003.  As noted above, during the three and six month periods
ended June 30, 2004 amortization of mortgage servicing rights has outpaced the
capitalization of new rights when compared with the same periods of 2003.

10

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3.   INTANGIBLE ASSETS

Intangible assets with infinite lives are included in other assets on the
consolidated balance sheets.  These assets totaled $3.7 million at June 30,
2004, December 31, 2003, and June 30, 2003.

Intangible assets with
infinite lives are subject to periodic impairment tests in accordance with SFAS
No. 142, on an annual basis, or more often, if events or circumstances indicate
that there may be impairment. Potential impairment of goodwill exists when the
carrying amount of a reporting unit exceeds its implied fair value. To the
extent a reporting unit's carrying amount exceeds its fair value, an indication
exists that the reporting unit's goodwill may be impaired and the reporting
unit's goodwill is estimated by allocating the reporting unit's fair value to
all of its assets (recognized and unrecognized) and liabilities as if the
reporting unit had been acquired in a business combination at the date of the
impairment test. If the implied fair value of the reporting unit's goodwill is
lower that its carrying amount, goodwill is impaired and is written down to the
implied fair value. The loss recognized is limited to the carrying amount of
goodwill. Once an impairment loss is recognized, future increases in fair value
will not result in the reversal of previously recognized losses.

Impairment valuations
as of June 30, 2004 indicated that no impairment charge was required as of that
test date, as the carrying amount of reporting units does not exceed implied
fair value. As
a result, no impairment loss was recorded during the six month period ended June
30, 2004.

The tables set forth
below illustrate the activity of intangible assets with finite lives, which are
comprised of customer list intangibles, included in other assets on the
consolidated balance sheets, and the related amortization, included in other
noninterest expense on the consolidated statements of income, during the three
and six month periods ended June 30 (in thousands).

For the three months ended June 30,2004
			2003Balance,
			beginning of period
			$   428
			574Amortization
			36
			37Balance,
			end of period
			$   392
			537


For the six months ended June 30,2004
			2003Balance,
			beginning of period
			$   464
			608Amortization
			72
			71Balance,
			end of period
			$   392
			537


Amortization of
intangible assets with finite lives totaled $144 thousand for the year ended
December 31, 2003.

Amortization expense
related to intangibles of $144 thousand is expected to be recorded for fiscal
years 2004 and 2005, $48 thousand for fiscal years 2006 and 2007, $45 thousand
for fiscal year 2008, and $33 thousand for fiscal year 2009.

4.   NET INCOME PER COMMON SHARE

Basic and diluted
earnings per share have been computed based on net income presented in the
accompanying consolidated statements of income divided by the weighted average
common shares outstanding or assumed to be outstanding as summarized below:

11

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For the three months ended June 30,2004
			2003BASIC
			Average
			common shares outstanding (denominator)
			6,266,931
			6,346,105DILUTED
			Average
			common shares outstanding
			6,266,931
			6,346,105Dilutive
			potential common shares
			114,336
			152,814Average
			diluted shares outstanding (denominator)
			6,381,267
			6,498,919


For the six months ended June 30,2004
			2003BASIC
			Average
			common shares outstanding
			(denominator)
			6,265,500
			6,336,455DILUTED
			Average
			common shares outstanding
			6,265,500
			6,336,455Dilutive
			potential common shares
			113,506
			147,127Average
			diluted shares outstanding (denominator)
			6,379,006
			6,483,582


Option shares
are excluded from the calculation of diluted earnings when the exercise price is
greater than the average market price of the common shares as of that date. 
At June 30, 2004, there were no option shares that were excluded from the
calculation of diluted earnings, based on information available to management at
that time.

5.   EMPLOYEE BENEFIT PLANS

Postretirement Benefits

Bancshares has a noncontributory defined benefit pension plan that covers all
full-time employees who have at least twelve months continuous service and have
attained age 21. The plan is designed to produce a designated retirement
benefit, and benefits are fully vested at five or more years of service. No
vesting occurs until five years of service has been achieved. The trust
department administers the plan. Contributions to the plan are made as required
by the Employee Retirement Income Security Act of 1974.

The
tables set forth below present the components of net period benefit cost during
the three and six month periods ended June 30 (in thousands).

For the three months ended June 30,2004
			2003Service
			cost
			$     119
			136Interest
			cost
			139
			152Expected
			return on plan assets
			(183)
			(200)Amortization of prior service cost
			2
			2Amortization of the net loss
			17
			29Net
			periodic benefit cost
			$       94
			119


For the six months ended June 30,2004
			2003Service
			cost
			$     267
			272Interest
			cost
			302
			305Expected
			return on plan assets
			(397)
			(400)Amortization of prior service cost
			4
			4Amortization of the net loss
			37
			58Net
			periodic benefit cost
			$    213
			239


Bancshares previously disclosed in its Annual Report on Form 10-K for the year
ended December 31, 2003 that it expected to contribute $1.3 million to its
noncontributory defined benefit pension plan during 2004. During the three and
six month periods ended June 30, 2004, $323 thousand and $335 thousand was
contributed, respectively.

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Stock Option PlanAt June 30, 2004, Bancshares had a stock-based employee and director option
plan, which is described more fully in Note 12 of Notes to Consolidated
Financial Statements included in its Annual Report on Form 10-K for the year
ended December 31, 2003.  SFAS No. 123, "Accounting for Stock-Based
Compensation," allows a company to either adopt the fair value method of
valuation or continue using the intrinsic valuation method presented under
Accounting Principles Bulletin ("APB") Opinion 25, "Accounting for Stock Issued
to Employees," to account for stock-based compensation. Bancshares has elected
to continue following APB Opinion 25 and provide pro forma net income and pro
forma earnings per share disclosures for employee stock option grants as if the
fair value-based method defined in SFAS No. 123 had been applied. As such, no
stock-based employee compensation cost has been reflected in net income, as all
stock options granted under these plans had an exercise price equal to the fair
market value of the underlying common stock on the date of grant.

In
December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of FASB Statement No. 123." This Statement amends SFAS No. 123 to
provide alternative methods of transition for a voluntary change to the fair
value-based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition and disclosure
provisions were required for financial statements for fiscal periods ending
after December 15, 2002. Bancshares adopted this standard effective December 31,
2002 and has included the required interim disclosures herein.

The tables set forth
below illustrate the impact the fair value recognition provisions of SFAS No.
123 to stock-based compensation would have had on net income and earnings per
share if Bancshares had applied them for the three and six month periods ended
June 30 (in thousands, except share data).

For the three months ended June 30,2004
			2003Net income, as reported
			$   2,796
			2,708Deduct: Total stock-based employee and
			director
            
			compensation expense determined under
             fair
			value-based methods for all awards,
             net of
			related tax effects
			34
			34Pro forma net income
			$   2,762
			2,674Earnings per shareBasic - as reported
			
			$    0.45
			0.43Basic - pro forma
			0.44
			0.42Diluted - as reported
			$    0.44
			0.42Diluted - pro forma
			0.43
			0.41




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For the six months ended June 30,2004
			2003Net income, as reported
			$   5,826
			5,610Deduct: Total stock-based employee and
			director
			             compensation expense determined under
              fair value-based
			methods for all awards,
             
			net of related tax effects
			67
			61Pro forma net income
			$   5,759
			5,549Earnings per shareBasic - as reported
			
			$    0.93
			0.89Basic - pro forma
			0.92
			0.88Diluted - as
			reported
			$    0.91
			0.87Diluted - pro forma
			0.90
			0.86




In
accordance with its 1997 Stock Compensation Plan, Bancshares granted 44,000
options during second quarter 2003 and 34,000 options during first quarter 2004.
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during 2004 and 2003, respectively: dividend yield
of 2.7% and 2.6%, expected volatility of 18% for grants during both years,
average risk-free interest rate of 4% for grants during both years, expected
lives of 10 years, and a vesting period of five years. The weighted average fair
value of options granted approximated $4.58 in 2004 and $4.38 in 2003. For
purposes of the pro forma calculation, compensation expense is recognized on a
straight-line basis over the vesting period.

In
November 2003, the FASB issued a tentative decision related to fair value
accounting of stock options requiring that all unvested options begin being
expensed in 2005 financial statements, which included guidance on how
equity-based awards will be valued, expensed, and classified. Bancshares
anticipated at that time that the adoption of such decisions would have an
impact on its financial position or results of operations although such impact
could not be determined at that time.

In
March 2004, the FASB formally proposed to require companies to recognize the
fair value of stock options and other stock-based compensation to employees for
2005 reporting periods, a policy consistent with the related international
standard released and with convergence between the two sets of standards. The
questions proposed at this point are how "share based payments" (to use the
International Accounting Standard Board's ("IASB") term adopted by the FASB)
should be valued and classified and the related implementation difficulties. The
exposure draft addresses only accounting for share-based awards to employees,
including employee-stock-purchase-plans (ESPPs). Accounting for
employee-stock-ownership-plan transactions (ESOPs) and awards to nonemployees
will be taken up in a later phase of the project. Comments on the exposure draft
were due by June 30, 2004.

On
July 20, 2004, the House passed a bill that would prevent the Securities and
Exchange Commission from putting into effect the FASB proposal to require
companies to expense employee stock options. The legislation would require that
public companies report only employee stock options granted to their CEOs and
four highest-paid officers. Small businesses would be exempted from expensing
options, and new public companies would be able to delay expensing for top
executives during their first three years. The House also approved an amendment
to the legislation to clarify that companies wishing to expense stock options
voluntarily may continue to do so. A similar bill in the Senate is still under
consideration. Due to the continually evolving nature of stock options and other
stock-based compensation accounting, Bancshares will stay abreast of related
literature and comply with any related requirements.

6.   BUSINESS SEGMENTS

Bancshares has one
principal operating subsidiary, The Palmetto Bank, which is evaluated regularly
by the chief operating decision makers in deciding how to allocate resources and
assess performance. This subsidiary, by virtue of exceeding certain quantitative
thresholds, is Bancshares' only reportable segment. The reportable segment also
provides demand transaction accounts and time deposit accounts to businesses and
individuals. The Palmetto Bank offers products and services primarily to
customers in South Carolina. Revenues for The Palmetto Bank are derived
primarily from interest and fees on loans, interest on investment securities,
service charges on deposits, and other customer service fees. No single customer
accounts for a significant amount of the revenues of the reportable segment.

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7.   COMMITMENTS AND CONTINGENT LIABILITIES

The Company is
currently subject to various legal proceedings and claims that have arisen in
the ordinary course of its business. In the opinion of management based on
consultation with external legal counsel, any reasonably foreseeable outcome of
such current litigation would not materially affect the Company's consolidated
financial position or results of operations.

















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

The following discussion and analysis is
presented to assist in understanding the financial condition and results of
operations of Bancshares.  This discussion should be read in conjunction
with the consolidated financial statements and related notes and other financial
data appearing in this report as well as in Bancshares' Annual Report on Form
10-K for the year ended December 31, 2003.  Results of operations for the
three and six month periods ended June 30, 2004 are not necessarily indicative
of results that may be attained for any other period.  Percentage calculations
contained herein have been calculated based upon actual, not rounded, results.

COMPANY OVERVIEW

Palmetto Bancshares is a bank holding company
headquartered in Laurens, South Carolina and organized in 1982 under the laws of
South Carolina. Through its wholly-owned subsidiary, The Palmetto Bank (the
"Bank"), and the Bank's wholly-owned subsidiary, Palmetto Capital, Inc.
("Palmetto Capital"), Bancshares engages in the general banking business through
30 retail branch offices in the Upstate South Carolina markets of Laurens,
Greenville, Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, and Oconee
counties (the "Upstate"). Throughout this report, "Bancshares" shall refer to
Palmetto Bancshares, Inc. and subsidiaries, except where the context requires
otherwise. The Bank was organized and chartered under South Carolina law in
1906.  Bancshares primarily operates through its wholly-owned subsidiary
bank, the Bank, which represents its only reportable segment.

The industry in which
the Bank operates exists primarily to provide an intermediary service to the
general public with funds to deposit and, by using these funds, to originate
loans in the markets served. The Bank provides a full range of banking
activities, including, but not limited to, checking, savings, money market, and
other time deposits for a wide range of consumer and commercial depositors,
loans for business, real estate, and personal uses, safe deposit box rental,
various electronic funds transfer services, telephone banking, and bank card
services. The Bank's indirect lending department establishes relationships with
Upstate automobile dealers to provide customer financing on qualifying
automobile purchases, and its mortgage banking operation meets a range of
customers' financial service needs by originating, selling, and servicing
mortgage loans. The Bank also offers both individual and commercial trust
services through an active trust department. Palmetto Capital offers customers
stocks, treasury and municipal bonds, mutual funds, and insurance annuities, as
well as college and retirement planning.

WEBSITE AVAILABILITY OF REPORTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION

The Bank's website, www.palmettobank.com, includes a link to the Securities and Exchange
Commission's Electronic Data Gathering, Analysis, and Retrieval ("EDGAR") system
which makes various reports filed with the Securities and Exchange Commission by
Bancshares, including, but not limited to, its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Ownership Reports
filed in conjunction with Section 16, and amendments to such reports, available,
free of charge.  These reports are made available as soon as reasonably
practicable after these reports are filed with, or furnished to, the Securities
and Exchange Commission.  The Securities and Exchange Commission's EDGAR
database may also be accessed through its website, www.sec.gov.

FORWARD-LOOKING STATEMENTS

In this report and in
other reports and proxy statements filed with the Securities and Exchange
Commission (the "SEC"), forward-looking statements (as defined in the Private
Securities Litigation Reform Act of 1995) are made. In addition, management may
make forward-looking statements orally. Broadly speaking, forward-looking
statements include, but are not limited to, projections of the revenues, income,
earnings per share, capital expenditures, dividends, capital structure, or other
financial items, descriptions of plans or objectives for future operations,
products or services, forecasts of future economic performance, and descriptions
of assumptions underlying or relating to any of the foregoing.

16

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Forward-looking statements discuss matters that are not historical facts.
Because they discuss future events or conditions, forward-looking statements
often include words such as "anticipate," "believe," "estimate," "expect,"
"intend," "plan," "project," "target," "can," "could," "may," "should," "will,"
"would," or similar expressions. Do not unduly rely on forward-looking
statements. Such statements give management's expectations about Bancshares'
future and are not guarantees. Forward-looking statements speak only as of the
date they are made, and no obligation is undertaken to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made to reflect the occurrence of unanticipated events.
In addition, certain statements included in future filings of Bancshares with
the SEC, in press releases, and/or in oral and written statements made by or
with the approval of Bancshares, which are not statements of historical fact,
constitute forward-looking statements.

There are several
factors, many beyond Bancshares' and its management's control, that could cause
results to differ from expectations. Some of these factors include, but are not
limited to,

- changes in economic and / or industry conditions
	and monetary policy;
- changes in interest rates, deposit rates, the
	net interest margin, and / or funding sources;
- market risk and inflation;
- risks inherent in making loans including
	repayment and collateral risk;
- volume of loan growth;
- the adequacy of the allowance for loan losses
	(the "Allowance") and the assessment of problem loans;
- the ability of Bancshares to meet its
	contractual obligations;
- fluctuations in consumer spending;
- competition in the banking industry and the
	related demand for banking products and services;
- dependence on senior management;
- technological changes;
- the ability to increase market share;
- the reliability of expense projections;
- risks associated with income taxes, including
	the potential for adverse adjustments;
- changes in accounting policies and practices;
- potential cost and impact of litigation; and
- the impact of recently-enacted or proposed
	legislation.

Many of these
factors, as well as other factors, such as credit, market, operational,
liquidity, interest rate, and other risks, are discussed in more detail in the
Bancshares' Annual Report on Form 10-K for the year ended December 31, 2003. Any
factor described in this Quarterly Report on Form 10-Q or in that Annual Report
on Form 10-K could by itself, or together with one or more factors, adversely
affect the business, financial condition, and / or results of operations of
Bancshares. Additionally, there are factors that may not be described in this
report that could also cause actual results to differ from expectations.

HIGHLIGHTS AS OF AND FOR THE PERIODS ENDED JUNE 30, 2004

Bancshares had $941.5 million in total assets and
30 branch offices in Upstate South Carolina at June 30, 2004. Bancshares
operates primarily through the Bank, its subsidiary.

17

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Bancshares derives
interest income through traditional banking activities such as generating loans
and earning interest on securities. Additional sources of income are derived
from fees on deposit accounts and from our various lines of business including
mortgage, brokerage, and trust management. Also, in conjunction with the
management of its securities portfolio, income is recognized on the sale of bond
and equity securities.

Improving the net
interest margin is critical to Bancshares' strategy to grow earnings. However,
the declining interest rate environment has continued to pressure loan yields.
Bancshares has taken actions to supplement the net interest margin in recent
times of declining loan yields. During 2003 the margin was impacted by lower
effective yields on mortgage-backed securities due to increased amortization of
premiums resulting from increased prepayment speeds of the underlying mortgages.
Beginning in late 2003, the securities available for sale portfolio was
restructured to assist in the stabilization of cash flows and the improvement
the effective yields in the portfolio. This shift has continued during the first
six months of 2004.  In addition, during the second quarter of 2004,
Bancshares borrowed $30 million in FHLB advances in an effort to improve the net
interest margin by employing these funds in higher yielding earning assets.

Net income for the quarter ended June 30, 2004
increased 3.2% to $2.8 million from $2.7 million in the comparable quarter of
2003. Basic earnings per common share increased 4.7% to $0.45 per common share
for the current quarter compared to the June 2003 quarter. On a diluted basis,
earnings per common share increased to $0.44 from $0.42 in the comparable 2003
quarter. For the same period, average diluted shares outstanding decreased 1.8%,
principally as a result of a stock purchase during third quarter 2003.

For
second quarter 2004, net interest income before the provision for loan losses,
the primary source of revenue, was 60.5% of total revenues. Net interest income
is the difference between the interest earned on assets, primarily loans and
securities, and the interest paid for liabilities to support such assets,
primarily deposits and borrowed funds. Net interest income for the three months
ended June 30, 2004 decreased 0.7% over the same period in 2003, principally due
to current interest rate environment in which the industry operates. Although
increases relating to investment security income were seen during the three
month period ended June 30, 2004 over the same period of 2003, these increases
were more than offset by a decline in return on loans.

Noninterest income, particularly fee income from
providing products and services that typically have not been deemed traditional
banking activities, represents an additional opportunity for revenue growth. For
the three month period ended June 30, 2004 noninterest income increased $103
thousand or 2.7%.  This increase was primarily the result of an increase in
net fees for trust and brokerage services of $96 thousand and an increase in
mortgage banking income over the same periods of $175 thousand.  These
increases were partially offset by a decline in investment security gains of
$186 thousand.

For the second quarter of 2004, noninterest
expenses totaled $8.8 million, an increase of $79 thousand over second quarter
2003. Salaries and other personnel expense, the largest component of noninterest
expense, accounted for approximately 57.7% of total noninterest expenses for the
quarter ended June 30, 2004.

Net income for the six month period ended June
30, 2004 increased 3.9% to $5.8 million from $5.6 million in the comparable
period of 2003. Basic earnings per common share increased 4.5% to $0.93 per
common share for the current quarter compared to the six month period ended June
30, 2003. On a diluted basis, earnings per common share increased to $0.91 from
$0.87 in the comparable 2003 period. For the same period, average diluted shares
outstanding decreased 1.6%, principally as a result of a stock repurchase during
third quarter 2003.

18

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For the
first six months of 2004, net interest income before the provision for loan
losses, the primary source of revenue, was 60.7% of total revenues. Net interest
income for the six months ended June 30, 2004 decreased 0.5% over the same
period in 2003, principally due to current interest rate environment in which
the industry operates. Although increases relating to investment security income
were seen during the six month period ended June 30, 2004 over the same period
of 2003, these increases were more than offset by a decline in return on loans.

Noninterest income, particularly fee income from
providing products and services that typically have not been deemed traditional
banking activities, represents an additional opportunity for revenue growth. For
the six month period ended June 30, 2004 noninterest income increased $391
thousand or 5.4%.  This increase was primarily the result of an increase in
net fees for trust and brokerage services of $168 thousand and an increase in
mortgage banking income over the same periods of $240 thousand.  These
increases were partially offset by a decline in investment security gains of
$173 thousand.

For the first six months of 2004, noninterest
expenses totaled $17.0 million, an increase of $315 thousand over same period of
2003. Salaries and other personnel expense, the largest component of noninterest
expense, increased $205 thousand, or 2.2% over the periods noted. Also
contributing to the increase in noninterest expense for the first six months of
2004 when compared with the first six months of 2003 was an increase in
marketing and advertising expenses of $149 thousand, or 34.1% and an increase in
expenses related to professional services of $128 thousand, or 45.1%. 
These increases in noninterest expenses were offset by a decline in postage
expense of $211 thousand, or 26.2%.

From December 31,
2003 to June 30, 2004, total assets increased $43.4 million to a balance of
$941.5 million, an increase of 4.8%. Total assets at June 30, 2003 totaled
$860.0 million.

In order to assist in
meeting interest-earning asset growth objectives, investment securities
available for sale increased $23.3 million over December 31, 2003 and $36.8
million over June 30, 2003.  In addition to supporting interest-earning
asset growth, management believes that this strategy will allow Bancshares to
provide additional interest income to offset lower loan originations and to
replace loan portfolio runoff.

Loan growth continued during the second quarter
of 2004. The total loan portfolio, which includes loans held for sale, increased
$23.5 million over December 31, 2003 and $43.5 million over June 30, 2003.

As a result of successful sales and promotional
campaign, total deposits, which includes traditional deposits, securities sold
under agreements to repurchase, and commercial paper increased $17.4 million
from December 31, 2003 to June 30, 2004.  Total deposits grew $42.0 million over
June 30, 2003.  Growth within the deposit portfolio during the six months
ended June 30, 2004 was relatively evenly divided between the checking, money
market, savings products, and retail repurchase agreements and was offset by a
decline of approximately $2.1 million in time deposits and $1.0 million in
commercial paper.  Growth within the deposit portfolio when comparing June
30, 2004 to balances at June 30, 2003 was similarly relatively evenly divided
between the checking, money market, savings products, and retail repurchase
agreements and was offset by a decline in commercial paper of $4.5 million. 
During this period, time deposits increased by $19.8 million.  The main
difference in growth in the deposit portfolio over the periods presented (six
months ended June 30, 2004 compared with twelve months ended June 30, 2004)
resides in the time deposit portfolio.  Although the Bank offered a
36-month Step Up Certificate of Deposit ("CD") product during both the third
quarter of 2003 and the second quarter of 2004, the response to the same product
offered during the third quarter of 2003 was much greater, due in part to
increased competition during the 2004 promotion. This increased response to the
2003 promotion resulted in a much higher growth of time deposits for the twelve
month period ended June 30, 2004 compared with the growth of the time deposit
portfolio for the six month period ended June 30, 2004.

19

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During second quarter 2004, consistent with the
decision to manage the investment portfolio to maintain a portfolio of high
quality, highly liquid investments yielding competitive returns, borrowings
increased from $18.0 million at December 31, 2003 to $43.3 million at June 30,
2004.  At June 30, 2003, such borrowings totaled $5.9 million.  See
Balance Sheet Review - Securities and Balance Sheet Review - Borrowings for
further discussion of the increase in borrowings.

Total shareholders'
equity increased $2.6 million over December 31, 2003 and $2.4 million over June
30, 2003.  During the first six months of 2004, shareholders' equity was
increased through the retention of earnings and stock option activity. These
increases were offset by a decline in comprehensive income and an increase in
cash dividends. Over June 30, 2003, a stock purchase transacted during the third
quarter 2003 also impacted the fluctuation. Bancshares' equity to asset ratio at
June 30, 2004 was 7.9% compared with 8.0% at December 31, 2003 and 8.4% at June
30, 2003.

CRITICAL ACCOUNTING POLICIES

Bancshares'
accounting and financial reporting policies are in conformity with generally
accepted accounting principles and with general practice within the banking
industry. The preparation of financial statements in conformity with such
principles requires management to make estimates and assumptions that impact the
reported amounts of assets and liabilities, the 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. During the annual
financial reporting process, management, in conjunction with Bancshares'
independent auditors, discusses the development and selection of the critical
accounting estimates with the Audit Committee of the Board of Directors. 
Additionally, the Audit Committee reviews Bancshares' Quarterly Reports on Form
10-Q and the Annual Reports on Form 10-K including all related disclosures.

In order to understand Bancshares' financial
position and results of operations, it is important to understand the more
critical accounting policies and the extent to which judgment and estimates are
used in applying those policies. Bancshares' significant accounting policies are
discussed in Item 7 and Note 1 of Notes to Consolidated Financial Statements of
its Annual Report on Form 10-K for the year ended December 31, 2003. Of these
significant accounting policies, policies regarding the accounting for its
allowance for loan losses, pension plan, mortgage servicing rights, and income
taxes, are considered to be the most critical accounting policies due to the
valuation techniques used and the sensitivity of these financial statement
amounts to the methods, assumptions, and estimates underlying these balances.
Accounting for these critical areas requires a significant degree of management
judgment that could be subject to revision as current information becomes
available. In order to assist in the determination of critical accounting
policies, management considers whether the accounting estimate requires
assumptions about matters that were highly uncertain at the time the accounting
estimate was made and whether different estimates that reasonably could have
been used in the current period, or changes in the accounting estimate that are
reasonably likely to occur from period to period, would have a material impact
on Bancshares' financial condition or results of operations.

Based on a critical
assessment of its accounting policies and the underlying judgments and
uncertainties impacting the application of these policies, management believes
that Bancshares' consolidated financial statements provide a meaningful and fair
presentation of its current financial condition. This is not to suggest that
other general risk factors, some of which are described in Forward-Looking
Statements, could not adversely impact this condition.

20

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BALANCE SHEET REVIEW

Securities
The primary objective of the management of the investment portfolio is to
maintain a portfolio of high quality, highly liquid investments yielding
competitive returns. These objectives are achieved through specific transaction
approvals from the Board of Directors. Bancshares is required under federal
regulations to maintain adequate liquidity to ensure safe and sound operations.
Investment decisions are made by authorized officers within policies established
by the Board of Directors. Investment balances are maintained 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 may differ in
terms of default risk, interest risk, liquidity risk, and expected rate of
return. Default risk is the risk that an issuer will be unable to make interest
payments or to repay the principal amount on schedule. United States Government
obligations are regarded as free of default risk. The issues of most government
agencies are backed by the strength of the agency itself plus a strong
implication that, in the event of financial difficulty, the federal government
would assist the agency.

The investment
securities portfolio has several purposes including to manage interest rate and
prepayment risk, to leverage capital through generating interest and dividend
income from the investment of funds, to provide liquidity to meet funding
requirements, and to provide collateral for pledges on public deposits and
securities sold under repurchase agreements. The following table reflects the
composition of the investment security available for sale portfolio at June 30,
2004, December 31, 2003, and June 30, 2003 (dollars in thousands).

June 30,
			
			
			December 31,2004
			
			
			2003
			
			
			2003Government agencies
			$
			10,178
			
			6.7%
			
			$
			25,138
			
			21.8%
			
			$
			25,311
			
			19.6%United States treasuries
			
			-
			
			-
			
			
			2,532
			
			2.2
			
			
			-
			
			-Municipalities
			
			68,432
			
			44.9
			
			
			39,188
			
			34.0
			
			
			55,321
			
			42.9Mortgage-backed securities
			
			73,599
			
			48.4
			
			
			48,522
			
			42.0
			
			
			48,298
			
			37.5Total investment securitiesavailable for sale
			$
			152,209
			
			100.0%
			
			$
			115,380
			
			100.0%
			
			$
			128,930
			
			100.0%


At June 30, 2004, the investment securities
portfolio grew to 16.2% of total assets from 14.4% at December 31, 2003. During
the first six months of 2004, deposit and borrowing growth outpaced loan growth,
and the resulting excess was employed within the securities portfolio.

As was the case
during the year ended December 31, 2003, investment securities previously held
within the agency portfolio have continued to be realigned into the
municipalities and mortgage backed security portfolios in order to meet the
purposes and objectives of the portfolio. The continued shift within the
investment portfolio during the six month period ended June 30, 2004 also
reflects the policy of concentrating on total return because mortgage backed and
municipals are expected to outperform on a total return basis in a rising
interest rate environment. Changes in interest rates and related prepayment
activity impact yields and fair values of securities, specifically mortgage
backed securities. Based on the current investment portfolio composition, in a
rising interest rate environment, related prepayment activity should decrease.
Decreasing prepayment activity extends the premium amortization period, thereby
improving yields.

The weighted average life and duration of the
securities portfolio is maintained to limit overall exposure, which also
provides adequate flexibility to proactively manage cash flow as market
conditions change. Generally, in rising interest rate environments the weighted
average life and duration of the securities portfolio is lengthened while in
falling interest rate environments the opposite is true. Management believes
that the economy is entering into a period of rising interest rates, and, as
such, the weighted average life and duration of its securities portfolio has
lengthened since June 30, 2003.  The duration of the securities portfolio
increased to approximately 3.69 years at June 30, 2004 from approximately 2.83
years at December 31, 2003 and approximately 2.57 years at June 30, 2003.



21

---



Investment securities, fully taxable equivalent,
including the unrealized gain or loss on available for sale securities averaged
$126.6 million during the three month period ended June 30, 2004, 13.6% above
the average for the corresponding period in 2003, of $111.5 million. For the six
month period ended June 30, 2004 such securities averaged $121.0 million
compared with $111.7 million for the same period of 2003. The majority of the
increase was attributable to securities purchased to leverage available capital.
The fully taxable equivalent average portfolio yield, including the unrealized
gain or loss on available for sale securities, increased for the three months
ended June 30, 2004 to 4.07% from 3.81% in same quarter of 2003. The average
portfolio yield increased for the six months ended June 30, 2004 to 4.12% from
4.06% in same period of 2003.  The securities yield increased due to the
seasoning of existing investments that were reinvested in longer duration,
higher yielding securities.

In accordance with the investment policy, all
investment securities are to be rated AA - A  so the credit risk is
minimal. At June 30, 2004, while security ratings were in compliance with the
policy guidelines, approximately 90% of the security portfolio was rated AAA. 
Additionally, at June 30, 2004, the entire MBS portfolio is fixed rate.

The net unrealized
loss on available for sale securities (pre-tax) totaled $1.0 million at June 30,
2004, down from a gain of $1.6 million at December 31, 2003. The net unrealized
loss on available for sale securities (pre-tax) at June 30, 2003 totaled $3.0
million.  The declining trend of the unrealized position of available for
sale securities at June 30, 2004 over the other periods presented results from
the recent restructuring of the portfolio.  As noted throughout this
report, beginning in late 2003, the securities available for sale portfolio was
restructured to assist in the stabilization of cash flows and the improvement
the effective yields in the portfolio. This shift has continued during the first
six months of 2004.  In addition, during the second quarter of 2004,
Bancshares borrowed $30 million in FHLB advances in an effort to improve the net
interest margin by employing these funds in higher yielding earning assets.
These events led to an interest rate increase of approximately 150 basis points
over the past 12 months as well as a lengthened duration within the portfolio.
This combination has resulted in an increase in unrealized losses within the
portfolio when compared with December 31, 2003 and June 30, 2003. At June 30,
2004 the Government agencies portfolio was in an unrealized loss position of $50
thousand, the municipal portfolio had an unrealized loss position of $409
thousand, and the mortgage-backed securities portfolio had an unrealized loss of
$542 thousand.

Other InvestmentsIn addition to the investments described in the preceding paragraphs, other
investments in securities June 30, 2004 include Federal Home Loan Bank ("FHLB")
common stock of $2.1 million. The Bank, as a member of the FHLB, is required to
acquire and hold shares of capital stock in the FHLB based generally upon the
Bank's balances of residential mortgage loans and FHLB advances. The Bank was in
compliance with this requirement at June 30, 2004.

Loan Portfolio
General.  Loans represent the most significant component of
interest-earning assets with average loans accounting for 84.6% and 83.9% of
average interest-earning assets for the six months ended June 30, 2004 as
compared with the year ended December 31, 2003. Average loans accounted for
84.1% of average interest-earning assets at June 30, 2003. The Bank strives to
maintain a diversified loan portfolio in an effort to spread risk and reduce
exposure to economic downturns that may occur within different segments of the
economy, geographic locations, or in particular industries. The loan portfolio
consists principally of commercial loans, commercial real estate loans, consumer
loans, sales finance loans, and mortgage loans. The loan portfolio is
diversified, and the borrowers' ability to repay their loans is not dependent
upon any specific economic segment. The Bank's business is not dependent on any
single customer or industry, or a few customers or industries. Although loans
may be originated outside of South Carolina, the majority of the loan portfolio
is originated in the Bank's primary market area of Upstate South Carolina.
Certain risks are inherent within any loan portfolio.  For a discussion of
such risks see Bancshares' Annual Report on Form 10-K for the year ended
December 31, 2003.

22

---



At June 30, 2004, total loans outstanding,
including mortgage loans held for sale, were $723.1 million, which equaled 88%
of total deposits, including retail repurchase agreements and commercial paper,
and 77% of total assets.  Total loans outstanding at December 31, 2003 and
June 30, 2003 totaled $699.6 million and $679.6 million, respectively.

Mortgage loans held
for sale were $4.0 million at June 30, 2004 compared with $6.4 million at
December 31, 2003 and $13.0 million at June 30, 2003, primarily related to lower
mortgage originations and sales.  The Bank makes both fixed rate and
adjustable rate mortgage loans with terms generally ranging from 10 to 30 years
and generally retains servicing on loans originated. Real estate loan
originations have been higher in recent years primarily due to record low market
interest rates resulting in increased refinancing activity, although a decline
in mortgage loan held for sale originations has been experienced in recent
months.

The following table
reflects the composition of the loan portfolio by loan type at June 30, 2004,
December 31, 2003, and June 30, 2003 (dollars in thousands).

|                              |   | June 30, |  |        | December 31, |  
|----------------------------- | - | -------- |  | ------ | ------------ | -
|                              |   | 2004     |  |        | 2003         |  
|Commercial business           | $ | 87,703   |  | 12.3%  |              | $
|Commercial real estate        |   | 443,243  |  | 62.3   |              |  
|Installment                   |   | 19,895   |  | 2.8    |              |  
|Installment real estate       |   | 48,385   |  | 6.8    |              |  
|Indirect                      |   | 15,210   |  | 2.1    |              |  
|Credit line                   |   | 2,034    |  | 0.3    |              |  
|Prime access                  |   | 38,067   |  | 5.4    |              |  
|Mortgage                      |   | 49,807   |  | 7.0    |              |  
|Bankcards                     |   | 10,199   |  | 1.4    |              |  
|Business manager              |   | 1,253    |  | 0.2    |              |  
|Other                         |   | 1,290    |  | 0.2    |              |  
|Gross Loans                   | $ | 717,086  |  | 100.8% |              | $
|Allowance for loan losses     |   | (7,983)  |  | (1.1)  |              |  
|Loans in Process              |   | 1,180    |  | 0.2    |              |  
|Deferred Loans Fees and costs |   | 777      |  | 0.1    |              |  
|Loans, net                    | $ | 711,060  |  | 100.0% |              | $

As reflected in the
table above, there were no significant fluctuations in the mix of the loan
portfolio when comparing balances at December 31, 2003 with those at June 30,
2004.   Management has continued its emphasis on loans secured by real
estate during the second quarter of 2004 due to the reduced amount of inherent
risk within such loans compared with those secured by collateral other than real
estate or loans that are unsecured. Additionally, as was the case during the
year ended December 31, 2003, the Bank has continued to see an increase in prime
access loans over the periods presented primarily resulting from the no closing
costs promotional offering for such loans.

At June 30, 2004 and
December 31, 2003, mortgage loans with principal balances totaling $269.6
million and $269.9 million were serviced for others with principal balances
totaling, respectively. Such balances totaled $265.8 million at June 30, 2003.

Credit Quality.  A willingness to take
credit risk is inherent in the decision to grant credit. Prudent risk-taking
requires a credit risk management system based on sound policies and control
processes that ensure compliance with those policies. The Bank believes it
maintains a conservative philosophy regarding its lending mix, and adherence to
underwriting standards is managed through a multi-layered credit approval
process and review of loans approved by lenders. Through loan review, reviews of
exception reports, and ongoing analysis of asset quality trends, compliance with
loan policies is managed.

23

---



A loan grade
classification system is used for the Bank's loan portfolio. Under this
classification system, loans graded "1" represent loans of superior quality.
Loans graded "2" represent loans of high quality. Loans graded "3" represent
loans that are satisfactory. Loans graded "4" represent loans that are
considered marginal. Problem assets are classified as "special mention,"
"substandard," "doubtful," or "loss," depending on the presence of certain
characteristics.

Assets determined to
be problem assets are reserved at a higher percentage in accordance with the
Allowance model than assets graded superior quality, high quality, satisfactory,
or marginal, all for which general reserves are provided. General allowances
represent loss allowances, which have been established to recognize the inherent
risks associated with lending activities, but which, unlike specific allowances,
have not been allocated to particular problem assets.

At June 30, 2004, there were $4.6 million of
loans designated "special mention," $11.3 million of loans designated as
"substandard," $1.3 million of loans designated as "doubtful," and $256 thousand
of loans designated as "loss." At December 31, 2003, there were $4.2 million of
loans designated "special mention," $12.1 million of loans designated as
"substandard," $1.1 million of loans designated as "doubtful," and $213 thousand
of loans designated as "loss." At June 30, 2003, there were $4.9 million of
loans designated "special mention," $11.8 million of loans designated as
"substandard," $840 thousand of loans designated as "doubtful," and $304
thousand of loans designated as "loss."

Overall, classified
assets decreased $95 thousand from December 31, 2003 to June 30, 2004. Material
increases were seen in the commercial, financial, and agricultural portfolio
offset by a decline in the general consumer portfolio. The 2003 calendar year
was a year of considerable economic uncertainty, nationally and in Upstate South
Carolina, due in large part to the continued uncertainty following the terrorist
attacks of September 11, 2001 and the United States' presence in Iraq.
Management believes that, although the economy has begun to show signs of
improvement, the residual impact of the weakened manufacturing sector continued
to impact the classified assets balances within the commercial, financial, and
agricultural portfolio through the first six months of 2004. The decline in
classified assets within the general consumer portfolio has contributed to the
loan quality within the current portfolio believed by management to contain
higher-quality indirect loans than the portfolio has seen in recent years.
Additionally, consumers are beginning to see benefits from job and income
growth during early 2004, allowing them to better service their personal
consumer debt.

Management
periodically reviews its loan portfolio and has, in the opinion of management,
appropriately classified and established Allowances against all assets requiring
classification under the regulation. See Allowance for Loan Losses for
additional discussion regarding established Allowances.

The following table
illustrates trends in problem assets and other asset quality indicators at the
dates indicated (dollars in thousands). The quarter ended June 30, 2003 is
included as a comparison for 2004 non-annualized amounts.

June 30,
   
   December 31,2004
   
   2003
   
   2003Nonaccrual loans
   3,044
   
   4,108
   
   3,828Total nonperforming loans
   3,044
   
   4,108
   
   3,828Other real estate owned
   3,074
   
   2,215
   
   2,170Repossessed automobiles
   207
   
   151
   
   243Total nonperforming assets
   6,325
   
   6,474
   
   6,241Loans past due 90 days and still accruing (1)
   91
   
   196
   
   212 Total nonperforming loans as a percentage of
      loans (2)
				0.42%
				
				0.62
				
				0.55Total nonperforming assets as a percentage
    of loans, other real estate owned, and repossessed automobiles (2)
				0.88
				
				0.97
				
				0.90Allowance for loan losses as apercentage of nonperforming loans
				2.62x
				
				1.71
				
				1.95
 (1)
			Substantially all of these loans are credit card loans.(2)
			Calculated using loans, net of unearned, excluding mortgage loans held for sale.


24

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Although a decline
was experienced in nonperforming loans from December 31, 2003 to June 30, 2004,
there was relatively little change in the mix. At December 31, 2003,
nonperforming loans were comprised of 71.0% of loans secured by real estate,
17.7% of commercial and industrial loans, and 11.3% of loans to individuals for
household, family, and other personal expenditures. At June 30, 2004,
nonperforming loans were comprised of 67.9% of loans secured by real estate,
21.3% of commercial and industrial loans, and 10.8% of loans to individuals for
household, family, and other personal expenditures. Management believes the
decreases of nonperforming loans over the time periods noted are a reflection of
management's more aggressive approach to managing loans.  Prior to recent
times that have experienced increased bankruptcies and job losses, more
flexibility was given for borrowers to make payments when they became
delinquent. However, in response to the current economic times, more strict
collection policies have been applied to such loans.  When the probability
of future collectibility on nonaccrual loans declines from possible to probable,
procedures are followed to remedy the default, including commencing foreclosure
action, if necessary.  As such, the decrease in nonaccrual loans at June
30, 2004 from December 31, 2003 has led to the increase in other real estate
owned over the same periods.  Real estate and personal property acquired by
the Bank as a result of repossession, foreclosure, or by deed in lieu of
foreclosure is classified within other assets on the consolidated balance sheet
until such time that it is sold. See Other Assets for a complete discussion of
this portfolio. Of the $1.2 million added to the real estate acquired in the
settlement of loans portfolio during the first six months of 2004, $928 thousand
was concentrated within two commercial real estate properties.  In
accordance with policy, appraisals were obtained on both properties at the time
that they were transferred into the real estate portfolio.  Based on
current information available to management at June 30, 2004, it is believed
that both properties were recorded at the lower of cost or estimated fair market
value less cost to sell.

Although credit quality indicators have signaled
improvement, the economic outlook remains uncertain.  Until sectors of the
economy stabilize (employment, consumer spending, etc.), credit quality
indicators will remain volatile. Future credit quality trends depend primarily
on the direction of the economy. Although the economic outlook appears to be
improving, economic forecasts are not always reliable. The Allowance model and
the inputs required are discussed in Allowance for Loan Losses. Assessing the
adequacy of the Allowance requires considerable judgment. Management's judgments
are based on numerous assumptions about current events, which management
believes to be reasonable based on the information available to them at the time
such assumptions are made. Management believes, however, that, although
nonperforming assets have increased and classified assets have remained
relatively unchanged when comparing June 30, 2004 with December 31, 2003, loss
exposure in the loan portfolio is identified, adequately reserved in a timely
manner, and closely monitored to ensure that changes are promptly addressed in
its analysis of Allowance adequacy.  Accordingly, management believes the
Allowance as of June 30, 2004 is adequate based on its assessment of probable
losses and available facts and circumstances then prevailing. 
Additionally, management believes that there will always remain a core level of
delinquent loans, nonperforming assets, and classified assets from normal
lending operations.  To this end, long-term goals include the management of
problem assets.

25

---



Allowance for Loan Losses
The Allowance is maintained at a level that management believes is sufficient to
cover inherent losses in the loan portfolio at a specific point in time.
Assessing the adequacy of the Allowance requires considerable judgment. The
adequacy of the Allowance is analyzed on a monthly basis using an internal
analysis model. For purposes of this analysis, adequacy is defined as a level
sufficient to absorb probable losses in the portfolio. An Allowance model is
used that takes into account factors including the composition of the loan
portfolio including risk grade classifications (based on an internally developed
grading system as described in Loan Portfolio), historical asset quality trends
including, but not limited to, previous loss experience ratios, management's
assessment of current economic conditions, and reviews of specific high risk
sectors of the portfolio. Management's judgments evolve from an assessment of
various issues, including but not limited to, the pace of loan growth, new
product offerings and characteristics, loan portfolio quality trends, and
uncertainty in current economic and business conditions. Loans are graded at
inception and are reviewed on a periodic basis to ensure that assigned risk
grades continue to be proper based on the definition of such classification. The
value of underlying collateral is also considered during this analysis. The
resulting monthly Allowance model and the related conclusions are reviewed and
approved by senior management. The analysis of Allowance adequacy includes
consideration for loan impairment.

The fair value of
mortgage loans held for sale is based on prices for outstanding commitments to
sell these loans. Typically, the carrying amount approximates fair value due to
the short-term nature of these instruments. Likewise, such instruments are not
included in the assumptions related to the Allowance model.

The methodology for
assessing the adequacy of the Allowance establishes both an allocated and
unallocated component. The allocated component is based principally on current
loan grades and historical loss rates. The unallocated component estimates
probable losses in the portfolio that are not fully captured in the allocated
Allowance. These analyses include, but are not necessarily limited to, industry
concentrations, model imprecision, and the estimated impact of current economic
conditions on historical loss rates. On a continual basis, management monitors
trends within the portfolio, both quantitative and qualitative, in order to
assess the reasonableness of the unallocated component.

The Allowance is also subject to examination and
adequacy testing by regulatory agencies, which may consider such factors as the
methodology used to determine adequacy and the size of the Allowance relative to
that of peer institutions, and other adequacy tests. In addition, such
regulatory agencies could require us to adjust our Allowance based on
information available to them at the time of their examination.

The Allowance totaled
$8.0 million and $7.5 million, and $7.0 million, at June 30, 2004, December 31,
2003 and June 30, 2003, respectively representing 1.11%, 1.08%, and 1.05% of
total loans, less mortgage loans held for sale, for the same periods.

The following table
sets forth the activity in the Allowance at and for the dates indicated (dollars
in thousands). The quarter ended June 30, 2003 is included as a comparison for
2004 non-annualized amounts. Please note that losses and recoveries are charged
or credited to the Allowance at the time realized.

26

---

At and for the six month
   
   At and for the yearperiod ended June 30,
   
   ended December 31,2004
   
   
   
   2003
   
   2003Allowance at beginning of period
   7,463
   
   
   
   6,402
   
   6,402Net charge-offs:Loans charged-off
   
   1,046
   
   
   
   1,262
   
   2,747Less: loans recovered
   
   66
   
   
   
   82
   
   208


980
   
   1,180
   
   2,539Additions to reserves through provision
   
   
   1,500
   
   1,800
   
   3,600Allowance at end of period
   $
   
   7,983
   
   7,022
   
   7,463Average loans excluding mortgageloans held for sale
   $
   705,893
   
   643,882
   
   659,683Loans, net of unearned, excluding mortgageloans held for sale
   
   719,043
   
   666,627
   
   693,213Net charge-offs as a % of average loansexcluding mortgage loans held forsale (annualized, where applicable)
   
   
   0.28%
   
   0.37
   
   0.38Allowance as a % of loans, net of unearned,excluding mortgage loans held for sale
   
   1.11
   
   1.05
   
   1.08


---

Total net loan
charge-offs decreased slightly to $980 thousand for the six months ended June
30, 2004 from $1.2 million for the same period of 2003. Annualized six month
period ended June 30, 2004 net charge-offs total $2.0 million compared with net
charge-offs for the year ended December 31, 2003 of $2.5 million.  When
comparing these periods, material fluctuations from period to period included
decreases within the secured by one to four family real estate loan portfolio
and the commercial and industrial loan portfolio.  Management believes that
these fluctuations can be attributed to the recent interest rate environment and
the general economic condition both locally and nationally, which has led to
increased consumer debt incurrence and refinancing, as well as the recent
indications of economic recovery including improvement in job opportunities
within our communities making consumers better able to service their debt. 
These improving conditions in the economy also impact the manufacturing sector
which in turn impacts a company's ability to service its debt.

Based on the current economic environment and
other factors that impact the assessment of the allowance for loan losses as
discussed above, management believes that the Allowance at June 30, 2004 is
maintained at a level adequate to provide for estimated probable losses in the
loan portfolio. See Loan Portfolio for discussions of factors impacting
management's assessment of the allowance for loan losses. Although property
acquired in settlement of loans increased from December 31, 2003 to June 30,
2004, nonaccrual loans, classified assets, and annualized net charge-offs all
experienced declines over the same periods noted.  As a result, management
believes that loss exposure in the loan portfolio is identified, adequately
reserved in a timely manner, and closely monitored to ensure that changes are
promptly addressed in its analysis of Allowance adequacy.  Accordingly,
management believes the Allowance at June 30, 2004 is adequate based on its
assessment of probable losses and available facts and circumstances then
prevailing.  Management's judgments regarding Allowance model inputs, which
are believed to be reasonable, may or may not prove valid in the future. Thus,
there can be no assurance that loan losses in future periods will not exceed the
current Allowance allocation or that future increases in the Allowance will not
be required, adversely impacting operating results.

Other Assets
At June 30, 2004, other assets totaled $18.3
million compared with $16.1 million at December 31, 2003, an increase of 14.0%. 
Other assets at June 30, 2003 totaled $15.9 million.

At June 30, 2004, major components of other
assets include prepaid expenses totaling $1.2 million, the Travelers Express
reserve totaling $1.9 million, net mortgage servicing rights totaling $2.4
million, pension plan assets totaling $3.1 million, other real estate owned
totaling $3.1 million, and $4.1 million of intangible assets.

At December 31, 2003, major components of other
assets included the Travelers Express reserve totaling $1.9 million, net
mortgage servicing rights which totaled $2.6 million, pension plan assets
totaling $2.6 million, other real estate owned totaling $2.2 million, and $4.2
million of intangible assets.

27

---



At June 30, 2003, major components of other
assets included the Travelers Express reserve totaling $1.9 million, net
mortgage servicing rights totaling $1.9 million, pension plan assets totaling
$2.8 million, other real estate owned totaling $2.2 million, and $4.2 million of
intangible assets.

From December 31,
2003 to June 30, 2004, prepaid expenses (excluding insurance) increased from
$597 thousand to $1.2 million.  Other than the impact of timing (annual
prepaid expenses would have been fully amortized at December 31, 2003 but would
have another six months of amortization at June 30, 2004), several items
materially impacted this increase.  A bond required relating to indirect
lending pending litigation totaled $50 thousand at June 30, 2004 but was not
required at December 31, 2003.  Also contributing to this increase are new
service agreements entered by the Bank to service various branch equipment. 
Prior to these new contracts, this equipment was charged on an as serviced
basis. The new agreements require an annual fee with service performed as needed
which results in a higher annual cost. However, the Bank believes that the new
agreements positively impact branch operations. At December 31, 2003 such
contracts totaled approximately $106 thousand while at June 30, 2004 such
contracts totaled approximately $257 thousand.  Due to timing, at June 30,
2004, $75 thousand in income was accrued in anticipation of the Bank's annual
receipt of income relating to credit card points.   At year-end,
monies are received and the balance is adjusted accordingly.  Therefore, at
December 31, 2003, there was no prepaid balance related to this receivable.
Other than these items identified, the increase of prepaid expenses over
December 31, 2003 related to the general nature of prepaid items as well as many
other fluctuations that individually do not impact the balances materially but
accumulate to a material balance due to the number of such items.

See Note 2 of Notes to Consolidated Financial
Statements contained herein for discussion of the Bank's mortgage servicing
rights asset.

See Note 5 of Notes to Consolidated Financial
Statements contained herein for discussion of Bancshares' noncontributory
defined benefit pension plan.

Real estate acquired
by the Bank as a result of repossession, foreclosure, or by deed in lieu of
foreclosure is classified within other assets on the consolidated balance sheet
until such time that it is sold. When property is acquired, it is recorded at
the lower of cost or estimated fair market value less cost to sell at the date
of acquisition, with any resulting write downs being taken through the
Allowance. Any subsequent write downs are taken through the consolidated
statement of income. Costs relating to the development and improvement of such
property are capitalized, and costs relating to holding the property are charged
to expense. Generally, any interest accrual on such loans would have ceased when
the loan became 90 days delinquent as discussed in Bancshares' Annual Report on
Form 10-K for the year ended December 31, 2003.

The following table
summarizes the changes in the Bank's real estate acquired in settlement of loans
portfolio, including the balance at the beginning and end of each period,
provision charged to income, and losses charged to the Allowance (in thousands).
The quarter ended June 30, 2003 is included as a comparison for 2004
non-annualized amounts.

At and for six months
   
   At and for the yearended June 30,
   
   ended December 31,2004
   
   2003
   
   2003Balance, at beginning of period
   $
   2,170
   
   2,468
   
   2,468Add: New real estate acquired in settlement of loans
   
   1,238
   
   668
   
   1,595Less: Sales of real estate acquired in settlement of loans
   
   225
   
   821
   
   1,534Less: Losses charged to the Allowance
   
   73
   
   60
   
   191Less: Provision charged to expense
   
   36
   
   40
   
   168Balance, at end of period
   $
   3,074
   
   2,215
   
   2,170


28

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Due to the relatively
low volume of properties within the other real estate owned portfolio, the
foreclosure of new property or the sale of an existing property can cause the
balance to fluctuate substantially on a quarterly basis.  Fluctuations of
these balances relate primarily to current economic conditions, which directly
impact the borrower's ability to service their debt. Of the $1.2 million added
to the real estate acquired in the settlement of loans portfolio during the
first six months of 2004, only $83 thousand was added during the second quarter. 
In accordance with the Bank's policy, appraisals were obtained on properties at
the time that they were transferred into the real estate portfolio.  Based
on current information available to management at June 30, 2004, it is believed
that both properties were recorded at the lower of cost or estimated fair market
value less cost to sell.  Additionally, all but $37 thousand of the sales
from the portfolio occurred during the second quarter of 2004.  Management
believes that the properties within the portfolio are marketable and the recent
signs of improvement within both the local and national economy will positively
impact the sale of the remaining properties within the portfolio.

See Note 3 of Notes to Consolidated Financial
Statements contained herein for discussion of Bancshares' finite and infinite
life intangible assets.

Deposits
Retail deposits have traditionally been the
primary source of funds for Bancshares and also provide a customer base for the
sale of additional financial products and services. Average deposits provided
funding for 92.2% of average earning assets in the first six months of 2004 and
93.2% in the first six months of 2003. The Bank faces stiff competition from
other banking and financial services companies in gathering deposits. The
percentage of funding provided by deposits has declined, and accordingly, the
Bank has developed other sources, such as FHLB advances and short-term
borrowings, to fund a portion of loan demand and increases in investment
securities. Bancshares sets strategic targets for net growth in deposit accounts
annually and has directed many efforts toward cross-selling thereby increasing
the products per banking relationship. Management believes that this is
consistent with the Bancshares' vision to provide superior customer service.
During the first six months of 2004, continued emphasis was placed on the growth
of deposits through internal and external referral programs and targeted deposit
promotions. In order to stimulate time deposit growth, during the second quarter
of 2004, the Bank offered a 36-month Step Up Certificate of Deposit ("CD")
product. This product allows a one-time rate "step up."

The Bank's traditional deposit accounts, which
include noninterest bearing, interest-bearing checking, money market, savings,
and time accounts increased $13.1 million during the first six months of 2004.
Management believes that conditions in fiscal 2004, 2003, and 2002 were
favorable for deposit growth as a result of factors such as the low returns on
investments and mutual funds that may have increased traditional deposit
inflows. Such favorable conditions were greater in 2002 in the wake of the 2001
terrorist attacks. As the economy started to show signs of improvement in 2003
coupled with the low interest rates offered on many deposit accounts, investors
began to regain some confidence, which is reflected by the slowing growth in the
deposit portfolio when comparing the growth during the first six months of 2004
to the growth during the first six months of 2003. The Bank's average cost of
these traditional deposits for the quarter ended June 30, 2004 was 1.46%
compared with 1.72% for the quarter ended June 30, 2003. The average cost of
traditional deposits for the year ended December 31, 2003 was 1.70%. Core
deposits, which include checking accounts, money market accounts, and savings
accounts, grew by $15.2 million during the first six months of 2004, or 3.7%,
while higher costing time balances decreased by $2.1 million, or 0.6%.  The
increase in core deposits reflects Bancshares' efforts to enhance its deposit
mix by working to attract lower-cost transaction accounts. Bancshares' deposit
referral campaigns are expected to play an integral part of achieving this goal.
The decline in time balances is the result of increased consumer confidence,
which often results in consumers reallocating investments to less conservative
investment options. Higher costing time balances for the first three months of
2004 were down $8.5 million from December 31, 2003.  Although balances at
June 30, 2004 remained down from the balance at December 31, 2003, progress was
made in a challenging deposit pricing market.  Much of this recovery is
attributed to the Bank's offering of the 36-month Step Up CD promotion started
in late May 2004.

29

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At June 30, 2004,
total traditional deposits as a percentage of liabilities were 90.5% compared
with 93.4% at December 31, 2003.  Contributing to this decrease was the
increase during the first six months of 2004 in the Bank's borrowing position.
See Borrowings for further discussion of this increase.

The composition of
the traditional deposit portfolio at June 30, 2004 follows: time accounts 45.1%,
checking accounts 37.4%, money market accounts 11.4%, and savings accounts 6.1%. 
Although the Bank saw growth within the traditional deposit portfolio from
December 31, 2003 to June 30, 2004, there was relatively little change in the
mix of these deposit accounts.

Borrowings
Bancshares uses both short-term and long-term
borrowings to fund growth of

earning assets in excess of deposit growth. The
following table reflects the borrowings composition at the dates indicated (in
thousands).

June 30,
   
   June 30,
   
   December 31,2004
   
   2003
   
   2003Retail repurchase agreements
   $
   18,790
   
   12,750
   
   13,525Commercial paper
   
   15,197
   
   19,676
   
   16,170Federal funds purchased
   
   13,286
   
   5,900
   
   18,000FHLB advances
   
   30,000
   
   --
   
   --Total borrowings
   $
   77,273
   
   38,326
   
   47,695




Borrowings increased
$29.6 million during the first six months of 2004 primarily resulting from the
employment of $30.0 million in FHLB advances during the second quarter of 2004. 
This increase was primarily attributable to an increased reliance on borrowings
to support earning asset growth. Offsetting this increase was a reduction in
federal funds purchased of $4.7 million.

Federal funds purchased are used to satisfy daily
funding needs. The increases in both the short-term balances are primarily to
support earning asset growth. Balances in these accounts can fluctuate on a
day-to-day basis.

FHLB advances are a source of funding which
Bancshares uses depending on the current level of deposits, management's
willingness to raise deposits through market promotions, the Bank's unused FHLB
borrowing capacity, and the availability of collateral to secure FHLB
borrowings. The following table reports information regarding Bancshares' FHLB
advance portfolio at June 30, 2004 (dollars in thousands).



Advance balance outstanding at June 30, 2004
   7,000
   
   13,000
   
   10,000Interest rate
   
   2.32%
   
   3.27
   
   3.85Maturity date
   6/14/05
   
   6/14/06
   
   6/14/07


Other LiabilitiesAt June 30, 2004, other liabilities totaled $4.8
million compared with $6.6 million at December 31, 2003, a decline of 27.7%.
Other liabilities at June 30, 2003 totaled $5.1 million.

The decrease in other
liabilities at June 30, 2004 compared with December 31, 2003 of $1.8 million
results from material fluctuations in several accounts. Accrued income taxes,
including both current and deferred income taxes, increased approximately $549
thousand at June 30, 2004 compared to December 31, 2003 primarily due to the
deferred tax position of Bancshares.  Deferred income taxes are those taxes
incurred as a result of current operations deferred until future periods. Net
deferred tax expense represents the change in the balance of deferred tax assets
or liabilities as reported on the balance sheet. The changes in deferred tax
assets and liabilities are determined based on the changes in differences
between the basis of assets and liabilities for financial reporting purposes and
the basis of assets and liabilities for tax purposes as measured by the enacted
tax rates that are estimated to be in effect when these differences reverse.
Deferred tax liabilities at June 30, 2004 exceeded those at December 31, 2003 by
$513 thousand. Offsetting this increase was a decline in taxes relating to the
unrealized gain on investment securities available for sale of approximately
$607 thousand due to a decrease in the unrealized gain on available for sale
securities at June 30, 2004 from December 31, 2003. At December 31, 2003 the
unrealized gain on available for sale securities totaled $607 thousand.  At
June 30, 2004, the unrealized position related to available for sale securities
was reclassified to an asset account consistent with the fact that the balance
had shifted from a gain to a loss.  See Capital Resources and Dividends for
more discussion regarding this fluctuation.  Expenses accrued but unpaid
declined from $1.7 million at December 31, 2003 to $907 thousand at June 30,
2004 primarily due to the nature of accrual accounts.  Many accrual
accounts are set up such that accruals are made throughout the year for year end
payment (property taxes, for example).  As such, it would be expected that
accruals after six months of the year would be less than those accrued by the
end of the year to be paid the first of the next years.  The largest
accrual at December 31, 2003 was the accrual for officer bonuses that were
accrued at December 31, 2003 but paid in January 2004.  The bonus accrual
at December 31, 2003 was $1.5 million.  At June 30, 2004 the bonus accrual
totaled $498 thousand. The majority of the remaining fluctuation in other
liabilities between December 31, 2003 and June 30, 2004 relates to decreases in
mortgage lending related accounts, primarily the mortgage servicing clearing
account, which decreased $1.5 million at June 30, 2004 from December 31, 2003. 
The volume of mortgage loans held for sale and the timing of funding loans sold
impact this account.

30

---



The decrease in other liabilities at June 30,
2004 compared with June 30, 2003 of $311 thousand results from material
fluctuations in several accounts. Taxes relating to the unrealized gain on
investment securities available for sale declined from $1.2 million at June 30,
2003 to a loss position at June 30, 2004.  Due to this gain loss shift
between the periods noted, the related taxes at June 30, 2004 were reclassified
to an asset balance leaving this liability account with a zero balance. See
Capital Resources and Dividends for more discussion regarding this fluctuation. 
The majority of the remaining material fluctuation in other liabilities between
June 30, 2003 and June 30, 2004 relates to decreases in mortgage lending related
accounts, primarily the mortgage servicing clearing account, which increased
$714 thousand at June 30, 2004 from June 30, 2003.  The volume of mortgage
loans held for sale and the timing of funding loans sold impact this account.

Capital Resources and Dividends
Shareholders' equity totaled $74.6 million and
$72.0 million at June 30, 2004 and December 31, 2003, respectively. 
Shareholders' equity totaled $72.1 million at June 30, 2003.  Shareholders'
equity as a percentage of total assets was 7.9% at June 30, 2004, 8.0% at
December 31, 2003, and 8.4% at June 30, 2003.  During the first six months
of 2004, shareholders' equity was impacted by the retention of earnings and
through stock option activity.  These increases were offset by declines in
comprehensive income. Cash dividends declared and paid during the first six
months of 2004 also offset these increases. The consolidated statements of
changes in shareholders' equity and comprehensive income contained herein
provide detail of the changes in stockholders' equity components during the
first six months of 2004.

During the first six
months of 2004, the dividend payout ratio was 30.1% compared with a payout ratio
of 27.1% during the same period of 2003. For the year ended December 31, 2003
the dividend payout ratio was 29.5%. Cash dividends per share for the three
months ended June 30, 2004 totaled $0.14, an increase of 16.7% over dividends
per share for the same quarter of 2003 of $0.12. Cash dividends per share for
the six months ended June 30, 2004 totaled $0.28, an increase over dividends per
share for the same period of 2003 of $0.24. The amount of dividends per share
declared is dependent on Bancshares' earnings, financial condition, capital
position, and such other factors, as the Board may deem relevant. Bancshares and
the Bank are subject to certain regulatory restrictions on the amount of
dividends they are permitted to pay as described in its Annual Report on Form
10-K for the year ended December 31, 2003.The ability of Bancshares to
pay dividends depends primarily on the ability of the Bank to pay dividends to
Bancshares.

31

---



Palmetto Bancshares Inc.'s book value per share
was $11.89 at June 30, 2004 compared with $11.49 at December 31, 2003 and $11.35
at June 30, 2003.

Impacting various
components of shareholders' equity was a stock purchase during 2003. 
During third quarter 2003, one hundred thousand shares of $5.00 par value common
stock were made available for purchase to Bancshares through an arm's length
transaction by a third party for $29.00 per share. Based on the facts presented
to management and the Board of Directors this transaction, which the Board of
Directors approved, was consummated on July 17, 2003 thereby reducing
outstanding shares and impacting average outstanding shares and all measures
that are based on these figures. Although Bancshares engaged in a stock purchase
during 2003, it does not have an active, open market stock purchase program.
Bancshares has engaged in no such purchase transactions since this purchase in
July 2003.

The net unrealized loss on available for sale
securities (pre-tax) totaled $1.0 million at June 30, 2004, down from a gain of
$1.6 million at December 31, 2003. The net unrealized loss on available for sale
securities (pre-tax) at June 30, 2003 totaled $3.0 million.  The declining
trend of the unrealized position of available for sale securities at June 30,
2004 over the other periods presented results from the recent restructuring of
the portfolio.  As noted throughout this report, beginning in late 2003,
the securities available for sale portfolio was restructured to assist in the
stabilization of cash flows and the improvement the effective yields in the
portfolio. This shift has continued during the first six months of 2004. 
In addition, during the second quarter of 2004, Bancshares borrowed $30 million
in FHLB advances in an effort to improve the net interest margin by employing
these funds in higher yielding earning assets. These events led to an interest
rate increase of approximately 150 basis points over the past 12 months as well
as a lengthened duration within the portfolio. This combination has resulted in
an increase in unrealized losses within the portfolio when compared with
December 31, 2003 and June 30, 2003. At June 30, 2004 the Government agencies
portfolio was in an unrealized loss position of $50 thousand, the municipal
portfolio had an unrealized loss position of $409 thousand, and the
mortgage-backed securities portfolio had an unrealized loss of $542 thousand.

Regulatory Capital RequirementsBancshares and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies. 
The guidelines are designed to make regulatory capital requirements more
sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure, and to minimize
disincentives for holding liquid assets. Under these guidelines, assets and
certain off-balance sheet items are assigned to broad risk categories, each with
appropriate weights. The resulting capital ratios represent capital as a
percentage of total risk weighted assets and certain off-balance sheet items.
Bancshares and the Bank exceeded the well-capitalized regulatory requirements at
June 30, 2004. Failure to meet minimum capital requirements can initiate certain
mandatory actions by regulators that, if undertaken, could have a material
effect on the financial statements.  Bancshares' and the Bank's capital
amounts and classifications are subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation
to ensure capital adequacy require Bancshares and the Bank to maintain minimum
amounts and ratios of total and Tier 1 capital (as defined in the regulation) to
risk-weighted assets (as defined in the regulation) and to average assets. 
At June 30, 2004, Bancshares and the Bank were each categorized as "well
capitalized" under the regulatory framework for prompt corrective action. 
To be categorized as "well capitalized," Bancshares and the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the following table (dollars in thousands).  There have been no
conditions or events of which management is aware since June 30, 2004 that would
change Bancshares' or Bank's classification.

32

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To be wellcapitalized underFor capital
   
   prompt correctiveActual
   
   
   
   adequacy purposes
   
   action provisionsamount
   
   ratio
   
   amount
   
   ratio
   
   amount
   
   ratioAt June 30, 2004Total capital to risk-weighted assetsBancshares
   $
   78,833
   
   10.49%
   
   $
   60,119
   
   8.00%
   
   N/A
   
   N/ABank
   
   78,625
   
   10.46
   
   
   60,119
   
   8.00
   
   $
   75,149
   
   10.00%Tier 1 capital to risk-weighted assetsBancshares
   $
   70,850
   
   9.43%
   
   $
   30,060
   
   4.00%
   
   N/A
   
   N/ABank
   
   70,642
   
   9.40
   
   
   30,060
   
   4.00
   
   $
   45,089
   
   6.00%Tier 1 capital to average assetsBancshares
   $
   70,850
   
   7.76%
   
   $
   36,511
   
   4.00%
   
   N/A
   
   N/ABank
   
   70,642
   
   7.74
   
   
   36,520
   
   4.00
   
   $
   45,650
   
   5.00%


For further
discussion of capital regulatory requirements, see Supervision and Regulations
contained in Item 1 of Bancshares' Annual Report on Form 10-K for the year ended
December 31, 2003.

Derivatives and Hedging ActivitiesDerivative transactions may be used by Bancshares
to better manage its interest rate sensitivity to reduce risks associated with
its lending, deposit taking, and borrowing activities. Bancshares recognizes any
derivatives as either assets or liabilities on the consolidated balance sheets
and reports these instruments at fair value with realized and unrealized gains
and losses included in either earnings or in other comprehensive income,
depending on the purpose for which the derivative is used and whether the
derivative qualifies for hedge accounting in accordance with SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities."

Derivative instruments expose a company to credit
and market risk. Credit risk, the risk that the counterparty to a derivative
instrument will fail to perform, is equal to the extent of the fair value gain
in a derivative. Credit risk is created when the fair value of a derivative
contract is positive since this generally indicates that the counterparty owes
the company. When the fair value of the derivative contract is negative no
credit risk exists since the company would owe the counterparty. Credit risk in
derivative instruments can be minimized by entering into transactions with
high-quality counterparties as evaluated by management. Market risk is the
adverse impact on the value of a financial instrument from a change in interest
rates or implied volatility of interest rates. Establishing and monitoring
limits as to the types and degree of risk that may be undertaken can manage
market risk associated with interest rate contracts. Any market risk associated
with derivatives used for interest rate risk management is fully incorporated
into Bancshares' interest rate sensitivity analysis.

The only derivative activity in which Bancshares
engages is commitments to originate fixed rate mortgage loans held for sale
where the purchasing party undertakes the interest rate lock risk. 
Accordingly, no interest rate risk is involved in such transactions. Commitments
are generally recorded at their fair value at the date of contract.  The
fee collected for such commitments determines such fair values.

Bancshares' accounting policies related to
derivative and hedging activities are discussed in Note 1 of Notes to
Consolidated Financial Statements contained within its Annual Report on Form
10-K for the year ended December 31, 2003.

Off-Balance Sheet ArrangementsIn the normal course
of business, Bancshares engages in a variety of financial transactions that, in
accordance with generally accepted accounting principles, are not recorded in
the financial statements or are recorded in amounts that differ from the
notional amounts. These transactions involve elements of credit, interest rate,
and liquidity risk. Such transactions are used for general corporate purposes or
to meet customer needs. Corporate purpose transactions are those used to manage
customers' requests for funding.

33

---



Off-balance sheet arrangements, which principally
include lending commitments, are described below. At June 30, 2004, Bancshares
had no interests in non-consolidated special purpose entities nor is it involved
in other off-balance sheet contractual relationships (other than those discussed
herein), unconsolidated related entities that have off-balance sheet
arrangements, or transactions that could result in liquidity needs.

Bancshares makes
contractual commitments to extend credit, which are legally binding agreements
to lend money to customers at predetermined interest rates for a specific period
of time. Bancshares also provides standby letters of credit. These lending
commitments are provided to customers in the normal course of business and the
credit policies and standards are applied when making these commitments.

For commercial
customers, loan commitments generally take the form of revolving credit
arrangements to finance customers' working capital requirements. For retail
customers, loan commitments are generally lines of credit secured by residential
property. Unused credit card lines are generally used for short-term borrowings.

Generally, unused
loan commitments are at adjustable rates that fluctuate with the prime rate or
are at fixed rates that approximate market rates.

The table set forth
below illustrates issued commitments to extend credit loan commitments and
unused credit card lines at June 30, 2004 (in thousands).

Home
			equity loans
			$    35,425Credit
			cards
			40,010Commercial real estate development
			57,193Other
			unused lines of credit
			35,926Total
			unused commitment and unused credit card lines
			$  168,554Standby
			letters of credit
			$     1,894


Outstanding
commitments on mortgage loans not yet closed, the majority of which include
interest rate lock commitments, amounted to approximately $4.2 million at June
30, 2004. These were principally single-family loan commitments. Commitments to
extend credit are agreements to lend to borrowers as long as there is no
violation of any condition established by the commitment letter. Commitments
generally have fixed expiration dates or other termination clauses. The majority
of the commitments will be funded within a 12-month period. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of credit,
is based on management's credit evaluation of the borrower. Collateral held
consists of residential properties. The Bank originates and services mortgage
loans. All of the loan sales within the first six months of 2004 were without
provision for recourse.

Standby letters of
credit represent an obligation of the Bank to a third party contingent upon the
failure of the Bank's customer to perform under the terms of an underlying
contract with the third party, or obligates the Bank to guarantee or stand as
surety for the benefit of the third party. The underlying contract may entail
either financial or nonfinancial obligations and may involve such things as the
customer's delivery of merchandise, completion of a construction contract,
release of a lien, or repayment of an obligation. Under the terms of a standby
letter of credit, generally, drafts will be drawn only when the underlying event
fails to occur as intended. The Bank can seek recovery of the amounts paid from
the borrower. However, standby letters of credit are generally not
collateralized. In recent months the Bank has reflected in its policy regarding
such commitments that collateral is encouraged with exceptions requiring
approvals. Commitments under standby letters of credit are usually for one year
or less. At June 30, 2004, the Bank has recorded no liability for the current
carrying amount of the obligation to perform as a guarantor and no contingent
liability is considered necessary, as the Bank believes the likelihood that it
will have to perform under such contracts is not likely. The maximum potential
amount of undiscounted future payments related to standby letters of credit at
June 30, 2004 was $1.9 million. Past experience indicates that many of these
standby letters of credit will expire unused. However, through its various
sources of liquidity, the Bank believes that it has the necessary resources to
meet these obligations should the need arise. Additionally, current fair values
of such guarantees are deemed immaterial at June 30, 2004.

34

---



The Bank originates
and services mortgage loans. At June 30, 2004 and December 31, 2003, mortgage
loans with principal balances totaling $269.6 million and $269.9 million were
serviced for others with principal balances totaling, respectively. Such
balances totaled $265.8 million at June 30, 2003.

LiquidityThe term liquidity
refers to the ability of Bancshares to generate adequate amounts of cash to meet
its needs. Management determines the desired level of liquidity in conjunction
with the Bancshares' Asset-Liability Committee. The level of liquidity is based
on management's strategic direction for Bancshares, commitments to make loans,
and the Asset-Liability Committee's assessment of the Bancshares' ability to
generate funds.

Proper liquidity
management is crucial to ensure that Bancshares is able to take advantage of new
business opportunities as well as meet the demands of its customers. In this
process, Bancshares focuses on assets and liabilities and on the manner in which
they combine to provide adequate liquidity to meet Bancshares' needs.

Liquidity is impacted
by its ability to attract and retain deposit accounts, activity in and sales
from its investment security and loan portfolios, alternative sources of funds,
and current earnings. Competition for deposits is intense in the markets served
by Bancshares. However, Bancshares has been able to attract deposits as needed
through pricing adjustments, expansion of its geographic market area, providing
quality customer service, and through its reputation among the communities it
serves. The deposit base is comprised of diversified customer deposits with no
one deposit or type of customer accounting for a significant portion. Therefore,
withdrawals are not expected to fluctuate significantly from historical levels.
The loan portfolio of the Bank is a source of liquidity through maturities and
repayments by existing borrowers. Loan demand has been constant, and loan
originations can be controlled through pricing decisions. The investment
securities portfolio is also an avenue for liquidity through scheduled
maturities, sales of investment securities, and prepayment of principal on
mortgage backed securities. Bancshares feels the risk that demand for its
products and services would reduce the availability of cash from operations is
not significant given the industry in which it operates. Although rapid
technological change could present risks in this area, Bancshares feels as
though it stays current on such changes. To review how these and other factors
have impacted liquidity, see consolidated statements of cash flow contained
herein.

Due to the fact that
Bancshares' sources of liquidity are often subject to various uncertainties
beyond its control, as a measure of protection, alternative funding sources have
been arranged through federal funds lines at correspondent banks and through the
Federal Reserve Discount Window. At June 30, 2004, Bancshares had unused
short-term lines of credit totaling $27 million.

The FHLB has
established an overall credit limit for any member.  Generally, this limit
is 40% of the member's total assets.  For purposes of overall credit limit,
total outstanding advances includes letters of credit and the market value of
interest rate swaps.  However, a member's eligibility to borrow in excess
of 30% of assets is subject to its meeting each of the following eligibility
criteria:

- Composite CAMELS rating of 1or 2 (including an
	Asset Quality component rating of 1 or 2);
- If CAMELS rating is older than 12 months, LACE
	rating of C+ or better; and
- Satisfactory Collateral Verification Review in
	the prior 12 months.

35

---



Any member approved
for a 40% limit shall be subject to a Collateral Risk Review at its next
scheduled review. Additionally, a member approved for a 40% credit limit and
that continues to meet the preceding eligibility criteria may request approval
to exceed the credit limit on an "over line" basis. A member may exceed the 40%
limit for a period not to exceed 12 months. The FHLB requires that securities,
qualifying single-family mortgage loans, and stock of the FHLB owned by the Bank
be pledged to secure any advances from the FHLB. The unused borrowing capacity
currently available from the FHLB (computed as discussed above) assumes that the
Bank's $2.1 million investment in FHLB stock, as well as certain securities and
qualifying mortgages, would be pledged to secure any future borrowings. At June
30, 2004, the Bank had drawn $30 million in FHLB advances against this line of
credit.

The liquidity ratio
is an indication of Bancshares' ability to meet its short-term funding
obligations. Bancshares' policy is to maintain a liquidity ratio between 10% and
25%. At June 30, 2004, the liquidity ratio was 17%. Management believes that the
liquidity sources during the first six months of 2004 were adequate to meet its
liquidity needs and to maintain the liquidity ratio within policy guidelines.

Management's review
at December 31, 2003 (which analyzes the forward-looking twelve month period)
concluded that its sources of liquidity appeared adequate to meet operational
needs and to maintain the liquidity ratio within policy guidelines.  During
the first six months of 2004, management was aware of no conditions or events
that would change this conclusion.

Bancshares' cash needs include general operating
expenses and the payment of dividends and interest on borrowings. 
Bancshares declared and paid cash dividends totaling $0.14 per share during both
the first and second quarters of 2004.  Although there can be no guarantee
that additional dividends will be paid in 2004, Bancshares plans to continue its
quarterly dividend payments.



36

---

EARNINGS REVIEW - COMPARISON OF THE RESULTS OF
OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003

OverviewNet income for the three months ended June 30,
2004 totaled $2.8 million, up 3.2% compared with $2.7 million for the second
quarter of 2003. Earnings per diluted share for second quarter 2004 were $0.44,
a 4.8% increase from $0.42 per diluted share in the second quarter 2003.
Earnings per basic share for second quarter 2004 were $0.45, a 4.7% increase
from $0.43 per basic share for second quarter 2003.

Average common shares outstanding on a diluted
basis were 6,381,267 for second quarter 2004, down 1.8% from 6,498,919 for
second quarter 2003. Average common shares outstanding on a basic basis were
6,266,931 for second quarter 2004, down from 6,346,105 for second quarter 2003.

Earnings increased during second quarter 2004 as
compared to the same period of 2003 due to several factors. Although the net
yield on interest-earning assets, fully tax equivalent, declined to 4.71% for
the three months ended June 30, 2004 from 5.07% for the same period of 2003, net
interest income, fully tax equivalent, increased slightly over the periods. Net
interest income after the provision for loan losses, fully tax equivalent, for
the three months ended June 30, 2004 and 2003 was $9.3 million and $9.1 million,
respectively, an increase of 1.8%.  Noninterest income for the three months
ended June 30, 2004 totaled $3.9 million, up 2.7% compared with $3.7 million for
second quarter 2003. Noninterest expense for the three months ended June 30,
2004 increased $79 thousand from the three months ended June 30, 2003.

Net Interest IncomeNet interest income
is the difference between gross interest and fees on interest-earning assets,
primarily loans and investment securities, and interest paid on deposits and
other interest-bearing liabilities and represents the largest component of
earnings for Bancshares. The net yield on interest-earning assets measures how
effectively a company manages the difference between the yield on
interest-earning assets and the rate paid on funds to support those assets.
Fully tax-equivalent net interest income adjusts the yield for assets earning
tax-exempt income to a comparable yield on a taxable basis. Balances of
interest-earning assets and successful management of the net interest margin
determine the level of net interest income. Changes in interest rates earned and
paid on assets and liabilities, the rate of growth of the asset and liability
base, the ratio of interest-earning assets to interest-bearing liabilities, and
the management of interest rate sensitivity factor into changes in net interest
income.

Bancshares' net yield
on interest-earning assets may be impacted by many factors. Competition for
deposit funds within the markets served range from many well-established
national and regional banks and Bancshares' ability to utilize retail sources of
funds.

The following table
presents average balance sheets and a net interest income analysis on a
tax-equivalent basis for the periods indicated (dollars in thousands).





37

---



For the three months ended June
  30,2004
			
			2003Average
			Income/
			Yield/
			
			Average
			Income/
			Yield/Balance
			Expense
			Rate
			
			Balance
			Expense
			RateASSETSInterest-earnings
  assetsFederal
  funds sold
			$       
  6,154
			$         
  14
			0.91
			%
			$    
  9,170
			$          28
			1.22
			%Federal
  Home Loan Bank stock and deposits
			2,622
			20
			3.07
			
			2,148
			19
			3.55Nontaxable
  investment securities (1) (3)
			61,449
			838
			5.48
			
			36,949
			576
			6.25Taxable
  investment securities (3)
			65,164
			443
			2.73
			
			74,509
			480
			2.58Loans,
  net of unearned (2)
			719,678
			11,232
			6.28
			
			668,590
			11,629
			6.98Total
  interest-earning assets
			855,067
			12,547
			5.90
			
			791,366
			12,732
			6.45Noninterest-earning
  assetsCash and
  due from banks
			26,188
			
			
			
			25,761Allowance
  for loan losses
			(7,739)
			
			
			
			(7,369)Premises
  and equipment, net
			22,240
			
			
			
			19,884Accrued
  interest
			3,729
			
			
			
			4,435Other
  assets
			17,340
			
			
			
			16,101Total
  noninterest-earning assets
			61,758
			
			
			
			58,812Total
  assets
			$   
  916,825
			
			
			
			$ 
  850,178LIABILITIES
  AND SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
  liabilitiesDemand
  deposits
			$   
  266,454
			$       
  220
			0.33
			%
			$ 
  248,357
			$       
  307
			0.50
			%Savings
			47,455
			33
			0.28
			
			41,865
			37
			0.35Time
			
			345,595
			2,134
			2.48
			
			331,760
			2,324
			2.81Total
  interest-bearing deposits
			659,504
			2,387
			1.46
			
			621,982
			2,668
			1.72Other
  interest-bearing liabilities
			55,055
			137
			1.00
			
			35,990
			57
			0.64Total
  interest-bearing liabilities
			714,559
			2,524
			1.42
			
			657,972
			2,725
			1.66Noninterest-bearing
  liabilitiesNoninterest-bearing
  deposits
			121,759
			
			
			
			113,288Other
  noninterest-bearing liabilities
			5,570
			
			
			
			7,497Total
  noninterest-bearing liabilities
			127,329
			
			
			
			120,785Total
  liabilities
			841,888
			
			
			
			778,757Shareholders'
  equity
			74,937
			
			
			
			71,421Total
  liabilities and shareholders' equity
			$   
  916,825
			
			
			
			$ 
  850,178NET
  INTEREST INCOME (FTE) (1) / NET YIELD ONINTEREST-EARNING
  ASSETS (FTE)
			
			$   
  10,023
			4.71
			%
			
			$   
  10,007
			5.07
			%Tax-equivalent
  adjustment (1)
			
			$       
  268
			
			
			
			$       
  184(1)
			Yields on
  nontaxable securities are stated on a fully taxable equivalent basis, using
  the applicable effective tax rate of32% for
  the three month period ended June 30, 2004 and 2003, respectively.  The
  adjustments made to convert nontaxableinvestments
  to a fully taxable equivalent basis were $268 and $184 for the 2004 and 2003
  periods, respectively.(2)
			Nonaccrual
  loans are included in average balances for yield computations.  The effect of
  foregone interest incomeas a
  result of loans on nonaccrual was not considered in the above analysis.  All
  loans and deposits are domestic.(3)
			The
  average balances for investment securities include the unrealized gain or
  loss recorded for available for sale securities.


38

---

Fully tax-equivalent
net interest income for the quarter ended June 30, 2004 increased $16 thousand,
or 0.2%, to $10.0 million from the quarter ended June 30, 2003.The fully
tax-equivalent net yield on interest-earning assets decreased to 4.71% for the
quarter ended June 30, 2004 from 5.07% for the quarter ended June 30, 2003. Net
interest income and the resulting net interest margin, although lower than that
for the three months ended June 30, 2004, was positively impacted by robust loan
growth and the effective management of deposit rates.

The fact that the
fully tax-equivalent net interest income remained relatively unchanged for the
quarter ended June 30, 2004 compared with the quarter ended June 30, 2003 was
principally a result of a continuing decline in average yields on
interest-earning assets relative to the reduction in the average cost of
interest-bearing liabilities. The weighted average yield on interest-earning
assets and weighted average cost of interest-bearing liabilities shown in the
previous table are derived by dividing interest income and expense by the
weighted average balances of interest-earning assets or interest-bearing
liabilities. Interest-sensitive liabilities repriced to an average cost of 1.42%
during the second quarter of 2004 from an average cost of 1.66% during the
second quarter of 2003. Average yields on interest-earning assets declined from
6.45% to 5.90% over the same periods. The decline of the weighted average yield
on interest-earning assets during second quarter 2004 over second quarter 2003
was primarily the result of the decreasing yields of the loan portfolio which is
a direct result of the current interest rate environment.  This decline was
only partially offset by repricing deposit accounts at lower rates as such
deposit accounts remain at lower limits due to historically low interest rates.
The weighted average yield of the loan portfolio decreased from 6.98% for second
quarter 2003 to 6.28% during second quarter 2004.

Management believes that the primary cause of the
changes in the yields and rates on interest-earning assets and interest-bearing
liabilities has been the action of the Federal Reserve Open Market Committee
during the past several years. During 2003, the Federal Reserve lowered the
federal funds target rate 25 basis points at the end of June, which followed a
50 basis point reduction in November 2002 and eleven downward adjustments in
2001. A large portion of Bank's adjustable rate loans reprice immediately
following an interest rate change by the Federal Reserve. Although the Federal
Reserve increased rates on July 1, 2004 for the first time since second quarter
2000 by 25 basis points, funding source changes take more time to filter into
the net interest margin, primarily because of the timed maturities of
certificates of deposit and borrowings.

Average interest-earning assets grew $63.7
million, or 8.0%, to $855.1 million for second quarter 2004 from $791.4 million
for second quarter 2003, primarily from the growth of loans and securities only
partially offset by a slight decline in average federal funds sold. Average
loans, including mortgage loans held for sale, were $719.7 million for second
quarter 2004 compared with $668.6 million for second quarter 2003. Average
interest-bearing traditional deposits increased from $622.0 million for second
quarter 2003 to $659.5 million for second quarter 2004. Average other
interest-bearing liabilities increased to $55.1 million from $36.0 million over
the same periods. Fluctuations in these average balances are typically
simultaneous with fluctuations in financial statement balances as noted in
respective sections of this report.

Provision for Loan LossesThe provision for
loan losses is a charge to earnings in a given period in order to maintain the
allowance for loan losses at an adequate level defined by the Allowance model.
The provision for loan losses is adjusted each month to reflect loan growth and
to allow for loan charge-offs, recoveries, and other factors that impact
management's assessment of the adequacy of the Allowance. Management's objective
is to maintain the Allowance at an adequate level to cover probable losses in
the portfolio. Additions to the Allowance 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
consideration in estimating loan losses. The provision for loan losses was $750
thousand and $900 thousand for the three months ended June 30, 2004 and 2003,
respectively.  At June 30, 2004 and 2003, the Allowance was $8.0 million
and $7.0 million and represented 1.11% and 1.05% of loans less mortgage loans
held for sale, respectively.

39

---



Net charge-offs
during the three months ended June 30, 2004 totaled $459 thousand compared with
$649 thousand during this first six months of 2003. When comparing the three
month period ended June 30, 2003 to that period ended June 30, 2004, material
portfolio fluctuations included net charge offs related to the loan portfolio
secured by one to four family real estate and the other consumer portfolio which
declined offset by loans secured by real estate nonresidential portfolio which
increased. The fluctuations of charge-offs within other loan portfolios did not
have as dramatic an impact on total charge-offs for the periods presented.

When comparing the
year ended December 31, 2003 to the annualized three month period ended June 30,
2004, material portfolio fluctuations included net charge offs related to the
loan portfolio secured by one to four family real estate, the commercial and
industrial portfolio, and the credit card portfolio all which declined and net
charge offs within the commercial and industrial portfolio for such loans
secured by real estate which increased. The fluctuations of charge-offs within
other loan portfolios did not have as dramatic an impact on total charge-offs
for the periods presented.

For both comparison
periods presented, decreases were experienced within the secured by one to four
family real estate loan portfolio. Management believes that these decreases can
be attributed to the recent interest rate and economic environment, both locally
and nationally, which has led to increased consumer debt incurrence and
refinancing and the recent indication that the economy is beginning to recover
from recent uncertain times which in turn impacts job opportunities within our
communities making consumers better able to service their debt.

When comparing the
charge offs for the three month period ended June 30, 2003 to that period ended
June 30, 2004, net charge offs related to loans secured by real estate
nonresidential has increased due to management's more aggressive approach to
collection of these loans.  As these loans were determined to be more
probable than not in terms of collection, remediation actions were taken
including, but not limited to, charge offs and foreclosure.  As noted in
Balance Sheet Review - Other Assets, charge offs were necessary in many cases
for large commercial properties (nonresidential secured by real estate) acquired
in settlement of loans, based on fair market value appraisals obtained. 
Due to the fact that such loans have only seasoned in recent months, these
charge offs were higher levels during the three months ended June 30, 2004 than
during the same period of 2003.

The last material
fluctuation when comparing net charge offs for the three months ended June 30,
2004 compared with the same period ended June 30, 2003 was a decline in net
charge offs related to the other consumer portfolio (excluding credit cards). 
During mid-1999 management noted deterioration in the performance of the
portfolio that resulted in the Bank redirecting its emphasis in indirect lending
to purchasing higher-quality indirect loans and reducing the number of
lower-quality loans in the portfolio. As expected, as the lower quality loans
seasoned, the level of charge-offs resulting from these loans increased with a
large portion of these charge-offs absorbed by the year ended December 31,2001.
Charge-offs within this portfolio have steadily declined since this time.
Management believes the loans in the current portfolio to be higher-quality
indirect loans, although a normal balance of inherent risk remains. Management
attributes much of the decline of net charge offs related to the other consumer
loan portfolio to this portion of the portfolio.

When comparing the
year ended December 31, 2003 to the annualized three month period ended June 30,
2004, in addition to the decline in net charge offs related to residential loans
secured by real estate, net charge offs related to commercial and industrial
portfolio loans have declined.  As these loans were determined to be more
probable than not in terms of collection, remediation actions were taken
including, but not limited to, charge offs.  However, since loans within
this portfolio are not secured by real estate, once the charge off process has
taken place, there is no property to acquire.  As noted in Balance Sheet
Review - Other Assets, activity relating to property acquired in the settlement
of loans has slowed dramatically since early 2004.  This is also the case
within the commercial and industrial portfolio resulting in a decline in net
charge offs.

40

---



In addition to
decreased net charge-offs contributing to the decline in the current quarter's
provision for loan losses, the decline in nonperforming loans and classified
assets over levels at both December 31, 2003 and June 30, 2003 also contributed
to this decline.  These factors were offset slightly by the impact of the
growth within the loan portfolio during the quarter. Although past experience
within the real estate and personal property acquired in settlement of loans
portfolio has impacted the analysis of the Allowance and resulting provision for
loan losses, the performance of this portfolio during the second quarter of 2004
positively impacted the analysis as less than $100 thousand of additions were
added during the period. Management's analysis of these factors, as documented
throughout this report, and the impact of these factors on the allowance for
loan losses and the provision for loan losses for the quarter ended June 30,
2004 resulted in a provision for loan losses for the second quarter of 2004 of
$750 thousand.  Based on this analysis, management supported a $150
thousand decline in the provision for loan losses from that booked during the
second quarter of 2003.  Despite the decline, management believes that the
Allowance is maintained at a level that is sufficient to cover inherent losses
in the loan portfolio at June 30, 2004. The Allowance as a percentage of total
loans less mortgage loans held for sale increased from 1.05% at June 30, 2003 to
1.11% at June 30, 2004.

Noninterest Income and ExpenseNoninterest income for the three months ended
June 30, 2004 totaled $3.9 million, up 2.7% compared with $3.7 million for
second quarter 2003. Noninterest expense for the three months ended June 30,
2004 increased $79 thousand from the three months ended June 30, 2003.

The increase in noninterest income during the
quarter ended June 30, 2004 over the quarter ended June 30, 2003 was the result
of fluctuations in several financial statement captions.  Mortgage banking
income increased $175 thousand during second quarter 2004 over the same quarter
2003.  Offsetting this increase was a decline of investment security gains
of $186 thousand to a balance of zero for the quarter ended June 30, 2004.

Mortgage banking income includes origination
income, mortgage servicing loss (net of the related amortization for the
mortgage servicing rights for portfolio mortgage loans), losses and recoveries
related to the impairment of mortgage servicing rights, and gains and losses on
sales of portfolio mortgage loans. As management projected in its Annual Report
on Form 10-K for the year ended December 31, 2003, due to the interest rate
environment, residential mortgage production during the first six months of 2004
has declined compared with recent years, resulting in reduced loan sale gains. 
Mortgage loans originated totaled $7.0 million during the second quarter of 2004
compared with $41.3 million during the same quarter of 2003. Sales during the
same periods totaled $9.5 million and $39.7 million, respectively.  Gains
on sales of loans totaled $137 thousand for the three months ended June 30,
2004, down $197 thousand from the three months ended June 30, 2003. The Bank
expects lower origination and sales figures to continue due to higher mortgage
loan rates. Processing fees relating to the origination of such loans also
declined over the same periods by $65 thousand to a balance of $31 thousand. 
Offsetting these declines in mortgage banking income was a decline in the
amortization and impairment of mortgage servicing rights.  Amortization of
mortgage servicing rights declined $385 thousand to $131 thousand for the three
months ended June 30, 2004 over the three months ended June 30, 2003. 
Additional impairment of mortgage servicing rights of $69 thousand was required
for the three months ended June 30, 2003, while additional impairment of $87
thousand was recorded during the three months ended June 30, 2004.

Effective in the
third quarter 2003, the Bank began utilizing the expertise of a third party to
determine the value of mortgage servicing rights ("MSRs") as well as the related
amortization and impairment of such rights. The external valuation utilizes
estimates for the amount and timing of mortgage loan repayments, estimated
prepayment rates, credit loss experience, costs to service loans, and discount
rates to determine an estimate of the fair value of mortgage servicing rights.
In regard to the valuation obtained for the three months ended June 30, 2004,
management believes that the modeling techniques and assumptions used in
conjunction with the valuation are reasonable.

41

---



The Bank's mortgage
banking strategy is to sell most of the loans it originates in the secondary
market with servicing rights retained. At June 30, 2004, the Bank's servicing
portfolio for loans sold had an aggregate principal balance of $269.6 million,
down from $269.9 million at December 31, 2003. Such balances totaled $265.8
million at June 30, 2003. The servicing portfolio has remained relatively
unchanged over these periods due to prepayments of loans from increased
refinancings resulting primarily from lower rates. At June 30, 2004, the Bank's
total servicing portfolio, including those serviced for in house loans, had an
aggregate principal balance of $319.4 million, up from $316.0 million at
December 31, 2003. Such balances totaled $308.5 million at June 30, 2003.

Investment security gains declined from a balance
of $186 thousand for the three months ended June 30, 2003 to a balance of zero
for the three months ended June 30, 2004.  The primary objective of the
management of the investment portfolio is to maintain a portfolio of high
quality, highly liquid investments yielding competitive returns. In order to
achieve this objective, the mix of securities with the portfolio has shifted
over the past 12 months resulting in a limited amount of investment security
gains available to be realized.  The net unrealized loss on available for
sale securities (pre-tax) totaled $1.0 million at June 30, 2004, down from a
gain of $1.6 million at December 31, 2003. The net unrealized loss on available
for sale securities (pre-tax) at June 30, 2003 totaled $3.0 million.  At
June 30, 2004 the Government agencies portfolio was in an unrealized loss
position of $50 thousand, the municipal portfolio had an unrealized loss
position of $409 thousand, and the mortgage-backed securities portfolio had an
unrealized loss of $542 thousand.  As such, realized security gains have
declined over the periods noted.

In the more
competitive financial services market of recent years, management has recognized
the importance of controlling noninterest expense to maintain and improve
profitability. Management also recognizes that there are operational costs that
continue to increase as a result of the present operating climate for regulated
financial institutions. The technical and operating environment for financial
institutions continues to require a well-trained and motivated staff, superior
operating systems, and sophisticated marketing efforts.

The increase within noninterest expense for the
three months ended June 30, 2004 from the three months ended June 30, 2003 was
the result of fluctuations in several accounts.  Postage and supply
expenses declined by $136 thousand from the three months ended June 30, 2003 to
the three months ended June 30, 2004 to a balance of $273 thousand.  During
the first six months of 2003, supply inventories were evaluated and obsolete
items were written off.  These write offs totaled approximately $100
thousand.  After adjusting for this write off, postage and supply expenses
between the periods declined slightly due to more aggressive expense management.
When comparing the same periods, other noninterest expense also declined by $135
thousand or 10.2%.  This decline was due to the effective controlling of
noninterest expenses by management.  Although this financial statement line
item declined in excess of 10%, no individual account balances contributed
materially to this decline.  Instead the decline was the result of slight
declines in many account balances. Offsetting these declines was an increase in
marketing and advertising expenses from the three month period ended June 30,
2003 to the same period of 2004.  Over this period, such expenses increased
$119 thousand or 47.0%.  The majority of the increase in marketing and
advertising expenses has occurred in conjunction with media costs, direct
marketing, and promotions.  In addition to day-to-day operational expenses
in each of these areas during the three months ended June 30, 2004, several
additional expenses were incurred that were not incurred during the same period
of 2003.  Marketing and advertising expenses were incurred during the
second quarter of 2004 relating to the certificate of deposit promotion offered
during that time.  In addition to these non-routine expenses, in early 2004
the Bank introduced a new customer referral program.  Through the program,
customers may earn a prize basket for the referral of new customers to the Bank. 
Expenses related with the advertising and prizes for this program also increased
marketing and advertising expenses during second quarter 2004 over the same
quarter of 2003.

42

---

Income TaxesIncome tax expense attributable to income from
continuing operations totaled $1.3 million for both the second quarter 2004 and
the second quarter 2003. The effective income tax rate was 32% for both the
three months ended June 30, 2003 and June 30, 2004.





















43

---



EARNINGS REVIEW - COMPARISON OF THE RESULTS OF
OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003

OverviewNet income for the six months ended June 30, 2004
totaled $5.8 million, up 3.9% compared with $5.6 million for the six months
ended June 30, 2003. Earnings per diluted share for the six months ended June
30, 2004 were $0.91, a 4.6% increase from $0.87 per diluted share for the same
period of 2003. Earnings per basic share for the six months ended June 30, 2004
were $0.93, a 4.5% increase from $0.89 per basic share for the six months ended
June 30, 2003.

Average common shares outstanding on a diluted
basis were 6,379,006 for the six months ended June 30, 2004, down 1.6% from
6,483,582 for the six months ended June 30, 2003. Average common shares
outstanding on a basic basis were 6,265,500 and 6,336,455 for the same periods.

Earnings increased during the six months ended
June 30, 2004 as compared to the same period of 2003 due to several factors.
Although the net yield on interest-earning assets, fully tax equivalent,
declined to 4.78% for the six months ended June 30, 2004 from 5.16% for the same
period of 2003, net interest income, fully tax equivalent, increased slightly
over the periods. Net interest income after the provision for loan losses, fully
tax equivalent, for the six months ended June 30, 2004 and 2003 was $18.5
million and $18.2 million, respectively, an increase of 1.8%.  Noninterest
income for the six months ended June 30, 2004 totaled $7.6 million, up 5.4%
compared with $7.2 million for six months ended June 30, 2003. Noninterest
expense for the six months ended June 30, 2004 increased $315 thousand from the
six months ended June 30, 2003.

Net Interest IncomeThe following table
presents average balance sheets and a net interest income analysis on a
tax-equivalent basis for the periods indicated (dollars in thousands).











44

---



For the six months ended June 30,2004
			
			2003Average
			Income/
			Yield/
			
			Average
			Income/
			Yield/Balance
			Expense
			Rate
			
			Balance
			Expense
			RateASSETSInterest-earnings
  assetsFederal
  funds sold
			$    
  5,996
			$         
  29
			0.97
			%
			$   10,358
			$         
  63
			1.23
			%Federal
  Home Loan Bank stock and deposits
			2,614
			39
			3.00
			
			2,138
			42
			3.96Nontaxable
  investment securities (1) (3)
			58,103
			1,588
			5.50
			
			35,660
			1,145
			6.47Taxable
  investment securities (3)
			62,852
			889
			2.84
			
			76,041
			1,104
			2.93Loans,
  net of unearned (2)
			711,607
			22,503
			6.36
			
			655,596
			23,172
			7.13Total
  interest-earning assets
			841,172
			25,048
			5.99
			
			779,793
			25,526
			6.60Noninterest-earning
  assetsCash and
  due from banks
			26,851
			
			
			
			27,652Allowance
  for loan losses
			(7,616)
			
			
			
			(6,957)Premises
  and equipment, net
			22,058
			
			
			
			19,832Accrued
  interest
			3,778
			
			
			
			4,273Other
  assets
			17,212
			
			
			
			15,940Total
  noninterest-earning assets
			62,283
			
			
			
			60,740Total
  assets
			$ 
  903,455
			
			
			
			$ 
  840,533LIABILITIES
  AND SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
  liabilitiesDemand
  deposits
			$ 
  264,990
			$       
  445
			0.34
			%
			$ 
  244,250
			$       
  611
			0.50
			%Savings
			45,831
			64
			0.28
			
			40,578
			76
			0.38Time
			
			347,794
			4,335
			2.51
			
			331,657
			4,764
			2.90Total
  interest-bearing deposits
			658,615
			4,844
			1.48
			
			616,485
			5,451
			1.78Other
  interest-bearing liabilities
			47,597
			202
			0.85
			
			35,037
			105
			0.60Total
  interest-bearing liabilities
			706,212
			5,046
			1.44
			
			651,522
			5,556
			1.72Noninterest-bearing
  liabilitiesNoninterest-bearing
  deposits
			117,257
			
			
			
			110,631Other
  noninterest-bearing liabilities
			5,549
			
			
			
			8,065Total
  noninterest-bearing liabilities
			122,806
			
			
			
			118,696Total
  liabilities
			829,018
			
			
			
			770,218Shareholders'
  equity
			74,437
			
			
			
			70,315Total
  liabilities and shareholders' equity
			$ 
  903,455
			
			
			
			$ 
  840,533NET
  INTEREST INCOME (FTE) (1) / NET YIELD ONINTEREST-EARNING
  ASSETS (FTE)
			
			$  
  20,002
			4.78
			%
			
			$  
  19,970
			5.16
			%Tax-equivalent
  adjustment (1)
			
			$       
  508
			
			
			
			$       
  371(1)
			Yields on
  nontaxable securities are stated on a fully taxable equivalent basis, using
  the applicable effective tax rate of32% for
  the six month period ended June 30, 2004 and 2003, respectively.  The
  adjustments made to convert nontaxableinvestments
  to a fully taxable equivalent basis were $508 and $371 for the 2004 and 2003
  periods, respectively.(2)
			Nonaccrual
  loans are included in average balances for yield computations.  The effect of
  foregone interest incomeas a
  result of loans on nonaccrual was not considered in the above analysis.  All
  loans and deposits are domestic.(3)
			The
  average balances for investment securities include the unrealized gain or
  loss recorded for available for sale securities.


45

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Fully tax-equivalent
net interest income for the six months ended June 30, 2004 increased $32
thousand, or 0.2%, to $20.0 million from the six month period ended June 30,
2003.The fully tax-equivalent net yield on interest-earning assets decreased to
4.78% for the six month period ended June 30, 2004 from 5.16% for the same
period ended June 30, 2003. Net interest income and the resulting net interest
margin, although lower that that for the six months ended June 30, 2004, was
positively impacted by robust loan growth and the effective management of
deposit rates.

The fact that the
fully tax-equivalent net interest income remained relatively unchanged for the
six month period ended June 30, 2004 compared with the same period ended June
30, 2003 was principally a result of a continuing decline in average yields on
interest-earning assets relative to the reduction in the average cost of
interest-bearing liabilities. The weighted average yield on interest-earning
assets and weighted average cost of interest-bearing liabilities shown in the
previous table are derived by dividing interest income and expense by the
weighted average balances of interest-earning assets or interest-bearing
liabilities. Interest-sensitive liabilities repriced to an average cost of 1.44%
during the first six months of 2004 from an average cost of 1.72% during the
first six months of 2003. Average yields on interest-earning assets declined to
5.99% from 6.60% over the same periods. The decline of the weighted average
yield on interest-earning assets during the first six months of 2004 over the
first six months of 2003 was primarily the result of the decreasing yields of
the loan portfolio which is a direct result of the current interest rate
environment.  This decline was only partially offset by repricing deposit
accounts at lower rates. The weighted average yield of the loan portfolio
decreased from 7.13% for the six month period ended June 30, 2003 to 6.36%
during the six month period ended June 30, 2004.

Management believes that the primary cause of the
changes in the yields and rates on interest-earning assets and interest-bearing
liabilities has been the action of the Federal Reserve Open Market Committee
during the past several years as discussed in Earnings Review - Comparison Of
The Results Of Operations For The Three Months Ended June 30, 2004 And 2003.

Average interest-earning assets grew $61.4
million, or 7.9%, to $841.2 million for the six month period ended June 30, 2004
from $779.8 million for the same period of 2003, primarily from the growth of
loans and securities only partially offset by a slight decline in average
federal funds sold. Average loans, including mortgage loans held for sale, were
$711.6 million for the six months ended June 30, 2004 compared with $655.6
million for the six months ended June 30, 2003. Average interest-bearing
traditional deposits increased from $616.5 million for the six months ended June
30, 2003 to $658.6 million for the six months ended June 30, 2004. Average other
interest-bearing liabilities increased to $47.6 million from $35.0 million over
the same periods. Fluctuations in these average balances are typically
simultaneous with fluctuations in financial statement balances as noted in
respective sections of this report.

Provision for Loan LossesThe provision for
loan losses was $1.5 million and $1.8 million for the six months ended June 30,
2004 and 2003, respectively.  At June 30, 2004 and 2003, the Allowance was
$8.0 million and $7.0 million and represented 1.11% and 1.05% of loans less
mortgage loans held for sale, respectively.

Net charge-offs during the six months ended June
30, 2004 totaled $980 thousand, or 0.28% of average net loans less mortgage
loans held for sale on an annualized basis, compared with $1.2 million during
this first six months of 2003, or 0.37% of average net loans less mortgage loans
held for sale on an annualized basis. The fluctuation in the mix of charge-offs
over the periods noted is similar to the trends discussed when comparing the
decline from December 31, 2003 to June 30, 2004 as noted in Balance Sheet Review
- Allowance for Loan Losses with only a few minor differences.  When
comparing the six month period ended June 30, 2003 to that period ended June 30,
2004, material portfolio fluctuations included net charge offs related to the
loan portfolio secured by one to four family real estate which declined offset
by loans secured by real estate nonresidential portfolio which increased. 
When comparing the year ended December 31, 2003 to the annualized six month
period ended June 30, 2004, material portfolio fluctuations included net charge
offs related to the loan portfolio secured by one to four family real estate
which declined and net charge offs within the commercial and industrial
portfolio for such loans not secured by real estate which also declined. The
fluctuations of charge-offs within other loan portfolios did not have as
dramatic an impact on total charge-offs for the periods presented. Fluctuation
trends when comparing net charge off information for the six month period ended
June 30, 2004 and June 30, 2003 are consistent with those discussed in Earnings
Review - Comparison Of The Results Of Operations For The Three Months Ended June
30, 2004 And 2003.

46

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For both comparison
periods presented, decreases were experienced within the secured by one to four
family real estate loan portfolio. Management believes that these decreases can
be attributed to the recent interest rate and economic environment, both locally
and nationally, which has led to increased consumer debt incurrence and
refinancing and the recent indication that the economy is beginning to recover
from recent uncertain times which in turn impacts job opportunities within our
communities making consumers better able to service their debt.

When comparing the
six month period ended June 30, 2003 to that period ended June 30, 2004, net
charge offs related to loans secured by real estate nonresidential has increased
due to management's more aggressive approach to collection of these loans. 
As these loans were determined to be more probable than not in terms of
collection, remediation actions were taken including, but not limited to, charge
offs and foreclosure.  As noted in Balance Sheet Review - Other Assets as
large commercial properties (nonresidential secured by real estate) acquired in
settlement of loans, based on fair market value appraisals obtained, charge offs
were necessary in many cases.  Due to the fact that such loans have only
seasoned in recent months, these charge offs at higher levels during the first
six months of 2004 than during the same period of 2003.

When comparing the
year ended December 31, 2003 to the annualized six month period ended June 30,
2004, net charge offs related to commercial and industrial portfolio loans have
decreased consistent when comparing the annualized three month period ended June
30, 2004 and the year ended December 31, 2003.  As these loans were
determined to be more probable than not in terms of collection, remediation
actions were taken including, but not limited to, charge offs.  However,
since loans within this portfolio are not secured by real estate, once the
charge off process has taken place, there is no property to acquire.  As
noted in Balance Sheet Review - Other Assets, activity relating to property
acquired in the settlement of loans has slowed dramatically since early 2004. 
Such is also the case within the commercial and industrial portfolio resulting
in a decline in net charge offs.

In addition to
decreased net charge-offs impacting the provision for loan losses decline during
the first six months of 2004 over the same period of 2003, the decline in
nonperforming loans and classified assets also played a role in this decline. 
These factors were offset by the impact of the growth within the loan portfolio
over the periods as well as the increase experienced in real estate and personal
property acquired in settlement of loans.  Management's analysis of these
factors, as documented throughout this report, and the impact of these factors
on the allowance for loan losses and the provision for loan losses for the six
month period ended June 30, 2004 resulted in a provision for loan losses for
that period of 2004 of $1.5 million.  Based on this analysis, management
supported a $300 thousand decline in the provision for loan losses from that
booked during the first six months of 2003. Despite the decline, management
believes that the Allowance is maintained at a level that is sufficient to cover
inherent losses in the loan portfolio at June 30, 2004. The Allowance as a
percentage of net loans less mortgage loans held for sale increased from 1.05%
at June 30, 2003 to 1.11% at June 30, 2004.

Noninterest Income and ExpenseNoninterest income for the six months ended June
30, 2004 totaled $7.6 million, up 5.4% compared with $7.2 million for the same
period of 2003. Noninterest expense for the six months ended June 30, 2004
increased $315 thousand from the six months ended June 30, 2003.

47

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The increase in noninterest income during the
first six months of 2004 over the first six months of 2003 was the result of
fluctuations in several financial statement captions.  Net fees for trust
and brokerage services increased $168 thousand, or 13.2% over the periods to a
balance of $1.4 million as of June 30, 2004. Mortgage banking income increased
$240 thousand during the first six months of 2004 over the same period of 2003. 
Offsetting this increase was a decline of investment security gains of $173
thousand to a balance of $108 thousand for the six month period ended June 30,
2004.

Net fees for trust
and brokerage services include fees earned through Palmetto Capital and the
trust department. At June 30, 2004, assets under Palmetto Capital's management
totaled $131.1 million as compared to the assets under management at June 30,
2003 of $108.4 million. At June 30, 2004, assets under the trust department's
management totaled $259.3 million as compared to the assets under management at
June 30, 2003 of $242.2 million. The increase in fees earned correlates to the
level of assets under management.

Mortgage loans
originated totaled $20.5 million during the six month period ended June 30, 2004
compared with $78.0 million during the same period of 2003. Sales during the
same periods totaled $23.2 million and $77.6 million, respectively.  Gains
on sales of loans totaled $347 thousand for the six months ended June 30, 2004,
down $326 thousand from the six months ended June 30, 2003. The Bank expects
lower origination and sales figures to continue due to higher mortgage loan
rates. Processing fees relating to the origination of such loans also declined
over the same periods by $114 thousand to a balance of $55 thousand. 
Offsetting these declines in mortgage banking income was a decline in the
amortization and impairment of mortgage servicing rights.  Amortization of
mortgage servicing rights declined $617 thousand to $320 thousand for the six
months ended June 30, 2004 over the six months ended June 30, 2003. 
Additional impairment of mortgage servicing rights of $133 thousand was required
for the six months ended June 30, 2003, while additional impairment of $119
thousand was recorded during the six months ended June 30, 2004.

Investment security gains declined from a balance
of $281 thousand for the six months ended June 30, 2003 to a balance of $108
thousand for the six months ended June 30, 2004.

The increase in noninterest expense for the six
months ended June 30, 2004 from the six months ended June 30, 2003 was the
result of fluctuations in several accounts.  Salaries and other personnel
expense increased $205 thousand, or 2.2% from the six months ended June 30, 2003
to the same period of 2004.  Additionally, marketing and advertising
expense from the six month period ended June 30, 2003 to the same period of 2004
increased $149 thousand and professional services expense increased $128
thousand over the same periods.  Offsetting these increases in noninterest
expenses was a decline in postage and supply expenses which declined by $211
thousand when comparing the same periods to a balance of $594 thousand. 
Other noninterest expense totaled $2.5 million for the six months ended June 30,
2003 and declined to $2.4 million during the six months ended June 30, 2004.

The increase in salaries and other personnel
expense for the six months ended June 30, 2004 compared with the same period of
2003 is due to increased expenses related primarily to employee medical
insurance benefits, life insurance premiums for executive officers, and
Bancshares' defined benefit pension plan. Expenses related to employee medical
insurance benefits increased $79 thousand over the first six months of 2003 to
$637 thousand.  Miscellaneous employee benefits, which include life
insurance premiums for executive officers, increased $96 thousand over the first
six months of 2003 to $246 thousand. Additionally, net expenses related to the
Bancshares' noncontributory defined benefit pension plan increased $88 thousand
during the six months ended June 30, 2004 over the same period of 2003.

During the first six months of 2003, supply
inventories were evaluated and obsolete items were written off.  These
write offs totaled approximately $100 thousand.  After adjusting for this
write off, postage and supply expenses between the periods declined due to more
aggressive expense management and the use of advanced technology utilizing
electronic versions of once printed forms.

48

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During the six month period ended June 30, 2004
marketing and advertising expenses totaled $586 thousand compared with $437
thousand during the first six months of 2003. The majority of the increase in
marketing and advertising expenses has occurred in conjunction with media costs,
newspaper advertising, direct marketing, and promotions.  In addition to
day-to-day operational expenses in each of these areas, during the six months
ended June 30, 2004, several additional expenses were incurred that were not
incurred during the same period of 2003.  Marketing and advertising
expenses were incurred during the first six months of 2004 relating to the
certificate of deposit promotion offered during that time.  In addition to
these non-routine expenses, in early 2004 the Bank introduced a new customer
referral program.  Through the program, customers may earn a prize basket
for the referral of new customers to the Bank.  Expenses related with the
advertising and prizes for this program also increased marketing and advertising
expenses during the first six months of 2004 over the same period of 2003.

The increase in professional services expense for
the six months ended June 30, 2004 compared with the same period of 2003 is due
to increased legal expenses relating to the loan portfolio.  As noted
within Balance Sheet Review - Loan Portfolio, the Bank has continued to see an
increase in prime access loans at June 30, 2004 over both December 31, 2003 and
June 30, 2003 primarily resulting from the no closing costs promotional offering
for such loans.  Synonymous with the increase in this loan portfolio is the
increase in the related legal expenses incurred in conjunction with the no
closing cost promotion.  Otherwise, the increase in this noninterest
expense is the result of costs incurred by the Bank to defend itself against
litigation brought about in the normal course of lending operations.

When comparing the same periods, other
noninterest expense declined by $120 thousand or 4.7%.  This decline was
due to the effective controlling of noninterest expenses by management. 
Although this financial statement line item declined in excess of $100 thousand,
no individual account balances contributed materially to this decline. 
Instead the decline was the result of slight declines in many account balances.

Income TaxesIncome tax expense attributable to income from
continuing operations totaled $2.7 million for the six month periods ended June
30, 2004 and June 30, 2003. The effective income tax rate was 32% for both the
six month periods ended June 30, 2003 and June 30, 2004.





49

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ACCOUNTING AND REPORTING MATTERS

The following is a summary of recent
authoritative pronouncements that could impact the accounting, reporting, and
disclosure of financial information by Bancshares.

In March 2004, the
FASB formally proposed to require companies to recognize the fair value of stock
options and other stock-based compensation to employees for 2005 reporting
periods, a policy consistent with the related international standard released
and with convergence between the two sets of standards. The questions proposed
at this point are how "share based payments" (to use the IASB term adopted by
the FASB) should be valued and classified and the related implementation
difficulties. The exposure draft addresses only accounting for share-based
awards to employees, including employee-stock-purchase-plans (ESPPs). Accounting
for employee-stock-ownership-plan transactions (ESOPs) and awards to
nonemployees will be taken up in a later phase of the project. Comments on the
exposure draft were due by June 30, 2004. On July 20, 2004, the House passed a
bill that would prevent the Securities and Exchange Commission from putting into
effect the FASB proposal to require companies to expense employee stock options.
The legislation would require that public companies report only employee stock
options granted to their CEOs and four highest-paid officers. Small businesses
would be exempted from expensing options, and new public companies would be able
to delay expensing for top executives during their first three years. The House
also approved an amendment to the legislation to clarify that companies wishing
to expense stock options voluntarily may continue to do so. A similar bill in
the Senate is still under consideration. Due to the continually evolving nature
of stock options and other stock-based compensation accounting, Bancshares will
stay abreast of related literature and comply with any related requirements.

Other accounting standards that have been issued
or proposed by the FASB or other standards-setting bodies that do not require
adoption until a future date are not expected to have a material impact on the
financial position or the results of operations of Bancshares upon adoption.







50

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Item 3.  Quantitative and
Qualitative Disclosures about Market Risk

Qualitative
DisclosuresMarket risk is the risk of loss from adverse changes in market prices
and rates. Market risk arises principally from interest rate risk inherent in
lending, deposit, borrowing, and investing activities that could potentially
reduce net interest income in future periods. This risk can also be reflected in
diminished current market values. Management actively monitors and manages its
interest rate risk exposure. Although other risks, such as credit and liquidity
risk, are managed 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 Bancshares' 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 Bancshares' business activities.

Due to the fact that
the net interest income of any financial institution is vulnerable to
fluctuations in interest rates, management attempts to mitigate this
vulnerability through effective Asset-Liability Management. Such Asset-Liability
Management should maintain a balance between exposure to interest rate
fluctuations and earnings. Bancshares defines Asset-Liability Management as the
process by which changes occur to the mix, maturity, and pricing of assets and
liabilities in an attempt to reduce a materially adverse impact on earnings
resulting from the direction, frequency, and magnitude of change in market
interest rates realizing that a sudden and / or substantial fluctuation in
interest rates will impact 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. Bancshares' goal then is
to minimize interest rate risk between interest-earning assets and
interest-bearing liabilities at various maturities through its Asset-Liability
Management. Through Asset-Liability Management, Bancshares seeks to achieve
steady growth of net interest income with an acceptable amount of interest rate
risk and sufficient liquidity.

Appropriate overall
balance sheet parameters and guidelines are influenced by general economic and
banking conditions and by the local market environment. Current parameters and
guidelines of the Asset-Liability Committee include maintaining the loan to
deposit ratio in a range of 75% to 90%, using an increase or decrease of 3% in
the federal funds rate over a twelve month period as a trigger for minimizing
exposure to interest rate shifts, maintaining a liquidity ratio as defined by
regulators in a range of 10% to 25%, and maintaining a dependency ratio as
defined by the regulators of 5% to 25%. It is noted that the projected negative
impact on net interest income for the twelve month period is not to exceed 20%
although management may have to take corrective action during a period of
sharply rising or falling interest rates. At June 30, 2004, Bancshares' loan to
deposit ratio was 88%, which falls within the policy's permitted range of 75% to
90%, and the liquidity ratio was 17%, which falls in the policy's permitted
range of 10% to 25%.

Quantitative
DisclosuresOne tool the Company utilizes in assessing Asset-Liability Management is
a simulation model used to analyze interest sensitivity gap (the difference
between the amount of rate sensitive assets maturing or repricing within a
specific time period and the amount of rate sensitive liabilities maturing or
repricing within the same time period). 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 following table
is a summary of Bancshares' one-year gap (dollars in thousands):



June 30, 2004Interest-earning assets maturing or
			repricing within one year
			$ 472,982Interest-bearing liabilities maturing or repricing within one year
			362,330Cumulative gap
			$ 110,652Gap as a percentage of total assets
			11.75%




51

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The above analysis does not take into account any
prepayments on mortgages, consumer or other loans, or securities.  All
maturities are stated in contractual terms.  The interest-sensitive gap
position, while not a complete measure of interest sensitivity, is reviewed
periodically to provide insights related to the static repricing structure of
assets and liabilities. The static gap position is limited because it does not
take into account changes in interest rates or changes in management's
expectations or intentions. Based on the June 30, 2004 dynamic gap position in a
one-year time period $473.0 million in interest-earning assets will reprice and
approximately $362.3 million in interest-bearing liabilities will reprice. This
current dynamic gap position results in a positive one-year gap position of
$110.7 million, or 11.75% of assets.

A
negative gap indicates that cumulative interest-sensitive liabilities exceed
cumulative interest-sensitive assets and suggests that net interest income would
decline if market interest rates increased. A positive gap suggests the reverse.
This relationship is not always ensured due to the repricing attributes of both
interest-sensitive assets and interest-sensitive liabilities.

An important aspect
of achieving satisfactory net interest income is the composition and maturities
of rate-sensitive assets and liabilities. It must be understood, however, that
such an analysis is as of the date noted and does not reflect the dynamics of
the market place. Therefore, management reviews simulated earnings statements on
a monthly basis to more accurately anticipate sensitivity to changes in interest
rates.

The earnings
statements reviewed monthly by management simulates Bancshares' consolidated
balance sheets and consolidated statements of income under several different
rate scenarios over a twelve month period. It reports a case in which variations
occur, from Bancshares' most likely forecast, when rates gradually increase and
decrease in increments of 100 basis points up to 300 basis points over the
coming twelve month period. Computation of the possible impact of hypothetical
interest rate changes are based on numerous assumptions, including relative
levels of market interest rates and loan prepayments, and should not be relied
upon as indicative of actual results. Further, the computations do not
contemplate any actions that could be taken in response to changes in interest
rates.

In conjunction with
the annual budgeting process for 2004, the Company projected a gradual increase
in rates rather than an immediate change. This projection was made because rates
typically change gradually over time rather than abruptly.

According to the
model as of the end of the second quarter 2004, if interest rates rise by 300
basis points over the coming twelve month period, net interest income would be
adversely affected by approximately $3.6 million, or 8.8%. This model also shows
that if interest rates rose by only 100 or 200 basis points over the coming
twelve month period, net interest income would be adversely affected by
approximately $843 thousand, or 2.1%, and $2.0 million, or 4.9%, respectively.
The model also shows that if interest rates dropped 300 basis points, net
interest income would be adversely impacted by approximately $4.3 million, or
10.6%. Similarly, if interest rates dropped by only 100 or 200 basis points over
the coming twelve month period, net interest income would be adversely impacted
by approximately $840 thousand, or 2.1%, and $2.8 million, or 6.8%,
respectively. The Asset-Liability Committee meets weekly to address such
interest-pricing issues. The projected negative impact on net interest income
for the twelve month period does not exceed the 20% threshold prescribed by the
Asset-Liability Committee's policy as noted previously.

52

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Item
4.  Controls and Procedures

Evaluation of
Disclosure Controls and ProceduresAn evaluation of Bancshares' disclosure controls and procedures (as
defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act
of 1934) was carried out under the supervision and with the participation of
Bancshares' Chairman and Chief Executive Officer and the Bank's Chairman and
Chief Executive Officer (Chief Accounting Officer) and several other members of
senior management as of the end of the period covered by this Quarterly Report
(the "Evaluation Date"). Bancshares' Chairman and Chief Executive Officer and
the Bank's Chairman and Chief Executive Officer (Chief Accounting Officer)
concluded as of the Evaluation Date that disclosure controls and procedures were
effective in ensuring that the information required to be disclosed by
Bancshares in the reports it files or submits under the Securities Exchange Act
of 1934 is (i) accumulated and communicated to management (including Bancshares'
Chairman and Chief Executive Officer and the Bank's Chairman and Chief Executive
Officer (Chief Accounting Officer)) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms.

Changes in
Internal ControlsDuring the second quarter of 2004, the Company did not make any changes
in its internal control over financial reporting or other factors that have
materially affected, or are reasonably likely to materially affect, that
control.



53



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PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

See Note 7 to the Consolidated Financial
Statements for a discussion of legal proceedings.

Item 2.  Changes in Securities, Use of
Proceeds and Issuer Purchases of Equity Securities

None

Item 3.  Defaults Upon Senior Securities

None

Item 4.  Submission of Matters to a Vote
of Securities Holders

The annual shareholders' meeting of Bancshares
was held on April 20, 2004.  4,886,324 shares were present in person or by
proxy of the shares of common stock entitled to vote at the Annual Meeting.

Proposal #1 - Election of Directors.  The
shareholders elected W. Fred Davis, Jr., David P. George, Jr. Michael D. Glenn,
and Ann B. Smith as directors of the Company for three year terms ending in
2007.  At the meeting the following directors were elected for the terms
specified:

|Term to Expire in 2007 | Number of VotesFor | Number of Votes
     Withheld |  | 
|---------------------- | ------------------ | ----------------------------- |  | 
|W. Fred Davis, Jr.     | 4,882,323          | 4,001                         |  | 
|David P. George, Jr.   | 4,878,323          | 8,001                         |  | 
|Michael D. Glenn       | 4,882,323          | 4,001                         |  | 
|Ann B. Smith           | 4,882,323          | 4,001                         |  | 

The following
directors' term of office continued after the meeting: L. Leon Patterson, J.
David Wasson, Jr., Sam B. Phillips, Jr., William S. Moore, John T. Gramling, II,
James M. Shoemaker, Jr., Paul W. Stringer, and Edward K. Snead, III.

Item 5.  Other Information

None

Item 6.  Exhibits and Reports on Form 8‐K

(a)  Exhibits

31.1      L. Leon
Patterson's Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2      Paul W. Stringer'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

(b)  Reports on Form 8-K

On April 19, 2004,
the Company furnished a Form 8-K announcing the earnings release dated April 14,
2004, which included selected financial data for the quarter ended March 31,
2004 and for select other previously reported periods.

On May 10, 2004, the Company furnished a Form 8-K
announcing the mailing of its quarterly earnings overview to shareholders dated
May 4, 2004, which included selected financial data for the quarter ended March
31, 2004 and for select other previously reported periods.



54

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SIGNATURES

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



PALMETTO BANCSHARES, INC.



By:

/s/      L. Leon Patterson L. Leon Patterson
 Chairman and Chief Executive Officer
 Palmetto Bancshares, Inc.



/s/      Paul W. Stringer Paul W. Stringer
 Chairman and Chief Executive Officer
 (Chief Accounting Officer)
 The Palmetto Bank

Date:  
August 9, 2004



55