| **U. S. SECURITIES AND EXCHANGE COMMISSION		WASHINGTON, D.C. 20549**                                                                                                                                                                                                                                                                                                                                 |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
| **FORM 10-Q**                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                 |
|  (X)                                                                                                                                                                                                                                                                                                                                                                                       | QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 | For the quarterly period ended September 30, 2008 |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   | OR |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|  (  )                                                                                                                                                                                                                                                                                                                                                                                      | TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 | For the transition period from __________ to  __________ |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
| Commission file number  0-26016                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
| **PALMETTO BANCSHARES, INC.**                                                                                                                                                                                                                                                                                                                                                                        |
| (Exact name of  registrant as specified in its charter)                                                                                                                                                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
| **South Carolina**                                                                                                                                                                                                                                                                                                                                                                                   |   | **74-2235055** |
| (State or other  jurisdiction of incorporation or organization)                                                                                                                                                                                                                                                                                                                                      |   | (IRS Employer  Identification No.) |
|                                                                                                                                                                                                                                                                                                                                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   |
| **301 Hillcrest Drive, Laurens, South Carolina**                                                                                                                                                                                                                                                                                                                                                     |   | **29360** |
| (Address of  principal executive offices)                                                                                                                                                                                                                                                                                                                                                            |   | (Zip Code) |
| ** **                                                                                                                                                                                                                                                                                                                                                                                           |   | ** ** | ** ** | ** ** | ** ** |   |   | ** ** | ** ** | ** ** | ** ** |   |
| **(864) 984–4551**                                                                                                                                                                                                                                                                                                                                                                              |
| (Registrant’s  telephone number)                                                                                                                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|  

Indicate by check mark  whether the registrant (1) has filed all reports required to be filed by  Section 13 or 15(d) of the Securities Exchange Act of  1934 during the preceding 12 months (or for such shorter period that the  registrant was required to file such reports), and (2)  has been subject to such filing requirements for the past 90 days. Yes X   No  __  |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|  

Indicate by check mark  whether the registrant is a large accelerated filer, an accelerated filer, a  non-accelerated filer,  or a smaller reporting  company. See definitions of "large accelerated filer,"  "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the  Exchange Act.                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   | Large accelerated filer [ ] |   |   | Accelerated filer [x] |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   | Non-accelerated filer [ ] |   |   | Smaller reporting company [  ] |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 | Indicate by check mark  whether the registrant is a shell company (as defined by Rule 12b-2 of the  Exchange Act).  Yes [ ] No [x] |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 | Indicate the number of  shares outstanding of each of the issuer's classes of common stock, as of the  latest practicable date. |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   | Class |   | Outstanding at November 7, 2008 |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   |  ----------------------------- |   |   ------------------------------- |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |   | Common stock, $5.00 par value |   | 6,442,090 |   |   |

 

 

 

----

 

 

 

 

 

 

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY** |
|-----------------------------------------------|
| **Table of  Contents**                        |
|                                          |   |   |   |   |
|                                          |   |   | Page |   |
|                                          |   |   |   |   |
| PART I - FINANCIAL INFORMATION                |   |   |
|                                          | Item 1. | Financial Statements | 3 |   |
|                                          | Item 2. | Management's Discussion and Analysis of Financial  Condition and Results of Operations | 33 |   |
|                                          | Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 64 |   |
|                                          | Item 4. | Controls and Procedures | 67 |   |
|                                          |   |   |   |   |
| PART II - OTHER INFORMATION                   |   |   |
|                                          | Item 1. | Legal Proceedings | 68 |   |
|                                          | Item 1A. | Risk Factors | 68 |   |
|                                          | Item 2. | Unregistered Sales of Equity Securities and Use of  Proceeds | 69 |   |
|                                          | Item 3. | Defaults Upon Senior Securities | 69 |   |
|                                          | Item 4. | Submission of Matters to a Vote of Security Holders | 69 |   |
|                                          | Item 5. | Other Information | 69 |   |
|                                          | Item 6. | Exhibits | 69 |   |
|                                          |   |   |   |   |
| SIGNATURES                                    | 70 |   |
|                                          |   |   |   |   |

 

 

1

----

 

 

 

*Certain statements contained inthis Quarterly Report on Form 10-Q that are not statements of historicalfact constitute forward-looking statements within the meaning of theSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities and Exchange Act of 1934, as amended, notwithstanding that such statements are not specificallyidentified as such. In addition, certain statements may be contained in theregistrant’s future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and writtenstatements made by or with the approval of the registrant that are notstatements of historical fact and constitute forward-looking statements. Broadlyspeaking, forward-looking statements include, but are not limited to,projections of the registrant’s revenues, income, earnings per common share,capital expenditures, dividends, capital structure, or other financial items,descriptions of plans or objectives of management for future operations,products or services, forecasts of the registrant’s future economicperformance, and descriptions of assumptions underlying or relating to any ofthe foregoing.  Because these statements 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,” “targeted,” “continue,” “remain,” or other similar expressions that are intended to identifyforward-looking statements but are not the exclusive means of identifying suchstatements.*

* *

*Forward-looking statementsinvolve risks and uncertainties that may cause actual results to differmaterially from those in such statements. Refer to the registrant’s AnnualReport on Form 10-K for the year ended December 31, 2007 for a discussion of thematerial risks and uncertainties that managementbelieves impact the registrant and may cause actual results to differ fromthose discussed in the forward-looking statements.*

* *

* *

*The registrant wishes to caution readers not to placeundue reliance on any forward-looking statements, which speak only as of thedate made. The registrant also wishes to advise readers that the factors listedabove could impact the registrant’s financial performance and could cause theregistrant’s actual results for future periods to differ materially from anyopinions expressed with respect to future periods in any current statements.The registrant does not undertake, and specifically disclaims any obligation,to publicly release the result of any revisions that may be made to anyforward-looking statements to reflect events or circumstances after the date ofsuch statements or to reflect the occurrence of anticipated or unanticipatedevents.*

* *

 

 

  

 

 

 

 

 

2

----

 

**PART I - FINANCIAL INFORMATION**

** **

**Item 1. Financial Statements**

 

 

| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY**                           |
|------------------------------------------------------------------------|
| **Consolidated (Interim) Balance Sheets**                              |
| **(dollars in thousands, except common and per share  data)**          |
|                                                                   |   |   |   |   |   |   |   |
| ** **                                                             |   |   |   |   | **September 30,** |   | **December 31,** |
|                                                                   |   |   |   |   | **2008** | ** ** | **2007** |
|                                                                   |   |   |   |   | (unaudited) |   |   |
| Assets                                                                 |   |   |   |   |   |   |
| Cash and cash equivalents                                              |   |   |   |   |
|                                                                   | Cash and due from banks |  $ |                 35,635 |   |                   42,450 |
|                                                                   | Federal funds sold |   |                          55 |   |                     9,782 |
|                                                                   |   | Total cash and cash  equivalents |                   35,690 |   |                   52,232 |
|                                                                   |   |   |   |   |   |   |   |
| Federal Home Loan Bank  ("FHLB") stock, at cost              |                     7,241 |   |                     2,617 |
| Investment securities  available for sale, at fair value               |                 130,321 |   |                   95,715 |
| Mortgage loans held for  sale                                          |   |                     5,220 |   |                     5,005 |
|                                                                   |   |   |   |   |   |   |   |
| Loans, gross                                                           |   |   |              1,129,336 |   |              1,044,770 |
|                                                                   | Less: allowance for loan  losses |   |                    (7,823) |   |                    (7,418) |
|                                                                   |   | Loans, net |   |              1,121,513 |   |              1,037,352 |
|                                                                   |   |   |   |   |   |   |   |
| Premises and equipment, net                                            |   |                   25,016 |   |                   25,133 |
| Premises held for sale                                                 |   |                     1,651 |   |                            -   |
| Goodwill, net                                                          |   |   |                     3,691 |   |                     3,691 |
| Core deposit intangibles,  net                                         |   |                          46 |   |                          79 |
| Accrued interest receivable                                            |   |                     6,080 |   |                     6,655 |
| Other                                                                  |   |   |   |                   17,741 |   |                   19,698 |
|                                                                   |   |   | Total assets |  $ |            1,354,210 |   |              1,248,177 |
|                                                                   |   |   |   |   |   |   |   |
| Liabilities and  shareholders' equity                                  |   |   |   |   |
| Liabilities                                                            |   |   |   |   |   |   |
| Deposits                                                               |   |   |   |   |   |   |
|                                                                   | Noninterest-bearing |  $ |               133,937 |   |                 135,111 |
|                                                                   | Interest-bearing |   |                 922,343 |   |                 923,683 |
|                                                                   |   | Total deposits |   |              1,056,280 |   |              1,058,794 |
|                                                                   |   |   |   |   |   |   |   |
| Retail repurchase  agreements                                          |   |                   21,817 |   |                   11,280 |
| Commercial paper (Master  notes)                                       |   |                   37,487 |   |                   26,326 |
| Other short-term borrowings                                            |   |                   59,000 |   |                   30,000 |
| Long-term borrowings                                                   |   |                   52,000 |   |                            -   |
| Accrued interest payable                                               |   |                     1,788 |   |                     2,042 |
| Other                                                                  |   |   |   |                     7,403 |   |                     9,479 |
|                                                                   |   | Total liabilities |   |              1,235,775 |   |              1,137,921 |
|                                                                   |   |   |   |   |   |   |   |
| Shareholders' equity                                                   |   |   |   |   |
| Common stock - par value  $5.00 per share;  authorized 10,000,000 |   |   |   |
|                                                                   | shares; issued and  outstanding 6,442,090 and 6,421,765 |   |   |   |
|                                                                   | at September 30, 2008 and  December 31, 2007, respectively |                   32,211 |   |                   32,109 |
| Capital surplus                                                        |   |   |                     2,036 |   |                     1,664 |
| Retained earnings                                                      |   |                   87,291 |   |                   79,221 |
| Accumulated other  comprehensive loss, net of tax                      |                    (3,103) |   |                    (2,738) |
|                                                                   |   | Total shareholders' equity |   |                 118,435 |   |                 110,256 |
|                                                                   |   |   |   |   |   |   |   |
|                                                                   |   |   | Total liabilities and  shareholders' equity | $
           1,354,210 

 

             1,248,177 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements

 

3

 

**PALMETTO BANCSHARES,  INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Income**

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods ended September 30,**

 

 

 

 

 

 

 

**2008**

** **

**2007**

Interest income

 

 

 

 

 

 

 

 

Interest earned and fees on  loans

 $

                                17,912 

 

                                  20,012 

 

Interest earned on  investment securities available for sale

 

 

 

 

 

United States Treasury and federal agencies  (taxable)

                                          -   

 

                                       322 

 

 

State and municipal  (nontaxable)

 

                                       449 

 

                                       464 

 

 

Mortgage-backed (taxable)

 

                                    1,216 

 

                                       299 

 

Dividends paid on FHLB  stock

 

                                         96 

 

                                         47 

 

Other

 

 

 

 

                                         43 

 

                                       149 

 

 

 

Total interest income

 

                                  19,716 

 

                                  21,293 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

Interest paid on deposits

 

 

                                    5,586 

 

                                    7,663 

 

Interest paid on retail  repurchase agreements

                                        55  

 

                                       149 

 

Interest paid on commercial  paper   

 

                                         88 

 

                                       312 

 

Interest paid on other  short-term borrowings

                                       353 

 

                                       414 

 

Interest paid on long-term  borrowings

 

                                       423 

 

                                         -    

 

 

 

Total interest expense

 

                                    6,505 

 

                                    8,538 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income 

 

                                  13,211 

 

                                  12,755 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

                                       687 

 

                                       400 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after  provision for loan losses

                                  12,524 

 

                                  12,355 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

Service charges on deposit  accounts, net

 

                                    2,135 

 

                                    2,001 

 

Fees for trust and  investment management and brokerage services

                                       744 

 

                                       736 

 

Mortgage-banking income,  net

 

                                       210 

 

                                       468 

 

Other 

 

 

 

 

                                    1,212 

 

                                    1,499 

 

 

 

Total noninterest income

 

                                    4,301 

 

                                    4,704 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

Salaries and other  personnel 

 

 

                                   5,910  

 

                                    7,040 

 

Occupancy

 

 

 

                                       824 

 

                                       752 

 

Furniture and equipment

 

 

                                       919 

 

                                       918 

 

Loss on disposition of  premises, furniture, and equipment

                                          -   

 

                                       346 

 

Marketing 

 

 

 

                                      277  

 

                                       208 

 

Amortization of core  deposit intangibles

 

                                         11 

 

                                         12 

 

Other 

 

 

 

 

                                    2,605 

 

                                    2,207 

 

 

 

Total noninterest expense

 

                                  10,546 

 

                                  11,483 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision  for income taxes

                                    6,279 

 

                                    5,576 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

                                    2,222 

 

                                   1,680  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 $

                                  4,057 

 

                                    3,896 

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

 

Net income - basic

 

 $

                                    0.63 

 

                                      0.61 

 

Net income - diluted

 

 

                                      0.62 

 

                                      0.60 

 

Cash dividends

 

 

 

                                      0.20 

 

                                      0.19 

 

Book value 

 

 

 

                                    18.38 

 

                                    17.02 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common  shares outstanding - basic

                             6,442,090 

 

                             6,392,721 

 

Weighted average common  shares outstanding - diluted

                             6,529,123 

 

                            6,500,962  

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements

 

4

 

**PALMETTO BANCSHARES,  INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Income**

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the nine month periods ended September 30,**

 

 

 

 

 

 

 

**2008**

** **

**2007**

Interest income

 

 

 

 

 

 

 

 

Interest earned and fees on  loans

 $

                                55,253 

 

                                  58,079 

 

Interest earned on  investment securities available for sale

 

 

 

 

 

United States Treasury and federal agencies (taxable)

                                       235 

 

                                    1,138 

 

 

State and municipal  (nontaxable)

 

                                    1,363 

 

                                    1,340 

 

 

Mortgage-backed (taxable)

 

                                    2,818 

 

                                       908 

 

Dividends paid on FHLB  stock

 

                                       239 

 

                                       122 

 

Other 

 

 

 

 

                                         98 

 

                                       600 

 

 

 

Total interest income

 

                                  60,006 

 

                                  62,187 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

Interest paid on deposits

 

 

                                  18,355 

 

                                  22,327 

 

Interest paid on retail  repurchase agreements

                                      224  

 

                                       425 

 

Interest paid on commercial  paper   

 

                                       319 

 

                                       839 

 

Interest paid on other short-term  borrowings

                                       862 

 

                                       497 

 

Interest paid on long-term  borrowings

 

                                       864 

 

                                       173 

 

 

 

Total interest expense

 

                                  20,624 

 

                                  24,261 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income 

 

                                  39,382 

 

                                 37,926  

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

                                    1,862 

 

                                    1,200 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision  for loan losses

                                  37,520 

 

                                  36,726 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

Service charges on deposit  accounts, net

 

                                   6,429  

 

                                    5,900 

 

Fees for trust and  investment management and brokerage services

                                    2,255 

 

                                    2,258 

 

Mortgage-banking income,  net

 

                                       847 

 

                                       987 

 

Investment securities gains

 

 

                                           1 

 

                                          -   

 

Other 

 

 

 

 

                                    4,016 

 

                                    3,402 

 

 

 

Total noninterest income

 

                                  13,548 

 

                                  12,547 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

Salaries and other  personnel 

 

 

                                  18,175 

 

                                  19,234 

 

Occupancy

 

 

 

                                    2,432 

 

                                    2,182 

 

Furniture and equipment

 

 

                                    2,848 

 

                                    2,751 

 

(Gain) loss on disposition  of premises, furniture, and equipment

                                         (2)

 

                                       346 

 

Marketing 

 

 

 

                                       900 

 

                                       695 

 

Amortization of core deposit  intangibles

 

                                         33 

 

                                         36 

 

Other 

 

 

 

 

                                    8,151 

 

                                    6,398 

 

 

 

Total noninterest expense

 

                                  32,537 

 

                                  31,642 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision  for income taxes

                                  18,531 

 

                                 17,631  

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

                                    6,499 

 

                                    5,909 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 $

                               12,032  

 

                                  11,722 

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

 

Net income - basic

 

 $

                                    1.87 

 

                                      1.84 

 

Net income - diluted

 

 

                                      1.84 

 

                                      1.81 

 

Cash dividends

 

 

 

                                      0.60 

 

                                      0.57 

 

Book value 

 

 

 

                                    18.38 

 

                                    17.02 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common  shares outstanding - basic

                             6,436,280 

 

                            6,385,625  

 

Weighted average common  shares outstanding - diluted

                             6,522,316 

 

                             6,484,293 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements

 

5

 

 

**PALMETTO BANCSHARES,  INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Changes in  Shareholders' Equity and Comprehensive Income**

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

 

 

** **

** **

** **

** **

** **

** **

** **

** **

**Accumulated**

** **

** **

 

**Shares of**

** **

** **

** **

** **

** **

** **

** **

**other**

** **

** **

 

**common**

** **

**Common**

** **

**Capital**

** **

**Retained**

** **

**comprehensive**

** **

** **

 

**stock**

** **

**stock**

** **

**surplus**

** **

**earnings**

** **

**(loss), net**

** **

**Total**

Balance at December 31,  2006

6,367,450 

 $

31,837 

 $

1,102 

 $

68,132 

 $

(695)

 $

100,376 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

           11,722 

 

 

 

           11,722 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income  (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Investment securities  available for sale

 

 

 

 

 

 

 

 

 

 

 

          Change in  unrealized position during the period, net

 

 

 

 

 

 

 

 

 

 

 

               of tax  impact of $71

 

 

 

 

 

 

 

 

(113)

 

 

          Reclassification  adjustment included

 

 

 

 

 

 

 

 

 

 

 

               in net  income, net of tax impact of $0

 

 

 

 

 

 

 

 

                                     -   

 

 

     Net unrealized loss on  investment securities available for sale

 

 

 

 

 

 

 

 

 

 

(113)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

11,609 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared and  paid ($0.57 per share)

 

 

 

 

 

 

(3,643)

 

 

 

(3,643)

Compensation expense  related to stock option plans

 

 

 

 

99 

 

 

 

 

 

99 

Common stock issued  pursuant to stock option plan

               32,810 

 

             164 

 

                     326 

 

 

 

 

 

490 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30,  2007

          6,400,260 

 $

32,001 

 $

1,527 

 $

76,211 

 $

(808)

 $

108,931 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31,  2007

          6,421,765 

 $

32,109 

 $

1,664 

 $

79,221 

 $

(2,738)

 $

110,256 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

           12,032 

 

 

 

           12,032 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income  (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Investment securities  available for sale

 

 

 

 

 

 

 

 

 

 

 

          Change in  unrealized position during the period, net

 

 

 

 

 

 

 

 

 

 

 

               of tax  impact of $219

 

 

 

 

 

 

 

 

(364)

 

 

          Reclassification  adjustment included

 

 

 

 

 

 

 

 

 

 

 

               in net  income, net of tax impact of $0

 

 

 

 

 

 

 

 

                                     (1)

 

 

     Net unrealized loss on  investment securities available for sale

 

 

 

 

 

 

 

 

 

 

               (365)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

11,667 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of  adoption of new accounting standard (See Note 1)

 

 

 

 

 

 

(99)

 

 

 

(99)

Cash dividend declared and  paid ($0.60 per share)

 

 

 

 

 

 

(3,863)

 

 

 

(3,863)

Compensation expense  related to stock option plans

 

 

 

 

                       70 

 

 

 

 

 

70 

Excess tax benefit from  stock-based awards

 

 

 

 

                       78 

 

 

 

 

 

78 

Common stock issued  pursuant to stock option plan

               20,325 

 

             102 

 

                     224 

 

 

 

 

 

326 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30,  2008

          6,442,090 

 $

 32,211 

 $

2,036 

 $

87,291 

 $

(3,103)

 $

118,435 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements

6

 

**PALMETTO BANCSHARES,  INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Cash Flows**

**(in thousands)**

 

 

 

 

 

 
   
 

 

 

 

 

 

 

 

 

**For the nine month periods ended September 30,**

 

 

 

 

 

 
   
**2008**

** **

**2007**

 

 

 

 

 

 

 

Operating activities

 

 
   
 

 

 

 

Net income

 

 
$
                  12,032 

 

                    11,722 

 

Adjustments to reconcile  net income to net cash provided by operating activities
   
 

 

 

 

 

Premises, furniture, and  equipment depreciation
   
                      1,470  

 

1,478 

 

 

Gain (loss) on disposition  of premises, furniture, and equipment
   
                              2 

 

                        (346)

 

 

Amortization of core  deposit intangibles
   
                            33 

 

                           36  

 

 

Amortization of unearned  discounts / premiums on investment securities available for sale, net
   
                            16 

 

                            62 

 

 

(Accretion) amortization of  unearned discounts / premiums on mortgage-backed investment securities	available for sale, net
   
                          (18)

 

                          111 

 

 

Investment securities gains
   
                            (1)

 

                            -   

 

 

Provision for loan losses
   
                      1,863  

 

                      1,200  

 

 

Originations of mortgage  loans held for sale
   
                  (60,856)

 

                  (41,388)

 

 

Sales of mortgage loans  held for sale
   
                    61,345 

 

                    42,221 

 

 

Gain on sales of mortgage  loans held for sale, net
   
                        (704)

 

                        (614)

 

 

Writedowns and losses on  sales of real estate acquired in settlement of loans
   
                            82 

 

                          171 

 

 

Compensation expense  related to stock option plan
   
                            70 

 

                            99 

 

 

Excess tax benefit from  stock-based awards
   
                            78 

 

                            -   

 

 

Decrease (increase) in  accrued interest receivable and other assets, net
   
                          758 

 

                    (1,277)

 

 

(Decrease) increase in  accrued interest payable and other liabilities, net
   
                    (1,090)

 

                      1,894  

 

 

 

Net cash provided by  operating activities
   
                    15,080 

 

                    15,369 

 

 

 

 

 

 
   
 

 

 

Investing activities

 

 
   
 

 

 

 

Maturities and calls of  investment securities available for sale
   
                    22,089 

 

                    40,090 

 

Purchases of investment securities  available for sale
   
                            -   

 

                  (22,333)

 

Purchases of  mortgage-backed investment securities available for sale
   
                  (66,536)

 

                    (1,646)

 

Repayments of  mortgage-backed investment securities available for sale
   
                      9,260  

 

                      3,812  

 

Purchases of FHLB stock
   
                    (5,029)

 

                        (630)

 

Redemptions of FHLB stock
   
                          405 

 

                            72 

 

Increase in loans, net

 
   
                  (88,654)

 

                  (67,508)

 

Sales of real estate  acquired in settlement of loans
   
                      3,202  

 

                         374 

 

Purchases of premises and  equipment, net
   
                    (3,006)

 

                    (1,114)

 

 

 

Net cash used in investing  activities
   
                (128,269)

 

                  (48,883)

 

 

 

 

 

 
   
 

 

 

 

 

 

 

 

 
   
 

 

 

Financing activities

 

 
   
 

 

 

 

(Decrease) increase in  transaction, money market, and savings deposit accounts, net
   
                  (51,360)

 

59,345 

 

Increase (decrease) in time  deposit accounts, net
   
                    48,846 

 

(56,431)

 

Increase (decrease) in  retail repurchase agreements, net
   
                    10,537 

 

(4,297)

 

Increase in commercial  paper, net
   
                    11,161 

 

9,648 

 

Increase in other  short-term borrowings
   
                    29,000 

 

                    27,000 

 

Increase in long-term  borrowings
   
                    52,000 

 

                            -   

 

Repayments of long-term  borrowings
   
                            -   

 

                  (10,000)

 

Proceeds from stock option  activity
   
                          326 

 

                          490 

 

Cash dividends declared and  paid on common stock
   
                    (3,863)

 

                    (3,643)

 

 

 

Net cash provided by  financing activities
   
                    96,647 

 

                    22,112 

 

 

 

 

 

 
   
 

 

 

Net decrease in cash and  cash equivalents
   
(16,542)

 

(11,402)

Cash and cash equivalents,  beginning of period
   
52,232 

 

46,666 

Cash and cash equivalents,  end of period
$
                  35,690 

 

                    35,264 

 

 

 

 

 

 
   
 

 

 

Supplemental cash flow  disclosures
   
 

 

 

 

Cash paid during the period  for:
   
 

 

 

 

 

Interest expense
$
                  20,878 

 

                    24,327 

 

 

Income taxes 

 
   
6,842 

 

6,018 

 

Significant noncash  activities
   
 

 

 

 

 

Net unrealized losses on  investment securities available for sale, net of tax
$
                     (364)

 

                        (113)

 

 

Loans transferred to real  estate acquired in settlement of loans, at fair value 
   
                      2,630  

 

                      6,115  

 

 

Premises reclassified as  held for sale, at fair value 
   
                      1,651  

 

                           -    

 

 

 

 

 

 
   
 

 

 

See Notes to Consolidated Interim Financial  Statements

7

 
 
 

 

 

 

**PALMETTOBANCSHARES, INC. AND SUBSIDIARY**

**Notes ToConsolidated Interim Financial Statements**

** **

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

 

*Natureof Operations*

* *

“PalmettoBancshares” is a regional financial services bank holding companyorganized in 1982 under the laws of South Carolina and headquartered inLaurens, South Carolina that provides, through itssubsidiary, The Palmetto Bank (the“Bank”), a broad array of commercial banking,consumer banking, trust and investment management, and brokerage servicesthroughout its market area primarily within northwest South Carolina (the“Upstate”).

* *

 

 

*Principles of Consolidation / Basis ofPresentation   *

*** ***

The accompanying ConsolidatedInterim Financial Statements include the accounts of Palmetto Bancshares, Inc.,(the “Company”), which includes its wholly owned subsidiary, the Bank, andthe Bank's wholly owned subsidiary, “Palmetto Capital.”  In management’sopinion, all significant intercompanyaccounts and transactions have been eliminated in consolidation. Theaccounting and financial reporting policies the Company follows conform, in allmaterial respects, to accounting principles generally accepted in the UnitedStates and to general practices within the financial services industry.

 

The Consolidated InterimFinancial Statements contained in this Quarterly Report on Form 10-Qhave not been audited by the Company’s independent registered public accountingfirm, but in the opinion of management, reflect all adjustments necessary for afair presentation of the Company’s financial position and results ofoperations. All such adjustments were of a normal and recurring nature, unlessotherwise disclosed. The ConsolidatedInterim Financial Statements have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation and with the instructions to Form 10-Q adopted by the SEC.Accordingly, the Consolidated InterimFinancial Statements do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements and should be read in conjunction with theCompany’s Consolidated Financial Statements,and notes thereto, for the year ended December 31, 2007, included in theCompany’s Annual Report on Form 10-K. Operating results for the interim periodsdisclosed herein are not necessarily indicative of the results that may beexpected for a full year or any future period.

 

*Use of Estimates*

* *

In preparing its ConsolidatedInterim Financial Statements, the Company’s management makes estimates andassumptions that impact the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities as of the date of the ConsolidatedInterim Financial Statements for the periods presented. Actual resultscould differ from these estimates and assumptions. Therefore, the results ofoperations for the three and nine month periods ended September 30, 2008 arenot necessarily indicative of the results of operations that may be expected infuture periods.

 
Business Segments
 

The Company adheres to the provisions of the FinancialAccounting Standards Board’s (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 131, "Disclosures About Segments of an Enterpriseand Related Information." Operating segments are components of anenterprise about which separate financial information is available that areevaluated regularly by the chief operating decision makers in deciding how toallocate resources and assess performance. SFAS No. 131 requires that a publicenterprise report a measure of segment profit or loss, certain specific revenueand expense items, segment assets, and information about the way that theoperating segments were determined, among other items. 

 

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

 

8

 

 

 

Asof September 30, 2008, the Company had made no changes to its determination inits Annual Report on Form 10-K for the year ended December 31, 2007 that it hadone reportable operating segment, banking.  

 
Reclassifications
* *

Certain amounts previously presented in the Company’s Consolidated Financial Statements for the yearended December 31, 2007 and the Company’s Consolidated Interim FinancialStatements for the three and nine month periods ended September 30, 2007have been reclassified to conform to current classifications.  No suchreclassifications had an impact on the prior period net income or retainedearnings as previously reported. 

 

Balance Sheet. The following table summarizes the Company’s Consolidated BalanceSheet at the date indicated, as then reported.

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Balance Sheet**

**(in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31,**

 

 

 

 

 

 

 

**2007**

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

Cash and due from banks

 

 

$

41,769 

 

 

Federal funds sold

 

 

10,463 

 

 

 

Total cash and cash equivalents

 

52,232 

 

 

 

 

 

 

 

 

 

FHLB stock, at cost

 

 

2,617 

 

Investment securities available for sale, at fair market value

95,715 

 

Mortgage loans held for sale

 

 

5,006 

 

 

 

 

 

 

 

 

 

Loans

 

 

 

 

1,044,770 

 

 

Less: allowance for loan losses

 

(7,418)

 

 

 

Loans, net

 

 

1,037,352 

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

25,133 

 

Goodwill

 

 

 

 

3,691 

 

Core deposit intangibles

 

 

79 

 

Accrued interest receivable

 

 

6,655 

 

Other

 

 

 

 

19,697 

 

 

 

 

Total assets

 

 

$

1,248,177 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

 

Liabilities

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Noninterest-bearing

 

 

$

135,111 

 

 

Interest-bearing

 

 

923,683 

 

 

 

Total deposits

 

 

1,058,794 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

11,280 

 

Commercial paper (Master notes)

 

26,326 

 

Federal funds purchased

 

 

30,000 

 

FHLB borrowings - long-term

 

 

- 

 

Accrued interest payable

 

 

2,042 

 

Other

 

 

 

 

9,479 

 

 

 

Total liabilities

 

 

1,137,921 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

Common stock

 

 

32,109 

 

Capital surplus

 

 

1,664 

 

Retained earnings

 

 

79,221 

 

Accumulated other comprehensive loss, net of tax

 

(2,738)

 

 

 

Total shareholders' equity

 

110,256 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,248,177 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents arecomprised of cash and due from bank balances as well as federal funds sold tocorrespondent banks.  Federal funds sold are essentially uncollateralized loansto other financial institutions. During 2007, interest-bearing cashbalances held at the FHLB were reported within federal funds sold.  During2008, management concluded that, although such balances were interest-bearing,they were not federal funds sold.  Within this Quarterly Report on Form 10-Q,prior period balances have been reclassified and are reported within the cashand due from banks. 

 

The Company originates certain mortgage loans with theintention of selling them in the secondary market.  A lag may occur from thetime that the sale proceeds are received by the Company and the time that allpaperwork is received and the appropriate entries are made to the Company’srecords.  At December 31, 2007, sale proceeds received were recorded in aclearing account.  At December 31, 2007, this clearing account was reportedwithin other in the assets section of the Consolidated Balance Sheet.  During2008, management concluded that, because that the sales proceeds relate toloans no longer held for sale, the clearing account should be offset againstmortgage loans held for sale. Within this Quarterly Report on Form 10-Q, priorperiod balances have been reclassified and are reported within mortgage loansheld for sale. 

 

9

 

 

 

Statements of Income. The following table summarizes the Company’s Consolidated InterimStatements of Income for the periods indicated, as then reported.

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated Interim Statement of Income**

 

**(in thousands) (unaudited)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three**

**month period**

**ended**

**September 30,**

**2007**

 

**For the nine**

**month period**

**ended**

**September 30,**

**2007**

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

Interest and fees on loans

 

$

20,012 

 

58,079 

 

Interest on investment securities available for sale

1,085 

 

3,386 

 

Interest on federal funds sold

 

149 

 

600 

 

Dividends on FHLB stock

 

47 

 

122 

 

 

 

Total interest income

 

21,293 

 

62,187 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

Interest on deposits

 

7,663 

 

22,327 

 

Interest on retail repurchase agreements

149 

 

425 

 

Interest on commercial paper

 

312 

 

839 

 

Interest on other short-term borrowings

414 

 

497 

 

Interest on long-term borrowings

- 

 

173 

 

 

 

Total interest expense

 

8,538 

 

24,261 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,755 

 

37,926 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

400 

 

1,200 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,355 

 

36,726 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

Service charges on deposit accounts

2,001 

 

5,900 

 

Fees for trust and brokerage services

736 

 

2,258 

 

Mortgage-banking income

 

468 

 

987 

 

Investment securities gains

 

- 

 

- 

 

Other

 

 

 

1,407 

 

3,164 

 

 

 

Total noninterest income

4,612 

 

12,309 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

Salaries and other personnel

 

7,040 

 

19,234 

 

Occupancy

 

 

375 

 

1,124 

 

Premises, furniture, and equipment leases and rentals

321 

 

946 

 

Premises, furniture, and equipment depreciation

492 

 

1,478 

 

Other furniture and equipment

 

482 

 

1,385 

 

Loss on disposition of premises, furniture, and equipment

346 

 

346 

 

Marketing

 

 

208 

 

695 

 

Amortization of core deposit intangibles

12 

 

36 

 

Other

 

 

 

2,115 

 

6,160 

 

 

 

Total noninterest expense

11,391 

 

31,404 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

5,576 

 

17,631 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

1,680 

 

5,909 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,896 

 

11,722 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Within this Quarterly Report on Form 10-Q, interest earnedon federal funds sold as well as interest earned on interest-bearing cashbalances held at the FHLB, both of which were previously reported withininterest on federal funds sold have been aggregated within other in theinterest income section of the Consolidated Interim Statements of Income.

 

During 2007, in an effort to provide more transparentinformation to readers of the Company’s Consolidated Interim Statements ofIncome, the Company reclassified certain expenses relating to the operation ofits automatic teller machines, the operation of its Internet banking product,and the offering of merchant and cardholder services.  During the three andnine month periods ended September 30, 2007, such amounts were reported net ofrelated income within other in the noninterest income section of theConsolidated Interim Statements of Income. Within this Quarterly Report on Form10-Q, prior period balances have been reclassified and are reported grosswithin other in the noninterest expense section of the Consolidated InterimStatements of Income. 

 

Within this Quarterly Report on Form 10-Q, occupancy,premises, furniture, and equipment balances that were previously reportedseparately within the noninterest expense section of the Consolidated InterimStatements of Income were aggregated due to such desegregated balances notmeeting materiality thresholds for presentation on the face of the Company’sConsolidated Interim Statements of Income.  The following table compares suchpreviously reported Consolidated Interim Statements of Income classificationsto current classifications for the periods indicated (in thousands).

 

10

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

**period ended**

**September 30, 2007**

 

**For the nine month**

**period ended**

**September 30, 2007**

As previously reported

 

 

 

 

			Occupancy

$

375 

 

1,124 

 

			Premises, furniture, and equipment leases and rentals

321 

 

946 

 

			Premises, furniture, and equipment depreciation

492 

 

1,478 

 

			Other furniture and equipment

482 

 

1,385 

 

 

$

1,670 

 

4,933 

As currently reported

 

 

 

 

			Occupancy

$

752 

 

2,182 

 

			Furniture and equipment

918 

 

2,751 

 

 

$

1,670 

 

4,933 

 

See Note 14 for information regarding the Company’spremises and equipment lease and rental expense for the periods covered by thisQuarterly Report on Form 10-Q.  See Note 5 for information regarding the Company’spremises and equipment depreciation for the periods covered by this QuarterlyReport on Form 10-Q.  

 

Statement of Cash Flows. Within this Quarterly Reporton Form 10-Q, in an effort to provide more detailed information to the readersof the Company’s Consolidated Interim Statement of Cash Flows, previouslyreported classifications for the nine month period ended September 30, 2007were reclassified in order to comply with current classifications.  Thefollowing table summarizes selected classifications as previously reported inthe Company’s Consolidated Interim Statement of Cash Flows for the periodindicated that have been subject to currentreclassifications (in thousands).

 

 

 

 

 

 

 

**For the nine month**

**period ended**

**September 30, 2007**

Depreciation, amortization, and accretion, net

$

1,687 

 

 

Purchase of investment securities available for sale

(23,979)

 

 

Maturities, redemption, calls, and principal repayments of investment securities available for sale

43,902 

 

 

Deposits, net

2,914 

 

 

 

The following table summarizes the reclassified reporting ofsuch classifications in the Company’s Consolidated Interim Statement of CashFlows within this Quarterly Report on Form 10-Q for the period indicated (in thousands).

 

 

 

 

 

**For the nine month**

**period ended**

**September 30, 2007**

Premises, furniture, and equipment depreciation

$

1,478 

Amortization of core deposit intangibles

36 

Amortization of unearned discounts / premiums on investment securities available for sale, net

62 

Amortization of unearned discounts / premiums on mortgage-backed		investment securities available for sale, net

111 

 

$

1,687 

 

 

Purchases of investment securities available for sale

$

(22,333)

Purchases of mortgage-backed investment securities available for sale

(1,646)

 

$

(23,979)

 

 

Maturities and calls of investment securities available for sale

$

40,090 

Repayments of mortgage-backed investment securities available for sale

3,812 

 

$

43,902 

 

 

Increase in transaction, money market, and savings deposit accounts, net

$

59,345 

Decrease in time deposit accounts, net

(56,431)

 

$

2,914 

 

 

 

As previously noted, during 2007, the clearing account inwhich mortgage loan sales proceeds are recorded until the paperwork isprocessed was reported within other in the assets section of the ConsolidatedBalance Sheet.  During 2008, the clearing account began being offset againstmortgage loans held for sale. Within this Quarterly Report on Form 10-Q, priorperiod balances have been reclassified and are reported within mortgage loansheld for sale. This reclassification impacted the reporting of cash flowsrelative to mortgage loans held for sale for the nine month period endedSeptember 30, 2007.  

 

11

 

The following table summarizes selected fluctuations andcash flows relative to mortgage loans held for sale as previously reported inthe Company’s Consolidated Interim Statement of Cash Flows for the periodindicated that have been subject to currentreclassifications (in thousands).

 

 

**For the nine month period			ended September 30, 2007**

Mortgage loans held for sale, December 31, 2006

$

1,675 

Mortgage loans held for sale, September 30, 2007

1,435 

Decrease in mortgage loans held for sale during the nine month period ended September 30, 2007

$

240 

 

 

Origination of mortgage loans held for sale

$

(48,991)

Proceeds from sale of mortgage loans held for sale

49,832 

Noncash reclass of loans to mortgage loans held for sale

13 

Gain on sale of mortgage loans, net

(614)

Decrease in mortgage loans held for sale during the nine month period ended September 30, 2007

$

240 

 

 

 

The following table summarizes the reclassified reporting ofsuch classifications in the Company’s Consolidated Interim Statement of CashFlows within this Quarterly Report on Form 10-Q for the period indicated (in thousands).

 
 
 

 

 

 

 

 

**For the nine month period			ended September 30, 2007**

Mortgage loans held for sale, December 31, 2006

$

1,670 

Mortgage loans held for sale, September 30, 2007

1,438 

Decrease in mortgage loans held for sale during the nine month period ended September 30, 2007

$

232 

 

 

Originations of mortgage loans held for sale

$

(41,388)

Sales of mortgage loans held for sale

42,221 

Noncash reclass of loans to mortgage loans held for sale

13 

Gain on sales of mortgage loans			held for sale, net

(614)

Decrease in mortgage loans held for sale during the nine month period ended September 30, 2007

$

232 

* *

*Recently Adopted Accounting Pronouncements*

 

Following is a summary of applicable accountingpronouncements adopted by the Company during the nine month period endedSeptember 30, 2008.

 

In September 2006, the FASB issuedSFAS No. 157, "Fair Value Measurements,” which provides guidance for usingfair value to measure assets and liabilities but does not expand the use offair value in any circumstance. SFAS No. 157 also requires expanded disclosuresabout the extent to which a company measures assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on an entity’s financial statements. The statement applies whenother standards require or permit assets and liabilities to be measured at fairvalue. SFAS No. 157 was effective for the Company forfiscal and interim periods beginning January 1, 2008.  Subsequently,in February 2008, the FASB issued FASB Staff Position (“FSP”) No. 157-2,“Effective Date of FASB Statement No. 157,” which delayed the effectivedate of SFAS No. 157 for nonrecurring, nonfinancial instruments to fiscal yearsbeginning after November 15, 2008. The Company adopted SFAS No. 157 forrecurring instruments and nonrecurring, financial instruments onJanuary 1, 2008. Because SFAS No. 157 provides guidance and amends onlythe disclosure requirements for fair value measurements, its adoption did nothave a material impact on the Company’s financial position, results ofoperations, or cash flows.  

 

In February 2007, the FASB issuedSFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB StatementNo. 115.” SFAS No. 159 permits entities to choose to measure eligibleitems at fair value at specified election dates. Unrealized gains and losses onitems for which the fair value option has been elected are reported in earningsat each subsequent reporting date. The fair value option may be appliedinstrument by instrument, with certain exceptions, is irrevocable (unless a newelection date occurs), and is applied only to entire instruments and notto portions of instruments. SFAS No. 159 was effective for the Company onJanuary 1, 2008. The Company did not elect the fair value option for anyfinancial assets or liabilities as of January 1, 2008. Its adoptions did nothave a material impact on the Company’s financial position, results ofoperations, or cash flows. 

 

 

 

12

 

 

 

 

 

In March 2007, the FASB ratified the consensus reached by the Emerging IssuesTask Force (“EITF”) in Issue No. 06-10, “Accounting for Collateral AssignmentSplit-Dollar Life Insurance Arrangements.”  The EITF’s consensus concluded thatan employer should recognize a liability for the postretirement benefit relatedto a collateral assignment split-dollar life insurance arrangement inaccordance with either SFAS No. 106, “*Employers' Accounting for Postretirement Benefits Other Than Pension,”* (if, in substance, a postretirement benefit plan exists)or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion—1967,”(if the arrangement is, in substance, an individual deferred compensationcontract) if the employer has agreed to maintain a life insurance policy duringthe employee's retirement or provide the employee with a death benefit based onthe substantive agreement with the employee. Additionally, the EITF concludedthat an employer should recognize and measure an asset based on the nature andsubstance of the collateral assignment split-dollar life insurance arrangement.The EITF observed that in determining the nature and substance of thearrangement, the employer should assess what future cash flows the employer isentitled to, if any, as well as the employee's obligation and ability torepay the employer. The consensus in this Issue is effective for fiscal yearsbeginning after December 15, 2007, including interim periods within thosefiscal years with earlier application permitted. The consensus further directedentities to recognize the effects of applying the consensus in this Issuethrough either (a) a change in accounting principle through a cumulative-effectadjustment to retained earnings or to other components of equity or net assetsin the statement of financial position as of the beginning of the year ofadoption or (b) a change in accounting principle through retrospective applicationto all prior periods. The Company adopted EITF No. 06-10 on January 1, 2008 asa change in accounting principle through a cumulative-effect adjustment toretained earnings totaling $99 thousand.

 

In November 2007, the SEC issuedStaff Accounting Bulletin (“SAB”) No. 109, “Written Loan CommitmentsRecorded at Fair Value Through Earnings,” which expressed the views of thestaff regarding written loan commitments that are accounted for at fair valuethrough earnings under generally accepted accounting principles. SAB No. 105, “Applicationof Accounting Principles to Loan Commitments,” provided the views of the staffregarding derivative loan commitments that are accounted for at fair valuethrough earnings pursuant to SFAS No. 133, “*Accountingfor Derivative Instruments and Hedging Activities*.” SAB No.105 stated that in measuring the fair value of a derivative loan commitment,the staff believed it would be inappropriate to incorporate the expected netfuture cash flows related to the associated servicing of the loan. This SABsuperseded SAB No. 105 and expressed the current view of the staff that,consistent with the guidance in SFAS No. 156, “*Accounting for Servicing of Financial Assets—an amendment of FASBStatement No. 140,”*****andSFAS No. 159, the expected net future cash flows related to theassociated servicing of the loan should be included in the measurement of allwritten loan commitments that are accounted for at fair value through earnings.SAB No. 105 also indicated that the staff believed that internally-developedintangible assets (such as customer relationship intangible assets) should notbe recorded as part of the fair value of a derivative loan commitment. This SABretained the staff view and broadens its application to all written loan commitmentsthat are accounted for at fair value through earnings. The staff expectedregistrants to apply the views in SAB No. 109 on a prospective basis toderivative loan commitments issued or modified in fiscal quarters beginningafter December 15, 2007. The guidance within SAB No. 109 was effective onJanuary 1, 2008.  The Company adopted the guidance of SAB No. 109 onJanuary 1, 2008.  Its adoption did not have a material impact on the Company’sfinancial position, results of operations, or cash flows.  

 

In October 2008, the FASB issued FSP No. 157-3,“Determining the Fair Value of a Financial Asset When the Market for That Assetis Not Active,” which clarified the application of SFAS No. 157 in an inactivemarket and illustrated how an entity would determine fair value when the marketfor a financial asset is not active. FSP No. 157-3 stated that an entity shouldnot automatically conclude that a particular transaction price is determinativeof fair value. Further, FSP No. 157-3 stated that in a dislocated market,judgment is required to evaluate whether individual transactions are forcedliquidations or distressed sales. When relevant observable market informationis not available, a valuation approach that incorporates management’s judgmentsabout the assumptions that market participants would use in pricing the assetin a current sale transaction would be acceptable. FSP No. 157-3 also indicatedthat quotes from brokers or pricing services may be relevant inputs whenmeasuring fair value but are not necessarily determinative in the absence of anactive market for the asset. Further, FSP No. 157-3 stated that in weighing abroker quote as an input to a fair value measurement, an entity should placeless reliance on quotes that do not reflect the result of market transactions.Further, the nature of the quote should be considered when weighing theavailable evidence. FSP No. 157-3 was effective immediately and applies toprior periods for which financial statements have not been issued, includinginterim or annual periods ending on or before September 30, 2008.Accordingly, the Company adopted FSP No. 157-3 prospectively, beginningJuly 1, 2008. Its adoption did not result in other-than-temporaryimpairment on any of the Company’s investment securities available for sale nordid it have a material impact on the Company’s financial position, results ofoperations, or cash flows.  

 

In October 2008, the SEC’s Office of the Chief Accountant(“OCA”) clarified its views on the application of other-than-temporary impairmentguidance in SFAS No. 115, “Accounting for Certain Investments in Debt andEquity Securities,” to certain perpetual preferred securities. The OCAconcluded that it would not object to a registrant applying another-than-temporary impairment model to investments in perpetual preferredsecurities that possess significant debt-like characteristics similar to theimpairment model applied to debt securities, provided there has been noevidence of deterioration in credit of the issuer. An entity was permitted toapply the OCA’s views in its financial statements included in filingssubsequent to the date of the letter. As such, the Company applied thisguidance to its financial statements as of and for the periods ending September30, 2008. Its application did not have a material impact on the Company’sfinancial position, results of operations, or cash flows.  

 

 

13

 

 

 

 

*Recently Issued Applicable Accounting Pronouncements*

 

In February 2008, the FASB issuedFSP No. 157-2, which delayed the effective date of SFAS No. 157 fornonrecurring, nonfinancial instruments to fiscal years beginning afterNovember 15, 2008. As such, the effective date of the application of SFASNo. 157 for such instruments is January 1, 2009.  Because SFAS No. 157provides guidance and amends only the disclosure requirements for fair valuemeasurements, its adoption did not have a material impact on the Company’sfinancial position, results of operations, or cash flows.  

 

InFebruary 2008, the FASB issued FSP No. 140-3, “Accounting for Transfers ofFinancial Assets and Repurchase Financing Transactions.”  FSP No. 140-3provides guidance on accounting for a transfer of a financial asset and thetransferor’s repurchase financing of the asset and presumes that an initialtransfer of a financial asset and a repurchase financing are considered part ofthe same arrangement (linked transaction) under SFAS No. 140, “Accounting forTransfers and Servicing of Financial Assets and Extinguishments ofLiabilities-a replacement of FASB Statement No. 125.” However, if certaincriteria are met, the initial transfer and repurchase financing are not to beevaluated as a linked transaction but are to be evaluated separately under SFASNo. 140.  FSP No. 140-3 is effective for the Company for fiscal and interimperiods beginning January 1, 2009. Earlier application is not permitted.The Company does not anticipate that the adoption of FSP No. 140-3 will have amaterial impact on its financial position, results of operations, or cashflows.  

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities—an amendment of FASB StatementNo. 133,” which requires enhanced disclosures about an entity’s derivative andhedging activities and thereby improves the transparency of financialreporting. SFAS No. 161 is effective for the Company on January 1,2009. Earlier application is encouraged.  SFAS No. 161 encourages, but does notrequire, comparative disclosures for earlier periods at initial adoption.Because SFAS No. 161 amends only the disclosure requirements for derivativeinstruments and hedged items, the Company does not anticipate that its adoptionwill have a material impact on its financial position, results of operations,or cash flows.  

 

InApril 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life ofIntangible Assets.”  FSP No. 142-3 amends the factors that should be consideredin developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under SFAS No. 142, “Goodwill and OtherIntangible Assets.”  FSP No. 142-3 is intended to improve the consistency between theuseful life of a recognized intangible asset under SFAS No. 142 and the periodof expected cash flows used to measure the fair value of the asset under SFASNo. 141R**and other United States generally accepted accounting principles.  FSP No. 142-3 iseffective for the Company for fiscal and interim periods beginningJanuary 1, 2009. Earlier application is not permitted. The Company iscurrently evaluating the impact that the adoption of FSP No. 142-3 may have onits financial position, results of operations, or cash flows.

 

InMay 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally AcceptedAccounting Principles.”   SFAS No. 162 identifies the sources of accountingprinciples and the framework for selecting the principles to be used in thepreparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles in theUnited States. This Statement is not intended to change current practice. However, the FASB provided transition provisions in the unusual circumstancethat the application of the provisions of this Statement results in a change inpractice.  This Statement is effective 60 days following the SEC’s approval ofthe Public Company Accounting Oversight Board amendments to AU Section 411,“The Meaning of Present Fairly in Conformity With Generally Accepted AccountingPrinciples.”  Such approval was obtained on September 16, 2008.  As such SFASNo. 162 will be effective November 15, 2008.  Because SFAS No. 162 onlyidentifies the sources of accounting principles and the framework for selectingthe principles to be used in the preparation of financial statements ofnongovernmental entities that are presented in conformity with generallyaccepted accounting principles in the United, the Company does not anticipatethat its adoption will have a material impact on its financial position,results of operations, or cash flows.  

 

14

 

 

In June 2008, the FASBissued EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-BasedPayment Transactions are Participating Securities.”  The EITF states that unvestedshare-based payment awards that contain nonforfeitable rights to dividends ordividend equivalents are participating securities and must be included in theearnings per share computation.  EITF No. 03-6-1 is effective for financialstatements issued for fiscal years beginning after December 15, 2008 andinterim periods within those years. All prior-period earnings per share datapresented must be adjusted retrospectively. Early application is notpermitted.  EITFNo. 03-6-1 is effective for the Company for fiscal and interim periodsbeginning January 1, 2009. The Company is currently evaluating the impactthat the adoption of EITF No. 03-6-1 may have on its financial position,results of operations, or cash flows.

 

In September 2008, the FASB issued FSP No. 133-1 andFASB Interpretation (“FIN”) No. 45-4, “Disclosures about Credit Derivatives andCertain Guarantees: An Amendment of FASB Statement No. 133 and FASBInterpretation No. 45; and Clarification of the Effective Date of FASBStatement No. 161.” These pronouncements are intended to improve disclosuresabout credit derivatives by requiring more information about the potentialadverse effects of changes in credit risk on the financial position, financialperformance, and cash flows of the sellers of credit derivatives. It amendsSFAS No. 133 to require disclosures by sellers of credit derivatives, includingcredit derivatives embedded in hybrid instruments. These pronouncements alsoamends FIN No. 45*,*“Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness toOthers,” to require an additional disclosure about the current status of thepayment / performance risk of a guarantee. The provisions of thesepronouncements that amend SFAS No. 133 and FIN No. 45 are effective forreporting periods (annual or interim) ending after November 15, 2008.These pronouncements are effective for the Company for the annual reportingperiod ending December 31, 2008.  The Company is currently evaluating theimpact that the adoption of EITF No. 03-6-1 may have on its financial position,results of operations, or cash flows.  However, because such pronouncementsamend only the disclosure requirements for credit derivatives and certainguarantees, the Company does not anticipate that its adoption will have amaterial impact on its financial position, results of operations, or cashflows.  

 

***2.       Cash and CashEquivalents***

 

The Federal Reserve Act requireseach depository institution to maintain reserves against its reservableliabilities as prescribed by Federal Reserve Board regulations. The Bank reportsits reservable liabilities to the Federal Reserve on a weekly basis.  Weeklyreporting institutions maintain reserves on their reservable liabilities with a30-day lag.  For the maintenance period ended on October 8, 2008, based onreservable liabilities from August 26, 2008 through September 8, 2008, theFederal Reserve required the Bank to maintain reserves of $10.1 million.  Dueto the Company’s levels of vault cash, $338 thousand in reserves was requiredto be maintained at the Company’s correspondent transaction settlement bank inaddition to $1.0 million that was required to be maintained with the FederalReserve. 

 

The Emergency EconomicStabilization Act of 2008 accelerated, to October 1, 2008, the effective datefor the Federal Reserve’s authority to pay interest on account balances thatdepository institutions hold at the Federal Reserve banks.  The provisions topay interest on such balances are contained in the Financial ServicesRegulatory Relief Act of 2006 with an original implementation date of October1, 2011.  Accordingly, interest will be paid on balances held to satisfyreserve requirements and on balances held in excess of required reservebalances and clearing balances commencing with the maintenance period beginningon October 9, 2008. The interest rate paid onrequired reserve balances will be the average targeted federal funds rateestablished by the Federal Open Market Committee over each reserve maintenanceperiod less 10 basis points. Paying interest on required reserve balancesshould essentially eliminate the opportunity cost of holding required reserves,promoting efficiency in the banking sector.  The rate paid on excessbalances will be set initially as the lowest targeted federal funds rate foreach reserve maintenance period less 75 basis points.  The formula for theinterest rate on excess balances may be adjusted subsequently in light ofexperience and evolving market conditions. The payment of interest onexcess reserves will permit the Federal Reserve to expand its balance sheet asnecessary to provide the liquidity to support financial stability whileimplementing the monetary policy that is appropriate in light of the FederalReserve System’s macroeconomic objectives of maximum employment and pricestability.

 

15

 

* *

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

 

General

 

During 2008, the Company began investing in collateralizedmortgage obligations. Collateralized mortgage obligations are a mortgage-backedsecurity sub-type in which the mortgages are ordered into tranches by somequality (such as repayment time) with each tranche sold as a separate security.These securities, in addition to the Company’s other investment securitiesavailable for sale, are accounted for in accordance with SFAS No. 115 asdiscussed in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2007.

 

The following tablesummarizes the composition of the Company’s investment securities available forsale portfolio at the dates indicated (dollars in thousands).

 

 

** **

** **

**September 30, 2008**

** **

**December 31, 2007**

** **

** **
   
**Total**

**% of total**

** **

**Total**

**% of total**

United States Treasury and federal agencies
$
                   -   

                -   

%

             20,743 

             21.7 

State and municipal 
   
             51,170 

             39.3 

 

             52,159 

             54.5 

Collateralized mortgage  obligations
   
             58,846 

             45.2 

 

                     -   

                -   

Other mortgage-backed  (federal agencies)
   
             20,305 

             15.5 

 

             22,813 

             23.8 

 

Total investment securities  available for sale
$
         130,321 

           100.0 

%

             95,715 

           100.0 

 

 

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

 

 

 

 

 

**September 30, 2008**

 

 

 
   
**Amortized cost**

**Gross unrealized gains**

**Gross unrealized losses**

**Fair  value**

 
   
 

 

 

 

 

United States Treasury and federal agencies
$
            -   

                -   

                -   

              -   

 

State and municipal
   
      51,085 

              300 

            (215)

      51,170 

 

Collateralized mortgage  obligation
   
      59,765 

                18 

            (937)

      58,846 

 

Other mortgage-backed  (federal agencies)
   
      20,465 

              134 

            (294)

      20,305 

 

 

Total investment securities  available for sale 
$
  131,315 

              452 

         (1,446)

    130,321 

 

 

 
   
 

 

 

 

 

 

 

**December 31, 2007**

 

 

 
   
**Amortized cost**

**Gross unrealized gains**

**Gross unrealized losses**

**Fair value**

 
   
 

 

 

 

 

United States Treasury and federal agencies
$
    20,725 

                26 

                (8)

      20,743 

 

State and municipal
   
      52,677 

                55 

            (573)

      52,159 

 

Other mortgage-backed  (federal agencies)
   
      22,722 

              196 

            (105)

      22,813 

 

 

Total investment securities  available for sale 
$
    96,124 

              277 

            (686)

      95,715 

 

The Company receives market valuationsmonthly from one of the fixed income industry’s leading broker / dealers andinvestment advisors. Market values provided are based upon equivalentcomparable securities that have actually traded in the marketplace on aspecified day. Market valuations are not matrix based but are based upon actualmarket participation. 

 

*Securities Pledgedand Liquidity*

 

Approximately 57% of the investment securities portfolio, atfair value, was pledged to secure public deposits and trust assets at September30, 2008 as compared with 80% at December 31, 2007.  Of the Company’s $74.4million pledged available for sale investment securities balance at September30, 2008, $47.4 million of the investment securities portfolio, at fair value,was securing public deposits and trust assets at September 30, 2008.  Of theCompany’s $76.6 million pledged available for sale investment securitiesbalance at December 31, 2007, $40.4 million of available for sale investmentsecurities were securing public deposits and trust assets.  The decrease inpledged securities as a percentage of the investment securities portfolio fromDecember 31, 2007 to September 30, 2008 was primarily the result of an increasein the portfolio.  

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities.  Approximately $46 million, or 36%, of the investmentsecurities portfolio, at fair value, was pledged to collateralize FHLB advancesand letters of credit as of September 30, 2008, of which $41.8 million wasavailable as lendable collateral.  In order to compute lendable collateralamounts, investment security market values are multiplied by a collateral valuepercentage. No investment securities were pledged at December 31, 2007 tocollateralize FHLB advances and letters of credit.

 

16

 

 

*Impairment Analysis*

* *

The following table summarizes thegross unrealized losses, fair value, and the number of securities in eachcategory of investment securities available for sale, aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position, at thedates indicated (dollars in thousands).

 

 

**September 30, 2008**

 

 

**Less than 12 months**

** **

**12 months or longer**

** **

**Total**

 

 

**#**

**Fair value**

**Gross 	unrealized losses**

** **

**#**

**Fair value**

**Gross 	unrealized 	losses**

** **

**#**

**Fair value**

**Gross 	unrealized 	losses**

State and municipal

      27 

 $
13,499 
 $
106 
 

      17 

      6,694 

              109 

 

      44 

    20,193 

              215 

Collateralized mortgage  obligation

      12 

         
50,470 
              
937 
 

       -   

            -   

                -   

 

      12 

    50,470 

              937 

Other mortgage-backed  (federal agencies)

        5 

          
 7,614 
              
185 
 

        5 

      4,319 

              109 

 

      10 

    11,933 

              294 

 

Total investment securities  available for sale 

      44 

 $
71,583 
 $
1,228 
 

      22 

    11,013 

              218 

 

      66 

    82,596 

           1,446 

 

 

 

 

 

 

 

 

 

  

 

 

**December 31, 2007**

 

 

**Less than 12 months**

** **

**12 months or longer**

** **

**Total**

 

 

**#**

**Fair 	value**

**Gross 	unrealized 	losses**

** **

**#**

**Fair market 	value**

**Gross 	unrealized 	losses**

** **

**#**

**Fair	value**

**Gross 	unrealized 	losses**

United States Treasury and federal agencies

       -   

 $
 -   
 $
 -   
 

        2 

      3,476 

                  8 

 

        2 

      3,476 

                  8 

State and municipal

      16 

      
6,135 
                
79 
 

      98 

    38,760 

              494 

 

    114 

    44,895 

              573 

Other mortgage-backed  (federal agencies)

        1 

         
733 
                
-   
 

      15 

    10,655 

              105 

 

      16 

    11,388 

              105 

 

Total investment securities  available for sale 

      17 

 $
 6,868 
 $
79 
 

    115 

    52,891 

              607 

 

    132 

    59,759 

              686 

 

The change in investment securities in a gross unrealizedlosses position at September 30, 2008 was largely due to decreases in marketinterest rates over the yields available at the time the underlying securitieswere purchased. The fair value is expected to recover as the bonds approachtheir maturity date or repricing date or if market yields for such investmentsdecline further. Gross unrealized losses increased $760 thousand from December31, 2007 to September 30, 2008 as a result of the purchase of collateralizedmortgage obligation.  Offsetting this increase in gross unrealized losses weredeclines with regard to the state and municipal and other mortgage-backedportfolios.  The increase in investment securities in a gross unrealized lossesposition at September 30, 2008 less than 12 months was concentrated within thecollateralized mortgage obligation portfolio.  The decline in investmentsecurities in a gross unrealized losses position at September 30, 2008 12months or longer was due to declines in the state and municipal and othermortgage-backed portfolios.

 

The initial indication of other-than-temporary impairmentfor debt securities is a decline in the market value below the amount recordedfor an investment and the severity and duration of the decline. In determiningwhether an impairment is other-than-temporary, management considers the lengthof time and the extent to which the market value has been below cost, recentevents specific to the issuer, including investment downgrades by ratingagencies and economic conditions of its industry, and the Company’s ability andintent to hold the investment for a period of time sufficient to allow for anyanticipated recovery. Also considered is the cause of the price decline(general level of interest rates and industry- and issuer-specific factors),the issuer’s financial condition, near-term prospects and current ability tomake future payments in a timely manner, the issuer’s ability to service debt,and any change in agencies’ ratings at evaluation date from acquisition dateand any likely imminent action. Any decline in the fair value of available forsale securities below cost that are deemed to be other-than-temporary isreflected in earnings as realized losses. As of September 30, 2008, the Companyhas received all principal and interest payments, believes that the principaland interest on these securities are fully recoverable, and has the ability andintent to hold the securities for a period of time sufficient for a recovery ofcost. Accordingly, management believes the gross unrealized losses detailed inthe preceding table are temporary, and, therefore, were notother-than-temporarily impaired as of September 30, 2008.

 

*Concentrations of Risk*

 

No state and municipal securityissuers issued securities with fair values exceeding 2% of total shareholders’equity at September 30, 2008. Four state and municipal security issuers issuedsecurities with fair values exceeding 1% of total shareholders’ equity atSeptember 30, 2008 ranging from 1.0% to 1.8%. Although all state and municipalinvestment securities are not rated “AAA,” all are within the Company’s ratingsstandards outlined in its Investment Policy which requires rated bonds to be balancedto average “Aa” to “A” by one of the major bond rating agencies. 

 

17

 

 

Collateralized mortgage obligationissuers issued securities with fair values ranging from 1.7% of totalshareholders’ equity at September 30, 2008 to 8.1% of total shareholders’equity at September 30, 2008. The following table summarizes issuerconcentration at fair value of other mortgage-backed investmentsecurities, by issuer, at September 30, 2008 (dollars in thousands).

 

 

 
   
**Federal National 	Mortgage Association**

** **

**Federal Home 	Loan Mortgage 	Corporation**

**Total**

Other mortgage-backed
$
        16,865 

 

             3,440 

      20,305 

 

 
   
 

 

 

 

As a percentage of  shareholders' equity
   
              14.2 

 % 

                 2.9 

          17.1 

 

 
   
 

 

 

 

 

At September 30, 2008,collateralized mortgage obligations and other mortgage-backed investmentsecurities were rated “AAA” by Standard and Poor's, Moody's, and / or FitchRatings.  This “AAA” rating is based not on the credit of the issuer, but ratheron the structure of the securities and the credit quality of the collateral.Further, during the three month period ended September 30, 2008, the UnitedStates government stepped in to help rescue the Federal National MortgageAssociation and the Federal Home Loan Mortgage Corporation.  The government putboth entities into conservatorships under the control of their regulator, theFederal Housing Finance Agency.  The takeover makes the government’s onceimplicit guarantee explicit.  

 

***4.       Loans***

 

Composition

 

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

 

 

 

**September 30,**

 

**December 31,**

** **

** **

**2008**

** **

**2007**

** **

** **
   
**Total**

**% of total**

** **

**Total**

**% of total**

Commercial business
$
          151,510 

      13.4 

%

          145,634 

      13.9 

Commercial real estate
   
            719,379 

      63.7 

 

          639,144 

      61.2 

Installment
   
              23,251 

        2.1 

 

            25,315 

        2.4 

Installment real estate
   
              82,316 

        7.3 

 

            75,721 

        7.3 

Indirect
   
              35,407 

        3.1 

 

            39,502 

        3.8 

Credit line
   
                1,939 

        0.2 

 

              2,188 

        0.2 

Prime access
   
              61,382 

        5.4 

 

            54,164 

        5.2 

Residential mortgage
   
              37,132 

        3.3 

 

            40,842 

        3.9 

Bankcards
   
              12,272 

        1.1 

 

            12,702 

        1.2 

Business manager
   
                   209 

         -   

 

                 326 

         -   

Other
   
                1,651 

        0.1 

 

              2,045 

        0.2 

Loans in process
   
                2,437 

        0.2 

 

              6,511 

        0.6 

Deferred loans fees and  costs
   
                   451 

        0.1 

 

                 676 

        0.1 

 

Loans, gross
$
       1,129,336 

    100.0 

%

       1,044,770 

    100.0 

 

 
   
 

 

 

 

 

 

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

 

 

 

**September 30,**

 

**December 31,**

** **

** **

**2008**

** **

**2007**

** **

** **
   
**Total**

**% of total**

** **

**Total**

**% of total**

Secured by real estate
   
 

 

 

 

 

 

Construction, land  development, and other land loans
$
          50,331 

        4.4 

 % 

            52,236 

        5.0 

 

Farmland
   
                 899 

        0.1 

 

              1,004 

        0.1 

 

Single-family residential
   
         	214,967 

      19.0 

 

          209,275 

      20.0 

 

Multifamily residential
   
            33,921 

        3.0 

 

            28,659 

        2.8 

 

Nonfarm nonresidential
   
          653,449 

      57.9 

 

          578,719 

      55.4 

Commercial and industrial
   
            89,413 

        7.9 

 

            77,555 

        7.4 

Obligations of states and  political subdivisions of the U.S.
   
              2,913 

        0.3 

 

              3,339 

        0.3 

General consumer and other
   
            83,443 

        7.4 

 

            93,983 

        9.0 

 

Loans, gross
$
     1,129,336 

    100.0 

%

       1,044,770 

    100.0 

 

 
   
 

 

 

 

 

 

Loans included in both of the preceding loan compositiontables are net of participations sold, and mortgage loans sold and serviced forothers.  Participations sold totaled $26.6 million and $14.6 million atSeptember 30, 2008 and December 31, 2007, respectively. Mortgage loans servicedfor the benefit of others amounted to $371.6 million and $346.3 million atSeptember 30, 2008 and December 31, 2007, respectively.  

 

18

 

 

*Pledged*

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities. Approximately $379 million, or 34%, of the loans,gross, excluding mortgage loans held for sale, were pledged to collateralizeFHLB advances and letters of credit at September 30, 2008, of which $160million was available as lendable collateral.  In order to compute lendablecollateral amounts, pledged loan unpaid principal balances are reduced by acollateral verification review extrapolation factor before being multiplied bya collateral value percentage.  

 

*Concentrations of Risk*

* *

Loan Type / IndustryConcentration. Categorized by loan purpose, the Company’s commercial realestate portfolio accounts for 63.7% of the Company’s gross loan portfolio. Thefollowing table summarizes the composition of the Company’s commercial realestate portfolio at September 30, 2008. For the purpose of this analysis,adjustments have been made to the balance of commercial real estate loans byloan purpose in order to conform the Company’s definition of commercial realestate loans to that of regulators. 

 

 

** Commercial real 	estate loans, 	adjusted by  concentration**

** **

** Commercial real 	estate loans, adjusted as a  percentage of tier 1 capital**

Residential

                   13.4 

%

                   66.6 

Land-only

                   21.0 

 

                 104.4 

Construction

                     7.0 

 

                   34.7 

Commercial - specific

                   40.5 

 

                 201.2 

Commercial - nonowner  occupied

                   18.0 

 

                   89.2 

Rounding

                     0.1 

 

                     0.4 

 

                 100.0 

%

                 496.5 

 

 

The following table further classifies materialconcentrations at September 30, 2008, defined as those exceeding 20% of the commercial real estateloans, adjusted portfolio and those exceeding 100% of tier 1 capital,both as summarized in the table above.  

 

 

 

 

** Commercial real 	estate loans, 	adjusted by  concentration**

** **

** Commercial real 	estate loans, 	adjusted as a percentage 	of tier 1 capital**

Land-only

 

 

 

 

Developed land

                   19.0 

%

                   94.5 

 

Undeveloped land

                     2.0 

 

                     9.9 

 

 

                   21.0 

%

                 104.4 

 

 

 

 

 

Commercial - specific

 

 

 

 

Hotels / motels

                   18.4 

%

                   91.4 

 

Restaurants

                     1.8 

 

                     8.7 

 

Convenience stores

                     1.4 

 

                     7.1 

 

Golf courses

                     2.6 

 

                   12.8 

 

Religious facilities

                   10.0 

 

                   49.8 

 

Assisted living facilities

                     5.8 

 

                   28.7 

 

Mobile home communities

                     0.5 

 

                     2.7 

 

 

                   40.5 

%

                 201.2 

 

The Company believes that the properties securing itscommercial real estate portfolio are diverse in terms of type. This diversityreduces the Company’s exposure to adverse economic events that impact anysingle industry.

 

19

 

Asset Quality

 

Nonaccrual and PastDue 90 Days. The following tablesummarizes nonaccrual loans and loans past due 90 days and still accruinginterest at the dates indicated (in thousands).

 

 
   
** September 30,**

** June 30,**

**March 31,**

**December 31,**

** September 30,**

 
   
**2008**

**2008**

**2008**

**2007**

**2007**

Nonaccrual loans
$
              21,468 

        6,419 

        5,606 

              4,810 

                  7,043 

Loans past due 90 days and  still accruing (1)
   
                       70 

           140 

          	176 

                 236 

                     210 

 
$
              21,538 

        6,559 

        5,782 

              5,046 

                  7,253 

 
   
 

 

 

 

 

(1) Substantially all of  these loans are bankcard loans

 

 

 

 

 

 

The following tablesummarizes foregone and collected interest relative to loans innonaccrual status at September 30, 2008 for the periods indicated (inthousands).  

 

** **

** **

**F****or the three month**

** **

**F****or the nine month**

** **

** **

**periods ended September 30,**

** **

**periods ended September 30,**

** **

** **
   
**2008**

**2007**

** **

**2008**

**2007**

Foregone interest 
$
              534 

                169 

 

                966 

                451 

Interest collected
   
                    4 

                    5 

 

                  13 

                  15 

 

 
   
 

 

 

 

 

 

 

Had all loans in nonaccrual status at September 30, 2008 andSeptember 30, 2007 been performing in accordance with their original terms,interest income would have been higher by $1.1 million and $979 thousand overthe nonaccrual periods, respectively.  The amount of total interest collectedover the nonaccrual periods relative to loans classified as nonaccrual at thesedates totaled $14 thousand and $18 thousand, respectively. 

 

Troubled Debt Restructurings. Troubled debt restructurings entered into by the Company during the first ninemonths of 2008 are subject to review by the Company, in accordance with theCompany’s loan review policies, to ensure loan classifications were inaccordance with applicable regulations.  Troubled debt restructurings areincluded in the Company’s analysis of allowance for loan loss adequacy.  AtSeptember 30, 2008 and December 31, 2007, the principal balance of such loanstotaled $1.2 million.  

 

Allowance for Loan Losses

 

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

 

** **

** **

**At and for the three month**

** **

**At and for the nine month**

** **

** **

**periods ended September 30,**

** **

**periods ended September 30,**

** **

** **
   
**2008**

**2007**

** **

**2008**

**2007**

Allowance for loan losses,  beginning of period
$
           7,645 

             8,515 

 

             7,418 

             8,527 

Provision for loan losses
   
                687 

                400 

 

             1,862 

             1,200 

 

 
   
 

 

 

 

 

Loans charged-off
   
              (542)

              (706)

 

           (1,560)

           (1,696)

Loan recoveries
   
                  33 

                  71 

 

                103 

                249 

 

Net loans charged-off
   
              (509)

              (635)

 

           (1,457)

           (1,447)

 

 
   
 

 

 

 

 

Allowance for loan losses,  end of period
 $
          7,823 

             8,280 

 

             7,823 

             8,280 

 

 
   
 

 

 

 

 

 

Management analyzes the adequacy ofthe allowance for loan losses on a monthly basis using an internal analysismodel.  No less than quarterly, the Company’s allowance for loan losses modeland conclusions are reviewed and approved by senior management. The allowancefor loan losses is a reserve established through a provision for loan lossescharged to expense, which represents management’s best estimate of probablelosses that have been incurred within the existing portfolio of loans. Theallowance for loan losses, in the judgment of management, is necessary toreserve for estimated loan losses and risks inherent in the loan portfolio. TheCompany’s allowance for loan loss methodology is based on guidance provided inSAB No. 102, “Selected Loan Loss Allowance Methodology andDocumentation Issues,” and includes allocations calculated in accordance withSFAS No. 114, “Accounting by Creditors for Impairment of aLoan” as amended by SFAS No. 118, “*Accountingby Creditors for Impairment of a Loan-Income Recognition and Disclosures—anamendment of FASB Statement No. 114,”* andallocations calculated in accordance with SFAS No. 5, “*Accounting for Contingencies*.” Accordingly, the methodology is based on historical lossexperience by type of loans, specific homogeneous risk pools, and specific lossallocations. The Company’s process for determining the appropriate level of theallowance for loan losses is designed to account for asset deterioration as itoccurs. The provision for loan losses reflects not only the necessary increasesin the allowance for loan losses related to newly identified criticized loans,but it also reflects actions taken related to other loans including, amongother things, any necessary increases or decreases in required allowance forloan losses for specific loans or loan pools. 

 

20

 

 

 

Impaired Loans.  TheCompany considers a loan to be impaired when, based upon current informationand events, management believes it is probable that the Company will be unableto collect all amounts due according to the contractual terms of the loanagreement.  The Company’s impaired loans include loans identified as impairedthrough review of its nonhomogeneous portfolio and troubled debtrestructurings.  SFAS No. 114 specifically states that the pronouncement neednot be applied to large groups of smaller-balance homogeneous loans that arecollectively evaluated for impairment.  Thus, the Company determined that SFASNo. 114 does not apply to its installment, credit card, or residential mortgageloan portfolios, except that it may choose to apply such provision to certain specificlarger loans as determined by management.  Specific allowance for loan lossesamounts are established on impaired loans, if deemed necessary, for thedifference between the loan amount and the fair value.  Fair value may bedetermined based upon the present value of expected cash flows, market price ofthe loan, if available, or value of the underlying collateral.  Expected cashflows are required to be discounted at the loan’s effective interest rate.  AtSeptember 30, 2008, all of the Company’s impaired loans were valued using thecollateral value method.  

 

Impaired loans may be left onaccrual status during the period the Company is pursuing repayment of theloan.  Impairment losses are recognized through a charge to the allowance forloan losses and a corresponding charge to the provision for loan losses. Adjustments to impairment losses due to changes in the fair value are alsorecognized through a charge to the allowance for loan losses and acorresponding charge to the provision for loan losses.  When an impaired loanis sold, transferred to the Company’s real estate acquired in settlement ofloans portfolio, or written-down, any specific allowance for loan lossesamounts is removed, as it is no longer necessary to properly record the loan atits fair value.

 

Impaired loans at September 30, 2008 totaled $33.3 million for which aspecific allowance of $3.1 million had been allocated.  Average impaired loansfor the three month period ended September 30, 2008 totaled $21.7 million. Average impaired loans for the nine month period ended September 30, 2008totaled $19.3 million.  Impaired loans without a specific allowance for loanlosses allocation at and for the period indicated were generally reservedwithin the allowance for loan losses.

 

***5.       Premisesand Equipment, Net***

* *

The following tablesummarizes the Company’spremises and equipment balances at the dates indicated (in thousands).

 

 

 
   
**September 30,**

**December 31,**

**September 30,**

 

 
   
**2008**

**2007**

**2007**

Land
$
      7,486 

              6,817 

              6,761 

Buildings 
   
      19,272 

            18,440 

            17,809 

Leasehold improvements
   
        2,834 

              2,247 

              2,156 

Furniture and equipment
   
      18,845 

            18,054 

            17,799 

Software
   
        3,370 

              3,273 

              3,260 

Bank automobiles
   
           941 

                 939 

                 909 

 

Premises and equipment,  gross
   
      52,748 

            49,770 

            48,694 

 

 
   
 

 

 

Accumulated depreciation 
   
     (26,081)

          (24,637)

          (24,218)

 

Premises and equipment, net
$
    26,667 

            25,133 

            24,476 

 

 
   
 

 

 

 

 
 
Long-lived assets to be sold are classified as held for saleand are no longer depreciated. Certain criteria must be met in order for thelong-lived asset to be classified as held for sale including that a sale isprobable and expected to occur within a one year period. Long-lived assetsclassified as held for sale are recorded at the lower of carrying amount or fairmarket value less the estimated costs to sell. The Company classified twoparcels of land, with a book value approximating $1.7 million at September 30,2008, as held for sale.  These parcels will be purchased within the next twelvemonths from the Company, at book value, in conjunction with the construction ofthe Company’s corporate headquarters in downtown Greenville. 

 

21

 

 

 

The renovations ofthe Company’s Woodruff Road (Greenville County) and Montague (Greenwood County)banking offices, previously reported in the Company’s Annual Report on Form10-K for the year ended December 31, 2007, were completed during the first ninemonths of 2008.  The related obligationswith regard to these renovations were also satisfied during this period.  TheCompany celebrated the grand reopening of its Woodruff Road banking office inMay 2008 and its Montague banking office in September 2008.

 

During the first quarter of 2008, the Company completedconstruction and celebrated the grand opening of its relocated Pendleton bankingoffice in Anderson County.  All contractual obligations had been satisfied withregard to this construction and relocation at September 30, 2008. The Companyowns its previous Pendleton banking office.  Management is currently evaluatingoptions for the previous location and has not yet concluded whether or not thislocation will be sold.  Therefore, these assets have not been classified asheld for sale.  At September 30, 2008, the book value of the improvementsrelative to this old location approximated market value, and such assetscontinue to be depreciated.  

 

During the first quarter of 2008, theCompany purchased property at the intersection of West Wade Hampton Boulevardand Middleton Way in Greenville County on which to construct and relocate itsexisting Greer banking office.  Constructionis currently underway at this location, and the Company expects to celebrateits grand opening of the new Greer banking office during the second quarter of2009.  Contractual capital expenditureobligations approximating $935 thousand remain relative to this banking office relocation and construction atSeptember 30, 2008. At September 30, 2008, the Company had not entered intocontractual obligations with regard to the furniture and equipment relative tothis relocated banking office. Therefore, such costs are not included in thepreceding contractual figure.  TheCompany expects to celebrate its grand opening of the new Greer banking officeduring the second quarter of 2009.  

 

During the first quarter of 2008, theCompany executed an operating building lease and an operating lease foradditional office space as part of its plans to expand into north central South Carolina in thePiedmont region. The Company upfittedthese leased banking offices and opened its first banking office in York Countyduring the third quarter of 2008. Contractual obligations had been satisfiedwith regard to these upfittings at September 30, 2008. The Company celebratedthe grand opening of its Rock Hill banking office in September 2008. Rentalexpenses for such operating leases for which the Company was obligated duringthe three and nine month periods ended September 30, 2008 totaled $18 thousandand $44 thousand, respectively.  Lease payments payable by the Company duringthe fourth quarter of 2008 will approximate those paid during the thirdquarter.  Although lease payments for periods subsequent to 2008 cannot bedetermined because lease payments depend on consumer price index changes,management does not believe that future minimum lease payments relative tothese locations will significantly differ from those for 2008.  Obligationsunder these operating lease agreements are payable over several years with thebuilding lease expiring in 2015 and the additional office space lease expiringin 2011.  

 

During April 2008, the Company consolidated its existingbanking office network, reducing the number of banking offices by three.Banking offices located at 3695 East North Street in Greenville County, 1490W.O. Ezell Boulevard in Spartanburg County, and 2915 North Main Street inAnderson County, all of which were leased banking offices, were consolidated.  Managementis currently evaluating its options with regard to these leased premises. Inaccordance with SFAS No. 146, “Accounting forCosts Associated with Exit or Disposal Activities,” a liability for costs thatwill continue to be incurred under a contract for its remaining term withouteconomic benefit to the entity shall be recognized and measured at its fairvalue when the entity ceases using the right conveyed by the contract.  Becausein each of these cases the contract is an operating lease, SFAS No. 146requires that the fair value of the liability at the cease-use date bedetermined based on the remaining lease rentals, reduced by estimated subleaserentals that could be reasonably obtained for the property, even if the entitydoes not intend to enter into a sublease. With regard to two of theseproperties, no liability was determined to be necessary in accordance with SFASNo. 146.  With regard to the third property, because the landlord may sell theproperty in the near term, which would eliminate the Company’s remaining termon the contract, the Company has not yet concluded its intent with regard tothis consolidated banking office location.  

 

During May 2008, the Company further consolidated itsexisting banking office network, reducing the number of banking offices byone.  Management is currently evaluating options with regard to the Company’sbanking office located at 4513 Main Street (Hodges) in Greenwood County, whichis owned by the Company and has not yet concluded whether or not this locationwill be sold.  Therefore, at September 30, 2008, the long-lived assetsassociated with this consolidated banking office have not been classified asheld for sale.  Additionally, such assets continue to be depreciated.  If theCompany chooses to sell this previous banking office location, it does notbelieve there will be a material associated loss. 

 

22

 

 

 

*Accumulated Depreciation Activity*

* *

The following table summarizes the activity impactingaccumulated depreciation at and for the periods indicated (in thousands).Depreciation balances were impacted during the period by the previous activitydiscussed.

 

 

** **

** **

** **

**At and for the three month**

** **

**At and for the nine month**

** **

** **

** **

**periods ended September 30,**

** **

**periods ended September 30,**

** **

** **

** **
 
**2008**

**2007**

** **

**2008**

**2007**

Accumulated depreciation,  beginning of period
$
              25,582			

                24,510			

** **

                24,637			

                23,597			

** **

** **

** **
 
** **

** **

** **

** **

** **

Depreciation
 
 

 

 

 

 

 

Buildings 
 
                     141			

                     141			

 

                     417			

                     361			

 

Leasehold improvements
 
                       37			

                       26			

 

                       99			

                       99			

 

Furniture and equipment
 
                     230			

                     234			

 

                     688			

                     717			

 

Software
 
                       45			

                       47			

 

                     130			

                     163			

 

Bank automobiles
 
                       46			

                       44			

 

                     136			

                     138			

 

 

Total depreciation
 
                     499			

                     492			

 

                  1,470			

                  1,478			

 

 

 
 
 

 

 

 

 

Disposals
 
                       -  			

                   (784)

 

                     (26)

                   (857)

 

 

 
 
 

 

 

 

 

Accumulated depreciation,  end of period
$
              26,081			

                24,218			

 

                26,081			

                24,218			

 

 

 
 
 

 

 

 

 

 

The following table summarizes the loss on disposition of premises and equipmentfor the three and nine month periods ended September30, 2007 (in thousands) in conjunction with the demolition of the previousdowntown Greenville banking office.  

 

 

 

 

 

 

 

 

 

**For the three and nine**

 

 

 

**month periods ended**

 

 

 

**September 30, 2007**

Assets written-off, gross

 

 

Leasehold improvements

$

715 

 

Furniture and equipment

396 

 

 

Total assets written-off, gross

1,111 

 

 

 

 

Accumulated depreciation written-off,			gross

 

 

Leasehold improvements

(384)

 

Furniture and equipment

(381)

 

 

Total accumulated depreciation written-off,			gross

(765)

 

 

 

 

 

 

Loss on disposition of premises, furniture, and equipment,			gross

$

346 

 

 

 

 

 

*Corporate Headquarters*

 

As discussed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company plansoccupancy during the first quarter of 2009.  During construction, the Companyis continuing to pay real property operating lease payments under its previouslease with the Lessor with regard to its previous downtown Greenville bankingoffice.  Upon occupancy, these real property operating lease payments will bereplaced with those required by the build-to-suit operating lease agreement. 

 

The Company anticipates that itwill be required to expend approximately $3 million during 2008 with regard tothe upfitting and furnishings of the new corporate headquarters facility. Suchassets will be placed into service upon occupancy.

 

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

** **

All of the Company’s goodwill resulted from past businesscombinations.  The Company performs its annual impairment testing as of June30. The Company’s impairment testing as of June 30, 2008 and June 30, 2007indicated that no impairment charge was required as of those dates.

 

23

 

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

 

 

 

 

 

**September 30, December 31,**

 

**2008**

**2007**

Core deposit intangibles, gross

$

1,779 

1,779 

     Less: accumulated amortization

(1,733)

(1,700)

Core deposit intangibles, net

$

46 

79 

 

 

 

 

***7.       Mortgage-Banking***

 

Mortgage loans serviced for the benefit of others amountedto $371.6 million and $346.3 million at September 30, 2008 and December 31,2007, respectively. 

 

Thebook value of the Company’s mortgage-servicing rights portfolio at bothSeptember 30, 2008 and December 31, 2007 was $2.9 million. The Company’s mortgage-servicing rightsportfolio is included within otherin the assets section of the Consolidated (Interim) Balance Sheets.Theaggregate fair value of the Company’s mortgage-servicing rights portfolio atSeptember 30, 2008 and December 31, 2007 was $3.7 million and $3.6 million,respectively.

 

The following tablesummarizes the changes inthe the Company’s mortgage-servicing rights portfolio at and for the periods indicated(in thousands). 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

 

**periods ended September 30,**

**periods ended September 30,**

 

 

 

**2008**

**2007**

 

**2008**

**2007**

Mortgage-servicing rights portfolio, net of valuation

 

 

 

 

 

 

allowance, beginning of period

$

3,002 

2,722 

 

2,949 

2,648 

 

 

Capitalized mortgage-servicing rights

201 

252 

 

686 

626 

 

 

Mortgage-servicing rights portfolio amortization

(290)

(61)

 

(716)

(362)

 

 

Change in mortgage-servicing rights portfolio valuation allowance

2 

1 

 

(4)

2 

Mortgage-servicing rights portfolio, net of valuation

 

 

 

 

 

 

allowance, end of period

$

2,915 

2,914 

 

2,915 

2,914 

 

 

 

 

 

 

 

 

 

The mortgage-servicingrights portfolio valuation allowance totaled $10 thousand and $2 thousand atSeptember 30, 2008 and 2007, respectively. Mortgage-servicing rightsamortization and valuation allowances are included within mortgage-bankingincome, net in the noninterest income section of the Consolidated InterimStatements of Income.

 

See Consolidated InterimStatements of Cash Flows for a summary of activity impacting the Company’smortgage-servicing rights portfolio during the nine month periods endedSeptember 30, 2008 and September 30, 2007.

 

*Mortgage-Banking Income, Net*

* *

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

**For the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

**2008**

 

**2007**

 

**2008**

 

**2007**

Mortgage-servicing fees

$

229 

 

204 

 

 

666 

 

613 

Gain on sales of mortgage loans held for sale,			net

214 

 

279 

 

704 

 

614 

Mortgage-servicing right amortization, impairment, and recoveries

(288)

 

(60)

 

(720)

 

(360)

Other mortgage-banking income

55 

 

45 

 

197 

 

120 

 

Total mortgage-banking income, net

$

210 

 

468 

 

 

847 

 

987 

 

 

 

 

 

 

 

 

 

 

24

 

 

 

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

* *

*Composition*

* *

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

 
 **September 30,****June 30,****March 31, ****December 31,****September 30,**
 

**2008**

**2008**

**2008**

**2007**

**2007**

Real estate acquired in settlement of loans

$

7,089 

8,332 

7,960 

7,743 

6,170 

Repossessed automobiles acquired in settlement of loans

463 

288 

369 

403 

295 

     Total property acquired in settlement of loans

$

7,552 

8,620 

8,329 

8,146 

6,465 

 

 

 

 

 

 

* *

*Activity*

* *

The following table summarizes the changesin the real estate acquired in settlement of loans portfolio, including thebalance at the beginning and end of the period, provision charged to expense,and losses charged to the allowance for loan losses related to the Company’sreal estate acquired in settlement of loans at and forthe periods indicated (in thousands). 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 
 
**2008**

**2007**

 
 
**2008**

**2007**

Real estate acquired in  settlement of loans, beginning of period
$
             8,332			

            717			

 
			 
             7,743			

            600			

 

Add: New real estate  acquired in settlement of loans and related adjustments
 
               1,841			

         5,533			

 
 
               2,630			

         6,115			

 

Less: Sales / recoveries of  real estate acquired in settlement of loans
 
              (3,071)

             (80)

 
 
              (3,202)

           (374)

 

Less: Provision charged to  expense
 
                   (13)

               -  			

 
 
                   (82)

           (171)

Real estate acquired in  settlement of loans, end of period
$
             7,089			

         6,170			

 
			 
             7,089			

         6,170			

 

 

***9.       Deposits***

* *

*Composition*

* *

The following table summarizesthe Company’s traditional deposit composition at the dates indicated (inthousands).

 
  
**September 30,**
**December 31,**

 

 

**2008**

**2007**

Transaction deposit accounts

$

489,094 

522,359 

Money market deposit accounts

96,935 

118,681 

Savings deposit accounts

38,546 

34,895 

Time deposit accounts $100,000 and greater

173,560 

150,398 

Time deposit accounts less than $100,000

258,145 

232,461 

 

Total traditional deposit accounts

$

1,056,280 

1,058,794 

 

At September 30, 2008, $832 thousand of overdrawntransaction deposit accounts had been reclassified as loan balances comparedwith $809 thousand at December 31, 2007.

* *

Interest Expense on Traditional Deposit Accounts

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

** For the nine month**

 

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

 

**2008**

**2007**

 

**2008**

**2007**

Transaction deposit accounts

$

1,051 

2,804 

 

4,309 

7,536 

Money market deposit accounts

403 

1,057 

 

1,614 

2,952 

Savings deposit accounts

35 

36 

 

97 

106 

Time deposit accounts

4,097 

3,766 

 

12,335 

11,733 

 

Total interest expense on traditional deposit accounts

$

5,586 

7,663 

 

18,355 

22,327 

 

 

 

 

 

 

 

 

 

25

 

 

***10.    Borrowings***

*** ***

FHLB Borrowings

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities.  The following table summarizes the Company’s FHLB borrowedfunds utilization and availability at thedates indicated (in thousands).

 

 

 

 

 
 
**September 30,**

**December 31,**

 

 

 
 
**2008**

**2007**

Available lendable loan  collateral value to serve against FHLB advances
$
         160,135			

            105,535			

Available lendable  investment security collateral value to serve against FHLB advances
 
             41,751			

                      -  			

 

 

 
 
 

 

Advances and letters of  credit
 
 

 

 

Short-term advances
 
           (59,000)

             (12,000)

 

Long-term advances
 
           (52,000)

                      -  			

 

Letters of credit
 
           (69,000)

             (69,000)

 

 

Total advances and letters  of credit
 
         (180,000)

             (81,000)

 

 

 
 
 

 

Available lendable  collateral value to serve against FHLB advances
$
           21,886			

              24,535			

 

 

 
 
 

 

 

 

Letters of credit are used tosecure public deposits as required or permitted by law.  

 

The following tablesummarizes the Company’s long-term FHLB borrowings at September 30, 2008(dollars in thousands).  The Company’s long-term FHLB advances do nothave embedded call options. 

 

 

 

 

 

 

Total

Borrowing balance

$

5,000 

 

12,000 

 

30,000 

 

5,000 

 

52,000 

Interest rate

			2.57%

2.75 

2.89 

3.61 

2.90 

Maturity date

3/8/2010

4/2/2010

3/7/2011

4/2/2013

 

 

 

*Federal Funds Accommodations*

* *

In addition to the FHLBborrowing capacity summarized above, at September 30, 2008, the Company hadaccess to federal funds funding from correspondent banks.  During April 2008, acorrespondent bank increased the Bank’s existing federal funds accommodation by$5 million. Additionally, during the third quarter of 2008, the Companyterminated one of its correspondent banking relationships, thereby reducing itsfederal funds accommodation by $5 million. The following table summarizes theCompany’s federal funds funding utilization and availability at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

 

 

**2008**

**2007**

 

		Federal funds accommodations

$

55,000 

50,000 

 

 

 

 

 

 

 

		Utilized federal funds accommodations

- 

(18,000)

 

 

 

 

 

 

 

		Unused federal funds accommodations

$

55,000 

32,000 

 

 

 

 

 

 

 

 

During October 2008, anadditional correspondent bank extended the Bank an unsecured discretionaryfederal funds accommodation in the amount of $10 million.

 

***11.    EmployeeBenefit Plans***

*** ***

*401(k) Plan*

 

During the three and nine month periods ended September 30,2008, the Company made matching contributions to its employee 401(k) plantotaling $87 thousand and $260 thousand, respectively. During the three andnine month periods ended September 30, 2007, the Company made matchingcontributions to its employee 401(k) plan totaling $85 thousand and $234thousand, respectively. 

 

During 2007, in conjunction with the audit of the Company’s401(k) Retirement Plan, an administrative error was discovered that hadresulted in participants being denied the opportunity to fully defer theappropriate amount of compensation under the plan.  During the third quarter of2007, the Company calculated and accrued the denied deferral amount and theresulting employer match, including missed earnings, and believes such amountstotal approximately $1.3 million through December 31, 2006. The Company accruedthis amount within salaries and other personnel in the noninterest expensesection of the Consolidated Interim Statements of Income for the three and ninemonth periods ended September 30, 2007. The Company contributed these amounts,in addition to those calculated for the period after December 31, 2006, to eachparticipant’s account during the fourth quarter of 2007 by correcting the errorunder guidelines established by the Internal Revenue Service.

 

26

 

 

 

 

*CollateralSplit-Dollar Life Insurance Arrangements*

* *

On January 1, 2008, the Companychanged its accounting policy and recognized a cumulative-effect adjustment toretained earnings totaling $99 thousand related to accounting for certaincollateral split-dollar life insurance arrangements in connection with theadoption of EITF No. 06-10. Deferred compensation expense related to suchcollateral split-dollar life insurance arrangements were less than $1 thousandfor both the three and nine month periods ended September 30, 2008.

 

***12.    EquityBased Compensation***

 

*Defined Benefit Pension Plan*

 

The Company adopted SFAS No. 158, “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans—an amendment of FASB StatementsNo. 87, 88, 106, and 132(R),” recognized the funded status of its definedbenefit postretirement plan, and provided the additional required disclosuresas of the year ended December 31, 2007. This Statement required, among otherthings, the recognition of the overfunded or underfunded status of pension andother postretirement benefit plans on the balance sheet. Under SFAS No. 158,gains and losses, prior service costs and credits, and any remaining transitionamounts under SFAS No. 87, “Employers' Accounting for Pensions,” and SFAS No.106, “Employers' Accounting for Postretirement Benefits Other Than Pensions,”that had not yet been recognized through net periodic benefit cost arerecognized in accumulated other comprehensive income, net of tax effects, untilthey are amortized as a component of net periodic cost. In accordance with SFAS No. 158, unless a businessentity remeasures both its plan assets and benefit obligations during thefiscal year, the funded status it reports in its Consolidated Interim BalanceSheet shall be the same asset or liability recognized in the previous year endConsolidated Balance Sheet adjusted for subsequent accruals of net periodicbenefit cost that exclude the amortization of amounts previously recognized inother comprehensive income and contributions to a funded plan, or benefitpayments. The Company’s net periodic benefit cost excluding the amortization ofamounts previously recognized in other comprehensive income for the nine monthperiod ended September 30, 2008 was immaterial.  Additionally, no contributionswere made during this period.  As reported in the Company’s Annual Report onForm 10-K for the year ended December 31, 2007, the fair market value of planassets totaled $15.9 million.  At September 30, 2008, the fair market value ofplan assets totaled $12.7 million.

 

Stock Option Plan

 

General. As of January 2007, all of the stock optionawards available for grant under the Palmetto Bancshares, Inc. 1997 StockCompensation Plan had been granted with various expiration dates throughDecember 31, 2016.  Of these, 177,830 stock option awards remained outstandingat September 30, 2008 with exercise prices ranging from $13.00 to $30.40. Allstock option awards granted have a vesting term of five years and an exerciseperiod of ten years.  

 

Stock Option CompensationExpense. The compensation cost that was charged against pretax net incomefor stock option awards granted during the three month periods ended September30, 2008 and 2007 was $23 thousand and $33 thousand, respectively. During thenine month periods ended September 30, 2008 and 2007, such compensation expensewas $70 thousand and $99 thousand, respectively. Management estimates thatstock option award forfeitures will not be significant and, therefore, does notadjust stock option compensation expense for forfeitures.

 

At September 30, 2008, based onstock option awards outstanding at that time, the total pretax compensationcost related to nonvested stock option awards granted under the Company’s stockoption plans but not yet recognized was $118 thousand. Stock optioncompensation expense is recognized on a straight-line basis over the stockoption award vesting period. Remaining stock option compensation expense isexpected to be recognized through 2011. 

 

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

 

27

 

 

 

 

 

 

 

 

 

 

**Stock options**

**outstanding**

**Weighted-**

**average**

**exercise**

**price**

Outstanding at December 31, 2006

251,670 

$

18.67 

 

Granted

800 

30.40 

 

Exercised

(32,810)

14.92 

Outstanding at September 30, 2007

219,660 

$

19.28 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2007

198,155 

$

20.29 

 

Granted

- 

- 

 

Exercised

(20,325)

16.03 

Outstanding at September 30, 2008

177,830 

$

20.78 

 

 

 

 

 

 

Cash received from stock optionaward exercises under the 1997 Stock Compensation Plan during the nine monthperiods ended September 30, 2008 and 2007 was $326 thousand and $490 thousand,respectively.

 

The total intrinsic value ofstock options exercised during the nine month period ended September 30, 2008was $517 thousand.

 

Stock Options Outstanding. The following table summarizes information regarding stock optionawards outstanding and exercisable at September 30, 2008.  

 

 

 

 

**Stock option awards outstanding**

**Options exercisable**

**Exercise price or range of**

**exercise prices**

**Number of**

**stock option awards**

**outstanding at**

**9/30/08**

**Weighted-**

**average**

**remaining**

**contractual**

**life (years)**

**Weighted-**

**average**

**exercise**

**price**

**Number of**

**stock option awards**

**exercisable**

**at 9/30/08**

**Weighted-**

**average**

**exercise**

**price**

 

$

13.00 

 

18,120 

1.25 

$

13.00 

18,120 

$

13.00 

 

$

13.50 

 

11,800 

2.25 

13.50 

11,800 

13.50 

$

15.00 

to

$

20.00 

58,910 

3.70 

17.25 

58,910 

17.25 

$

23.30 

to

$

26.60 

55,200 

5.65 

24.63 

35,200 

24.14 

$

27.30 

to

$

30.40 

33,800 

7.27 

27.37 

12,320 

27.38 

 

 

Total

177,830 

4.64 

$

20.78 

136,350 

$

19.06 

 

Based on the last known tradingprice of the Company’s common stock known by management, the intrinsic value ofstock options outstanding and exercisable at September 30, 2008 was $3.1million. 

 

Restricted Stock Plan

* *

On February 19, 2008, the Company’s Board of Directors adopted, subject to shareholder approval, the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan, which provides for the grant of stock awards to the Company’s employees, officers, and directors.  The Company’s shareholders approved the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan on April 15, 2008. A total of 250,000 shares of common stock have been reserved for issuance pursuant to awards under the plan, subject to its anti-dilution provisions. 

 

***13.    NetIncome per Common Share***

 

The following table summarizes the Company’s reconciliationof the numerators and denominators of the basic and diluted net income percommon share computations for the periods indicated.

 

** **

 

 

 

 

 

 

 

 

 

**For the three month**

 

**For the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

**2008**

**2007**

 

**2008**

**2007**

Weighted average common shares outstanding - basic

6,442,090 

6,392,721 

 

6,436,280 

6,385,625 

 

Dilutive impact resulting from potential common share issuances

87,033 

108,241 

 

86,036 

98,668 

Weighted average common shares outstanding - diluted

6,529,123 

6,500,962 

 

6,522,316 

6,484,293 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

Net income - basic

$

0.63 

0.61 

 

1.87 

1.84 

 

Net income - diluted

0.62 

0.60 

 

1.84 

1.81 

 

28

 

 

At September 30, 2008, all outstanding stock option awardswere included in the calculation of diluted net income per common share becausethe exercise price of all stock option awards was lower than the average marketprice as determined by the average trading price of the last five known tradesof the Company’s common stock.

 

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

 

Guarantees

 

The Company issues standby letters of credit for customersin connection with contracts between the customers and third parties. Standbyletters of credit guarantee that the third parties will receive specified fundsif customers fail to meet their contractual obligations. The Company isobligated to make payment if a customer defaults. At September 30, 2008, theCompany recorded no liability for its obligation to perform as a guarantorunder standby letters of credit. The maximum potential amount of undiscountedfuture payments related to standby letters of credit at September 30, 2008 was$10.3 million compared with $11.2 million at December 31, 2007.  Historically,standby letters of credit have expired unused. However, through its varioussources of liquidity, the Company believes that it has the necessary resourcesavailable to meet these obligations should the need arise.  Additionally, theCompany does not believe that the current fair value of such guarantees wasmaterial at September 30, 2008.

 

The Company enters into indemnification agreements in theordinary course of business under which it agrees to indemnify third partiesagainst any damages, losses, and expenses incurred in connection with legal andother proceedings arising from relationships or transactions with the Company.Because the extent of the Company’s obligations under these agreements dependsentirely upon the occurrence of future events, its potential future liabilityunder these agreements is not determinable. 

 

*Derivatives*

 

See Note15 for discussion regarding theCompany’s commitments related to derivative loancommitments and related forward loan sales commitments.  

 

Capital Expenditure Obligations

 

The Company’s commitments forpremises and equipment activities were disclosed in its Annual Report on Form10-K for the year ended December 31, 2007.  Other than as discussed in Note 5,there has been no significant change in future minimum lease payments payableby the Company as then reported.  

 

As discussed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007, the Companyanticipates that it will be required to expend approximately $3 million during2008 with regard to the upfitting and furnishings of the new corporateheadquarters facility. 

 

*Real Property Operating LeaseObligations*

 

As discussed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007, the Companyleases certain of its office facilities and real estate relating to bankingservices under operating leases.  Other than as discussed in Note 5 with regardto banking office consolidations and the opening of the Rock Hill bankingoffice, there has been no significant change in future minimum lease paymentspayable by the Company as then reported.  

 

As discussed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company plansoccupancy during the first quarter of 2009.  During construction, the Companyis continuing to pay real property operating lease payments under its previous leasewith the Lessor with regard to its previous downtown Greenville bankingoffice.  Upon occupancy, these real property operating lease payments will bereplaced with those required by the build-to-suit operating lease agreement. 

 

Legal Proceedings

 

The Company is currently subject to variouslegal proceedings and claims that have arisen in the ordinary course of itsbusiness. In the opinion of management, based on consultation with externallegal counsel, any reasonably foreseeable outcome of such current litigationwould not materially impact the Company's financial condition or results ofoperations. 

 

29

 

 

 

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

 

Interest rate lock commitments for residential mortgageloans that the Company intends to sell are considered freestanding derivatives.The Company’s interest rate exposure on these derivative loan commitments ishedged with forward sales commitments (freestanding derivatives - economichedges). 

 

For interest rate lock commitments issued prior toJanuary 1, 2008, a zero fair value for the derivative loan commitment wasrecorded at inception consistent with SAB No. 105. Effective January 1,2008, in accordance with SAB No. 109, the expected net future cash flowsrelated to the associated servicing of the loan as part of the fair valuemeasurement of derivative loan commitments were required to be included, atinception and during the life of the loan commitment.  The implementation ofSAB No. 109 did not have a material impact on the valuation of the Company’sloan commitments. Changes subsequent to inception are based on changes in fairvalue of the underlying loan resulting from the exercise of the commitment andchanges in the probability that the loan will not fund within the terms of thecommitment (referred to as a fall-out factor). The value of the underlying loanis impacted primarily by changes in interest rates and the passage of time.However, changes in investor demand, such as concerns about credit risk, canalso cause changes in the spread relationships between underlying loan valueand the derivative financial instruments that cannot be hedged. At September30, 2008, and December 31, 2007, the fair value of the Company’s derivativeassets related to derivative loan commitments and itsforward loan sales commitments was immaterial. 

 

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

 

Effective January 1, 2008, the Company adopted SFAS No. 157.SFAS No. 157 defines fair value, establishes a framework for measuring fair value,and expands disclosures about fair value measurements.  SFAS No. 157has been applied prospectively and defines fair value as the price that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurementdate.  SFAS No. 157 also establishes a fair value hierarchy thatrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value.

 

In accordance with SFAS No.157, the Company groups its financial assets and financial liabilities measuredat fair value in three levels, based on the markets in which the assets andliabilities are traded and the reliability of the assumptions used to determinefair value.  These levels are:

 
- Level 1 - Valuation is based     upon quoted prices for identical instruments traded in active markets.
- Level 2 - Valuation is based     upon quoted prices for similar instruments in active markets, quoted     prices for identical or similar instruments in markets that are not     active, and model-based valuation techniques for which all significant     assumptions are observable in the market.
- Level 3 - Valuation is generated     from model-based techniques that use significant assumptions not     observable in the market. These unobservable assumptions reflect estimates     of assumptions that market participants would use in pricing the asset or     liability. Valuation techniques include use of option pricing models,     discounted cash flow models and similar techniques.

 

The following table presents the Company’s assets that aremeasured at fair value on a recurring basis and the level within the SFAS No.157 hierarchy in which the fair value measurements fall at September 30, 2008(in thousands).

 

** **

 

 

 

 

 

 

 

 

**Level 1**

**Level 2**

**Level 3**

**Fair value**

Investment securities available for sale

$

- 

130,321 

- 

130,321 

 

The fair value of investment securities available for salemay be determined by various valuation methodologies.  Where quotedmarket prices are available in an active market, securities are classifiedwithin Level 1. Level 1 securities may include exchange traded equities. Ifquoted market prices are not available, fair values are estimated by usingpricing models or quoted prices of securities with similar characteristics.  Level2 securities may include United States Treasury securities, obligations ofgovernment corporations and agencies, obligations of states and politicalsubdivisions, mortgage-backed securities, collateralized mortgage obligations,and corporate bonds. In certain cases where Level 1 or Level 2 inputs are notavailable, securities are classified within Level 3 of the hierarchy and mayinclude subordinated tranches of collateralized mortgage obligations andinvestments in financial institution trust preferred securities.

 

30

 

The Company receives market valuations monthly from one of the fixedincome industry’s leading broker / dealers and investment advisors. Marketvalues provided are based upon equivalent comparable securities that haveactually traded in the marketplace on a specified day. Market valuations are notmatrix based but are based upon actual market participation. 

 

The Company may be required, from time to time, to measure certainother financial assets and liabilities at fair value on a nonrecurringbasis.  These adjustments to fair value usually result fromapplication of lower-of-cost-or-market accounting or writedowns of individualassets.  The following table provides the level of valuationassumptions used to determine each adjustment and the fair value of the assetson a nonrecurring basis at September 30, 2008 (in thousands).

 

** **

 

 

 

 

 

 

 

 

**Level 1**

**Level 2**

**Level 3**

**Fair value**

Impaired loans

$

- 

30,205 

- 

30,205 

 

Loans for which it is probable that the Company will notcollect all principal and interest due according to contractual terms aremeasured for impairment in accordance with the provisions of SFAS No.114.  The Company’s impaired loans include loans identified asimpaired through review of its nonhomogeneous portfolio and troubled debtrestructurings.  The Company determined that SFAS No. 114 does not apply to itsinstallment, credit card, or residential mortgage loan portfolios, except thatit may choose to apply such provision to certain specific larger loans as determinedby management.  Specific allowance for loan losses amounts are established onimpaired loans, if deemed necessary, for the difference between the loan amountand the fair value.  Fair value may be determined based upon the present valueof expected cash flows, market price of the loan, if available, or value of theunderlying collateral.  Expected cash flows are required to be discounted atthe loan’s effective interest rate.  At September 30, 2008, all of theCompany’s impaired loans were valued using the collateral value method. Impaired loans had a carrying amount of $33.3 million, with a valuationallowance of $3.1 million, at September 30, 2008.

 

*Fair Value Option*

 

In February 2007, the FASB issuedSFAS No. 159, which permits entities to choose to measure eligibleitems at fair value at specified election dates. Unrealized gains and losses onitems for which the fair value option has been elected are reported in earningsat each subsequent reporting date. The fair value option may be appliedinstrument by instrument, with certain exceptions, is irrevocable (unless a newelection date occurs), and is applied only to entire instruments and notto portions of instruments. The main intent of SFAS No. 159 was to mitigate thedifficulty in determining reported earnings caused by a “mixed-attribute model”(that is, reporting some assets at fair value and others using a differentvaluation method such as amortized cost). The project is separated into twophases. This first phase addresses the creation of a fair value option forfinancial assets and liabilities.  A second phase will addresscreating a fair value option for selected nonfinancial items. SFAS No. 159was effective for the Company on January 1, 2008. The Company did not elect thefair value option for any financial assets or liabilities as of January 1,2008. As such, its adoptions did not have a material impact on the Company’sfinancial position, results of operations, or cash flows. 

 

***17.    RegulatoryCapital Requirements***

 

Thefollowing table summarizes Palmetto Bancshares’ and the Bank’s actual andrequired capital ratios at the dates indicated (dollars in thousands). As ofSeptember 30, 2008, the Company and the Bank were categorized as “wellcapitalized” under the regulatory framework based on the most recentnotification from federal banking agencies. Since September 30, 2008, therehave been no conditions or events that have resulted in a material change inthe Company's or the Bank's category.

 

31

 

 

 

 

 

 

 

**Actual**

**For capital adequacy**

**purposes**

**To be "well capitalized"**

**under prompt**

**corrective action**

**provisions**

 

 

 

 

 

**amount**

**ratio**

**amount**

**ratio**

**amount**

**ratio**

**At September 30, 2008**

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

125,334 

10.37% 

96,667 

8.00 

n/a 

n/a 

 

Bank

 

 

124,840 

10.33 

96,667 

8.00 

120,833 

10.00 

 

 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

117,511 

9.73 

48,333 

4.00 

n/a 

n/a 

 

Bank

 

 

117,017 

9.68 

48,333 

4.00 

72,500 

6.00 

 

 

 

 

 

 

 

 

 

 

 

*Tier 1 leverage ratio*

 

 

 

 

 

 

 

 

Company

 

 

117,511 

8.74 

53,752 

4.00 

n/a 

n/a 

 

Bank

 

 

117,017 

8.70 

53,774 

4.00 

67,217 

5.00 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At September 30, 2007**

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

113,947 

10.39% 

87,734 

8.00 

n/a 

n/a 

 

Bank

 

 

113,683 

10.37 

87,737 

8.00 

109,671 

10.00 

 

 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

105,667 

9.64 

43,867 

4.00 

n/a 

n/a 

 

Bank

 

 

105,403 

9.61 

43,868 

4.00 

65,803 

6.00 

 

 

 

 

 

 

 

 

 

 

 

*Tier 1 leverage ratio*

 

 

 

 

 

 

 

 

Company

 

 

105,667 

8.90 

47,469 

4.00 

n/a 

n/a 

 

Bank

 

 

105,403 

8.89 

47,407 

4.00 

59,258 

5.00 

 

32

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

 

Thefollowing discussion and analysis presents the more significant factorsimpacting the Company’s financial condition as of September 30, 2008, resultsof operations for the three and nine month periods ended September 30, 2008,and cash flows for the nine month period ended September 30, 2008. Thisdiscussion should be read in conjunction with the Company’s ConsolidatedInterim Financial Statements and the notes thereto included in this QuarterlyReport on Form 10-Q and the Company’s Consolidated Financial Statements, andnotes thereto, for the year ended December 31, 2007, included in the Company’sAnnual Report on Form 10-K.  Results for the three and nine month periods endedSeptember 30, 2008 are not necessarily indicative of the results for the yearending December 31, 2008 or any future period.  Percentage calculationscontained herein have been calculated based on actual not rounded resultspresented herein.

 

***Critical Accounting Policies and Estimates***

 

*General*

 

The Company’s significantaccounting policies are fundamental to understanding its results of operationsand financial condition, because some accounting policies require the use ofestimates and assumptions that may impact the value of assets or liabilitiesand financial results. Such policies are critical because they requiremanagement to make difficult, subjective, and complex judgments about mattersthat are inherently uncertain and because it is likely that materiallydifferent amounts would be reported under different conditions or usingdifferent assumptions. As reported in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007, these policies govern the Company’sallowance for loan losses, the valuation of its mortgage-servicing rightsportfolio, and its defined benefit pension plan. On an annual basis,management, in conjunction with the Company’s independent registered publicaccounting firm, discusses the development and selection of the criticalaccounting estimates with the Audit Committee of the Company’s Board ofDirectors. For additional information regarding the Company’s criticalaccounting policies and estimates, refer to theCompany’s Annual Report on Form 10-K for the Year Ended December 31, 2007.

 

During the three month period endedSeptember 30, 2008, the Company determined the following additional significantaccounting policy to be critical.

 

Fair Value of Financial Instruments

 

The Company uses fair value measurements to record fairvalue adjustments to certain financial instruments and determine fair valuedisclosures. 

 

At September 30, 2008, the determination of fair valuesof investment securities available for sale used valuation methodologiesinvolving market-derived information, collectively Level 2 measurements, tomeasure fair value. Such fair value measurements were based upon recentobservable market activity of such assets or comparable assets (other thanforced or distressed transactions) that occur in sufficient volume and do notrequire significant adjustment using unobservable inputs.

 

The Company uses prices from independent pricing services andto a lesser extent, indicative (non-binding) quotes from independent brokers,to measure fair value of the Company’s investment securities. The Companyvalidates prices received from pricing services or brokers using a variety ofmethods, including, but not limited to, comparison to secondary pricingservices, corroboration of pricing by reference to other independent marketdata such as secondary broker quotes and relevant benchmark indices, and reviewof pricing by Company personnel familiar with market liquidity and other marketrelated conditions. Generally, the Company does not adjust prices received frompricing services or brokers, unless it is evident the fair value measurement isnot consistent with SFAS No. 157. 

 

***QuarterlyHighlights***

 

Thefollowing overview of quarterly highlights should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations in its entirety.

 

 

 

33

 

*SelectedFinancial Data*

 

 

 
 
 

 

 

 

 

**Percent change for the**

 

 

 

 

 

 

 

 
 
 

 

 

 

 

**three month period ended**

 

 

 

 

 

 

 

 

**For the three month**

 

**September 30, 2008 over**

 

**For the nine month**

 

 

 

 

 

**period ended**

 

**the three month period ended**

 

**period ended**

 

**Percent**

** **

** **

		 
 
**September 30, 2008**

** **

**June 30, 2008**

**September 30, 2007**

** **

**June 30, 2008**

** **

**September 30, 2007**

** **

**September 30, 2008**

**September 30, 2007**

** **

**change**

** **

** **

		 
 
** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

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

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **
 
** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

*For the Period*
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income
$
             4,057		

 

               4,329		

              3,896		

 

                         (6.3)

 % 

                              4.1 

 

              12,032		

              11,722		

 

             2.6		

 

Net income per common share  - diluted
 
                 0.62		

 

                 0.66		

                0.60		

 

                         (6.1)

 

                              3.3 

 

                  1.84		

                  1.81		

 

             1.7		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profitability ratios  (annualized)
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income to average total  assets
 
                 1.20		

 % 

                 1.32		

                1.30		

 

                        (9.1)

 

                            (7.7)

 

                  1.23		

                  1.34		

 

            (8.2)

 

 

Net income to average total  shareholders' equity
 
               13.78		

 

               15.08		

              14.35		

 

                         (8.6)

 

                            (4.0)

 

                13.96		

                14.92		

 

            (6.4)

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Efficiency ratio (1)
 
               60.22		

 % 

               59.54		

              65.08		

 

                           1.1 

 

                            (7.5)

 

                61.47		

                62.43		

 

            (1.5)

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends per common  share
$
               0.20		

 

                 0.20		

                0.19		

 

                            -   

 

                              5.3 

 

                  0.60		

                  0.57		

 

             5.3		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common  shares outstanding - basic
 
        6,442,090		

 

        6,435,515		

       6,392,721		

 

                           0.1 

 

                              0.8 

 

         6,436,280		

         6,385,625		

 

             0.8		

 

Weighted average common  shares outstanding - diluted
 
        6,529,123		

 

        6,521,169		

       6,500,962		

 

                           0.1 

 

                              0.4 

 

         6,522,316		

         6,484,293		

 

             0.6		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average investment  securities available for sale
$
         132,069		

 

           132,074		

          102,154		

 

                            -   

 

                            29.3 

 

            122,152		

            107,744		

 

           13.4		

 

Average total loans
 
        1,126,781		

 

        1,108,127		

          999,044		

 

                           1.7 

 

                            12.8 

 

         1,101,390		

            973,358		

 

           13.2		

 

Average total assets
 
        1,347,695		

 

        1,321,740		

       1,188,923		

 

                           2.0 

 

                            13.4 

 

         1,310,124		

         1,170,757		

 

           11.9		

 

Average traditional  deposits (2)
 
           912,379		

 

           908,039		

          862,946		

 

                           0.5 

 

                              5.7 

 

            913,879		

            865,529		

 

             5.6		

 

Average total deposits (3)
 
           964,051		

 

           958,654		

          906,554		

 

                           0.6 

 

                              6.3 

 

            963,098		

            905,216		

 

             6.4		

 

Average shareholders'  equity
 
           117,134		

 

           115,472		

          107,704		

 

                           1.4 

 

                              8.8 

 

            115,114		

            105,036		

 

             9.6		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin
 
                 4.13		

 % 

                 4.39		

                4.54		

 

                         (5.9)

 

                            (9.0)

 

                  4.26		

                  4.61		

 

            (7.6)

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

*At Period End*
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities  available for sale
$
         130,321		

 

           133,199		

            96,287		

 

                        (2.2)

 

                            35.3 

 

            130,321		

              96,287		

 

           35.3		

 

Total loans
 
        1,134,556		

 

        1,118,323		

       1,007,310		

 

                           1.5 

 

                           12.6  		

 

         1,134,556		

         1,007,310		

 

           12.6		

 

Allowance for loan losses
 
               7,823		

 

               7,645		

              8,280		

 

                           2.3 

 

                            (5.5)

 

                7,823		

                8,280		

 

            (5.5)

 

Goodwill, net
 
               3,691		

 

               3,691		

              3,691		

 

                            -   

 

                               -   

 

                3,691		

                3,691		

 

               -  		

 

Core deposit intangibles,  net
 
                    46		

 

                    57		

                   90		

 

                       (19.3)

 

                          (48.9)

 

                     46		

                     90		

 

          (48.9)

 

Total assets
 
        1,354,210		

 

        1,342,355		

       1,188,850		

 

                           0.9 

 

                            13.9 

 

         1,354,210		

         1,188,850		

 

           13.9		

 

Traditional deposits (2)
 
        1,056,280		

 

        1,050,679		

          996,495		

 

                           0.5 

 

                              6.0 

 

         1,056,280		

            996,495		

 

             6.0		

 

Total deposits (3)
 
        1,115,584		

 

        1,098,659		

       1,037,261		

 

                           1.5 

 

                              7.6 

 

         1,115,584		

         1,037,261		

 

             7.6		

 

Shareholders' equity
 
           118,435		

 

           114,714		

          108,931		

 

                           3.2 

 

                              8.7 

 

            118,435		

            108,931		

 

             8.7		

 

Tier 1 risk-based capital
 
           117,511		

 

           114,699		

          105,667		

 

                           2.5 

 

                            11.2 

 

            117,511		

            105,667		

 

           11.2		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital ratios
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders' equity  as a percentage of total assets
 
                 8.75		

 % 

                 8.55		

                9.16		

 

                           2.3 

 

                           (4.5)

 

                  8.75		

                  9.16		

 

            (4.5)

 

 

Tier 1 risk-based capital
 
                 9.73		

 

                 9.57		

                9.64		

 

                           1.7 

 

                             0.9  		

 

                  9.73		

                  9.64		

 

             0.9		

 

 

Total risk-based capital
 
               10.37		

 

               10.21		

              10.39		

 

                           1.6 

 

                           (0.2)

 

                10.37		

                10.39		

 

            (0.2)

 

 

Tier 1 leverage 
 
                 8.74		

 

                 8.71		

                8.90		

 

                           0.3 

 

                            (1.8)

 

                  8.74		

                  8.90		

 

            (1.8)

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common shares outstanding
 
        6,442,090		

 

        6,442,090		

       6,400,260		

 

                            -   

 

                             0.7  		

 

         6,442,090		

         6,400,260		

 

             0.7		

 

Book value per common share
$
             18.38		

 

               17.81		

              17.02		

 

                           3.2 

 

                             8.0  		

 

                18.38		

                17.02		

 

             8.0		

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employees (full-time  equivalent)
 
                  402		

 

                  421		

                 420		

 

                        (4.5)

 

                            (4.3)

 

                   402		

                   420		

 

            (4.3)

 

 

 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

 

The efficiency ratio is  		computed by dividing noninterest expense by total revenue (net interest income and  noninterest income).

 

 

 

 

 

(2)

 

Traditional deposits include  transaction, money market, savings, and time deposit accounts.

 

 

 

 

 

(3)

 

Total deposits include  traditional and nontraditional deposits, which include retail repurchase  agreements and commercial paper.

 

 

 

 

 

34

 

*EconomicSummary*

 

The economic events of the past twelve months have beenunprecedented.  The failure of several large financial institutionsalong with the conservatorship of the Federal National Mortgage Association andthe Federal Home Loan Mortgage Corporation driven by the diminution in housingvalues and subprime mortgage lending has resulted in multiple actions by theUnited States government. On October 3, 2008, the Congress passed the EmergencyEconomic Stabilization Act of 2008 (the “EESA”), which provides up to $700billion and grants new authorities to the United States Treasury Department(the “Treasury”), the Federal Reserve Board and the FDIC for initiatives torestore stability and liquidity to United States markets.  ManyEuropean nations have also taken actions to inject liquidity and capital intocritical financial institutions in order to stabilize world markets.

 

On October 14, 2008, the Treasury, Federal Reserve Board andFDIC jointly announced a sweeping plan to invest in banks and thrifts to helprestore confidence in the United States banking system. Some of the actionstaken by these governmental agencies include: 

 
- Temporarily increasing FDIC insurance coverage to $250,000     from $100,000 through December 31, 2009; 
- Reducing the targeted federal funds rate and the discount     rate; 
- Temporarily guaranteeing money market mutual funds;
- Introducing a capital purchase program whereby the     Treasury will purchase up to $250 billion in senior preferred shares from     healthy qualifying financial institutions; and 
- Introducing a Temporary Liquidity Guarantee Program (the     “TLGP”) whereby the FDIC will guarantee newly issued senior unsecured debt     and provide unlimited FDIC insurance coverage for noninterest-bearing     transaction accounts for a period of time without charge followed by an     annualized 10 basis point assessment for the insurance coverage above     $250,000 on such accounts.  The Bank has until December 5, 2008     to opt out of the TLGP and is currently evaluating its participation     options with regard to the TLGP.

 

One of the provisions resulting from the EESA is theTreasury Capital Purchase Program (the “CPP”), which provides direct equityinvestment of perpetual preferred stock by the Treasury in qualified financialinstitutions.  The program is voluntary and requires an institutionto comply with a number of restrictions and provisions, including limits onexecutive compensation, stock redemptions and declaration ofdividends.  Applications must be submitted by November 14, 2008 andare subject to approval by the Treasury.  The CPP provides for aminimum investment of 1% of risk-weighted assets, with a maximum investmentequal to the lesser of 3 percent of total risk-weighted assets or $25billion.  The perpetual preferred stock investment will have a dividendrate of 5% per year, until the fifth anniversary of the Treasury investment,and a dividend of 9%, thereafter.  The CPP also requires the Treasuryto receive warrants for common stock equal to 15% of the capital invested bythe Treasury.  The Company is currently evaluating its participationoptions with regard to the CPP. In order to be eligible to participate in** **thisprogram, the Company would be required to file a proxy statement requestingshareholder approval to authorize the issuance of** **preferred stock.  Participationin the program would be subject to receiving such shareholder approval andapproval by the Treasury. Regardless of the Company’sparticipation, governmental intervention and new regulations under theseprograms could materially and adversely impact the Company’s business,financial condition, results of operations, or cash flows.

 

Strategy

 

Growth and service strategies have potential to offset thetighter net interest margin with volume as the customer base grows throughexpanding the Company’s footprint, while maintaining and developing existingrelationships.  During 2008, the Bank opened a new banking office inRock Hill.  In addition, the Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company plansoccupancy during the first quarter of 2009.  The Company believes positiveoutcomes in the future will result from the expansion of its geographicfootprint, investments in infrastructure and technology, and continued focus onplacing customers first. 

 

*ExecutiveSummary*

* *

Totalassets increased during the nine month period ended September 30, 2008,primarily due to an increase in the loan and investment securities portfolios.

 

35

 

 

 

Loans continue to be the largest component of the Company’s mix ofassets. Total loans increased $84.8million, or 8.1% at September 30, 2008 over December31, 2007 primarily as a result of growth within the commercial realestate portfolio. 

 

Investment securities available for sale increased $34.6 million, or 36.2% at September 30,2008 over December 31, 2007 primarily within the collateralizedmortgage obligation sector of the portfolio.The Company began investingin collateralized mortgage obligations during the first quarter of 2008.  During the three month period ended June 30, 2008, theremaining securities in the Company’s government-sponsored enterprises sector of the portfolio matured.  Because interest spreads within this sector became extremelynarrow, the Company reinvested these maturing funds as well as additional fundsin collateralizedmortgage obligations that managementbelieved were undervalued due to the market discount that has been applied tothe entire mortgage related marketplace.  

 

Traditional deposit accounts continue to be the Company’sprimary source of funding.  Traditional deposit accounts decreased $2.5million, or 0.2% during the nine month periodended September 30, 2008.  Nontraditional deposit accounts, comprised of retailrepurchase agreements and commercial paper, supplement the Company’s source offunding provided through traditional deposit accounts.  Such accounts increased$8.1 million, or 18.5% over the same periods.  The combination of increasingcompetition and alternative investment options has made it more difficult togrow deposits accounts. 

 

To supplement funding of asset growth provided throughdeposit accounts, management has primarily employed proceeds from maturinginvestment securities issued by government-sponsored enterprises and borrowedfunds.  Total borrowed funding increased $81.0 million during the nine monthperiod ended September 30, 2007 to $111.0 million all of which were secured byappropriate collateral.  At September 30, 2008, the Company had $21.9 millionin secured FHLB borrowing availability and $55.0 million in unsecuredcorrespondent banking availability for liquidity.  Management is not aware ofany changes in the availability of such borrowed funding as a result of thecurrent economic environment.

 

Beginning in late March 2008 andcontinuing into early April 2008, the Company transacted a series of long-termFHLB borrowings intended to support supplement net interest income throughinvestments in available for sale securities. Although FHLB borrowings do notalways result in lower interest expense, management believes that such fundingcan increase net interest income if employed in higher yield interest-earningassets. The Company used these long-term FHLB borrowings to invest incollateralized mortgage obligations.  The impact of these transactionssupplemented net interest income growth during the three month period endedSeptember 30, 2008.

 

The Company earned $4.1 million, or $0.62 per diluted share,during the three month period ended September 30, 2008. Net income increased$161 thousand, or 4.1%, during the three month period ended September 30, 2008from the same period of 2007.  The following table summarizes the components ofnet income for the periods indicated (dollars in thousands).  

 

 

 

**For the three month**

 

 

 

 

 

**periods ended September 30,**

**Dollar**

**Percent**

 

 

 

**2008**

**2007**

**variance**

**variance**

 

Interest income

$

19,716 

21,293 

(1,577)

(7.4)

%

Interest expense

6,505 

8,538 

(2,033)

(23.8)

 

 

Net interest income

13,211 

12,755 

456 

3.6 

 

Provision for loan losses

687 

400 

287 

71.8 

 

 

Net interest income after provision for loan losses

12,524 

12,355 

169 

1.4 

 

Noninterest income

4,301 

4,358 

(57)

(1.3)

 

Noninterest expense

10,546 

11,137 

(591)

(5.3)

 

 

Net income before provision for income taxes

6,279 

5,576 

703 

12.6 

 

Provision for income taxes

2,222 

1,680 

542 

32.3 

 

 

Net income

$

4,057 

3,896 

161 

4.1 

%

 

 

 

 

 

 

 

 

Net interest income increased $456 thousand, or 3.6%, from the three monthperiod ended September 30, 2007 with the same period of 2008.  Thefollowing table summarizes the dollar amount of changes in interest income andinterest expense attributable to changes in average volume of interest-earningassets and interest-bearing liabilities, respectively, and the dollar amount ofchanges in interest income and interest expense attributable to changes inaverage interest rates when comparing the three month period ended September 30,2008 with the three month period ended September 30, 2007 (in thousands). The impact of the combination of rate and volume change has been dividedproportionately between the rate change and volume change. The comparisonbetween the periods includes an additional change factor that summarizes theimpact of the difference in the number of days of each year.

 

36

 

 

 

 

 

 

 

 

 

 

**Change in**

**average**

**volume**

**Change in**

**average**

**rate**

**Change due**

**to**

**difference**

**in number**

**of days**

**Total**

**change**

Total interest income

$

3,821 

(5,344)

(54)

(1,577)

Total interest expense

658 

(2,674)

(17)

(2,033)

 

Net interest income

$

3,163 

(2,670)

(37)

456 

 

 

 

 

 

 

 

Average loans accounted for88.4% of average interest-earning assets during the three month period endedSeptember 30, 2008 compared with 89.7% during the three month period endedSeptember 30, 2007. Average loans increased$127.7 million, or 12.8%, during the three month period endedSeptember 30, 2008 compared with the same period of2007. Interest earned on loans during the three month period endedSeptember 30, 2008 decreased 163 basis points to 6.32% from the same period of2007.

 

Averageinvestmentsecurities available for sale also increased$29.9 million, or 29.3%, during the three month period endedSeptember 30, 2008 compared with the same period of2007 primarily due to the collateralizedmortgage obligation sector of the portfolio.  Interest earned on investment securities available for saleduring the three month period endedSeptember 30, 2008 increased 81 basis points to 5.02% from the same period of2007.

 

Averagetraditional deposit accounts increased $49.4 million, or 5.7% during the three month period ended September 30,2008 compared with the same period of 2007.  Average nontraditional deposit accounts, comprisedof retail repurchase agreements and commercial paper, supplement the Company’ssource of funding provided through traditional deposit accounts. Interestpaid on traditional deposit accounts during the three month period ended September 30,2008 decreased 108 basis points to 2.44% from the same period of 2007.

 

Inorder to supplement asset growth funding, total average borrowed fundingincreased from an average of $29.9 million during the three month period endedSeptember 30, 2007 to $114.9 million during the same period of 2008, anincrease of $85.0 million.  Interest paid on total borrowedfunding during the three month period endedSeptember 30, 2008 decreased 281 basis points to 2.69% from the same period of2007.

 

Due to the fact that the FederalReserve did not take any action with regard to the prime interest rate or thefederal funds interest rate during the three month period ended September 30,2008, management expected that, from a rate perspective, net interest incomewould remain relatively unchanged during the period over the prior quarter. The following table summarizes the components of net interest income for theperiods indicated (dollars in thousands).  

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

 

 

 

 

**periods ended**

 

 

 

 

 

**September 30,**

**June 30,**

**Dollar**

**Percent**

 

 

 

**2008**

**2008**

**variance**

**variance**

 

Total interest income

$

19,716 

20,050 

(334)

(1.7)

%

Total interest expense

6,505 

6,428 

77 

1.2 

 

 

Net interest income

$

13,211 

13,622 

(411)

(3.0)

%

 

 

 

 

 

 

 

 

The slight decline in net interestincome from the three month period ended June 30, 2008 to the three monthperiod ended September 30, 2008 was primarily the result of nonaccrual interestreversed during the three month period ended September 30, 2008. The impact ofthe previously discussed FHLB borrowings transaction supplemented net interestincome growth during the three month period ended September 30, 2008 and thethree month period ended June 30, 2008.

 

Net interest margin forthe three month period ended September 30, 2008 was 4.13% compared with 4.54%for the three month period ended September 30, 2007. During the secondhalf of 2007 and continuing into the third and fourth quarters 2008, thefinancial markets experienced significant volatility resulting from thecontinued fallout of subprime lending and the global liquiditycrises.  A multitude of government initiatives along with rate cutsby the Federal Reserve have been designed to improve liquidity for thedistressed financial markets. The ultimate objective of these efforts has beento help the beleaguered consumer, and reduce the potential surge of residentialmortgage loan foreclosures and stabilize the banking system. The relationshipbetween declining interest-earning assets yields and more slowly declininginterest-bearing liability costs has caused, and may likely continue to cause,net interest margin compression.  

 

37

 

 

Noninterest income decreased $403thousand, or 8.6%, during the three month period ended September 30, 2008 overthe same period of 2007.  The following table summarizes fluctuations innoninterest income for the periods indicated (dollars in thousands).  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

 

 

 

 

 

 

**periods ended**

 

 

 

 

 

 

 

**September 30,**

**September 30,**

**Dollar**

**Percent**

 

 

 

 

 

**2008**

**2007**

**variance**

**variance**

 

 

Noninterest income

 

 

 

 

 

 

 

Service charges on deposit accounts, net

$

2,135 

2,001 

134 

6.7 

%

 

 

Fees for trust and investment management and brokerage services

744 

736 

8 

1.1 

 

 

 

Mortgage-banking income, net

210 

468 

(258)

(55.1)

 

 

 

Other

1,212 

1,499 

(287)

(19.1)

 

 

 

 

Total noninterest income

$

4,301 

4,704 

(403)

(8.6)

%

 

 

 

 

 

 

 

 

 

 

 

The increase in service charges on deposit accounts, net wasdriven primarily by an increase in nonsufficient funds and overdraft activity.Despite the substantial decline during the three month period ended September30, 2008 in the S&P 500 from a year ago, fees for trust and investmentmanagement and brokerage services remained stable over the periods presented. The decline in mortgage-banking income, net was driven primarily by an increasein amortization relative to the Company’s mortgage-servicing rights portfolio. The fluctuation of other from the three month period ended September 30, 2007to the same period of 2008 was impacted by the Company’s sale of its MasterCardstock.  During the third quarter of 2007, the Bank converted its shares ofClass B common stock on a one-for-one basis into shares of Class A common stockfor subsequent sale to public investors.  This transaction resulted in pretaxincome, net of transaction fees, totaling $487 thousand.  

 

The Company continues to be disciplined about its efforts tomanage expenses.  To this end, noninterest expense decreased $937 thousand, or8.2%, during the three month period ended September 30, 2008 over the sameperiod of 2007.  The following table summarizes fluctuations in noninterestexpense for the periods indicated (dollars in thousands).  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

 

 

 

 

 

 

**periods ended**

 

 

 

 

 

 

 

**September 30,**

**September 30,**

**Dollar**

**Percent**

 

 

 

 

 

**2008**

**2007**

**variance**

**variance**

 

 

Noninterest expense

 

 

 

 

 

 

 

Salaries and other personnel

$

5,910 

7,040 

(1,130)

(16.1)

%

 

 

Occupancy

824 

752 

72 

9.6 

 

 

 

Furniture and equipment

919 

918 

1 

0.1 

 

 

 

Loss on disposition of premises, furniture, and equipment

- 

346 

(346)

(100.0)

 

 

 

Marketing

277 

208 

69 

33.2 

 

 

 

Amortization of core deposit intangibles

11 

12 

(1)

(8.3)

 

 

 

Other

2,605 

2,207 

398 

18.0 

 

 

 

 

Total noninterest expense

$

10,546 

11,483 

(937)

(8.2)

%

 

 

 

 

 

 

 

 

 

 

 

Salariesand other personnel expense decreased by $1.1 million to $5.9 million duringthe three month period ended September 30, 2008 from $7.0 million during thethree month period ended September 30, 2007. 

 

Employee and officer salariesremained relatively unchanged from the three month period ended September 30,2007 to the same period of 2008 as the Company was able to gain efficienciesthrough the consolidating of four branches during the second quarter of 2008. Such expense savings were offset by the expense of annual merit raises foremployees and officers as well as the addition of new officer positions includingthose positions created in connection with the opening of the new Rock Hillbanking office.  The Bank celebrated the grand opening of its Rock Hill bankingoffice during September 2008. 

 

The following table summariesnonrecurring transactions, all of which were disclosed in the Company’sQuarterly Report on Form 10-Q for the Quarter Ended September 30, 2007,that resulted in additional salaries and other personnel expense for the three monthperiod ended September 30, 2007 of $1.1 million when compared with the threemonth period ended September 30, 2008 (in thousands).

 

 

 

 

 

Cash surrender value of life insurance (income)

$

898 

401(k) error contribution (expense)

(1,325)

Pension (expense)

(627)

 

Nonrecurring salaries and other personnel transactions

$

(1,054)

 

 

 

 

During the second quarter of 2007, the Company signed abuild-to-suit lease agreement with regard to the relocation of its corporateheadquarters to Greenville, South Carolina.  Under the terms of this agreement,the Company’s new headquarters is being constructed on the site of theCompany’s current downtown Greenville banking office that is leased from thesame lessor. In conjunction with the demolition of the previous downtownGreenville banking office, the Company wrote off $346 thousand in leaseholdimprovements during the third quarter of 2007.  

 

38

 

Othernoninterest expense increased by $398 thousand to $2.6 million during the threemonth period ended September 30, 2008 from $2.2 million during the three monthperiod ended September 30, 2007. The increase was impacted by increased FDICdeposit insurance assessments.
 Asset Quality
 

The following tables summarize asset quality trends at andfor the periods indicated (dollars in thousands).  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

 

 

 

 

**2008**

 

**2007**

 

 

 

Classified assets

$

45,415 

 

15,033 

 

 

 

Impaired loans

33,257 

 

5,256 

 

 

 

Nonaccrual loans

21,468 

 

4,810 

 

 

 

Nonperforming assets

29,020 

 

12,956 

 

 

 

Allowance for loan losses

7,823 

 

7,418 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

**For the nine month**

 

 

 

**periods ended**

 

**periods ended**

 

 

 

**September 30,**

 

**September 30,**

 

 

 

**2008**

 

**2007**

 

**2008**

**2007**

Net loans charged-off

$

509 

 

635 

 

1,457 

1,447 

 

 

 

 

 

 

 

 

 

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

0.18 

%

0.25 

 

0.18 

0.20 

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

0.69 

 

0.82 

 

0.69 

0.82 

Allowance for loan losses as a percentage of nonaccrual loans

36.44 

 

117.56 

 

36.44 

117.56 
(1) Calculated using loans excluding mortgage loans			held for sale, net of unearned income excluding allowance for loan			losses
 

The Company is not immune to the negative consequencesarising from overall economic weakness and, in particular, a sharp downturn inthe housing industry nationally. As such, asset quality trends may continue totrend higher than historical levels. 
 
Classified assets increased primarily in portfolios impactedby real estate conditions. Four commercial real estate loans approximating$20.3 million, all of which were considered impaired under SFAS No. 114 atSeptember 30, 2008, were classified as substandard during the nine month periodended September 30, 2008. 

 

Nonaccrual loans and nonperforming assets also increased atSeptember 30, 2008 over December 31, 2007 reflecting economic conditions,primarily in portfolios impacted by real estate conditions. Three of the fourcommercial real estate loans classified during the nine month period endedSeptember 30, 2008 were also placed in nonaccrual status during the periodaccounting for $16.3 million of the increase in nonaccrual loans over theperiod. 

 

Increases in commercial real estate classified, impaired,and nonaccrual loans have been a result of the conditions in the real estatemarkets and general consumer economy.  As consumers have cut back ondiscretionary spending, the Company has experienced that some of its commercialportfolios that are dependent on such spending have weakened. Until conditionsimprove in the real estate markets, the Company will continue to hold moreclassified and nonperforming assets, as it is currently the most economicoption available. The Company expects that the amount of classified andnonperforming loans will change due to portfolio growth, economic conditions,portfolio seasoning, routine problem loan recognition and resolution throughcollections, sales, or charge-offs. The performance of any one loan can be impactedby external factors, such as economic or market conditions, or factorsimpacting a particular borrower. Until conditionsimprove in the real estate and liquidity markets, the Company will continue toexperience increased levels of classified and nonperforming assets.

 

The Company’s has largely avoided many of the more riskyproducts others in the mortgage industry have offered. The Company has notoffered certain mortgage products such as negative amortizing mortgages oroption adjustable rate mortgages. Additionally, the Company continuallyevaluates and modifies its credit policies to address unacceptable levels ofrisk as they are identified. 

 

39

 

 
Third Quarter Premises and Equipment Progress Highlights
 
- The Bank completed upfitting     efforts, gained occupancy, and celebrated the grand opening of its Rock     Hill banking office during September 2008. 
- The Bank completed renovation     efforts, gained occupancy, and celebrated the grand opening of its     renovated Montague banking office during September 2008. 
- Construction is in progress on     the Company’s relocated Greer banking office, and the Company expects to     celebrate its grand opening of the new Greer banking office during the     second quarter of 2009.  

 

***Financial Condition*****

* *

*Overview*

* *

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated (Interim) Balance Sheets**

 

**(in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2008**

 

**2007**

 

**variance**

 

**variance**

 

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

$

35,635 

 

42,450 

 

(6,815)

 

(16.1)

%

 

Federal funds sold

 

 

55 

 

9,782 

 

(9,727)

 

(99.4)

 

 

 

Total cash and cash equivalents

 

35,690 

 

52,232 

 

(16,542)

 

(31.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB stock, at cost

 

 

7,241 

 

2,617 

 

4,624 

 

176.7 

 

Investment securities available for sale, at fair value

 

130,321 

 

95,715 

 

34,606 

 

36.2 

 

Mortgage loans held for sale

 

 

5,220 

 

5,005 

 

215 

 

4.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, gross

 

 

 

1,129,336 

 

1,044,770 

 

84,566 

 

8.1 

 

 

Less: allowance for loan losses

 

(7,823)

 

(7,418)

 

(405)

 

5.5 

 

 

 

Loans, net

 

 

1,121,513 

 

1,037,352 

 

84,161 

 

8.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

25,016 

 

25,133 

 

(117)

 

(0.5)

 

Premises held for sale

 

 

1,651 

 

- 

 

1,651 

 

100.0 

 

Goodwill, net

 

 

 

3,691 

 

3,691 

 

- 

 

- 

 

Core deposit intangibles, net

 

 

46 

 

79 

 

(33)

 

(41.8)

 

Accrued interest receivable

 

 

6,080 

 

6,655 

 

(575)

 

(8.6)

 

Other

 

 

 

 

17,741 

 

19,698 

 

(1,957)

 

(9.9)

 

 

 

 

Total assets

 

 

$

1,354,210 

 

1,248,177 

 

106,033 

 

8.5 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing

 

 

$

133,937 

 

135,111 

 

(1,174)

 

(0.9)

%

 

Interest-bearing

 

 

922,343 

 

923,683 

 

(1,340)

 

(0.1)

 

 

 

Total deposits

 

 

1,056,280 

 

1,058,794 

 

(2,514)

 

(0.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

21,817 

 

11,280 

 

10,537 

 

93.4 

 

Commercial paper (Master notes)

 

37,487 

 

26,326 

 

11,161 

 

42.4 

 

Other short-term borrowings

 

 

59,000 

 

30,000 

 

29,000 

 

96.7 

 

Long-term borrowings

 

 

52,000 

 

- 

 

52,000 

 

100.0 

 

Accrued interest payable

 

 

1,788 

 

2,042 

 

(254)

 

(12.4)

 

Other

 

 

 

 

7,403 

 

9,479 

 

(2,076)

 

(21.9)

 

 

 

Total liabilities

 

 

1,235,775 

 

1,137,921 

 

97,854 

 

8.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

 

32,211 

 

32,109 

 

102 

 

0.3 

 

Capital surplus

 

 

 

2,036 

 

1,664 

 

372 

 

22.4 

 

Retained earnings

 

 

87,291 

 

79,221 

 

8,070 

 

10.2 

 

Accumulated other comprehensive loss, net of tax

 

(3,103)

 

(2,738)

 

(365)

 

13.3 

 

 

 

Total shareholders' equity

 

118,435 

 

110,256 

 

8,179 

 

7.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,354,210 

 

1,248,177 

 

106,033 

 

8.5 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Investment Activities
 

The Company’s investmentsecurities available for sale consist of debt securities held primarily forliquidity, interest rate risk management, and long-term yield enhancement.  Thefollowing table summarizes the composition of the Company’s investmentsecurities available for sale portfolio at the dates indicated (dollars inthousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2008**

 

**December 31, 2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

			United States Treasury and federal agencies

$

- 

- 

%

20,743 

21.7 

State and municipal

51,170 

39.3 

 

52,159 

54.5 

Collateralized mortgage obligations

58,846 

45.2 

 

- 

- 

Other mortgage-backed (federal agencies)

20,305 

15.5 

 

22,813 

23.8 

 

Total investment securities available for sale

$

130,321 

100.0 

%

95,715 

100.0 

 

 

 

 

 

 

 

 

During 2008, the Company beganinvesting in collateralized mortgage obligations. Collateralized mortgageobligations are a mortgage-backed security sub-type in which the mortgages areordered into tranches by some quality (such as repayment time) with eachtranche sold as a separate security. These securities, in addition to theCompany’s other investment securities available for sale, are accounted for inaccordance with SFAS No. 115 as discussed in the Company’s Annual Report onForm 10-K for the year ended December 31, 2007.

 

40

 

Thefollowing table summarizes the amortized cost and fair value composition of theCompany’s investment securities available for sale portfolio at the datesindicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2008**

 

**December 31, 2007**

 

 

**Amortized**

**Fair**

 

**Amortized**

**Fair**

 

 

**cost**

**value**

 

**cost**

**value**

			United States Treasury and federal agencies

$

- 

- 

 

20,725 

20,743 

State and municipal

51,085 

51,170 

 

52,677 

52,159 

Collateralized mortgage obligations

59,765 

58,846 

 

- 

- 

Other mortgage-backed (federal agencies)

20,465 

20,305 

 

22,722 

22,813 

     Total investment securities available for sale

$

131,315 

130,321 

 

96,124 

95,715 

 

 

 

 

 

 

 

 

The Company receives market valuations monthly from one ofthe fixed income industry’s leading broker / dealers and investment advisors.Market values provided are based upon equivalent comparable securities thathave actually traded in the marketplace on a specified day. Market valuationsare not matrix based but are based upon actual market participation. 

 

Securities Pledgedand Liquidity. Approximately57% of the investment securities portfolio, at fair value, was pledged tosecure public deposits and trust assets at September 30, 2008 as compared with80% at December 31, 2007.  Of the Company’s $74.4 million pledged available forsale investment securities balance at September 30, 2008, $47.4 million of theinvestment securities portfolio, at fair value, was securing public depositsand trust assets at September 30, 2008.  Of the Company’s $76.6 million pledgedavailable for sale investment securities balance at December 31, 2007, $40.4million of available for sale investment securities were securing publicdeposits and trust assets.  The decrease in pledged securities as a percentageof the investment securities portfolio from December 31, 2007 to September 30,2008 was primarily the result of an increase in the portfolio.  

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities.  Approximately $46 million, or 36%, of the investmentsecurities portfolio, at fair value, was pledged to collateralize FHLB advancesand letters of credit as of September 30, 2008 of which $41.8 was available aslendable collateral.  In order to compute lendable collateral amounts,investment security market values are multiplied by a collateral valuepercentage. No investment securities were pledged at December 31, 2007 tocollateralize FHLB advances and letters of credit.

 

Impairment Analysis.**Thefollowing table summarizes the gross unrealized losses, fair value, and the numberof securities in each category of investment securities available for sale,aggregated by investment category and length of time that individual securitieshave been in a continuous unrealized loss position, at the dates indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2008**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

State and municipal

27 

$

13,499 

$

106 

 

17 

6,694 

109 

 

44 

20,193 

215 

Collateralized mortgage obligation

12 

50,470 

937 

 

- 

- 

- 

 

12 

50,470 

937 

Other mortgage-backed (federal agencies)

5 

7,614 

185 

 

5 

4,319 

109 

 

10 

11,933 

294 

 

Total investment securities available for sale

44 

$

71,583 

$

1,228 

 

22 

11,013 

218 

 

66 

82,596 

1,446 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

 

 

 

 

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

			United States Treasury and federal agencies

- 

$

- 

$

- 

 

2 

3,476 

8 

 

2 

3,476 

8 

State and municipal

16 

6,135 

79 

 

98 

38,760 

494 

 

114 

44,895 

573 

Other mortgage-backed (federal agencies)

1 

733 

- 

 

15 

10,655 

105 

 

16 

11,388 

105 

 

Total investment securities available for sale

17 

$

6,868 

$

79 

 

115 

52,891 

607 

 

132 

59,759 

686 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

41

 

 

The change in investment securities in a gross unrealizedlosses position at September 30, 2008 was largely due to decreases in marketinterest rates over the yields available at the time the underlying securitieswere purchased. The fair value is expected to recover as the bonds approachtheir maturity date or repricing date or if market yields for such investmentsdecline further. Gross unrealized losses increased $760 thousand from December31, 2007 to September 30, 2008 as a result of the purchase of collateralizedmortgage obligation.  Offsetting this increase in gross unrealized losses weredeclines with regard to the state and municipal and other mortgage-backedportfolios.  The increase in investment securities in a gross unrealized lossesposition at September 30, 2008 less than 12 months was concentrated within thecollateralized mortgage obligation portfolio.  The decline in investmentsecurities in a gross unrealized losses position at September 30, 2008 12months or longer was due to declines in the state and municipal and othermortgage-backed portfolios.

 

The initial indication of other-than-temporary impairmentfor debt securities is a decline in the market value below the amount recordedfor an investment and the severity and duration of the decline. In determiningwhether an impairment is other-than-temporary, management considers the lengthof time and the extent to which the market value has been below cost, recentevents specific to the issuer, including investment downgrades by ratingagencies and economic conditions of its industry, and the Company’s ability andintent to hold the investment for a period of time sufficient to allow for anyanticipated recovery. Also considered is the cause of the price decline(general level of interest rates and industry- and issuer-specific factors),the issuer’s financial condition, near-term prospects and current ability tomake future payments in a timely manner, the issuer’s ability to service debt,and any change in agencies’ ratings at evaluation date from acquisition dateand any likely imminent action. Any decline in the fair value of available forsale securities below cost that are deemed to be other-than-temporary isreflected in earnings as realized losses. As of September 30, 2008, the Companyhas received all principal and interest payments, believes that the principaland interest on these securities are fully recoverable, and has the ability andintent to hold the securities for a period of time sufficient for a recovery ofcost. Accordingly, management believes the gross unrealized losses detailed inthe preceding table are temporary, and, therefore, were notother-than-temporarily impaired as of September 30, 2008. However, underlyingconsiderations may be impacted in future periods by changes in conditions thatwere not known to management at the time of the issuance of the Company’s ConsolidatedInterim Financial Statements. Thus, there can be no assurance that the Companywill not be required to recognize other-than-temporarily impairment in futureperiods, thus adversely impacting the Company’s business, financial condition,results of operations, or cash flows.

 

Concentrations of Risk. Nostate and municipal security issuers issued securities with fair valuesexceeding 2% of total shareholders’ equity at September 30, 2008. Four stateand municipal security issuers issued securities with fair values exceeding 1%of total shareholders’ equity at September 30, 2008 ranging from 1.0% to 1.8%.Although all state and municipal investment securities are not rated “AAA,” allare within the Company’s ratings standards outlined in its Investment Policywhich requires rated bonds to be balanced to average “Aa” to “A” by one of themajor bond rating agencies. 

 

Collateralized mortgage obligationissuers issued securities with fair values ranging from 1.7% of totalshareholders’ equity at September 30, 2008 to 8.1% of total shareholders’equity at September 30, 2008.  The following table summarizes issuer fair valueconcentration of other mortgage-backed investment securities, by issuer, atSeptember 30, 2008 (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

**Federal**

**National**

**Mortgage**

**Association**

 

**Federal**

**Home Loan**

**Mortgage**

**Corporation**

**Total**

Other mortgage-backed

$

16,865 

 

3,440 

20,305 

 

 

 

 

 

 

As a percentage of shareholders' equity

14.2 

%

2.9 

17.1 

 

At September 30, 2008,collateralized mortgage obligations and other mortgage-backed investmentsecurities were rated “AAA” by Standard and Poor's, Moody's, and / or FitchRatings.  This AAA rating is based not on the credit of the issuer, but ratheron the structure of the securities and the credit quality of the collateral.Further, during the three month period ended September 30, 2008, the UnitedStates government stepped in to help rescue the Federal National MortgageAssociation and the Federal Home Loan Mortgage Corporation.  The government putboth entities into conservatorships under the control of their regulator, theFederal Housing Finance Agency.  The takeover makes the government’s onceimplicit guarantee explicit.  

 

42

 

 

*Lending Activities*

* *

Composition. Thefollowing table summarizes gross loans, categorized by loan purpose, excludingthose mortgage loans held for sale, at the dates indicated (dollars inthousands). 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

 

 

 

**2008**

 

**2007**

 

 

 

 

**Total**

**% of**

**total**

 

**Total**

**% of**

**total**

 

 

Commercial business

$

151,510 

13.4 

%

145,634 

13.9 

 

 

Commercial real estate

719,379 

63.7 

 

639,144 

61.2 

 

 

Installment

23,251 

2.1 

 

25,315 

2.4 

 

 

Installment real estate

82,316 

7.3 

 

75,721 

7.3 

 

 

Indirect

35,407 

3.1 

 

39,502 

3.8 

 

 

Credit line

1,939 

0.2 

 

2,188 

0.2 

 

 

Prime access

61,382 

5.4 

 

54,164 

5.2 

 

 

Residential mortgage

37,132 

3.3 

 

40,842 

3.9 

 

 

Bankcards

12,272 

1.1 

 

12,702 

1.2 

 

 

Business manager

209 

- 

 

326 

- 

 

 

Other

1,651 

0.1 

 

2,045 

0.2 

 

 

Loans in process

2,437 

0.2 

 

6,511 

0.6 

 

 

Deferred loans fees and costs

451 

0.1 

 

676 

0.1 

 

 

 

Loans, gross

$

1,129,336 

100.0 

%

1,044,770 

100.0 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

 

 

**2008**

 

**2007**

 

 

 

**Total**

**% of**

**total**

 

**Total**

**% of**

**total**

 

Secured by real estate

 

 

 

 

 

 

 

Construction, land development, and other land loans

$

50,331 

4.4 

%

52,236 

5.0 

 

 

Farmland

899 

0.1 

 

1,004 

0.1 

 

 

Single-family residential

			214,967 

19.0 

 

209,275 

20.0 

 

 

Multifamily residential

33,921 

3.0 

 

28,659 

2.8 

 

 

Nonfarm nonresidential

653,449 

57.9 

 

578,719 

55.4 

 

Commercial and industrial

89,413 

7.9 

 

77,555 

7.4 

 

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

2,913 

0.3 

 

3,339 

0.3 

 

General consumer and other

83,443 

7.4 

 

93,983 

9.0 

 

 

Loans, gross

$

			1,129,336 

100.0 

%

1,044,770 

100.0 

 

 

 

 

 

 

 

 

 

 

Loans included in both of the preceding loan compositiontables are net of participations sold, and mortgage loans sold and serviced forothers.  Participations sold totaled $26.6 million and $14.6 million atSeptember 30, 2008 and December 31, 2007, respectively. Mortgage loans servicedfor the benefit of others amounted to $371.6 million and $346.3 million atSeptember 30, 2008 and December 31, 2007, respectively. 

 

Loans Pledged. To borrow from the FHLB, members mustpledge collateral to secure advances and letters of credit.  Acceptablecollateral includes a variety of single-family residential loans, commercialreal estate loans, home equity lines of credit, and multifamily residentialloans as well as a number of types of securities. Approximately $379 million,or 34%, of the loans, gross, excluding mortgage loans held for sale, werepledged to collateralize FHLB advances and letters of credit at September 30,2008 of which $160 million was available as lendable collateral.  In order tocompute lendable collateral amounts, pledged loan unpaid principal balances arereduced by a collateral verification review extrapolation factor before beingmultiplied by a collateral value percentage.  

 

Concentrations of Risk.Loan Type / Industry Concentration. Categorized by loan purpose, the Company’scommercial real estate portfolio accounts for 63.7% of the Company’s gross loanportfolio. The following table summarizes the composition of the Company’scommercial real estate portfolio at September 30, 2008. For the purpose of thisanalysis, adjustments have been made to the balance of commercial real estateloans by loan purpose in order to conform the Company’s definition ofcommercial real estate loans to that of regulators. 

 

43

 

 

 

 

 

 

 

 

**Commercial**

**real estate**

**loans, adjusted**

**by**

**concentration**

 

**Commercial**

**real estate**

**loans, adjusted**

**as a percentage**

**of tier 1 capital**

Residential

13.4 

%

66.6 

Land-only

21.0 

 

104.4 

Construction

7.0 

 

34.7 

Commercial - specific

40.5 

 

201.2 

Commercial - nonowner occupied

18.0 

 

89.2 

Rounding

0.1 

 

0.4 

 

100.0 

%

496.5 

 

 

 

 

 

The following table further classifies materialconcentrations at September 30, 2008, defined as those exceeding 20% of the commercial real estateloans, adjusted portfolio and those exceeding 100% of tier 1 capital, both assummarized in the table above.  

 

 

 

 

 

 

 

 

**Commercial**

**real estate**

**loans, adjusted**

**by**

**concentration**

 

**Commercial**

**real estate**

**loans, adjusted**

**as a percentage**

**of tier 1 capital**

Land-only

 

 

 

 

Developed land

19.0 

%

94.5 

 

Undeveloped land

2.0 

 

9.9 

 

 

21.0 

%

104.4 

 

 

 

 

 

Commercial - specific

 

 

 

 

Hotels / motels

18.4 

%

91.4 

 

Restaurants

1.8 

 

8.7 

 

Convenience stores

1.4 

 

7.1 

 

Golf courses

2.6 

 

12.8 

 

Religious facilities

10.0 

 

49.8 

 

Assisted living facilities

5.8 

 

28.7 

 

Mobile home communities

0.5 

 

2.7 

 

 

40.5 

%

201.2 

 

 

 

 

 

 

The Company believes that the properties securing itscommercial real estate portfolio are diverse in terms of type. This diversityreduces the Company’s exposure to adverse economic events that impact anysingle industry.

 

44

 

 

 
 
Asset Quality. Classified and Nonperforming Assets. Thefollowing table summarizes the composition of the Company’s classified assets,categorized by FDIC code, at the datesindicated (dollars in thousands). 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2008**

 

 

 

**Special**

**mention**

 

**Substandard**

**Doubtful**

**Loss**

**Total**

 

**As a**

**percentage**

**of loans,**

**gross (1)**

 

**As a**

**percentage**

**of**

**applicable**

**portfolio,**

**gross (1)**

Secured by real estate

 

 

 

 

 

 

 

 

 

 

 

Construction, land development, and other land loans

$

- 

 

2,327 

- 

- 

2,327 

 

0.2 

%

4.6 

 

Farmland

- 

 

- 

226 

- 

226 

 

- 

 

25.1 

 

Single-family residential

668 

 

5,113 

265 

- 

6,046 

 

0.5 

 

2.8 

 

Multifamily residential

- 

 

224 

- 

- 

224 

 

- 

 

0.7 

 

Nonfarm nonresidential

1,960 

 

31,170 

605 

- 

33,735 

 

3.0 

 

5.2 

Commercial and industrial

250 

 

1,014 

1,121 

- 

2,385 

 

0.2 

 

2.7 

General consumer and other

34 

 

418 

20 

- 

472 

 

0.1 

 

0.6 

 

 

Total classified loans

$

2,912 

 

40,266 

2,237 

- 

45,415 

 

4.0 

%

4.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of loans, gross (1)

0.2 

%

3.6 

0.2 

- 

4.0 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

 

 

 

 

**Special**

**mention**

 

**Substandard**

**Doubtful**

**Loss**

**Total**

 

**As a**

**percentage**

**of loans,**

**gross (1)**

 

**As a**

**percentage**

**of**

**applicable**

**portfolio,**

**gross (1)**

Secured by real estate

 

 

 

 

 

 

 

 

 

 

 

Construction, land development, and other land loans

$

- 

 

182 

- 

- 

182 

 

- 

%

0.3 

 

Farmland

- 

 

- 

223 

- 

223 

 

- 

 

22.2 

 

Single-family residential

176 

 

3,646 

370 

- 

4,192 

 

0.4 

 

2.0 

 

Nonfarm nonresidential

1,578 

 

6,033 

238 

- 

7,849 

 

0.8 

 

1.4 

Commercial and industrial

118 

 

1,451 

647 

- 

2,216 

 

0.2 

 

2.9 

General consumer and other

20 

 

322 

29 

- 

371 

 

- 

 

0.4 

 

 

Total classified loans

$

1,892 

 

11,634 

1,507 

- 

15,033 

 

1.4 

%

1.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of loans, gross (1)

0.2 

%

1.1 

0.1 

- 

1.4 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the allowance for loan losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

45

 

 

 

The following tablesummarizes the composition of the Company’s nonperforming assets, whichincludes itsnonaccrual loans, categorized by FDIC code, at the dates indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**June 30,**

**March 31,**

**December 31,**

**September 30,**
 

 

**2008**

 

**2008**

**2008**

**2007**

**2007**

Secured by real estate

 

 

 

 

 

 

 

Construction, land development, and other land loans

$

- 

 

184 

184 

182 

- 

 

Single-family residential

1,660 

 

1,487 

829 

781 

936 

 

Nonfarm nonresidential

19,127 

 

4,228 

3,844 

3,164 

5,288 

Commercial and industrial

513 

 

438 

631 

567 

684 

General consumer and other

168 

 

82 

118 

116 

135 

 

Total nonaccrual loans

21,468 

 

6,419 

5,606 

4,810 

7,043 

 

 

 

 

 

 

 

 

Real estate acquired in settlement of loans

7,089 

 

8,332 

7,960 

7,743 

6,170 

Repossessed automobiles acquired in settlement of loans

463 

 

288 

369 

403 

295 

 

Total assets acquired in settlement of loans

7,552 

 

8,620 

8,329 

8,146 

6,465 

 

 

 

 

 

 

 

 

 

Total nonperforming assets

$

29,020 

 

15,039 

13,935 

12,956 

13,508 

 

 

 

 

 

 

 

 

Loans past due 90 days and still accruing (1)

$

70 

 

140 

176 

236 

210 

 

 

 

 

 

 

 

 

Loans,			gross (2)

$

1,129,336 

 

1,114,522 

1,072,825 

1,044,770 

1,005,872 

 

 

 

 

 

 

 

 

Total assets

1,354,210 

 

1,342,355 

1,295,775 

1,248,177 

1,188,850 

 

 

 

 

 

 

 

 

Nonaccrual loans as a percentage of:

 

 

 

 

 

 

 

loans and foreclosed assets (2)

1.89 

%

0.57 

0.52 

0.46 

0.70 

 

total assets

1.59 

 

0.48 

0.43 

0.39 

0.59 

 

 

 

 

 

 

 

 

Nonperforming assets as a percentage of:

 

 

 

 

 

 

 

loans and foreclosed assets (2)

2.55 

%

1.34 

1.29 

1.23 

1.33 

 

total assets

2.14 

 

1.12 

1.08 

1.04 

1.14 

 

 

 

 

 

 

 

 

(1)

Substantially all of these loans are bankcard loans

 

 

 

 

 

 

(2)

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

 

 

The following table summarizes the changesin the real estate acquired in settlement of loans portfolio, including thebalance at the beginning and end of the period, provision charged to expense,and losses charged to the allowance for loan losses related to the Company’sreal estate acquired in settlement of loans at and forthe periods indicated (in thousands). 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**
			 			 
**periods ended September 30,**			 
**periods ended September 30,**

 

 

**2008**

**2007**

 

**2008**

**2007**

Real estate acquired in settlement of loans, beginning of period

$

8,332 

717 

 

 

7,743 

600 

 

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

1,841 

5,533 

 

2,630 

6,115 

 

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

(3,071)

(80)

 

(3,202)

(374)

 

Less: Provision charged to expense

(13)

- 

 

(82)

(171)

Real estate acquired in settlement of loans, end of period

$

7,089 

6,170 

 

 

7,089 

6,170 

 

 

 

 

 

 

 

 

Two loan relationships compriseapproximately 76% of the real estate acquired in settlement of loans portfolio,one of which was added during the three month period ended September 30, 2008totaling $1.2 million.  With regard to the other relationship comprising thistotal, the lead bank is managing the operations of the property and iscurrently working with an external firm to market the property.  The Bank was a20% participant in the loan relationship and is now a 20% owner of thecollateral property.  Expenses related to the holding of this property withinthe real estate acquired in settlement of loans portfolio totaled $363 thousandduring the nine month period ended September 30, 2008.   Both relationships were carried at market value at September30, 2008 based on management’s best judgment and information available at thattime.  Virtually all of the $3.1 million sold from the portfolio during thethree month period ended September 30, 2008 was related to one property onwhich the Company realized no loss.  

 

Classified assets increased $30.4 million to $45.4million at September 30, 2008, from $15.0 million at December 31, 2007while nonperforming assets increased $16.1 million over the same periods,reflecting economic conditions, primarily in portfolios impacted by real estateconditions. Four commercial real estate loans approximating $20.3 million, allof which were considered impaired under SFAS No. 114 at September 30, 2008,were classified as substandard during the nine month period ended September 30,2008. 

 

46

 

Nonaccrual loans increased $16.7 million to $21.5million at September 30, 2008, from $4.8 million at December 31, 2007while nonperforming assets increased $16.1 million over the same periods alsoreflecting economic conditions, primarily in portfolios impacted by real estateconditions. Three of the four commercial real estate loans classified duringthe nine month period ended September 30, 2008 were also placed in nonaccrualstatus during the period accounting for $16.3 million of the increase innonaccrual loans over the period. 

 

Increases in commercial real estate classified andnonaccrual loans have been a result of the conditions in the real estatemarkets and general consumer economy.  As consumers have cut back ondiscretionary spending, the Company has experienced that some of its commercialportfolios that are dependent on such spending have weakened. Until conditionsimprove in the real estate markets, the Company will continue to hold moreclassified and nonperforming assets, as it is currently the most economicoption available. The Company expects that the amount of classified andnonperforming loans will change due to portfolio growth, economic conditions,portfolio seasoning, routine problem loan recognition and resolution throughcollections, sales, or charge-offs. The performance of any one loan can beimpacted by external factors, such as economic or market conditions, or factorsimpacting a particular borrower. Until conditionsimprove in the real estate and liquidity markets, the Company will continue toexperience increased levels of classified and nonperforming assets.

 

See Allowance for Loan Losses below for discussion regarding the Company’s methodology regarding the impactimpaired loans have on the Company’s allowance for loan loss.

 

The Company’s has largely avoided many of the more riskyproducts others in the mortgage industry have offered. The Company has notoffered certain mortgage products such as negative amortizing mortgages oroption adjustable rate mortgages. Additionally, the Company continuallyevaluates and modifies its credit policies to address unacceptable levels ofrisk as they are identified. 

 

Troubled Debt Restructurings. Troubled debt restructurings entered into by the Company during the first ninemonths of 2008 are subject to review by the Company, in accordance with theCompany’s loan review policies, to ensure loan classifications were inaccordance with applicable regulations.  Troubled debt restructurings areincluded in the Company’s analysis of allowance for loan loss adequacy.  AtSeptember 30, 2008 and December 31, 2007, the principal balance of such loanstotaled $1.2 million.  

 

Potential Problem Loans. Potentialproblem loans consist of loans that are generally performing in accordance withcontractual terms but for which management has concerns about the ability ofthe borrower to continue to comply with repayment terms because of theborrower’s potential operating or financial difficulties. Management generallyconsiders all commercial loans classified as substandard and doubtful not innonaccrual status to fit into the category of potential problem loans andmonitors these loans closely and reviews performance on a regular basis. As ofSeptember 30, 2008, the Company had potential problem loans totaling $34.6million. Potential problem loans are included in the Company’s analysis ofallowance for loan loss adequacy.  

 

Allowance for Loan Losses.General. The Company’s process for determining theappropriate level of the allowance for loan losses is designed to account forasset deterioration as it occurs.  Management analyzes the adequacy ofthe allowance for loan losses on a monthly basis using an internal analysismodel.  No less than quarterly, the Company’s allowance for loan losses modeland conclusions are reviewed and approved by senior management. The allowancefor loan losses is a reserve established through a provision for loan lossescharged to expense, which represents management’s best estimate of probablelosses that have been incurred within the existing portfolio of loans atthe balance sheet date. The allowance for loanlosses, in the judgment of management, is necessary to reserve for estimatedloan losses and risks inherent in the loan portfolio. The Companyassumes that its allowance for loan losses as a percentage of net loanscharged-off and nonaccrual loans will change at different points in time basedon credit performance, loan mix, and collateral values.  The Company’s allowance for loan loss methodology is basedon guidance provided in SAB No. 102 and includes allocationscalculated in accordance with SFAS No. 114, as amended bySFAS No. 118 and allocations calculated in accordance withSFAS No. 5. Accordingly, the methodology is based on historical lossexperience by type of loans, specific homogeneous risk pools, and specific lossallocations. The provision for loan losses reflects not only the necessaryincreases in the allowance for loan losses related to newly identifiedcriticized loans, but it also reflects actions taken related to other loansincluding, among other things, any necessary increases or decreases in requiredallowance for loan losses for specific loans or loan pools. 

 

47

 

 

 

 

Impaired Loans. The Companyconsiders a loan to be impaired when, based upon current information andevents, management believes it is probable that the Company will be unable tocollect all amounts due according to the contractual terms of the loanagreement.  The Company’s impaired loans include loans identified as impairedthrough review of its nonhomogeneous portfolio and troubled debtrestructurings.  SFAS No. 114 specifically states that the pronouncement neednot be applied to large groups of smaller-balance homogeneous loans that arecollectively evaluated for impairment.  Thus, the Company determined that SFASNo. 114 does not apply to its installment, credit card, or residential mortgageloan portfolios, except that it may choose to apply such provision to certainspecific larger loans as determined by management.  Specific allowance for loanlosses amounts are established on impaired loans, if deemed necessary, for thedifference between the loan amount and the fair value.  Fair value may bedetermined based upon the present value of expected cash flows, market price ofthe loan, if available, or value of the underlying collateral.  Expected cashflows are required to be discounted at the loan’s effective interest rate.  AtSeptember 30, 2008, all of the Company’s impaired loans were valued using thecollateral value method.  

 

Impaired loans may be left onaccrual status during the period the Company is pursuing repayment of theloan.  Impairment losses are recognized through a charge to the allowance forloan losses and a corresponding charge to the provision for loan losses. Adjustments to impairment losses due to changes in the fair value are alsorecognized through a charge to the allowance for loan losses and acorresponding charge to the provision for loan losses.  When an impaired loanis sold, transferred to the Company’s real estate acquired in settlement ofloans portfolio, or written-down, any specific allowance for loan lossesamounts is removed, as it is no longer necessary to properly record the loan atits fair value.

 

Impaired loans at September 30, 2008 totaled $33.3 million for which aspecific allowance of $3.1 million had been allocated.  Average impaired loansfor the three month period ended September 30, 2008 totaled $21.7 million. Average impaired loans for the nine month period ended September 30, 2008totaled $19.3 million.  Impaired loans without a specific allowance for loanlosses allocation at and for the period indicated were generally reservedwithin the allowance for loan losses.

 

Activity. The following table summarizes activity within the allowance for loanlosses at and forthe periods indicated (dollars in thousands). Losses and recoveries are chargedor credited to the allowance for loan losses at the time realized. Thecomposition of loans charged-off and loan recoveries are categorized by FDICcode. 

 

 

 

 

 

 

48

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

**periods ended September**

**30,**

 

**At and for the nine month**

**periods ended September**

**30,**

 

 

 

 

 

**2008**

 

**2007**

 

**2008**

 

**2007**

 

Allowance for loan losses, beginning of period

$

7,645 

 

8,515 

 

7,418 

 

8,527 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

687 

 

400 

 

1,862 

 

1,200 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans charged-off

 

 

 

 

 

 

 

 

 

Secured by real estate

 

 

 

 

 

 

 

 

 

 

Single-family residential

98 

 

149 

 

195 

 

361 

 

 

 

Nonfarm nonresidential

23 

 

236 

 

135 

 

394 

 

 

Commercial and industrial

123 

 

72 

 

368 

 

210 

 

 

General consumer

298 

 

249 

 

862 

 

731 

 

 

 

 

Total loans charged-off

542 

 

706 

 

1,560 

 

1,696 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan recoveries

 

 

 

 

 

 

 

 

 

Secured by real estate

 

 

 

 

 

 

 

 

 

 

Single-family residential

7 

 

2 

 

9 

 

35 

 

 

 

Nonfarm nonresidential

5 

 

9 

 

8 

 

12 

 

 

Commercial and industrial

1 

 

30 

 

17 

 

51 

 

 

General consumer

20 

 

30 

 

69 

 

151 

 

 

 

 

Total loan recoveries

33 

 

71 

 

103 

 

249 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off

509 

 

635 

 

1,457 

 

1,447 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses, end of period

$

7,823 

 

8,280 

 

7,823 

 

8,280 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average loans (1)

$

1,122,113 

 

997,301 

 

1,094,637 

 

970,999 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending loans (1)

1,129,336 

 

1,005,872 

 

1,129,336 

 

1,005,872 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans

21,468 

 

7,043 

 

21,468 

 

7,043 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

0.18 

%

0.25 

 

0.18 

 

0.20 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

0.69 

 

0.82 

 

0.69 

 

0.82 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of nonaccrual loans

36.44 

 

117.56 

 

36.44 

 

117.56 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

Until real estate valuesstabilize, the loan portfolio may produce higher than historical loss levels.

 

Management considers its allowance for loan losses atSeptember 30, 2008 appropriate and adequate to cover current losses in the loanportfolio. However, underlying assumptions may be impacted in future periods bychanges in economic conditions, the impact of regulatory examinations, and thediscovery of information with respect to borrowers, which was not known tomanagement at the time of the issuance of the Company’s Consolidated InterimFinancial Statements. As such, management’s assumptions may or may not provevalid. Thus, there can be no assurance that credit deterioration and loanlosses in future periods will not exceed the current allowance for loan lossesamount or that future increases in the allowance for loan losses will not berequired. Additionally, no assurance can be given that management’s ongoingevaluation of the loan portfolio, in light of changing economic conditions andother relevant factors, will not require significant future additions to theallowance for loan losses, thus adversely impacting the Company’s business,financial condition, results of operations, or cash flows.

 

49

 

*Deposit Activities*

* *

The following tablesummarizes the Company’s traditional deposit composition at the datesindicated (dollars in thousands).

 

 

 

**September 30,**

 

**December 31,**

 

 

**2008**

 

**2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Noninterest-bearing transaction deposit accounts

$

133,937 

12.7 

%

135,111 

12.7 

Interest-bearing transaction deposit accounts

355,157 

33.6 

 

387,248 

36.6 

 

Transaction deposit accounts

489,094 

46.3 

 

		522,359 

49.3 

 

 

 

 

 

 

 

Money market deposit accounts

		96,935 

9.2 

 

118,681 

11.2 

Savings deposit accounts

38,546 

3.6 

 

34,895 

3.3 

Time deposit accounts

431,705 

40.9 

 

382,859 

36.2 

 

Total traditional deposit accounts

$

		1,056,280 

100.0 

%

1,058,794 

100.0 

 

Dependence ontraditional deposit account funding declined from December 31, 2007 toSeptember 30, 2008.  At December 31, 2007, traditional deposit accounts as apercentage of liabilities totaled 93.0% compared with 85.5% at September 30,2008. 

 

In addition to traditional deposit accounts, the Companyoffers nontraditional deposit accounts through its retail repurchase andcommercial paper agreements.  The followingtable summarizes the Company’s nontraditional deposit composition at thedates indicated (dollars in thousands).

 

 

 

**September 30,**

 

**December 31,**

 

 

**2008**

 

**2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Retail repurchase agreements

$

21,817 

36.8 

%

11,280 

30.0 

Commercial paper (Master notes)

37,487 

63.2 

 

26,326 

70.0 

 

Total nontraditional deposit accounts

$

59,304 

100.0 

%

37,606 

100.0 

 

Dependence on nontraditionaldeposit account funding increased from December 31, 2007 to September 30,2008.  At December 31, 2007, nontraditional deposit accounts as a percentage ofliabilities were 3.3% compared with 4.8% at September 30, 2008. 

 

The following table summarizes dependence on total deposit account funding at the dates indicated (dollars in thousands).

 

 

 

**June 30,**

**December 31,**

**Dollar**

**Percent**

 

 

 

**2008**

**2007**

**variance**

**variance**

 

Total traditional deposit accounts

$

1,056,280 

1,058,794 

(2,514)

(0.2)

%

Total nontraditional deposit accounts

59,304 

37,606 

21,698 

57.7 

 

 

Total deposit accounts

$

1,115,584 

1,096,400 

19,184 

1.7 

%

 

The slight increase in funding provided by total depositaccounts during the first nine months of 2008 resulted in the Company relyingmore heavily on alternative funding sources from which to fund asset growth. 

 

*Borrowing Activities*

* *

In addition to depositaccounts, which are the Company’s primary funding source for assetgrowth, the Company borrows funds tosupplement its supply of lendable funds, to assist in meeting depositwithdrawal requirements, and to fund growth of interest-earning assetsin excess of traditional deposit growth.Management believes that by locking in borrowed funding, liquidity risk can bereduced. 

 

The following tablesummarizes the Company’s borrowed funds composition at the dates indicated (dollarsin thousands).

 

 

 

**September 30, 2008**

 

**December 31, 2007**

 

 

 

**Total**

**% of total**

 

**Total**

**% of total**

 

Other short-term borrowings

$

59,000 

53.2 

%

30,000 

100.0 

 

Long-term borrowings

52,000 

46.8 

 

- 

- 

 

 

Total borrowings

$

111,000 

100.0 

%

30,000 

100.0 

 

 

The Company’s reliance on borrowed funds increased by $81.0million during the first nine months of 2008 because alternative fundingsources were inadequate to cover asset growth. Borrowings as a percentage oftotal liabilities were approximately 9.0% and 2.6% at September 30, 2008 andDecember 31, 2007, respectively. 

 

50

 

 

 

FHLB Borrowings.**To borrow from the FHLB,members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes a variety of single-family residential loans,commercial real estate loans, home equity lines of credit, and multifamilyresidential loans as well as a number of types of securities.  The following table summarizes the Company’s FHLB borrowedfunds utilization and availability at thedates indicated (in thousands).

 

 

 

 

**September 30,**

**December 31,**

 

 

 

 

 

**2008**

**2007**

 

 

Available lendable loan collateral value to serve against FHLB advances

$

160,135 

105,535 

 

 

Available lendable investment security collateral value to serve against FHLB advances

41,751 

- 

 

 

 

 

 

 

 

 

 

Advances and letters of credit

 

 

 

 

 

Short-term advances

(59,000)

(12,000)

 

 

 

Long-term advances

(52,000)

- 

 

 

 

Letters of credit

(69,000)

(69,000)

 

 

 

 

Total advances and letters of credit

(180,000)

(81,000)

 

 

 

 

 

 

 

 

 

Available lendable collateral value to serve against FHLB advances

$

21,886 

24,535 

 

 

 

Letters of credit are used tosecure public deposits as required or permitted by law.  

 

The following tablesummarizes the Company’s long-term FHLB borrowings at September 30, 2008(dollars in thousands).  The Company’s long-term FHLB advances do nothave embedded call options. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

Borrowing balance

$

5,000 

 

12,000 

 

30,000 

 

5,000 

 

52,000 

Interest rate

		2.57%

2.75 

2.89 

3.61 

2.90 

Maturity date

3/8/2010

4/2/2010

3/7/2011

4/2/2013

 

 

 

Federal Funds Accommodations. In addition to the FHLBborrowing capacity summarized above, at September 30, 2008, the Company hadaccess to federal funds funding from correspondent banks.  During April 2008, acorrespondent bank increased the Bank’s existing federal funds accommodation by$5 million. Additionally, during the third quarter of 2008, the Companyterminated one of its correspondent banking relationships, thereby reducing itsfederal funds accommodation by $5 million. The following table summarizes theCompany’s federal funds funding utilization and availability at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

 

**2008**

**2007**

		Federal funds accomodations

$

55,000 

50,000 

 

 

 

 

 

		Utilized federal funds accomodations

- 

(18,000)

 

 

 

 

 

		Unused federal funds accomodations

$

55,000 

32,000 

 

 

 

 

 

 

During October 2008, anadditional correspondent bank extended the Bank an unsecured discretionaryfederal funds accommodation in the amount of $10 million.

 

Availability. As previously discussed, at September 30,2008, the Company had $21.9 million in secured FHLB borrowing availability and$55.0 million in unsecured correspondent banking availability for liquidity. Management is not aware of any changes in the availability of such borrowedfunding as a result of the current economic environment.

 

51

 

*Capital*

* *

General. The following table summarizes capital keyperformance indicators at and for theperiods indicated (dollars in thousands, except common and per sharedata).

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

 

 

**2008**

 

**2007**

 

**2008**

 

**2007**

 

Total shareholders' equity

$

118,435 

 

108,931 

 

118,435 

 

108,931 

 

Average total shareholders' equity

117,134 

 

107,704 

 

115,114 

 

105,036 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders' equity as a percentage of total assets

8.75 

%

9.16 

 

8.75 

 

9.16 

 

Total average shareholders' equity as a percentage of total average assets

8.69 

 

9.06 

 

8.79 

 

8.97 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends per common share

$

0.20 

 

0.19 

 

0.60 

 

0.57 

 

Dividend payout ratio

31.72 

%

31.21 

 

32.11 

 

31.08 

 

 

The Company’s dividend payout ratio calculates thepercentage of earnings paid to shareholders in dividends. 

 

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

 

 

 

 

**At and for the nine month**

 

 

 

 

		 

**period ended September 30, 2008**
 

 

Total shareholders' equity, beginning of period

$

110,256 

 

 

 

 

 

 

 

 

Additions to shareholders' equity during period

 

 

 

 

Net income

12,032 

 

 

 

		Common stock issued pursuant to stock option plan

326 

 

 

 

		Compensation expense related to stock option plan

70 

 

 

 

Excess tax benefit from stock-based awards

78 

 

 

 

 

Total additions to shareholders' equity during period

12,506 

 

 

 

 

 

 

 

 

Reductions in shareholders' equity during period

 

 

 

 

Net unrealized loss on investment securities available for sale

(365)

 

 

 

Cumulative effect of adoption of EITF No. 06-10

(99)

 

 

 

Cash dividends declared and paid

(3,863)

 

 

 

 

Total reductions in shareholders' equity during period

(4,327)

 

 

 

 

 

 

 

 

Total shareholders' equity, end of period

$

118,435 

 

 

 

AccumulatedOther Comprehensive (Loss).  Thefollowing table summarizes the components of accumulated other comprehensive(loss) at September 30, 2008.

 

Investment securities available for sale

$

(617)

 

Defined benefit pension plan

(2,486)

 

 

Accumulated other comprehensive loss, net of tax

$

(3,103)

 

 

RegulatoryCapital Requirements. Underregulatory requirements, reported accumulated other comprehensive income /(loss) amounts do not increase or reduce regulatory capital and are notincluded in the calculation of risk-based capital and leverage ratios. TheCompany and the Bank are required to meet regulatory capital requirements thatcurrently include several measures of capital.  As of September 30, 2008, theCompany and the Bank were categorized as “well capitalized” under theregulatory framework based on the most recent notification from federal bankingagencies. Since September 30, 2008, there have been no conditions or eventsthat have resulted in a material change in the Company's or the Bank'scategory.

 

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

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

 

**2008**

 

**2007**

 

**2008**

 

**2007**

Cash dividends per common share

$

0.20 

 

0.19 

 

0.60 

 

0.57 

Cash dividends declared and paid

1,287 

 

1,216 

 

3,863 

 

3,643 

Dividend payout ratio

31.72 

%

31.21 

 

32.11 

 

31.08 

 

52

 

The Company has historically paid dividends on a quarterlybasis. The Company’s dividend payout ratio calculates the percentage ofearnings paid to shareholders in dividends. TheCompany’s Board of Directors currently expects to continue to pay regular cashdividends but may change this policy at any time in its discretion.  There canbe no assurance as to future dividends because they are dependent on theCompany’s financial condition, results of operations, or cash flows, as well as capital and dividend regulations. 

 

Emergency Economic Stabilization Act of 2008. One ofthe provisions resulting from the EESA is the CPP, which provides direct equity investment of perpetual preferredstock by the Treasury in qualified financial institutions.  Theprogram is voluntary and requires an institution to comply with a number ofrestrictions and provisions, including limits on executive compensation, stockredemptions and declaration of dividends.  Applications must besubmitted by November 14, 2008 and are subject to approval by theTreasury.  The CPP provides for a minimum investment of 1% ofrisk-weighted assets, with a maximum investment equal to the lesser of 3percent of total risk-weighted assets or $25 billion.  The perpetualpreferred stock investment will have a dividend rate of 5% per year, until thefifth anniversary of the Treasury investment, and a dividend of 9%,thereafter.  The CPP also requires the Treasury to receive warrantsfor common stock equal to 15% of the capital invested by theTreasury.  The Company is currently evaluating its participationoptions with regard to the CPP. In order to be eligible to participate in** **thisprogram, the Company would be required to file a proxy statement requestingshareholder approval to authorize the issuance of** **preferredstock.  Participation in the program would be subject to receivingsuch shareholder approval and approval by the Treasury. Regardless of theCompany’s participation, governmental intervention and new regulations underthese programs could materially and adversely impact the Company’s business,financial condition, results of operations, or cash flows.

 

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

 

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

*** ***

***Freestanding DerivativeFinancial Instruments and Hedging Activities***

 

See Part I – FinancialInformation, Item 1. Financial Statements, Note 15 contained herein fordiscussion regarding the Company’s derivativefinancial instruments and hedging activities.  

 

***Earnings Review***

 

 

 

 

 

 

 

53

 
Quarter Overview
 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated Interim Statements of Income**

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

 

 

 

 

 

 

 

 

 

 

**ended September 30,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2008**

 

**2007**

 

**variance**

 

**variance**

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

Interest earned and fees on loans

 

$

17,912 

 

20,012 

 

(2,100)

 

(10.5)

%

 

Interest earned on investment securities available for sale

1,665 

 

1,085 

 

580 

 

53.5 

 

 

Dividends paid on FHLB stock

 

96 

 

47 

 

49 

 

104.3 

 

 

Other

 

 

 

43 

 

149 

 

(106)

 

(71.1)

 

 

 

 

Total interest income

 

19,716 

 

21,293 

 

(1,577)

 

(7.4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Interest paid on deposits

 

5,586 

 

7,663 

 

(2,077)

 

(27.1)

 

 

Interest paid on retail repurchase agreements

55 

 

149 

 

(94)

 

(63.1)

 

 

Interest paid on commercial paper

88 

 

312 

 

(224)

 

(71.8)

 

 

Interest paid on other short-term borrowings

353 

 

414 

 

(61)

 

(14.7)

 

 

Interest paid on long-term borrowings

423 

 

- 

 

423 

 

100.0 

 

 

 

 

Total interest expense

 

6,505 

 

8,538 

 

(2,033)

 

(23.8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

13,211 

 

12,755 

 

456 

 

3.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

687 

 

400 

 

287 

 

71.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,524 

 

12,355 

 

169 

 

1.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts, net

2,135 

 

2,001 

 

134 

 

6.7 

 

 

Fees for trust and investment management and brokerage services

744 

 

736 

 

8 

 

1.1 

 

 

Mortgage-banking income, net

 

210 

 

468 

 

(258)

 

(55.1)

 

 

Other

 

 

 

1,212 

 

1,499 

 

(287)

 

(19.1)

 

 

 

 

Total noninterest income

4,301 

 

4,704 

 

(403)

 

(8.6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

Salaries and other personnel

 

5,910 

 

7,040 

 

(1,130)

 

(16.1)

 

 

Occupancy

 

 

824 

 

752 

 

72 

 

9.6 

 

 

Furniture and equipment

 

919 

 

918 

 

1 

 

0.1 

 

 

Loss on disposition of premises, furniture, and equipment

- 

 

346 

 

(346)

 

(100.0)

 

 

Marketing

 

 

277 

 

208 

 

69 

 

33.2 

 

 

Amortization of core deposit intangibles

11 

 

12 

 

(1)

 

(8.3)

 

 

Other

 

 

 

2,605 

 

2,207 

 

398 

 

18.0 

 

 

 

 

Total noninterest expense

10,546 

 

11,483 

 

(937)

 

(8.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

6,279 

 

5,576 

 

703 

 

12.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

2,222 

 

1,680 

 

542 

 

32.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

4,057 

 

3,896 

 

161 

 

4.1 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

0.63 

 

0.61 

 

0.02 

 

3.3 

%

 

Net income - diluted

 

0.62 

 

0.60 

 

0.02 

 

3.3 

 

 

Cash dividends

 

0.20 

 

0.19 

 

0.01 

 

5.3 

 

 

Book value

 

 

18.38 

 

17.02 

 

1.36 

 

8.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,442,090 

 

6,392,721 

 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,529,123 

 

6,500,962 

 

 

 

 

 

 

Net interest margin forthe three month period ended September 30, 2008 was 4.13% compared with 4.54%for the three month period ended September 30, 2007. Average interest-earningassets increased $159.7 million, or 14.3% over the same periods.

 

Earnings resulted in areturn on average shareholders’ equity of 13.78% and 14.35% for the three monthperiods ended September 30, 2008 and 2007. Return on average assets was 1.20%and 1.30% for the same periods.

 

Net Interest Income. General. Net interest income is the differencebetween interest income earned on interest-earning assets, primarily loans andinvestment securities, and interest expense paid on interest-bearing depositsand other interest-bearing liabilities.  This measure represents the largestcomponent of income for the Company. The net interest margin measures howeffectively the Company manages the difference between the interest incomeearned on interest-earning assets and the interest expense paid for funds tosupport those assets. Changes in interest rates earned on interest-earning assetsand interest rates paid on interest-bearing liabilities, the rate of growth ofthe interest-earning assets and interest-bearing liabilities base, the ratio ofinterest-earning assets to interest-bearing liabilities, and the management ofinterest rate sensitivity factor into changes in net interest income.

 

Average Balance Sheets and NetInterest Income / Margin Analysis. The following table summarizes the Company’saverage balance sheets and net interest income analysis for the periodsindicated (dollars in thousands). The Company's interest yield earned oninterest-earning assets and interest rate paid on interest-bearing liabilitiesshown in the table are derived by dividing interest income and expense by theaverage balances of interest-earning assets or interest-bearing liabilities.The following table does not include a tax-equivalent adjustment to netinterest income for interest-earning assets earning tax-exempt income to acomparable yield on a taxable basis.

 

54

 

 

 

 

 

 

For the three month periods ended September 30, 

 

 

 

 

 

2008

 

2007

** **

 

 

 

 

Average 

Income/ 

Yield/ 

 

Average 

Income/ 

Yield/ 

** **

 

 

 

 

balance

expense

rate

 

balance

expense

rate

** **

Assets

 

 

 

 

 

 

 

 

 

 

Interest-earnings assets

 

 

 

 

 

 

 

 

 

Other

 

 $                 8,345 

 $                43 

          2.05 

%

 $              10,117 

 $              149 

          5.84 

%

 

FHLB stock

                    6,840 

                   96 

          5.58 

 

                   3,047 

                   47 

          6.12 

 

 

Investment securities  available for sale, nontaxable (2)

                  51,379 

                 449 

          3.48 

 

                 51,393 

                 464 

          3.58 

 

 

Investment securities  available for sale, taxable (2)

                  80,690 

              1,216 

          6.00 

 

                 50,761 

                 621 

          4.85 

 

 

Loans, net of unearned (1)

             1,126,781 

            17,912 

          6.32 

 

               999,044 

            20,012 

          7.95 

 

 

 

Total interest-earning  assets

             1,274,035 

            19,716 

          6.16 

 

            1,114,362 

            21,293 

          7.58 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-earning assets

 

 

 

 

 

 

 

 

 

Cash and due from banks

                  29,550 

 

 

 

                 31,842 

 

 

 

 

Allowance for loan losses

                   (7,695)

 

 

 

                  (8,408)

 

 

 

 

Premises and equipment, net

                  24,892 

 

 

 

                 24,735 

 

 

 

 

Premises held for sale

                    1,651 

 

 

 

                          -   

 

 

 

 

Goodwill, net

                    3,688 

 

 

 

                   3,688 

 

 

 

 

Core deposit intangibles,  net

                         53  

 

 

 

                        97 

 

 

 

 

Accrued interest receivable

                    6,081 

 

 

 

                   6,091 

 

 

 

 

Other 

 

                  15,440 

 

 

 

                 16,516 

 

 

 

 

 

Total noninterest-earning  assets

                  73,660 

 

 

 

                 74,561 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 $          1,347,695 

 

 

 

 $         1,188,923 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and  Shareholders' Equity

 

 

 

 

 

 

 

 

Liabilities  

 

 

 

 

 

 

 

 

 

Interest-bearing  liabilities

 

 

 

 

 

 

 

 

 

Transaction deposit  accounts

 $             363,120 

 $           1,051 

          1.15 

%

 $            372,334 

 $           2,804 

          2.99 

%

 

Money market deposit  accounts

                104,104 

                 403 

          1.54 

 

               116,050 

              1,057 

          3.61 

 

 

Savings deposit accounts

                  38,971 

                   35 

          0.36 

 

                 40,440 

                   36 

          0.35 

 

 

Time deposit accounts

                406,184 

              4,097 

          4.01 

 

               334,122 

              3,766 

          4.47 

 

 

 

Total interest-bearing  deposits

                912,379 

              5,586 

          2.44 

 

               862,946 

              7,663 

          3.52 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase  agreements

                  17,534 

                   55 

          1.25 

 

                 14,187 

                 149 

          4.17 

 

 

Commercial paper (Master  notes)

                  34,138 

                   88 

          1.03 

 

                 29,421 

                 312 

          4.21 

 

 

Other short-term borrowings

                  62,907 

                 353 

          2.23 

 

                 29,885 

                 414 

          5.50 

 

 

Long-term borrowings

                  52,000 

                 423 

          3.24 

 

                          -   

                    -   

      100.00 

 

 

 

Total interest-bearing  liabilities

             1,078,958 

              6,505 

          2.40 

 

               936,439 

              8,538 

          3.62 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing  liabilities

 

 

 

 

 

 

 

 

 

Noninterest-bearing  deposits

                141,756 

 

 

 

               135,249 

 

 

 

 

Accrued interest payable

                    2,153 

 

 

 

                   2,427 

 

 

 

 

Other 

 

                    7,694 

 

 

 

                   7,104 

 

 

 

 

 

Total noninterest-bearing  liabilities

                151,603 

 

 

 

               144,780 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

             1,230,561 

 

 

 

            1,081,219 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

                117,134 

 

 

 

               107,704 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and  shareholders' equity

 $          1,347,695 

 

 

 

 $         1,188,923 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME / NET  YIELD ON

 

 

 

 

 

 

 

 

 

INTEREST-EARNING ASSETS 

 

 $         13,211 

          4.13 

%

 

 $         12,755 

          4.54 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Calculated including  mortgage loans held for sale.  Nonaccrual loans are included in average  balances for yield computations.  

 

 

 

 

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

 

 

 

 

and deposits are domestic.

 

 

 

 

 

 

 

 

(2)

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

 

 

 

 

55

 

Rate / Volume Analysis. As summarized in the precedingtable, net interest income increased $456 thousand, or 3.6%, during the threemonth period ended September 30, 2008 over the same period of 2007.  Thefollowing table summarizes the dollar amount of changes in interest income andinterest expense attributable to changes in average volume and the amountattributable to changes in average interest rates when comparing the threemonth period ended September 30, 2008 to the three month period ended September30, 2007 (in thousands).  The impact of the combination of rate and volumechange has been divided proportionately between the rate change and volumechange. The comparison between the periods includes an additional change factorthat summarizes the impact of the difference in the number of days of eachyear.

 

 

 

 

 

**Change in**

**average**

**volume**

**Change in**

**average**

**rate**

**Change**

**due to**

**difference**

**in number**

**of days**

**Total**

**change**

Interest-earnings assets

 

 

 

 

 

Other

 

$

(22)

(84)

- 

(106)

 

FHLB stock

54 

(4)

(1)

49 

 

Investment securities available for sale

354 

230 

(4)

580 

 

		Loans

3,435 

(5,486)

(49)

(2,100)

 

 

Total interest income

$

3,821 

(5,344)

(54)

(1,577)

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

Interest-bearing deposits

$

470 

(2,531)

(16)

(2,077)

 

Retail repurchase agreements

48 

(142)

- 

(94)

 

Commercial paper (Master notes)

60 

(284)

- 

(224)

 

Other short-term borrowings

(132)

71 

- 

(61)

 

Long-term borrowings

212 

212 

(1)

423 

 

 

Total interest expense

$

658 

(2,674)

(17)

(2,033)

 

 

 

 

 

 

 

 

 

 

 

Net interest income

$

3,163 

(2,670)

(37)

456 

 

 

 

 

 

 

 

 
		 		
Federal Reserve Rate Net InterestIncome Influence. The Federal Reserve did not take any action with regard tothe prime interest rate or the federal funds interest rate during the threemonth period ended September 30, 2008.  Therefore, management expected that,from a rate perspective, net interest income would remain relatively unchangedduring the period over the prior quarter.  The following table summarizesinterest income and interest expense for the three month periods endedSeptember 30, 2008 and June 30, 2008 (dollars in thousands).  

 

 

 

**For the three month**

 

 

 

 

 

**periods ended**

 

 

 

 

 

**September 30,**

**June 30,**

**Dollar**

**Percent**

 

 

 

**2008**

**2008**

**variance**

**variance**

 

Total interest income

$

19,716 

20,050 

(334)

(1.7)

%

Total interest expense

6,505 

6,428 

77 

1.2 

 

 

Net interest income

$

13,211 

13,622 

(411)

(3.0)

%

 

The slight decline in net interestincome from the three month period ended June 30, 2008 to the three monthperiod ended September 30, 2008 was primarily the result of nonaccrual interestreversed during the three month period ended September 30, 2008. The impact ofthe previously discussed FHLB borrowings transaction supplemented net interestincome growth during the three month period ended September 30, 2008 and thethree month period ended June 30, 2008.

 

Provision for Loan Losses.  The provision for loan losses reflects not only thenecessary increases in the allowance for loan losses related to newlyidentified criticized loans, but it also reflects actions taken related toother loans including, among other things, any necessary increases or decreasesin required allowance for loan losses for specific loans or loan pools. Theprovision for loan losses totaled $687 thousand for the three month periodended September 30, 2008 compared with $400 thousand for the same period of2007. See Financial Condition – Lending Activities, included elsewhere in thisitem, for discussion regarding thefactors impacting the amount added to the allowancefor loan losses through its provision for loan losses.

 

56

 

Noninterest Income. Service Charges on Deposit Accounts, Net. Servicecharges on deposit accounts, net comprise a significant component ofnoninterest income.  The following table summarizes service charges on depositaccounts, net as a percentage of average fee impacted deposit accounts for the periods indicated (dollars in thousands).Management believes that service charges on deposit accounts, net as apercentage of total average transaction deposit accounts, annualized wereimpacted primarily by an increase in nonsufficient funds and overdraftactivity during the three month period endedSeptember 30, 2008.

 

 

 

**For the three month periods**

 

 

**ended September 30,**

 

 

**2008**

**2007**

Service charges on deposit accounts, net

$

2,135 

2,001 

 

 

 

 

Average interest-bearing transaction deposit accounts

$

363,120 

372,334 

Average interest-bearing money market deposit accounts

104,104 

116,050 

Average interest-bearing savings deposit accounts

38,971 

40,440 

Average noninterest-bearing transaction deposit accounts

141,756 

135,249 

Total average fee impacted deposit accounts

$

647,951 

664,073 

 

 

 

 

Service charges on deposit accounts, net as a percentage of total

 

 

average fee		impacted deposit accounts, annualized

1.3% 

1.2 

 

Mortgage-Banking Income, Net. The Company sells most of theresidential mortgage loans it originates in the secondary market and retainsservicing rights. Mortgage loans serviced for the benefit of others amounted to$371.6 million and $346.3 million at September 30, 2008 and December 31, 2007,respectively. Mortgage loans serviced for the benefit of others amounted to$339.4 million at September 30, 2007. The following table summarizes the componentsof mortgage-banking income for the periods indicated (dollars in thousands).

 

 

 

**For the three month**

 

 

**periods ended September 30,**

 

 

**2008**

 

**2007**

Mortgage-servicing fees

$

229 

 

204 

Gain on sales of mortgage loans held for sale,		net

214 

 

279 

Mortgage-servicing right amortization, impairment, and recoveries

(288)

 

(60)

Other mortgage-banking income

55 

 

45 

 

Total mortgage-banking income, net

$

210 

 

468 

 

 

 

 

 

Mortgage-servicing fees as a percentage of mortgage loans

 

 

 

 

serviced for the benefit of others at period end, annualized

0.25 

%

0.24 

 

Other.During 2007, in conjunction with a change in service providers, the recordingof merchant services was changed from a net income and expense method to agross income and expense method.  This change impacted the comparability ofother noninterest income during the three month period ended September 30, 2008compared with the same period of 2007. The following table summarizes therelated account for the periods indicated (in thousands).

 
		 		 
**For the three month**
 
		 
**periods ended September 30,**

 

 

**2008**

**2007**

Merchant income

$

290 

71 

Merchant expense

(223)

- 

 

Merchant income, net

$

67 

71 

 

Merchant income is included in other noninterest income onthe Consolidated Interim Statements of Income, and merchant expense accountsare included in other noninterest expense on the Consolidated InterimStatements of Income.  Although the fluctuation in merchant income, net hadrelatively little impact on the Company’s Consolidated Interim Statements ofIncome over the periods noted, the change in recording method did impact thebreakout within other noninterest income and other noninterest expense of theConsolidated Interim Statements of Income. The following table adjusts reportedother noninterest income for the merchant income account for the periodsindicated (in thousands).  

 

 

 

**For the three month**

 

 

**periods ended September 30,**

 

 

**2008**

**2007**

Other noninterest income

$

1,212 

1,499 

Merchant income

(290)

(71)

     Other noninterest income, adjusted

$

922 

1,428 

 

 

57

 

 

 

 

 

After adjusting for this account, other noninterest incomedecreased $506 thousand, or 35.4%, during the three month period endedSeptember 30, 2008 over the same period of 2007.  

 

The fluctuation in adjusted other noninterest income fromthe three month period ended September 30, 2007 to the same period of 2008 wasimpacted by the Company’s 2007 sale of its MasterCard stock.  During the thirdquarter of 2007, the Bank converted its shares of Class B common stock on aone-for-one basis into shares of Class A common stock for subsequent sale topublic investors.  This transaction resulted in pretax income, net oftransaction fees, totaling $487 thousand.  

 

NoninterestExpense. Salaries and OtherPersonnel.  Comprising 56.0% of noninterest expense during the three monthperiod ended September 30, 2008 and 61.3% of noninterest expense during thesame period of 2007, salaries and other personnel expense decreased by $1.1million over the periods. The decrease in salaries and other personnel expenseresulted from several factors, both recurring and nonrecurring in nature.

 

The following nonrecurringtransactions, all of which were disclosed in the Company’s Quarterly Report onForm 10-Q for the Quarter Ended September 30, 2007, that resulted in additionalsalaries and other personnel expense for the three month period ended September30, 2007 of $1.1 million when compared with the three month period endedSeptember 30, 2008 (in thousands). 

 

 

 

 

 

Cash surrender value of life insurance (income)

$

898 

401(k) error contribution (expense)

(1,325)

Pension (expense)

(627)

 

Nonrecurring salaries and other personnel transactions

$

(1,054)

 

 

 

 

Employee and officer salariesremained relatively unchanged from the three month period ended September 30,2007 to the same period of 2008 as the Company was able to gain efficienciesthrough the consolidating of four branches during the second quarter of 2008. Such expense savings were offset by the expense of annual merit raises foremployees and officers as well as the addition of new officer positionsincluding those positions created in connection with the opening of the newRock Hill banking office.  The Bank celebrated the grand opening of its RockHill banking office during September 2008. 

 

Loss on Disposition of Premises, Furniture, and Equipment.During the second quarter of 2007, the Company signed a build-to-suit leaseagreement with regard to the relocation of its corporate headquarters toGreenville, South Carolina.  Under the terms of this agreement, the Company’snew headquarters is being constructed on the site of the Company’s currentdowntown Greenville banking office that is leased from the same lessor. Inconjunction with the demolition of the previous downtown Greenville bankingoffice, the Company wrote off $346 thousand in leasehold improvements duringthe third quarter of 2007.  

 

Other.  As noted above, during 2007, in conjunction with achange in service providers, the recording of merchant services was changedfrom a net income and expense method to a gross income and expense method. This change impacted the comparability of other noninterest expense during thethree month period ended September 30, 2008 compared with the same period of2007. The following table adjusts reported other noninterest expense for themerchant expense accounts for the periods indicated (in thousands).  

 

 

 

**For the three month**

 

 

**periods ended September 30,**

 

 

**2008**

**2007**

Other noninterest expense

$

2,605 

2,207 

Merchant expense

(223)

- 

 

Other noninterest expense, adjusted

$

2,382 

2,207 

 

 

 

 

 

After adjusting for this account, other noninterest expenseincreased $175 thousand, or 7.9%, during the three month period ended September30, 2008 over the same period of 2007.  

 

 

 

58

 
As reportedin the Company’s Annual Report on Form 10-K for the year ended December 31,2007, in November 2006, the FDIC adoptedfinal regulations that set deposit insurance assessment rates that took effectin 2007. The Bank received aone-time assessment credit of $576 thousand that could be applied againstfuture premiums, beginning in 2007, subject to certain limitations. Any remaining credit couldbe used tooffset up to 90% of subsequent annual assessments through 2010. The increase inFDIC premiums during the three month period ended September 30, 2008 over thesame period of 2007 was due to the fact that the Company had utilized its one-time assessment credit against deposit insurance assessments due.  During the threemonth period ended September 30, 2008, the Company expensed $197 thousand in Financing Corporation (“FICO”) and depositinsurance assessments compared with $50 thousand expensed during the sameperiod of 2007, which was comprised totally of FICO assessments.  
 

Provision for Income Taxes.  Income tax expensetotaled $2.2 million for the three month period ended September 30, 2008,compared with $1.7 million for the same period of 2007.  The Company’seffective tax rate was 35.4% for the three month period ended September 30,2008 compared with 30.1% for the three month period ended September 30, 2007.The increase in the effective tax rate when comparing the two periods wasprimarily the result of the recognition of an increase in nontaxable incomerelative to cash surrender value of key man life insurance during the thirdquarter of 2007. The Company’s effective income tax rate is expected to beapproximately 35% for 2008. 

 
Year-to-Date Overview 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

 

 

 

 

 

**Consolidated Interim Statements of Income**

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

 

 

 

 

 

 

 

 

**periods ended September 30,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2008**

 

**2007**

 

**variance**

 

**variance**

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

Interest earned and fees on loans

 

$

55,253 

 

58,079 

 

(2,826)

 

(4.9)

%

 

Interest earned on investment securities available for sale

4,416 

 

3,386 

 

1,030 

 

30.4 

 

 

Dividends paid on FHLB stock

 

239 

 

122 

 

117 

 

95.9 

 

 

Other

 

 

 

98 

 

600 

 

(502)

 

(83.7)

 

 

 

 

Total interest income

 

60,006 

 

62,187 

 

(2,181)

 

(3.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Interest paid on deposits

 

18,355 

 

22,327 

 

(3,972)

 

(17.8)

 

 

Interest paid on retail repurchase agreements

224 

 

425 

 

(201)

 

(47.3)

 

 

Interest paid on commercial paper

319 

 

839 

 

(520)

 

(62.0)

 

 

Interest paid on other short-term borrowings

862 

 

497 

 

365 

 

73.4 

 

 

Interest paid on long-term borrowings

864 

 

173 

 

691 

 

399.4 

 

 

 

 

Total interest expense

 

20,624 

 

24,261 

 

(3,637)

 

(15.0)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

39,382 

 

37,926 

 

1,456 

 

3.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

1,862 

 

1,200 

 

662 

 

55.2 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

37,520 

 

36,726 

 

794 

 

2.2 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts, net

6,429 

 

5,900 

 

529 

 

9.0 

 

 

Fees for trust and investment management and brokerage services

2,255 

 

2,258 

 

(3)

 

(0.1)

 

 

Mortgage-banking income, net

 

847 

 

987 

 

(140)

 

(14.2)

 

 

Investment securities gains

 

1 

 

- 

 

1 

 

100.0 

 

 

Other

 

 

 

4,016 

 

3,402 

 

614 

 

18.0 

 

 

 

 

Total noninterest income

13,548 

 

12,547 

 

1,001 

 

8.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

Salaries and other personnel

 

18,175 

 

19,234 

 

(1,059)

 

(5.5)

 

 

Occupancy

 

 

2,432 

 

2,182 

 

250 

 

11.5 

 

 

Furniture and equipment

 

2,848 

 

2,751 

 

97 

 

3.5 

 

 

(Gain) loss on disposition of premises, furniture, and equipment

(2)

 

346 

 

	(348)

 

	(100.6)

 

 

Marketing

 

 

900 

 

695 

 

205 

 

29.5 

 

 

Amortization of core deposit intangibles

33 

 

36 

 

(3)

 

(8.3)

 

 

Other

 

 

 

8,151 

 

6,398 

 

1,753 

 

27.4 

 

 

 

 

Total noninterest expense

32,537 

 

31,642 

 

	895 

 

	2.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

18,531 

 

17,631 

 

900 

 

5.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

6,499 

 

5,909 

 

590 

 

10.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

12,032 

 

11,722 

 

310 

 

2.6 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

1.87 

 

1.84 

 

0.03 

 

1.6 

%

 

Net income - diluted

 

1.84 

 

1.81 

 

0.03 

 

1.7 

 

 

Cash dividends

 

0.60 

 

0.57 

 

0.03 

 

5.3 

 

 

Book value

 

 

18.38 

 

17.02 

 

1.36 

 

8.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,436,280 

 

6,385,625 

 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,522,316 

 

6,484,293 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin forthe nine month period ended September 30, 2008 was 4.26% compared with 4.61%for the nine month period ended September 30, 2007. Average interest-earningassets increased $134.9 million, or 12.3% over the same periods.

 

Earnings resulted in areturn on average shareholders’ equity of 13.96% and 14.92% for the nine monthperiods ended September 30, 2008 and 2007, respectively. Return on averageassets was 1.23% and 1.34% for the same periods.

 

Net Interest Income. AverageBalance Sheets and Net Interest Income / Margin Analysis. The following tablesummarizes the Company’s average balance sheets and net interest incomeanalysis for the periods indicated (dollars in thousands). The following tabledoes not include a tax-equivalent adjustment to net interest income forinterest-earning assets earning tax-exempt income to a comparable yield on ataxable basis.

 

59

 

 

 

 

 

 

 

For the nine month periods ended September 30,

 

 

 

 

 

2008

 

2007

** **

 

 

 

 
   
Average 
   
Income/ 

Yield/ 

 
   
Average 
   
Income/ 

Yield/ 

** **

 

 

 

 
   
balance
   
expense

rate

 
   
balance
   
expense

rate

** **

Assets

 

 
   
 
   
 

 

 
   
 
   
 

 

 

Interest-earnings assets
   
 
   
 

 

 
   
 
   
 

 

 

 

Other

 

$
               5,397 
$
                    98 

         2.43 

%
$
               15,517 
$
                  600 

         5.17 

%

 

FHLB stock
   
                 5,263 
   
                    239 

         6.07 

 
   
                   2,724 
   
                    122 

         5.99 

 

 

Investment securities  available for sale, nontaxable (2)
   
               52,093 
   
                 1,363 

         3.49 

 
   
                 49,973 
   
                 1,340 

         3.59 

 

 

Investment securities  available for sale, taxable (2)
   
               70,059 
   
                 3,053 

         5.82 

 
   
                 57,771 
   
                 2,046 

         4.74 

 

 

Loans, net of unearned (1)
   
          1,101,390 
   
               55,253 

         6.70 

 
   
               973,358 
   
               58,079 

         7.98 

 

 

 

Total interest-earning  assets
   
          1,234,202 
   
               60,006 

         6.49 

 
   
            1,099,343 
   
               62,187 

         7.56 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

Noninterest-earning assets
   
 
   
 

 

 
   
 
   
 

 

 

 

Cash and due from banks
   
               31,421 
   
 

 

 
   
                 30,841 
   
 

 

 

 

Allowance for loan losses
   
               (7,531)
   
 

 

 
   
                  (8,426)
   
 

 

 

 

Premises and equipment, net
   
               24,482 
   
 

 

 
   
                 24,861 
   
 

 

 

 

Premises held for sale
   
                 1,651 
   
 

 

 
   
 -   
   
 

 

 

 

Goodwill, net
   
                 3,688 
   
 

 

 
   
                   3,688 
   
 

 

 

 

Core deposit intangibles,  net
   
                      63 
   
 

 

 
   
                      109 
   
 

 

 

 

Accrued interest receivable
   
                 6,150 
   
 

 

 
   
                   5,975 
   
 

 

 

 

Other 

 
   
               15,998 
   
 

 

 
   
                 14,366 
   
 

 

 

 

 

Total noninterest-earning  assets
   
               75,922 
   
 

 

 
   
                 71,414 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

 

 

 

Total assets
$
1,310,124 
   
 

 

 
$
          1,170,757 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

Liabilities and  Shareholders' Equity
   
 
   
 

 

 
   
 
   
 

 

 

Liabilities  

 
   
 
   
 

 

 
   
 
   
 

 

 

Interest-bearing  liabilities
   
 
   
 

 

 
   
 
   
 

 

 

 

Transaction deposit  accounts
$
380,673 
$
4,309 

         1.51 

%
$
             352,138 
$
               7,536 

         2.86 

%

 

Money market deposit  accounts
   
             108,041 
   
                 1,614 

         2.00 

 
   
               114,380 
   
                 2,952 

         3.45 

 

 

Savings deposit accounts
   
               37,735 
   
                      97 

         0.34 

 
   
                 41,518 
   
                    106 

         0.34 

 

 

Time deposit accounts
   
             387,430 
   
               12,335 

         4.25 

 
   
               357,493 
   
               11,733 

         4.39 

 

 

 

Total interest-bearing  deposits
   
             913,879 
   
               18,355 

         2.68 

 
   
               865,529 
   
               22,327 

         3.45 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

 

Retail repurchase  agreements
   
               18,159 
   
                    224 

         1.65 

 
   
                 13,502 
   
                    425 

         4.21 

 

 

Commercial paper (Master  notes)
   
               31,060 
   
                    319 

         1.37 

 
   
                 26,185 
   
                    839 

         4.28 

 

 

Other short-term borrowings
   
               45,876 
   
                    862 

         2.51 

 
   
                 11,932 
   
                    497 

         5.57 

 

 

Long-term borrowings
   
               37,861 
   
                    864 

         3.05 

 
   
                   6,044 
   
                    173 

         3.83 

 

 

 

Total interest-bearing  liabilities
   
          1,046,835 
   
               20,624 

         2.63 

 
   
               923,192 
   
               24,261 

         3.51 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

Noninterest-bearing  liabilities
   
 
   
 

 

 
   
 
   
 

 

 

 

Noninterest-bearing  deposits
   
             137,908 
   
 

 

 
   
               133,663 
   
 

 

 

 

Accrued interest payable
   
                 2,295 
   
 

 

 
   
                   2,455 
   
 

 

 

 

Other 

 
   
                 7,972 
   
 

 

 
   
                   6,411 
   
 

 

 

 

 

Total noninterest-bearing  liabilities
   
             148,175 
   
 

 

 
   
               142,529 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

 

 

Total liabilities
   
          1,195,010 
   
 

 

 
   
            1,065,721 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

Shareholders' equity
   
             115,114 
   
 

 

 
   
               105,036 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

 

 

Total liabilities and  shareholders' equity
$
1,310,124 
   
 

 

 
$
1,170,757 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

NET INTEREST INCOME / NET  YIELD ON
   
 
   
 

 

 
   
 
   
 

 

 

 

INTEREST-EARNING ASSETS 
   
 
$
39,382 

         4.26 

%
   
 
$
37,926 

         4.61 

%

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

 

 

 

 
   
 
   
 

 

 
   
 
   
 

 

 

(1)

Calculated including  mortgage loans held for sale.  Nonaccrual loans are included in average  balances for yield computations.  

 

 

 

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

 

 

 

and deposits are domestic.
   
 
   
 

 

 
   
 
   
 

 

 

(2)

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

 

 

 

 

60

 

 

 

 

Rate / Volume Analysis. Assummarized in the preceding table, net interest income increased $1.5 million,or 3.8%, during the nine month period ended September 30, 2008 over the sameperiod of 2007.  The following table summarizes the dollar amount of changes ininterest income and interest expense attributable to changes in average volumeand the amount attributable to changes in average interest rates when comparingthe nine month period ended September 30, 2008 to the nine month period endedSeptember 30, 2007 (in thousands).  The impact of the combination of rate andvolume change has been divided proportionately between the rate change andvolume change. The comparison between the periods includes an additional changefactor that summarizes the impact of the difference in the number of days ofeach year.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Change in**

**average**

**volume**

**Change in**

**average**

**rate**

**Change**

**due to**

**difference**

**in number**

**of days**

**Total**

**change**

 

Interest-earnings assets

 

 

 

 

 

 

Other

 

$

(276)

(225)

(1)

(502)

 

 

FHLB stock

115 

2 

- 

117 

 

 

Investment securities available for sale

485 

542 

3 

1,030 

 

 

	Loans 

13,285 

(16,161)

50 

(2,826)

 

 

 

Total interest income

$

13,609 

(15,842)

52 

(2,181)

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

Interest-bearing deposits

$

1,340 

(5,329)

17 

(3,972)

 

 

Retail repurchase agreements

264 

(465)

- 

(201)

 

 

Commercial paper (Master notes)

196 

(716)

- 

(520)

 

 

Other short-term borrowings

451 

(87)

1 

365 

 

 

Long-term borrowings

719 

(28)

- 

691 

 

 

 

Total interest expense

$

2,970 

(6,625)

18 

(3,637)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

$

10,639 

(9,217)

34 

1,456 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal Reserve Rate Net Interest Income Influence. Thefollowing table summarizes the actions taken by the Federal Reserve with regardto the prime interest rate or the federal funds interest rate thereby impactingnet interest income for the nine month periods ended September 30, 2007 andSeptember 30, 2008.  

 

 

 

 

 

 

 

**Prime**

**rate**

 

**Federal**

**funds rate**

 

Rate, at December 31, 2006

8.25 

%

5.25 

 

 

 

 

 

 

Changes in rate

(0.50)

 

(0.50)

 

 

 

 

 

 

Rate, at September 30, 2007

7.75 

%

4.75 

 

 

 

 

 

 

 

 

 

 

 

Rate, at December 31, 2007

7.25 

%

4.25 

 

 

 

 

 

 

Changes in rate

(2.25)

 

(2.25)

 

 

 

 

 

 

Rate, at September 30, 2008

5.00 

%

2.00 

 

 

 

 

 

 

 

Provision for Loan Losses.  The provision for loan losses totaled $1.8 million for thenine month period ended September 30, 2008 compared with $1.2 million for thesame period of 2007. See Financial Condition – Lending Activities, includedelsewhere in this item, for discussionregarding the factors impacting the amount addedto the allowance for loan losses, through its provision for loan losses.

 

Noninterest Income. Service Charges on Deposit Accounts, Net. Thefollowing table summarizes service charges on deposit accounts, net as apercentage of average fee impacted deposit accounts forthe periods indicated (dollars in thousands). Management believes that servicecharges on deposit accounts, net as a percentage of total average transactiondeposit accounts, annualized were impacted primarily by an increase innonsufficient funds and overdraft activity during thenine month period ended September 30, 2008.

61

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

 

**periods ended September 30,**

 

 

 

**2008**

**2007**

 

Service charges on deposit accounts, net

$

6,429 

5,900 

 

 

 

 

 

 

Average interest-bearing transaction deposit accounts

$

380,673 

352,138 

 

Average interest-bearing money market deposit accounts

108,041 

114,380 

 

Average interest-bearing savings deposit accounts

37,735 

41,518 

 

Average noninterest-bearing transaction deposit accounts

137,908 

133,663 

 

Total average transaction deposit accounts

$

664,357 

641,699 

 

 

 

 

 

 

Service charges on deposit accounts, net as a percentage of total

 

 

 

average fee	impacted deposit accounts

1.3% 

1.2 

 

 

Mortgage-Banking Income, Net. The following table summarizesthe components of mortgage-banking income, net for the periods indicated(dollars in thousands).

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

**periods ended September 30,**

 

 

**2008**

 

**2007**

Mortgage-servicing fees

$

666 

613 

Gain on sales of mortgage loans held for sale,	net

704 

614 

Mortgage-serciving right amortization, impairment, and recoveries

(720)

 

(360)

Other mortgage-banking income

197 

120 

 

Total mortgage-banking income, net

$

847 

987 

 

 

 

 

 

Mortgage-servicing fees as a percentage of mortgage loans

 

 

 

 

serviced for the benefit of others at period end, annualized

0.24 

%

0.24 

 

 

 

 

 

 

Other. As notedabove, during 2007, in conjunction with a change in service providers, therecording of merchant services was changed from a net income and expense methodto a gross income and expense method.  This change impacted the comparabilityof other noninterest expense during the nine month period ended September 30,2008 compared with the same period of 2007. The following table summarizes therelated account for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

**For the nine month**

 
   
**periods ended September 30,**

 

 

**2008**

**2007**

Merchant income

$

872 

163 

Merchant expense

(677)

- 

 

Merchant income, net

$

195 

163 

 

 

 

 

 

Merchant income is included in other noninterest income onthe Consolidated Interim Statements of Income, and merchant expense accountsare included in other noninterest expense on the Consolidated InterimStatements of Income.  Although the fluctuation in merchant income, net hadrelatively little impact on the Company’s Consolidated Interim Statements of Incomeover the periods noted, the change in recording method did impact the breakoutwithin other noninterest income and other noninterest expense of theConsolidated Interim Statements of Income. The following table adjusts reportedother noninterest income for the merchant income account for the periodsindicated (in thousands).  

 

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

**periods ended September 30,**

 

 

**2008**

**2007**

Other noninterest income

$

4,016 

3,402 

Merchant income

(872)

(163)

       Other noninterest income, adjusted

$

3,144 

3,239 

 

 

 

 

 

After adjusting for this account, other noninterest incomedecreased $95 thousand, or 2.9%, during the nine month period ended September30, 2008 over the same period of 2007.  The following table summarizessignificant fluctuations, both recurring and nonrecurring in nature, withinother noninterest income, adjusted for the periods indicated (dollars inthousands).

 

62

 

 

 

 

**For the nine month**

 

 

 

 

 

**periods ended September 30,**

**Dollar**

**Percent**

 

 

 

**2008**

**2007**

**variance**

**variance**

 

Automatic teller machine fee

$

926 

763 

163 

21.4 

%

Debit card

1,114 

992 

122 

12.3 

 

Moneygram

121 

193 

(72)

(37.3)

 

Miscellaneous

259 

529 

(270)

(51.0)

 

 

 

$

2,420 

2,477 

(57)

(2.3)

%

 

 

 

 

 

 

 

 

Included within miscellaneous income for the nine monthperiod ended September 30, 2008 was a pretax first quarter gain ofapproximately $226 thousand, recorded in March 2008, resulting from themandatory redemption of a portion of its Class B Visa, Inc. shares as part ofVisa's recent initial public offering.  

 

Included within miscellaneous income for the nine monthperiod ended September 30, 2007 was a pretax first quarter gain ofapproximately $487 thousand resulting from the Company’s sale of its MasterCardstock.  During the third quarter of 2007, the Bank converted its shares ofClass B common stock on a one-for-one basis into shares of Class A common stockfor subsequent sale to public investors.  

 

Noninterest Expense. Salaries and Other Personnel. Comprising 55.9% ofnoninterest expense during the nine month period ended September 30, 2008 and60.8% of noninterest expense during the same period of 2007, salaries and otherpersonnel expense decreased by $1.1 million over the periods. This increaseresulted from several factors, both recurring and nonrecurring in nature.
 
The following nonrecurringtransactions, all of which were disclosed in the Company’s Quarterly Report onForm 10-Q for the Quarter Ended September 30, 2007, resulted in additionalsalaries and other personnel expense for the nine month period ended September30, 2007 of $1.3 million over those for the same period of 2008.  

 

 

 

 

 

Cash surrender value of life insurance (income)

$

898 

401(k) error contribution (expense)

(1,325)

Pension (expense)

(902)

 

Nonrecurring salaries and other personnel transactions

$

(1,329)

 

 

 

 

Employee and officer salaries,including officer incentive plan expense, increased slightly from the ninemonth period ended September 30, 2007 to the same period of 2008. Contributingto this increase were annual merit raises for employees and officers as well asthe addition of new officer positions including those positions created inconnection with the opening of the new Rock Hill banking office.  The Bankcelebrated the grand opening of its Rock Hill banking office during September2008. 

 

Loss on Disposition of Premises, Furniture, and Equipment.During the second quarter of 2007, the Company signed a build-to-suit leaseagreement with regard to the relocation of its corporate headquarters toGreenville, South Carolina.  Under the terms of this agreement, the Company’snew headquarters will be constructed on the site of the Company’s currentdowntown Greenville banking office that is leased from the same lessor. Inconjunction with the demolition of the current downtown Greenville bankingoffice, the Company wrote off $346 thousand in leasehold improvements duringthe third quarter of 2007.  

 

Marketing expenses increased $205 thousand during the ninemonth period ended September 30, 2008 over the same period of 2007 primarily asa result of increases in expenses related to the advertisement of promotionaldeposit products and additional expenses related to the opening of the new RockHill banking office.

 

Other.  As noted above, during 2007, the recording ofmerchant services was changed from a net income and expense method to a grossincome and expense method.  This change impacted the comparability of othernoninterest expense during the nine month period ended September 30, 2008compared with the same period of 2007. The following table adjusts reportedother noninterest expense for the merchant expense accounts for the periodsindicated (in thousands).  

 

63

 

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

**periods ended September 30,**

 

 

**2008**

**2007**

Other noninterest expense

$

8,151 

6,398 

Merchant expense

(677)

- 

 

Other noninterest expense, adjusted

$

7,474 

6,398 

 

 

 

 

 

After adjusting for these accounts, other noninterest expense increased $1.1million, or 16.8%, during the nine month period ended September 30, 2008 overthe same period of 2007.  The following table summarizes significantfluctuations within other noninterest expense, adjusted for the periodsindicated (in thousands).

 

 

 

 

 

 

 

 

 

**For the nine month**

 

 

 

**periods ended September 30,**

**Dollar**

 

 

**2008**

**2007**

**variance**

FDIC assessment

$

545 

119 

426 

Sundry losses

199 

40 

159 

Real estate acquired in settlement of loans writedowns

426 

152 

274 

 

 

$

1,170 

311 

859 

 

During the second quarter of 2006, as a result of a softwareupgrade, the Company experienced a temporary delay in check processing andelectronic check processing.  At December 31, 2006, the Bank had exposure, andreserved for within other noninterest expense in the Consolidated InterimStatements of Income, of approximately $174 thousand related to itemsuncollected at that date.  Subsequently, during the first three months of 2007,the Bank collected virtually all of these items.  Therefore, this reserve wasreversed during the first quarter of 2007.  Excluding this nonrecurringreversal, sundry losses would have been $214 thousand for the nine month periodended September 30, 2007.  

 

Expenses related to real estate acquired in settlement ofloans during the nine month period ended September 30, 2008 totaled $426thousand, substantially all of which was related to the holding of the Bank’spurchased portion of a participation agreement relative to a commercial realestate property within the portfolio.The lead bank is managing the operations of the property and is currentlyworking with an external firm to market the property.  The Bank was a 20%participant in the loan relationship and is now a 20% owner of the collateralproperty.  As such, the Bank must cover 20% of the costs related to theproperty.

 

Provision for Income Taxes.  Income tax expense totaled $6.5 million for thenine month period ended September 30, 2008, compared with $5.9 million for thesame period of 2007.  The Company’s effective tax rate was 35.1% for the ninemonth period ended September 30, 2008 compared with 33.5% for the nine monthperiod ended September 30, 2007. The increase in the effective tax rate whencomparing the two periods was primarily the result of the recognition of anincrease in nontaxable income relative to cash surrender value of key man lifeinsurance during the third quarter of 2007.  The Company’s effective income taxrate is expected to be approximately 35% for 2008. 
 
***Recently Issued / Adopted Accounting Pronouncements*****

 

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

 

Item 3.  Quantitativeand Qualitative Disclosures about Market Risk

 

Asset / liability management involves the evaluation,monitoring, and management of interest rate risk, market risk, liquidity, andfunding. 

 

64

 

***Interest Rate Risk***

 

Interest rate risk, which potentially can have a significantearnings impact, is an integral part of being a financial intermediary. TheCompany is subject to interest rate risk because: 

 
- Assets and liabilities may     mature or reprice at different times (for example, if assets reprice     faster than liabilities and interest rates are generally falling, earnings     will initially decline);
- Assets and liabilities may     reprice at the same time but by different amounts (for example, when the     general level of interest rates is falling, the Company may reduce rates     paid on checking and savings deposit accounts by an amount that is less     than the general decline in market interest rates);
- Short-term and long-term market     interest rates may change by different amounts (for example, the shape of     the yield curve may affect new loan yields and funding costs differently);     or
- The remaining maturity of     various assets or liabilities may shorten or lengthen as interest rates     change (for example, if long-term mortgage interest rates decline sharply,     mortgage-backed securities held in the investment securities available for     sale portfolio may prepay significantly earlier than anticipated – which     could reduce portfolio income).

 

Interest rates may also have a direct or indirect impact onloan demand, credit losses, mortgage origination volume, the mortgage-servicingrights portfolio, the value of the Company’s pension plan assets and liability,and other financial instruments directly or indirectly impacting earnings.

The Company assesses interest raterisk by comparing its most likely earnings plan with various earningssimulations using different interest rate scenarios. Simulation estimatesdepend on, and will change with, the size and mix of the Company’s actual andprojected balance sheet at the time of each simulation. As of September 30,2008, the following table summarizes the forecasted impact on net interestincome using a base case scenario given upward and downward movement ininterest rates of 100 basis points and 200 basis points.

 

**Interest rate scenario**

**Percentage**

**change in net**

**interest**

**income from**

**base**

Up 200 basis points

(6.12)

%

Up 100 basis points

(3.08)

 

Down 100 basis points

1.60 

 

Down 200 basis points

1.09 

 

 

 

 

 

Overall,the model results indicate that the Company’s balance sheet is liabilitysensitive. A liability sensitive balance sheet suggests that in fallinginterest rate environment, net interest income would increase and during anincreasing interest rate environment, net interest income would decrease.

 

The following table shows the Company’s one-year dynamic gapat September 30, 2008 (dollars in thousands).

 

 

 

 

 

Interest-earning assets maturing or repricing within one year

$

761,699 

 

Interest-bearing liabilities maturing or repricing within one year

874,933 

 

Cumulative gap

$

(113,234)

 

 

 

 

Cumulative gap as a percent of total assets

(8.4)

%

 

 

 

 

The Company's negative gap indicates that cumulative interest-bearingliabilities exceed cumulative interest-earning assets and suggests increasingnet interest income in periods of declining interest rates.  Thisrelationship may not always be ensured due to the repricing attributes of bothinterest-earning assets and interest-bearing liabilities and the shape of theyield curve. As the table above indicates, management believes that theCompany's net interest income will be positively impacted by a decline ininterest rates.

 

***Mortgage Banking Interest Rate and Market Risk*****

* *

The Company originates, funds and services mortgage loans, which subjects it tovarious risks, including credit, liquidity, and interest rate risks. Based onmarket conditions and other factors, the Company may reduce unwanted credit andliquidity risks by selling some of the mortgage loans it originates. On theother hand, the Company may hold originated mortgage loans in its loan portfolioas an investment for growing base of core deposits. The Company determineswhether the loans will be held for investment or held for sale at the time ofcommitment. The Company may subsequently change its intent to hold loans forinvestment and sell some or all of its mortgage loans in conjunction with asset/ liability management. 

 

Interest rate and market risk can be substantial in the mortgage-bankingbusiness. Changes in interest rates may potentially impact total origination andservicing fees, the fair value of the mortgage-servicing rights portfolio, thevalue of mortgage loans held for sale, the associated income and loss reflectedin mortgage-banking noninterest income, and the value of derivative loancommitments (interest rate locks) extended to mortgage applicants. 

 

65

 

Interest rates impact the amount and timing of originationand servicing fees because consumer demand for new mortgages and the level ofrefinancing activity are sensitive to changes in mortgage interest rates.Typically, a decline in mortgage interest rates will lead to an increase inmortgage originations and fees and may also lead to an increase in servicingfee income, depending on the level of new loans added to the mortgage-servicingrights portfolio and prepayments. Given the time it takes for consumer behaviorto fully react to interest rate changes, as well as the time required forprocessing a new application, providing the commitment, and selling the loan,interest rate changes will impact origination and servicing fees with a lag.The amount and timing of the impact on origination and servicing fees willdepend on the magnitude, speed, and duration of the change in interest rates. 

 

A decline in interest rates generally increases thepropensity for refinancing, reduces the expected duration of themortgage-servicing rights portfolio, increases the amortization of themortgage-servicing rights portfolio and, therefore, reduces the book value themortgage-servicing rights portfolio. This increase in amortization results inincreased charges to income. An increase in interest rates generally has the oppositeimpact. However, an increase in interest rates can also reduce mortgage loandemand and, therefore, reduce origination income. 

 

As part of the Company’s mortgage-banking activities, itenters into commitments to fund residential mortgage loans at specified timesin the future. A mortgage loan commitment is an interest rate lock that bindsthe Company to lend to a potential borrower at a specified interest rate andwithin a specified period of time. These loan commitments are derivative loancommitments if the loans that will result from the exercise of the commitmentswill be held for sale. These derivative loan commitments, if material, arerecognized at fair value in the balance sheet with changes in their fair valuesrecorded as part of mortgage-banking noninterest income. For interest rate lockcommitments issued prior to January 1, 2008, a zero fair value for thederivative loan commitment was recorded at inception consistent with SAB No.105. Effective January 1, 2008, in accordance with SAB No. 109, theexpected net future cash flows related to the associated servicing of the loanas part of the fair value measurement of derivative loan commitments wererequired to be included, at inception and during the life of the loancommitment.  The implementation of SAB No. 109 did not have a material impacton the valuation of the Company’s loan commitments. Changes subsequent toinception are based on changes in fair value of the underlying loan resultingfrom the exercise of the commitment and changes in the probability that theloan will not fund within the terms of the commitment (referred to as afall-out factor). The value of the underlying loan is impacted primarily bychanges in interest rates and the passage of time. At September 30, 2008, and December31, 2007, the fair value of the Company’s derivative assets related to derivative loan commitments and its forward loansales commitments were immaterial. 

 

Outstanding derivative loan commitments expose the Companyto the risk that the price of the mortgage loans underlying the commitmentsmight decline due to increases in mortgage interest rates from inception of therate lock to the funding of the loan. To minimize this risk, the Companyutilizes forward sales commitments as economic hedges against the potentialdecreases in the values of the loans. The Company expects that these derivativefinancial instruments will experience changes in fair value that will eitherfully or partially offset the changes in fair value of the derivative loancommitments. However, changes in investor demand, such as concerns about creditrisk, can also cause changes in the spread relationships between underlyingloan value and the derivative financial instruments that cannot be hedged. 

 

***Market Risk – Equity Markets*****

 

Changes in equity market prices may indirectly impact theCompany’s net income by impacting the value of third party assets undermanagement and, therefore, related fee income, particular borrowers, whoseability to repay principal and / or interest may be affected by the stockmarket, or brokerage activity, related commission income and other businessactivities. Each business line monitors and manages these indirect risks. 

 

***Liquidity and Funding*****

* *

The objective of effective liquidity management is to ensurethat the Company can meet customer loan requests, customer deposit maturities /withdrawals and other cash commitments efficiently under both normal operatingconditions and under unpredictable circumstances of industry or market stress.To achieve this objective, the Company’s Asset / Liability Committeeestablishes and monitors liquidity guidelines that require sufficientasset-based liquidity to cover potential funding requirements and to avoidover-dependence on volatile, less reliable funding markets. 

 

66

 

 

Debt securities in the securities available for saleportfolio provide asset liquidity, in addition to the immediately liquidresources of cash and due from banks and federal funds sold. Asset liquidity isfurther enhanced by the Company’s ability to sell loans in secondary marketsand to pledge select assets to access secured borrowing facilities. Corecustomer deposits have historically provided a sizeable source of relativelystable and low-cost funds. Additional funding is provided by short-term andlong-term borrowings. 

 
Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls andProcedures
 

An evaluation of theCompany’s disclosure controls and procedures (as defined in Section 13(a)-14(c)of the Securities Exchange Act of 1934) was carried out under the supervisionand with the participation of the Company’s Chief Executive Officer, thePresident and Chief Operating Officer (Principal Financial Officer) and several other members of the Company’ssenior management as of September 30, 2008, the last day of the period covered by this QuarterlyReport. The Company’s ChiefExecutive Officer and the President and Chief Operating Officer (Principal FinancialOfficer) concluded that theCompany’s disclosure controls and procedures were effective as of September 30,2008 in ensuring that the information required to be disclosed by the Companyin the reports it files or submits under the Securities Exchange Act of 1934 is(i) accumulated and communicated to the Company’s management (including the ChiefExecutive Officer and the President and Chief Operating Officer (Principal FinancialOfficer)) in a timely manner, and is(ii) recorded, processed, summarized, and reported within the time periodsspecified in the SEC’s rules and forms.

 
Third Quarter Internal Control Changes
 

During the third quarter of 2008, the Company did not make any changesin its internal controls over financial reporting that has materially affectedor is reasonably likely to materially affect those controls.

 

 

 

 

 

 

 

 

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PART II – OTHER INFORMATION

 

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

 

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

 

**Item 1A. Risk Factors**

 

For a discussion of certain risk factors that could causethe Company’s financial results and condition to vary materially from period toperiod or cause actual results to differ from expectations for future financialand business performance, refer to the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007. These risks are exacerbated by the recentdevelopments in national and international financial markets, and the Companyis unable to predict what impact these uncertain market conditions will have onthe company.  During 2008, the capital and credit markets have experiencedextended volatility and disruption. In the last 90 days, the volatility anddisruption have reached unprecedented levels.  There can be no assurance thatthese unprecedented recent developments will not materially and adverselyimpact the Company’s business, financial condition, results of operations, orcash flows. The Company has identified the following risk factors as a resultof the recent developments in national and international financial markets.  

 

o      Lower or negativerevenue growth because of the Company’s inability to cross-sell more productsto its existing customers;

o      Decreased demand forthe Company’s products and services and lower revenue and earnings because ofan economic recession;

o      Reduced fee incomefrom the Company’s trust and brokerage businesses because of a fall in stockmarket prices;

o      Lower net interestmargin, decreased mortgage loan originations and reductions in the value of theCompany’s mortgage-servicing rights portfolio due to changes in interest rates;

o      Increased fundingcosts due to market illiquidity and increased competition for deposit funding;

o      Increased fundingcosts due to increased competition for borrowed funding;

o      Negative impact on theCompany’s liquidity due to the availability of borrowedfunding;

o      Reduced earnings dueto higher credit losses generally and specifically because:

o     Losses in theCompany’s real estate loan portfolios are greater than expected due to economicfactors, including declining home values, increasing interest rates, increasingunemployment, or changes in payment behavior, or other factors; and / or

o     The Company’s loansare concentrated by loan type, industry segment, borrower type, or location ofthe borrower or collateral;

o      Higher credit lossesdue to federal or state legislation or regulatory action that reduces theamount that the Company’s borrowers are required to pay us;

o      Higher credit lossesdue to federal or state legislation or regulatory action that limits theCompany’s ability to foreclose on properties or other collateral or makesforeclosure less economically feasible;

o      Changes to theallowance for loan losses following periodic examinations by bankingregulators;

o      Negative impact on theCompany’s mortgage-servicing rights and investment portfolios because offinancial difficulties or credit downgrades of mortgage and bond issuers;

o      Reduced earnings dueto writedowns of the carrying value of investment securities available for salefollowing a determination that the securities are other-than-temporarilyimpaired;

o      Changes in accountingpolicies or in accounting standards, and changes in how accounting standardsare interpreted or applied;

o      Reduced earnings dueto actual returns on pension plan assets being lower than expected, resultingin an increase in future net periodic benefit expense;

o      Federal and stateregulations;

o      The loss of checkingand savings account deposits to alternative investments such as the stockmarket and higher-yielding fixed income investments; and

o      Fiscal and monetarypolicies of the Federal Reserve Board.

 

68

 

 

 

 

 

As described in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the Bank is a member of the Deposit InsuranceFund (“DIF”). The FDIC uses the DIF to cover insured deposits in the eventof a bank failure and maintains the fund by assessing member banks an insurancepremium. Recent failures have caused the DIF to fall below the minimum balancerequired by law, forcing the FDIC to consider action to rebuild the fund byraising the insurance premiums assessed member banks. Depending on thefrequency and severity of bank failures, the increase in premiums could besignificant and negatively impact the Company’s earnings. 

 

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

 

None

 

**Item3. Defaults Upon Senior Securities**

** **

None

 

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

** **

None

 

**Item5. Other Information**

** **

None

** **

**Item6. Exhibits**

 

31.1         L.Leon Patterson's Certification Pursuant to Section 302 of the Sarbanes-OxleyAct of 2002 

31.2         PaulW. Stringer's Certification Pursuant to Section 302 of the Sarbanes-Oxley Actof 2002 

32            Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Exhibits 31.1, 31.2, and32 have been filed with the SEC in conjunction with this Quarterly Report onForm 10-Q. Copies of these exhibits are available upon written requestto Lauren S. Greer, The Palmetto Bank, Post Office Box 49, Laurens, SouthCarolina 29360.

 

69

 

 

 

 

 

 

                                                                                                                                                

 

**SIGNATURES**

 

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

 

 

 

PALMETTOBANCSHARES, INC.

 

 

 

By:

 

 

/s/ L. Leon Patterson                    

L.Leon Patterson

Chairmanand Chief Executive Officer

PalmettoBancshares, Inc.

 

 

/s/ Paul W. Stringer

PaulW. Stringer

Presidentand Chief Operating Officer, 

ChiefAccounting Officer

PalmettoBancshares, Inc.

 

 

Date:November 10, 2008

 

70

 

 

 

 

 

**EXHIBITINDEX**

 

 

Exhibit No.
Description

 
 

31.1
L.Leon Patterson’s Certification Pursuant to Section 302 of the Sarbanes-OxleyAct of 2002 

 
 

31.2
PaulW. Stringer’s Certification Pursuant to Section 302 of the Sarbanes-Oxley Actof 2002

 
 

32
CertificationsPursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

* *

 

 

 

 

 

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