U. S. SECURITIES AND EXCHANGE
  COMMISSION
  WASHINGTON, D.C. 20549FORM 10-Q(X)
  QUARTERLY
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
  June 30, 2007OR(  )
  TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from
  __________ to __________Commission file number  0-26016PALMETTO BANCSHARES, INC.(Exact name of registrant as specified in its
  charter)South Carolina
  
  74-2235055(State or other jurisdiction of
  incorporation or organization)
  
  (IRS Employer Identification No.)301 Hillcrest Drive, Laurens,
  South Carolina
  
  29360(Address of principal executive
  offices)
  
  (Zip Code)(864) 9844551
  
  www.palmettobank.com(Registrants telephone number)
  
  (Registrants web site)Indicate
  by check mark whether the registrant (1) has filed all reports required to be
  filed by Section 13 or
  15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
  (or for such shorter period that the
  registrant was required to file such reports), and (2) has been subject to
  such filing requirements for the
  past 90 days. Yes X   No __Indicate
  by check mark whether the registrant is a large accelerated filer, an
  accelerated filer, or a non-accelerated
  filer.  See definition of "accelerated filer and large accelerated
  filer" in Rule 12b-2 of the Exchange
  Act.Large
  accelerated filer [ ]
  Accelerated
  filer [x]
  Non-accelerated
  filer [ ]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 August 6, 2007-----------------------------
  
  -------------------------------Common stock, $5.00 par value
  
  6,389,660      
     PALMETTO
  BANCSHARES, INC. AND SUBSIDIARYTable of
  ContentsPagePART I -   FINANCIAL INFORMATIONItem 1.
  Financial Statements
  3Item 2.
  Management's Discussion and Analysis of Financial
  Condition and
  23Results of OperationsItem 3.
  Quantitative and Qualitative Disclosures about Market Risk
  50Item 4.
  Controls and Procedures
  51PART II -  OTHER INFORMATIONItem 1.
  Legal Proceedings
  52Item 4.
  Submission of Matters to a Vote of Security Holders
  52Item 6.
  Exhibits
  52SIGNATURES
  53
    2   
   Table of Contents PART 1 - FINANCIAL INFORMATION ITEM 1. Financial Statements PALMETTO BANCSHARES,
				INC. AND SUBSIDIARYConsolidated Balance Sheets(dollars in thousands, except common and per
				share data)June 30,
				
				December 31,2007
				
				2006(unaudited)ASSETSCash and cash equivalentsCash and due from banks
				
				
				$
				33,286
				
				43,084Federal funds sold
				
				
				
				9,972
				
				3,582Total cash and cash equivalents
				
				
				43,258
				
				46,666Federal Home Loan Bank ("FHLB") stock, at cost
				
				
				2,527
				
				2,599Investment securities available for sale, at fair
				market value
				
				104,708
				
				116,567Mortgage loans held for sale
				
				
				
				1,293
				
				1,675Loans
				
				
				
				
				
				986,529
				
				945,913Less: allowance for loan losses
				
				
				
				(8,515)
				
				(8,527)Loans, net
				
				
				
				978,014
				
				937,386Premises and equipment, net
				
				
				
				24,952
				
				24,494Goodwill
				
				
				
				
				
				3,691
				
				3,691Other intangible assets
				
				
				
				102
				
				126Accrued interest receivable
				
				
				
				6,201
				
				6,421Other
				
				
				
				
				
				15,123
				
				13,511Total assets
				
				
				$
				1,179,869
				
				1,153,136LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
				
				
				$
				137,182
				
				133,623Interest-bearing
				
				
				
				864,643
				
				859,958Total deposits
				
				
				
				1,001,825
				
				993,581Retail repurchase agreements
				
				
				
				12,145
				
				14,427Commercial paper (Master notes)
				
				
				
				27,737
				
				20,988Other short-term borrowings
				
				
				
				24,500
				
				6,000Long-term borrowings
				
				
				
				-
				
				10,000Accrued interest payable
				
				
				
				1,523
				
				1,584Other
				
				
				
				
				
				6,748
				
				6,180Total liabilities
				
				
				
				1,074,478
				
				1,052,760Commitments and contingencies (Note 14)Shareholders' EquityCommon stock - par value $5.00 per share;
				authorized 10,000,000shares; issued and outstanding 6,389,660 and
				6,367,450at June 30, 2007 and December 31, 2006,
				respectively
				
				31,948
				
				31,837Capital surplus
				
				
				
				
				1,391
				
				1,102Retained earnings
				
				
				
				73,531
				
				68,132Accumulated other comprehensive loss, net of tax
				
				
				(1,479)
				
				(695)Total shareholders' equity
				
				
				
				105,391
				
				100,376Total liabilities and shareholders' equity
				$
				1,179,869
				
				1,153,136See Notes to Consolidated Interim Financial
				Statements.
 3 
   Table of Contents   PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Income(dollars in thousands, except common and per share
			data)For the three month periods ended June 30,2007
			
			2006(unaudited)Interest incomeInterest and fees on loans
			
			$
			19,301
			
			17,115Interest on investment securities available for sale:Government-sponsored enterprises (taxable)
			381
			
			509State and municipal (nontaxable)
			
			452
			
			496Mortgage-backed securities (taxable)
			297
			
			210Interest on federal funds sold
			
			
			227
			
			393Dividends on FHLB stock
			
			
			38
			
			46Total interest income
			
			20,696
			
			18,769Interest expenseInterest on deposits
			
			
			7,437
			
			6,029Interest on retail repurchase agreements
			
			130
			
			177Interest on commercial paper
			
			289
			
			206Interest on other short-term borrowings
			
			54
			
			16Interest on long-term borrowings
			
			78
			
			173Total interest expense
			
			7,988
			
			6,601Net interest income
			
			12,708
			
			12,168Provision for loan losses
			
			
			433
			
			525Net interest income after provision for loan losses
			12,275
			
			11,643Noninterest incomeService charges on deposit accounts
			
			1,991
			
			2,042Fees for trust and brokerage services
			
			826
			
			847Mortgage-banking income
			
			
			171
			
			275Investment securities gains
			
			
			-
			
			1Other
			
			
			
			
			877
			
			811Total noninterest income
			
			3,865
			
			3,976Noninterest expenseSalaries and other personnel
			
			
			6,057
			
			5,709Occupancy
			
			
			
			379
			
			371Furniture and equipment
			
			
			422
			
			438Premises and equipment leases and rentals
			
			335
			
			331Premises and equipment depreciation
			
			480
			
			519Marketing
			
			
			
			219
			
			332Amortization of core deposit intangibles
			
			12
			
			12Other
			
			
			
			
			1,967
			
			2,373Total noninterest expense
			
			9,871
			
			10,085Net income before provision for income taxes
			6,269
			
			5,534Provision for income taxes
			
			
			2,204
			
			1,803Net income
			
			$
			4,065
			
			3,731Common and Per Share DataNet income - basic
			
			$
			0.64
			
			0.59Net income - diluted
			
			
			0.63
			
			0.58Cash dividends
			
			
			
			0.19
			
			0.18Book value
			
			
			
			16.49
			
			14.73Weighted average common shares outstanding - basic
			6,385,483
			
			6,354,888Weighted average common shares outstanding - diluted
			6,499,649
			
			6,429,759See Notes to Consolidated Interim Financial
			Statements.
   4 
   Table of Contents  PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Income(dollars in thousands, except common and per share
			data)For the six month periods ended June 30,2007
			
			2006(unaudited)Interest incomeInterest and fees on loans
			
			$
			38,067
			
			33,568Interest on investment securities available for sale:Government-sponsored enterprises (taxable)
			816
			
			1,039State and municipal (nontaxable)
			
			876
			
			993Mortgage-backed securities (taxable)
			609
			
			432Interest on federal funds sold
			
			
			451
			
			586Dividends on FHLB stock
			
			
			75
			
			99Total interest income
			
			40,894
			
			36,717Interest expenseInterest on deposits
			
			
			14,664
			
			11,263Interest on retail repurchase agreements
			
			276
			
			351Interest on commercial paper
			
			527
			
			344Interest on other short-term borrowings
			
			83
			
			114Interest on long-term borrowings
			
			173
			
			382Total interest expense
			
			15,723
			
			12,454Net interest income
			
			25,171
			
			24,263Provision for loan losses
			
			
			800
			
			1,050Net interest income after provision for loan losses
			24,371
			
			23,213Noninterest incomeService charges on deposit accounts
			
			3,899
			
			4,028Fees for trust and brokerage services
			
			1,522
			
			1,628Mortgage-banking income
			
			
			519
			
			497Investment securities gains
			
			
			-
			
			3Other
			
			
			
			
			1,757
			
			1,723Total noninterest income
			
			7,697
			
			7,879Noninterest expenseSalaries and other personnel
			
			
			12,194
			
			11,484Occupancy
			
			
			
			749
			
			754Furniture and equipment
			
			
			903
			
			935Premises and equipment leases and rentals
			
			625
			
			646Premises and equipment depreciation
			
			986
			
			1,022Marketing
			
			
			
			487
			
			738Amortization of core deposit intangibles
			
			24
			
			24Other
			
			
			
			
			4,045
			
			4,548Total noninterest expense
			
			20,013
			
			20,151Net income before provision for income taxes
			12,055
			
			10,941Provision for income taxes
			
			
			4,229
			
			3,560Net income
			
			$
			7,826
			
			7,381Common and Per Share DataNet income - basic
			
			$
			1.23
			
			1.17Net income - diluted
			
			
			1.21
			
			1.15Cash dividends
			
			
			
			0.38
			
			0.36Book value
			
			
			
			16.49
			
			14.73Weighted average common shares outstanding - basic
			6,382,019
			
			6,349,099Weighted average common shares outstanding - diluted
			6,480,454
			
			6,423,970See Notes to Consolidated Interim Financial
			Statements.
   5  
   Table of Contents  PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Changes in Shareholders'
		Equity and Comprehensive Income(dollars in thousands, except common and per share
		data)(unaudited)AccumulatedShares of
		
		
		
		
		
		
		
		
		
		
		
		othercommon
		
		
		Common
		
		
		Capital
		
		
		Retained
		
		
		comprehensivestock
		
		
		stock
		
		
		surplus
		
		
		earnings
		
		
		(loss), net
		
		
		TotalBalance at December 31, 2005
		
		6,331,335
		
		$
		31,656
		
		$
		659
		
		$
		57,532
		
		$
		(906)
		
		$
		88,941Net income
		
		
		
		
		
		
		
		
		
		
		7,381
		
		
		
		
		
		7,381Other comprehensive income, net of tax:Unrealized holding gains arising during period, netof tax effect of $511
		
		
		
		
		
		
		
		
		
		
		
		
		
		(816)Plus: reclassification adjustment includedin net income, net of tax effect of $1
		
		
		
		
		
		
		
		
		
		
		
		
		(2)Net unrealized gains on securities
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		(818)Comprehensive income
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		6,563Cash dividend declared and paid ($0.36 per share)
		
		
		
		
		
		
		
		
		
		(2,287)
		
		
		
		
		
		(2,287)Compensation expense related to stock options
		
		
		
		
		
		
		55
		
		
		
		
		
		
		
		
		55Exercise of stock options
		
		25,300
		
		
		127
		
		
		227
		
		
		
		
		
		
		
		
		354Balance at June 30, 2006
		
		6,356,635
		
		$
		31,783
		
		$
		941
		
		$
		62,626
		
		$
		(1,724)
		
		$
		93,626Balance at December 31, 2006
		
		6,367,450
		
		$
		31,837
		
		$
		1,102
		
		$
		68,132
		
		$
		(695)
		
		$
		100,376Net income
		
		
		
		
		
		
		
		
		
		
		7,826
		
		
		
		
		
		7,826Other comprehensive income, net of tax:Unrealized holding gains arising during period, netof tax effect of $491
		
		
		
		
		
		
		
		
		
		
		
		
		
		(784)Plus: reclassification adjustment includedin net income, net of tax effect of $0
		
		
		
		
		
		
		
		
		
		
		
		
		-Net unrealized gains on securities
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		(784)Comprehensive income
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		
		7,042Cash dividend declared and paid ($0.38 per share)
		
		
		
		
		
		
		
		
		
		(2,427)
		
		
		
		
		
		(2,427)Compensation expense related to stock options
		
		
		
		
		
		
		66
		
		
		
		
		
		
		
		
		66Exercise of stock options
		
		22,210
		
		
		111
		
		
		223
		
		
		
		
		
		
		
		
		334Balance at June 30, 2007
		
		6,389,660
		
		$
		31,948
		
		$
		1,391
		
		$
		73,531
		
		$
		(1,479)
		
		$
		105,391See Notes to Consolidated Interim Financial Statements.     6 
   Table of Contents  PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Cash Flows(in thousands)For the six month periods ended June 30,2007
			
			2006(unaudited)Cash flows from operating activitiesNet income
			
			
			$
			7,826
			
			7,381Adjustments to reconcile net income to net cashprovided by operating activitiesDepreciation, amortization, and accretion, net
			
			1,109
			
			1,007Investment securities gains
			
			-
			
			(3)Provision for loan losses
			
			800
			
			1,050Origination of mortgage loans held for sale
			
			(27,466)
			
			(26,763)Proceeds from sale of mortgage loans held for sale
			
			28,183
			
			28,627Gain on sale of mortgage loans
			
			(335)
			
			(290)Compensation expense related to stock options granted
			
			66
			
			55Loss on disposition of other real estate owned
			
			465
			
			1,309Recovery from write down of mortgage-servicing rights
			
			(1)
			
			(133)Increase of other assets, net
			
			(980)
			
			(2,144)Increase (decrease) of other liabilities, net
			
			998
			
			(531)Net cash provided by operating activities
			
			10,665
			
			9,565Cash flows from investing activitiesPurchase of investment securities available for sale
			
			(22,332)
			
			(10,566)Maturities, redemption, calls, and principal
			repayment of investment securities available for sale
			
			32,817
			
			15,697Proceeds from sales of investment securities
			available for sale
			
			-
			
			4,129Redemption of FHLB stock
			
			72
			
			1,345Purchase of FHLB stock
			
			-
			
			(158)Origination of loans, net
			
			(42,010)
			
			(23,621)Proceeds on sale of other real estate owned
			
			(294)
			
			(1,121)Purchases of premises and equipment
			
			(1,444)
			
			(2,079)Net cash used in investing activities
			
			(33,191)
			
			(16,374)Cash flows from financing activitiesDeposits, net
			
			
			
			8,244
			
			62,894(Decrease) increase of retail repurchase agreements,
			net
			
			(2,282)
			
			1,233Increase in commercial paper, net
			
			6,749
			
			4,189Increase (decrease) of other short-term borrowings,
			net
			
			18,500
			
			(17,900)Decrease of long-term borrowings, net
			
			(10,000)
			
			(13,000)Other common stock activity
			
			334
			
			354Cash dividends paid on common stock
			
			(2,427)
			
			(2,287)Net cash provided by financing activities
			
			19,118
			
			35,483Net increase (decrease) of cash and cash equivalents
			
			(3,408)
			
			28,674Cash and cash equivalents, beginning of the period
			
			46,666
			
			37,976Cash and cash equivalents, end of the period
			$
			43,258
			
			66,650Supplemental Cash Flow DataCash paid during the period forInterest expense
			$
			15,784
			
			12,245Income taxes
			
			
			3,618
			
			3,924Significant noncash investing and financing
			activities(Decrease) increase of unrealized loss on investment
			securities available for sale
			$
			(1,275)
			
			(1,328)Loans transferred to other real estate owned, at fair
			market value
			
			582
			
			83See Notes to Consolidated Interim Financial
			Statements.
     7  
   Table of Contents     PALMETTO
BANCSHARES, INC. AND SUBSIDIARY Notes To
Consolidated Interim Financial Statements (Unaudited)  1.Summary
of Significant Accounting Policies  The significant accounting policies followed by the Company
for interim financial reporting are consistent with the accounting policies
followed for annual financial reporting.  The unaudited Consolidated
Interim Financial Statements and footnotes are presented in accordance with the
instructions for the Quarterly Report on Form 10-Q.  The information contained
in the footnotes included in the Companys latest Annual Report on Form 10-K
should be referred to in connection with the reading of these unaudited
Consolidated Interim Financial Statements.  Principles of Consolidation  The accompanying Consolidated
Financial Statements include the accounts of Palmetto Bancshares, Inc. (the
Company), which includes its wholly owned subsidiary, The Palmetto Bank (the
Bank), and the Bank's wholly owned subsidiary, Palmetto Capital, Inc.
("Palmetto Capital").  In managements opinion, all significant intercompany accounts and
transactions have been eliminated in consolidation, and all adjustments
necessary for a fair presentation of the financial condition and results of
operations for periods presented have been included. Any such adjustments are
of a normal and recurring nature.  Assets held by the Company or its
subsidiary in a fiduciary or agency capacity for customers are not included in
the Companys Consolidated Financial
Statements as such items do not represent assets of the Company or its
subsidiary.  Use of Estimates  The accounting and reporting policies of the Company conform
to accounting principles generally accepted in the United States of America and
to general practices within the banking industry. In preparing its Consolidated Financial Statements, the Companys
management makes estimates and assumptions that impact the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
as of the date of the Consolidated Financial Statements for the periods
presented. Actual results could differ from these estimates and
assumptions. As such, the results of operations for the three and six month
periods ended June 30, 2007 are not necessarily indicative of the results of
operations that may be expected in future periods.  Reclassifications  Certain amounts previously presented in the Companys Consolidated Financial Statements for
prior periods have been reclassified to conform to current classifications. 
All such reclassifications had no impact on prior period net income or retained
earnings as previously reported.  During the second half of 2006, the Company made the
following reclassifications in the Consolidated Statements of Income:  Certain accounts related to service charges on deposit
     accounts in the Other Noninterest Income and Other Noninterest Expense
     line items were reclassified to the Service Charges on Deposit Accounts
     line item.  Certain accounts in the Occupancy line item and the
     Furniture and Equipment line item were reclassified to the Premises and
     Equipment Leases and Rentals line item and the Premises and Equipment
     Depreciation line item.  Certain accounts in the Other Noninterest Expense line
     item were reclassified to the Amortization of Core Deposit Intangibles
     line item.  Certain accounts in the Marketing line item were deemed
     to, more often than not, include expenses applicable to general branch
     operations instead of expenses for creating, communicating, and delivering
     value to customers and for managing customer relationships, so the Company
     began classifying this account in the Other Noninterest Expense line item.  8 
   Table of Contents     The following table summarizes the Companys Consolidated Statements
of Income for the three and six month periods ended June 30, 2006 as reported
prior to these reclassifications (in thousands).  For the three
  
  For the sixmonth period ended
  
  month period ended6/30/2006
  
  6/30/2006Noninterest
  incomeService charges
  on deposit accounts
  $
  2,047
  
  4,105Fees for trust
  and brokerage services
  
  847
  
  1,628Mortgage-banking
  income
  
  275
  
  497Investment
  securities gains
  
  1
  
  3Other
  
  
  910
  
  1,829Total noninterest
  income
  
  4,080
  
  8,062Noninterest
  expenseSalaries and
  other personnel
  
  5,709
  
  11,484Net occupancy
  
  699
  
  1,391Furniture and
  equipment
  
  960
  
  1,966Marketing and
  advertising
  
  340
  
  796Postage and
  supplies
  
  347
  
  736Telephone
  
  182
  
  395Professional
  services
  
  259
  
  480Other
  
  
  1,693
  
  3,086Total noninterest
  expense
  
  10,189
  
  20,334Net noninterest
  expense
  $
  6,109
  
  12,272
  Intangible Assets  Intangible assets, included in Other Assets on the Consolidated
Balance Sheets, include goodwill and other identifiable assets, such as
customer lists, resulting from acquisitions.  Goodwill, in this context, is the
excess of the purchase price in an acquisition transaction over the fair market
value of the net assets acquired. Customer list intangibles are amortized on a
hybrid double-declining, straight-line basis over such assets estimated useful
life.  In accordance with SFAS No. 142, Goodwill and Other Intangible Assets,
goodwill is not amortized but is tested annually for impairment or at any time
an event occurs, or circumstances change, that may trigger a decline in the
value of the reporting unit. Such impairment testing calculations include
estimates. Furthermore, the determination of which intangible assets have
finite lives is subjective as is the determination of the amortization period for
such intangible assets. The Company tests for goodwill impairment by
determining the fair market value for each reporting unit and comparing the
fair market value to the carrying amount of the applicable reporting unit. If
the carrying amount exceeds fair market value, the potential for impairment
exists, and a second step of impairment testing is performed. In the second
step, the fair market value of the reporting units goodwill is determined by
allocating the reporting units fair market value to all of its assets
(recognized and unrecognized) and liabilities as if the reporting unit had been
acquired in a business combination at the date of the impairment test. If the
implied fair market value of reporting unit goodwill is less than its carrying
amount, goodwill is impaired and is written-down to its fair market value. The
loss recognized is limited to the carrying amount of goodwill.  Once an
impairment loss is recognized, future increases in fair market value will not
result in the reversal of previously recognized losses. The Company performs
its annual impairment testing as of June 30 by applying the above process to
its reportable operating segment of banking. The Companys impairment testing
as of June 30, 2007 indicated that no impairment charge was required as of that
date.  See Note 7 for further discussion regarding the Companys
intangible assets.  Recently Issued Accounting Pronouncements  In September 2006, theFinancial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 157, Fair Value Measurements.
	SFAS No. 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. This standard does not require any new fair
value measurements but rather eliminates inconsistencies found in various prior
pronouncements. SFAS No. 157 is effective for the Company on January 1, 2008.
The Company does not believe the adoption of SFAS No. 157 will have a material
impact on its financial position, results of operations and cash flows.  9 
   Table of Contents    In September 2006, the FASB issued
SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans, which amends SFAS No. 87 and SFAS No. 106 to require
recognition of the overfunded or underfunded status of pension and other
postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains
and losses, prior service costs and credits, and any remaining transition
amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized
through net periodic benefit cost will be recognized in accumulated other
comprehensive income, net of tax effects, until they are amortized as a
component of net periodic cost. The measurement date  the date at which the
benefit obligation and plan assets are measured  is required to be the
companys fiscal year end. The recognition and disclosure provisions of SFAS
No. 158 differ for an employer that is an
issuer of publicly traded equity securities (as definedby the Standard)
and an employer that is not. As the
Company does not meet the definition of an
issuer of publicly traded equity securities (as definedby the Standard)for purposes of this Standard, the Company is notrequired to recognize the funded status of a defined benefit
postretirement plan and to provide the required disclosures until the end of
the fiscal year ending after June 15, 2007
with the exception of the provisions for the measurement date which are
effective for fiscal years ending after December 15, 2008. The Company is
currently evaluating the impact that the adoption of SFAS No. 158 will have on
its financial position, results of operations, and cash flows.  In September 2006, the FASB
ratified the consensuses reached by the FASBs
Emerging Issues Task Force (EITF) relating to EITF No. 06-4 Accounting for
the Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements.  EITF No. 06-4 addresses employer accounting for endorsement split-dollar life
insurance arrangements that provide a benefit to an employee that extends to
postretirement periods.  In such instances, a liability should be recognized
for future benefits in accordance with SFAS No. 106, *Employers' Accounting for Postretirement Benefits
Other Than Pensions,*or Accounting Principles Board (APB)
Opinion No. 12, *Omnibus Opinion1967.*EITF No. 06-4 is effective for fiscal years beginning after December 15,
2007. Entities should recognize the effects of applying this Issue through
either a change in accounting principle through a cumulative-effect adjustment
to retained earnings or to other components of equity or net assets in the
statement of financial position as of the beginning of the year of adoption or
a change in accounting principle through retrospective application to all prior
periods.  Although, the Company does not believe the adoption of EITF
No. 06-4 will have a material impact on the Companys financial position,
results of operations, or cash flows, management is currently analyzing the
impact of adoption.  In September 2006, the FASB
     ratified the consensus reached related to EITF 06-5,Accounting
     for Purchases of Life InsuranceDetermining the Amount That Could Be
     Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting
     for Purchases of Life Insurance.  EITF No. 06-5 states that a
     policyholder should consider any additional amounts included in the
     contractual terms of the insurance policy other than the cash surrender
     value in determining the amount that could be realized under the insurance
     contract.  EITF No. 06-5 also states that a policyholder should
     determine the amount that could be realized under the life insurance
     contract assuming the surrender of an individual-life by individual-life
     policy (or certificate by certificate in a group policy). EITF No. 06-5 is
     effective for fiscal years beginning after December 15, 2007. 
     Although, the Company does not believe the adoption of EITF No.
     06-5 will have a material impact on the Companys financial position,
     results of operations, or cash flows, management is currently analyzing
     the impact of adoption.  10 
   Table of Contents     In February 2007, the FASB issued
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities
− Including an amendment of SFAS No. 115.  This statement permits, but
does not require, entities to measure many financial instruments at fair
value.  The objective of the statement is to provide entities with an
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex
hedge accounting provisions.  Entities electing this option will apply it when
the entity first recognizes an eligible instrument and will report unrealized
gains and losses on such instruments in current earnings.  This statement
applies to all entities, specifies certain election dates, can be applied on an
instrument−by−instrument basis with some exceptions, is irrevocable
and applies only to entire instruments.  One exception is demand deposit
liabilities, which are explicitly excluded as qualifying for fair value.  With
respect to SFAS No. 115,*Accounting for Certain Investments
in Debt and Equity Securities,*available for sale and held to maturity securities at
the effective date are eligible for the fair value option at that date.  If the
fair value option is elected for those securities at the effective date, cumulative
unrealized gains and losses at that date shall be included in the cumulative
effect adjustment and, thereafter, such securities will be accounted for as
trading securities.  SFAS No. 159 is effective for the Company on January 1,
2008.  Earlier adoption is permitted in 2007 if the Company also elects to
apply the provisions of SFAS No. 157.  The Company did not early adopt SFAS No.
159 and believes that it is unlikely that it will expand its use of fair value
accounting upon the January 1, 2008 effective date. Other accounting standards
may have been issued or proposed by the FASB or other standards-setting bodies
that are not applicable to the Companys business.  Recently Adopted Accounting Pronouncements  Accounting standards issued by the FASB or other
standards-setting bodies may have been adopted that were not applicable to the
Companys business and, therefore, did not have a material impact on the
Companys financial position, results of operations or cash flows.  2.Cash and Cash
Equivalents  The following table summarizes the composition of cash and cash
equivalents at the dates indicated (in thousands).  June 30,
  December 31,2007
  2006Cash working
  funds
  $
  7,903
  9,190Noninterest-earning
  demand depositsin other banks
  
  16,707
  23,511In-transit funds
  
  8,676
  10,383Interest-earning
  federal funds sold
  
  9,972
  3,582Total cash and
  cash equivalents
  $
  43,258
  46,666
  The average outstanding federal funds sold for the three month periods ended June 30, 2007 and 2006 were $19.1 million and $29.9 million, respectively.  The average outstanding federal funds sold for the six month periods ended June 30, 2007 and 2006 were $18.3 million and $24.4 million, respectively.  The maximum amount of federal funds sold at any month-end during the three and six month periods ended June 30, 2007 was $12.1 million and $35.1 million, respectively.  The maximum amount of federal funds sold at any month-end during both the three and six month periods ended June 30, 2006 was $45.5 million.  The Company is required to
maintain average reserve balances computed by applying prescribed percentages
to its various types of deposits.  At June 30, 2007, the Federal Reserve
required that the Company maintain $9.0 million in reserve balances.  Due to
the Companys levels of vault cash, no reserves were required to be maintained
with Bank of America, however, $1.0 million was required to be maintained with
the Federal Reserve Bank of Richmond.  3.Investment
Securities Available for Sale  The following tables summarize the amortized cost, gross unrealized
gains, gross unrealized losses, and fair market values of investment securities
available for sale at the dates indicated (in thousands). 11 
   Table of Contents  June 30, 2007Gross
  Gross
  FairAmortized
  unrealized
  unrealized
  marketcost
  gains
  losses
  valueGovernment-sponsored
  enterprises
  $
  29,672
  -
  (93)
  29,579State and
  municipal
  
  53,343
  9
  (1,728)
  51,624Mortgage-backed
  
  24,099
  -
  (594)
  23,505Total investment securitiesavailable for
  sale
  $
  107,114
  9
  (2,415)
  104,708December 31, 2006Gross
  Gross
  FairAmortized
  unrealized
  unrealized
  marketcost
  gains
  losses
  valueGovernment-sponsored
  enterprises
  $
  42,554
  -
  (171)
  42,383State and
  municipal
  
  48,780
  56
  (822)
  48,014Mortgage-backed
  
  26,362
  72
  (264)
  26,170Total investment
  securitiesavailable for
  sale
  $
  117,696
  128
  (1,257)
  116,567
  The following table summarizes the gross unrealized losses,
fair market value, and the number of securities in each category of investment
securities available for sale, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at June 30, 2007 and December 31, 2006 (dollars in thousands).  June 30, 2007Less than 12 months
  
  12 months or longer
  
  TotalFair
  Gross
  
  
  Fair
  Gross
  
  
  Fair
  Grossmarket
  unrealized
  
  
  market
  unrealized
  
  
  market
  unrealized#
  value
  losses
  
  #
  value
  losses
  
  #
  value
  lossesGovernment-sponsored
  enterprises
  7
  $
  18,177
  $
  35
  
  6
  11,402
  58
  
  13
  29,579
  93State and
  municipal
  26
  
  9,474
  
  255
  
  98
  37,802
  1,473
  
  124
  47,276
  1,728Mortgage-backed
  5
  
  8,786
  
  199
  
  25
  13,584
  395
  
  30
  22,370
  594Total investment
  securitiesavailable for
  sale
  38
  $
  36,437
  $
  489
  
  129
  62,788
  1,926
  
  167
  99,225
  2,415  December 31, 2006Less than 12 months
  
  12 months or longer
  
  TotalFair
  Gross
  
  
  Fair
  Gross
  
  
  Fair
  Grossmarket
  unrealized
  
  
  market
  unrealized
  
  
  market
  unrealized#
  value
  losses
  
  #
  value
  losses
  
  #
  value
  lossesGovernment-sponsored
  enterprises
  3
  $
  2,980
  $
  3
  
  10
  39,402
  168
  
  13
  42,382
  171State and
  municipal
  10
  
  4,898
  
  52
  
  91
  34,437
  770
  
  101
  39,335
  822Mortgage-backed
  -
  
  -
  
  -
  
  30
  16,327
  264
  
  30
  16,327
  264Total investment
  securitiesavailable for
  sale
  13
  $
  7,878
  $
  55
  
  131
  90,166
  1,202
  
  144
  98,044
  1,257
  Management believes that the above summarized unrealized
losses are due to interest rate changes, rather than credit quality, on
investments that the Company classifies to indicate that sale is a possibility
but also for which the Company has the ability to hold until maturity.  If
liquidity is needed, the Company does not automatically chose an impaired or
the most impaired security to sell to provide needed liquidity, but rather
considers many factors including, but not limited to, asset  liability
management. Since the Company has the ability and intent to hold these
investments until a market price recovery or maturity, management does not
consider these investments to be other-than-temporarily impaired.  The following table summarizes the percentage of the
applicable investment segments of the investment securities available for sale
by Moodys credit ratings at June 30, 2007.  State and
  
  Mortgage-municipal
  
  backedA3
  
  2
  %
  -Aa1
  4
  
  -Aaa
  78
  
  100Not rated
  16
  
  -Total
  100
  %
  100
  12 
   Table of Contents  Of the state and municipal investment securities not rated
by Moodys at June 30, 2007, 97% was rated Aaa by Standard and Poors while 3%
was rated Aa+.  The following tables summarize the gross realized gains and losses of
investment securities available for sale at the dates indicated (in thousands).  For the three month
  
  For the six monthperiods ended June 30,
  
  periods ended June 30,2007
  2006
  
  2007
  2006Realized gains
  $
  -
  1
  
  -
  25Realized losses
  
  -
  -
  
  -
  (22)Net unrealized
  gains (losses)
  $
  -
  1
  
  -
  3
     Public funds are bank deposits
of state and local municipalities and typically require that the Bank pledge
investment grade securities to the accounts to ensure repayment.  Approximately
75% of the investment securities portfolio was pledged to secure public
deposits as of June 30, 2007 as compared with 62% at December 31, 2006 and 94%
at June 30, 2006.  Approximately 42.6% of investment securities portfolio
secured public deposits as of June 30, 2007 as compared with 38% at December
31, 2006 and 74% at June 30, 2006.  Concentrations of Credit Risk. The Companys investment portfolio consists principally of
securities issued by government-sponsored enterprises, and securities issued by
states and municipalities within the United States. The Company places its
deposits and correspondent accounts with, and sells its federal funds to, high
quality institutions.  Management believes credit risk associated with
correspondent accounts is not significant.  4.Loans  The following table summarizes
loans, by loan purpose, excluding those mortgage loans held for sale, by
classification at the dates indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalCommercial
  business
  $
  120,916
  12.4
  %
  112,264
  12.0Commercial real
  estate
  
  618,084
  63.1
  
  593,377
  63.2Installment
  
  23,280
  2.4
  
  22,139
  2.4Installment real
  estate
  
  68,633
  7.0
  
  66,161
  7.0Indirect
  
  43,098
  4.4
  
  43,634
  4.6Credit line
  
  1,926
  0.2
  
  1,982
  0.2Prime access
  
  52,272
  5.3
  
  53,883
  5.7Residential
  mortgage
  
  42,920
  4.4
  
  35,252
  3.7Bankcards
  
  11,461
  1.2
  
  11,813
  1.3Business manager
  
  316
  -
  
  370
  -Other
  
  1,623
  0.2
  
  1,793
  0.2Loans, unadjusted
  gross
  
  984,529
  100.6
  
  942,668
  100.3Loans in process
  
  1,279
  0.1
  
  2,587
  0.3Deferred loans
  fees and costs
  
  721
  0.1
  
  658
  0.1Loans, adjusted
  gross
  
  986,529
  100.8
  
  945,913
  100.7Mortgage loans
  held for sale
  
  1,293
  0.1
  
  1,675
  0.2Total loans,
  gross
  
  987,822
  100.9
  
  947,588
  100.9Allowance for
  loan losses
  
  (8,515)
  (0.9)
  
  (8,527)
  (0.9)Total loans, net
  $
  979,307
  100.0
  %
  939,061
  100.0
  Loans included in the table are
net of participations sold, and mortgage loans sold and serviced for others.  Mortgage
loans serviced for the benefit of others amounted to $330.2 million, $325.1
million, and $312.8 million at June 30, 2007, December 31, 2006, and June 30,
2006, respectively. See Note 6 for further
discussion regarding the Companys mortgage-servicing
rights portfolio. Net gains on the sale of mortgage loans included in
Mortgage Banking Income in the Companys Consolidated Statements of Income
totaled $157 thousand and $132 thousand for the three month periods ended June
30, 2007 and 2006, respectively. Net gains on the sale of mortgage loans
totaled $335 thousand and $290 thousand for the six month periods ended June
30, 2007 and 2006, respectively.  The following table summarizes nonaccrual loans and loans past due 90
days and still accruing interest at the dates indicated (in thousands).  June 30,
  December 31,
  June 30,2007
  2006
  2006Nonaccrual loans
  $
  12,436
  6,999
  6,551Loans past due 90
  days and still accruing (1)
  
  290
  260
  122$
  12,726
  7,259
  6,673(1) Substantially
  all of these loans are bankcard loans
     13 
   Table of Contents   The following table summarizes the activity impacting the
allowance for loan losses (Allowance) for the periods indicated (in
thousands).   For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Allowance,
  beginning of period
  $
  8,460
  8,727
  
  
  8,527
  8,431Provision for
  loan losses
  
  433
  525
  
  
  800
  1,050Loans charged-off
  
  (460)
  (433)
  
  
  (990)
  (712)Loan recoveries
  
  82
  60
  
  
  178
  110Net loans
  charged-off
  
  (378)
  (373)
  
  
  (812)
  (602)Allowance, end of
  period
  $
  8,515
  8,879
  
  
  8,515
  8,879
  Troubled debt restructurings entered into by the Company
during the three month periods ended June 30, 2007 were reviewed by the Company
to ensure loan classifications were in accordance with applicable regulations. 
Any specific allocations identified during the review based on probable losses
have been included in the Companys Allowance for the applicable period.  The Company makes contractual
commitments to extend credit that are legally binding agreements to lend money
to customers at predetermined interest rates for a specific period of time. 
The Company also provides standby letters of credit.  See Note 14 for further discussion regarding the Companys
commitments.  At June 30, 2007, of its approximately $102.0 million
qualifying loans available to serve as collateral against borrowings and
letters of credit from the FHLB, the Company pledged as collateral $78.5
million.  5.Premises
and Equipment, Net  The following table summarizes the Companys premises and
equipment balances at the dates indicated (in thousands).  June 30,
  December 31,2007
  2006Land
  $
  6,703
  6,305Buildings
  
  17,611
  17,124Leasehold
  improvements
  
  2,857
  2,847Furniture and
  equipment
  
  18,167
  17,762Software
  
  3,238
  3,194Bank automobiles
  
  886
  859Premises and
  equipment, gross
  
  49,462
  48,091Accumulated
  depreciation and amortization
  
  (24,510)
  (23,597)Premises and equipment,
  net
  $
  24,952
  24,494
  At June 30, 2007, the Company had thirty-two full-service
banking offices in the Upstate region of South Carolina in the following
counties: Laurens County (4), Greenville County (10), Spartanburg County (6),
Greenwood County (5), Anderson County (3), Cherokee County (2), Pickens County
(1), and Oconee County (1) in addition to two Palmetto Capital offices
independent of banking office locations, 39 automatic teller machine (ATM)
locations (including nine in nonbanking office locations), and five limited
service banking offices located in retirement centers in the Upstate.   One
principal banking office is located in each of the following counties: Laurens,
Greenville, Spartanburg, Greenwood, and Anderson.  During the first six months of 2007, the Bank completed its
purchase of real estate on which it plans to construct and relocate its
existing Pendleton banking office in Anderson County. Additionally, during the
first six months of 2007, the Bank completed the renovation of its Montague
banking office in Greenwood County, completed the upfit of, and relocated to,
its temporary downtown Greenville banking office to be used during the
construction of the Companys new corporate headquarters, and added a new
nonbanking office ATM location at Batesville Plaza Shopping Center in
Greenville County.   14 
   Table of Contents The table set forth below summarizes the activity impacting
accumulated depreciation for the periods indicated (in thousands). Depreciation
balances were impacted during the period by the activity discussed herein.      For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Accumulated
  depreciation, beginning of period
  $
  24,030
  22,262
  
  
  23,597
  21,759DepreciationBuildings
  
  108
  118
  
  
  220
  233Leasehold
  improvements
  
  33
  46
  
  
  73
  82Furniture and
  equipment
  
  237
  248
  
  
  483
  496Software
  
  55
  68
  
  
  116
  135Bank automobiles
  
  47
  39
  
  
  94
  76Total
  depreciation
  
  480
  519
  
  
  986
  1,022Disposals
  
  -
  (71)
  
  
  (73)
  (71)Accumulated
  depreciation, end of period
  $
  24,510
  22,710
  
  
  24,510
  22,710
  6.Mortgage-Servicing Rights  The Company sells a portion of its originated fixed-rate and
adjustable-rate mortgage loans servicing retained. All of the Companys loan
sales have been without recourse. Mortgage loans serviced for the benefit of
others amounted to $330.2 million, $325.1 million, and $312.8 million at June
30, 2007, December 31, 2006, and June 30, 2006, respectively. Mortgage loans
serviced for the benefit of others are held by the Company or its subsidiary in
a fiduciary or agency capacity for customers and, as such, are not included in
the Companys Consolidated Financial
Statements as such items do not represent assets of the Company or its
subsidiary.  The following table summarizes
the changes in the Companys mortgage-servicing rights portfolio for the
periods indicated (dollars in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  
  2006
  
  2007
  2006Mortgage-servicing
  rights portfolio, net of valuationallowance,
  beginning of period
  $
  2,785
  
  2,628
  
  2,648
  2,626Capitalized
  mortgage-servicing rights
  
  207
  
  149
  
  410
  319Mortgage-servicing
  rights portfolio amortization
  
  (270)
  
  (123)
  
  (337)
  (405)Change in
  mortgage-servicing rights portfolio valuation allowance
  
  -
  
  19
  
  1
  133Mortgage-servicing
  rights portfolio, net of valuationallowance, end of
  period
  $
  2,722
  
  2,673
  
  2,722
  2,673Mortgage-servicing
  rights portfolio amortization as a percentage of themortgage-servicing
  rights portfolio, beginning of period, andcapitalized
  mortgage-servicing rights during the period
  
  36.2
  %
  17.8
  
  22.2
  27.7
  Mortgage-servicing rights
amortization and valuation allowances are included in Mortgage-Banking Income
on the Consolidated Statements of Income.  The
aggregate fair market value of the Companys mortgage-servicing rights
portfolio at June 30, 2007, December 31, 2006, and June 30, 2006 was $4.1 million, $3.6 million, and $3.6 million ,
respectively.  15 
   Table of Contents  The following table summarizes the activity impacting the
valuation allowance for impairment of the mortgage-servicing rights portfolio
for the periods indicated (in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Valuation
  allowance, beginning of period
  $
  3
  34
  
  4
  148Aggregate
  additions charged and reductions credited to operations
  
  -
  (19)
  
  (1)
  (133)Valuation
  allowance, end of period
  $
  3
  15
  
  3
  15
    See Consolidated Statements of Cash Flows for a further discussion of the
activity impacting the Companys mortgage-servicing rights portfolio.  7.Intangible
Assets  The following table summarizes intangible assets,
which are included in Other Assets on the Consolidated Balance Sheets, net of
accumulated amortization, at the dates indicated (in thousands).  June 30,
  December 31,2007
  2006Goodwill
  $
  3,691
  3,691Customer list
  intangibles
  
  102
  126Total intagible
  assets
  $
  3,793
  3,817
  The
following table summarizes the
activity of intangible assets with finite lives, which are comprised of
customer list intangibles, and the related amortization, which is included in
Other Noninterest Expense in the Consolidated Statements of Income, for the
periods indicated (in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Balance, at
  beginning of period
  $
  114
  163
  
  
  126
  175Less:
  amortization
  
  (12)
  (12)
  
  
  (24)
  (24)Balance, at end
  of period
  $
  102
  151
  
  
  102
  151
  The
following table summarizes the
gross carrying amount and accumulated amortization of intangible assets with finite
lives at the dates indicated (in thousands).  June 30,
  December 31,
  June 30,2007
  2006
  2006Customer list
  intangibles, gross
  $
  1,779
  1,779
  
  1,779Less:
  accumulated amortization
  
  (1,677)
  (1,653)
  
  (1,628)Customer list
  intangibles, net
  $
  102
  126
  
  151
  In its Annual Report on Form
10-K for the year ended December 31, 2006, the
Company estimated amortization expense related to intangible assets with finite lives of $48
thousand for the year ended December 31, 2007, $45 thousand for the year ended
December 31, 2008, and $34 thousand for the year ended December 31, 2009.  Management
is aware of no material events or uncertainties that would cause amortization
expense related to the Companys intangible
assets with finite lives not to be indicative of future financial
condition or results of operations or that would cause future financial
condition or results of operations to differ materially from these projections.  The Companys intangible assets with infinite lives (goodwill) are subject to periodic impairment tests that are
performed by the Company as of June 30 annually, or more often, if events or
circumstances indicate that there may be impairment. The valuation as of June
30, 2007 indicated that no impairment charge was required as of that date. Management
is aware of no material events or uncertainties that have occurred since June 30, 2007 that would indicate that there might be
impairment.  8.Real
Estate and Personal Property Acquired in Settlement of Loans  The following table summarizes real estate and
personal property acquired in settlement of loans for the periods indicated (in thousands).  June 30,
  December 31,
  June 30,2007
  2006
  2006Real estate
  acquired in settlement of loans
  $
  717
  600
  728Repossessed
  automobiles acquired in settlement of loans
  
  386
  319
  357Total
  property acquired in settlement of loans
  $
  1,103
  919
  1,085
  16 
   Table of Contents     The following table summarizes the changes in the
Companys real estate acquired in settlement of loans, including the balance at
the beginning and end of each period, provision charged to expense, and losses
charged to the Allowance related to the Companys real estate acquired in
settlement of loans for the periods indicated (in thousands).  At and for the three month
  
  At and for the six monthperiods ended June 30,
  
  periods ended June 30,2007
  2006
  
  2007
  2006Real estate
  acquired in settlement of loans, beginning of period
  $
  934
  932
  
  600
  1,954Add: New real
  estate acquired in settlement of loans
  
  81
  31
  
  582
  83Less: Sales /
  recoveries of real estate acquired in settlement of loans
  
  (294)
  (190)
  
  (294)
  (1,121)Less: Provision
  charged to expense
  
  (4)
  (45)
  
  (171)
  (188)Real estate
  acquired in settlement of loans, end of period
  $
  717
  728
  
  717
  728
  Based on the Companys regular
review of fair market values of real estate acquired in settlement of loans and
writedowns taken as a result of those reviews, management believes that the
properties within the portfolio were properly valued at June 30, 2007.  9.Deposits  The
following table summarizes
the Companys deposit composition at the dates indicated (in thousands).  June 30,
  December 31,2007
  2006Transaction
  deposit accounts
  $
  500,398
  447,236Money market
  deposit accounts
  
  108,903
  124,874Savings deposit
  accounts
  
  41,590
  41,887Time deposit
  accounts
  
  350,934
  379,584Total deposit
  accounts
  $
  1,001,825
  993,581
  At June 30, 2007, $518 thousand of overdrawn transaction
deposit accounts had been reclassified as loan balances compared with $606
thousand at December 31, 2006.  The table set forth below summarizes the Companys interest
expense on deposit accounts costs for the periods indicated (in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Transaction and
  money market deposit accounts
  $
  3,447
  2,150
  
  6,627
  3,745Savings deposit
  accounts
  
  36
  38
  
  70
  73Time deposit
  accounts
  
  3,954
  3,841
  
  7,967
  7,445Total interest
  expense on deposit accounts
  $
  7,437
  6,029
  
  14,664
  11,263
  10.Short-Term
Borrowings  Short-term borrowings at June 30, 2007 totaled
$64.4 million compared to $41.4 million at December 31, 2006.  Borrowings
as a percentage of total liabilities were approximately 6.0% and 4.9% at June
30, 2007 and December 31, 2006, respectively. The following table summarizes the Companys borrowings composition at
the dates indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalRetail repurchase
  agreements
  $
  12,145
  18.9
  %
  14,427
  34.8Commercial paper
  
  27,737
  43.1
  
  20,988
  50.7Other short-term
  borrowings
  
  24,500
  38.0
  
  6,000
  14.5Total borrowings
  $
  64,382
  100.0
  %
  41,415
  100.0
   If needed, funding sources have been arranged through
federal funds lines at correspondent banks, the Federal Reserve Discount
Window, and the FHLB.  17 
   Table of Contents      At June 30, 2007, the Company had additional funding sources
at correspondent banks totaling $50 million that were accessible at the
Companys option of which $15 million had been utilized. Due to the maturity
terms of such sources, utilized borrowed funds are considered to be short-term.
During April 2007, Nexity Bank extended the Bank a federal funds accommodation
in the amount of $10 million for a period beginning on April 25, 2007 and
ending April 30, 2008 subject to specified terms and conditions. Advances under
this accommodation are advances of federal funds with a maturity of the next
Banking Day (the next day other than Saturday or Sunday on which banking
business is conducted in South Carolina). This additional federal funds
accommodation in the amount of $10 million increased the Companys accessible
funding sources from $40 million to $50 million.  At June 30, 2007, of its approximately $102.0 million available
credit based on qualifying loans to serve as collateral against borrowings and
letters of credit from the FHLB, the Company employed $9.5 million in
borrowings, all of which was determined to be short-term when employed, and
employed $69.0 million in a letter of credit used to secure public deposits as
required or permitted by law.  FHLB letters of credit provide an attractive alternative
to using traditional collateral for various transactions. Advantages of FHLB
letters of credit include enhancing member liquidity (substituting letter of
credit for securities as collateralization of public unit deposits) and
utilization of residential mortgage loans as collateral for the letters of
credit. However, the utilization of FHLB letters of credit reduces the
Companys available credit based on qualifying loans to serve as collateral. 
The Company uses the FHLB letter of credit for collateralization of public
deposits. At June 30, 2007, the Company had approximately $23.5 million
available credit based on qualifying loans to serve as collateral against
short-term borrowings, long-term borrowings, and / or letters of credit from
the FHLB.  11.Long-Term
Borrowings  Long-term borrowings are those having maturities greater
than one year when executed. The Companys remaining $10.0 million in long-term
FHLB borrowings matured on June 14, 2007. These $10.0 million in long-term FHLB
borrowings were outstanding at June 30, 2006.  As noted above with regard to short-term borrowings, at June
30, 2007, of its approximately $102.0 million available credit based on
qualifying loans to serve as collateral against borrowings and letters of
credit from the FHLB, the Company employed $9.5 million in borrowings, all of
which was determined to be short-term when employed, and employed $69.0 million
in a letter of credit used to secure public deposits as required or permitted
by law.  At June 30, 2007, the Company had approximately $23.5 million
available credit based on qualifying loans to serve as collateral against
short-term borrowings, long-term borrowings, and / or letters of credit from
the FHLB.  12.Employee
Benefit Plans  Postretirement Benefits  Cost of Benefit Plan. The
following table summarizes the
combined net postretirement benefit expense components for the Companys
defined benefit pension plan, which is included in Salaries and Other Personnel
Expense on the Consolidated Statements of Income, at and for the periods
indicated (in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Service cost
  $
  197
  141
  
  
  390
  282Interest cost
  
  231
  165
  
  
  457
  330Expected return
  on plan assets
  
  (321)
  (229)
  
  
  (635)
  (458)Amortization of
  prior service cost
  
  4
  3
  
  
  8
  6Amortization of
  loss
  
  28
  20
  
  
  55
  40Postretirement
  benefit expense, net
  $
  139
  100
  
  
  275
  200
  Expected Contributions. Contributions to the
Companys defined benefit pension plan assets totaling $1.1 million are
expected during fiscal year 2007. Contributions during the second quarter of
2007 totaled $275 thousand compared with $308 thousand during the second
quarter of 2006. Contributions during the first six months of 2007 totaled $549
thousand compared with $617 thousand during the same period of 2006.  18 
   Table of Contents    Stock Option Plans  Determining Fair Value. The following table
summarizes the stock-based awards granted by the Company, the fair market value of each award granted
as estimated on the date of grant using the Black-Scholes option-pricing model,
and the weighted average assumptions used for such grants for the grant dates
indicated.  Stock-based awards granted during thesix month period ended June 30,2007
  
  2006Grant Date
  1/16/2007
  
  6/20/2006
  
  1/17/2006Stock option
  awards granted
  800
  
  5,000
  
  10,000Option price
  $            30.40
  
  27.30
  
  27.30Fair market value
  of stock option awards
  $              6.24
  
  4.79
  
  3.39Expected dividend
  yields
  2.5
  %
  2.7
  
  2.7Expected
  volatility
  13
  %
  5
  
  5Risk-free
  interest rate
  5
  %
  5
  
  4Expected term (years)
  10
  
  10
  
  10Vesting period
  (years)
  5
  
  5
  
  5
  Stock Option Compensation
Expense.The compensation cost that was charged against pretax net income
during the second quarter of 2007 related stock options was $33 thousand
compared with $30 thousand during the second quarter of 2006.  Expense during
the first six months of 2007 totaled $66 thousand compared with $55 thousand
during the same period of 2006.  At June 30, 2007, based on
options outstanding at that time, the total compensation cost related to
nonvested stock option awards granted under the Companys stock option plans
but not yet recognized was $255 thousand. Stock option compensation expense is
recognized on a straight-line basis over the vesting period of the option. The
Company expects to recognize this cost over a remaining period of 4.5 years.  Stock Option Activity.
The following table summarizes stock
option activity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan
for the periods indicated.  Weighted-averageStock options
  exerciseoutstanding
  priceOutstanding at
  December 31, 2005
  252,785
  $
  16.63Granted
  15,000
  
  27.30Forfeited
  -
  
  -Exercised
  (25,300)
  
  14.00Outstanding at
  June 30, 2006
  242,485
  $
  17.57Outstanding at
  December 31, 2006
  251,670
  $
  18.67Granted
  800
  
  30.40Forfeited
  -
  
  -Exercised
  (22,210)
  
  15.06Outstanding at
  June 30, 2007
  230,260
  $
  19.06
   19 
   Table of Contents   Cash received from stock option
exercises under the Companys stock option plan for the six month periods ended
June 30, 2007 and 2006 was $334 thousand and $354 thousand, respectively.  401(k) Retirement Plan  During the three month periods ended June 30, 2007 and 2006,
the Company made matching contributions to employee 401(k) retirement plans
totaling $71 thousand, and $65 thousand, respectively. During the six month
periods ended June 30, 2007 and 2006, the Company made matching contributions
to employee 401(k) retirement plans totaling $149 thousand, and $134 thousand,
respectively.  13.Net
Income per Common Share   The following table summarizes the Companys reconciliation
of the numerators and denominators of the basic and diluted net income per
common share computations for the periods indicated.  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Weighted average
  common shares outstanding - basic
  6,385,483
  6,354,888
  
  6,382,019
  6,349,099Dilutive impact
  resulting from potential common share issuances
  114,166
  74,871
  
  98,435
  74,871Weighted average
  common shares outstanding - diluted
  6,499,649
  6,429,759
  
  6,480,454
  6,423,970Per Share DataNet income -
  basic
  $
  0.64
  0.59
  
  1.23
  1.17Net income -
  diluted
  
  0.63
  0.58
  
  1.21
  1.15
   At June 30, 2007, all outstanding options were included in
the calculation of diluted net income per common share because the exercise
price of all options was lower than the average market price as determined by
an independent valuation of common shares.  The Company paid cash dividends of $0.19 and $0.18 per share
for the three month periods ended June 30, 2007 and 2006, respectively and cash
dividends of $0.38 and $0.36 per share for the six month periods ended June 30,
2007 and 2006, respectively.  14.Commitments
and Contingencies  Legal Proceedings  The Company is currently subject to various legal
proceedings and claims that have arisen in the ordinary course of its business.
In the opinion of management, based on consultation with external legal
counsel, any reasonably foreseeable outcome of such current litigation would
not materially impact the Company's financial condition or results of
operations. Lease Agreements  During the second quarter of 2007, the Company signed a
build-to-suit lease agreement with regard to the relocation of its corporate
headquarters to Greenville, South Carolina.  Under the terms of this agreement,
the Companys new headquarters will be constructed on the site of the Companys
current downtown Greenville banking office that is leased from the same lessor.
The lease provides for an initial term of fifteen
years and five options to extend the term after the initial term expiration
date, of five years each.  In conjunction with the demolition of the
current downtown Greenville banking office, the Company anticipates an
immaterial write off in leasehold improvements during the third quarter of
2007.  The Company anticipates construction completion during the third quarter
of 2008. The Company is currently analyzing the accounting treatment of this
lease agreement. The Company filed a Current Report on Form 8-K on June 26,
2007 to announce its entry into this material definitive agreement.  20 
   Table of Contents   During the second quarter of 2007, the Company executed a
ground lease contract on which to put in service a nonretail office ATM
location at Woodmont Village Shopping Center on Highway 25 in Moonville, South
Carolina.  The Company plans to have this location in service by January 2008.  Lending Commitments  The Companys contractual commitments to extend credit increased
slightly from $265.8 million at December 31, 2006 to $266.6 million at June 30,
2007.  The following table summarizes the Companys contractual commitments
to extend credit, by collateral
type, at June 30, 2007 (in thousands).     Commercial and industrial
  $
  25,964Real estate
  
  177,034Credit line
  
  7,663Bankcards
  
  43,508Others
  
  12,406Total contractual
  commitments to extend credit
  $
  266,575
  Guarantees  At June
30, 2007, the Company recorded no liability for the current carrying amount of
the obligation to perform as a guarantor, and no contingent liability was
considered necessary as such amounts were not considered material.  The maximum
potential amount of undiscounted future payments related to standby letters of
credit at June 30, 2007 was $9.2 million compared with $8.3 million at December
31, 2006.  Past experience indicates that these standby letters of credit will
expire unused. However, through its various sources of liquidity, the Company
believes that it has the necessary resources available to meet these
obligations should the need arise.  Additionally,
the Company does not believe that the current fair market value of such
guarantees was material at June 30, 2007.  Other Off-Balance Sheet Arrangements  At
June 30, 2007, the Company engaged in no
transactions, agreements, or other contractual arrangements to which an entity
unconsolidated with the Company is a party, under which the Company has:  Any
     obligation under a guarantee contract;  A
     retained or contingent interest in assets transferred to an unconsolidated
     entity or similar arrangement that serves as credit, liquidity or market
     risk support to such entity for such assets;  Any
     obligation under a contract that would be accounted for as a derivative
     instrument considering exceptions; or  Any
     obligation arising out of a variable interest in an unconsolidated entity that
     is held by, and material to, the Company, where such entity provides
     financing, liquidity, market risk or credit risk support to, or engages in
     leasing, hedging or research and development services with, the Company.  21 
   Table of Contents  Other  During
the second quarter of 2007, in conjunction with the audit of the Companys
benefit plans, a discrepancy was discovered with regard to a definition in the
benefit plans legal plan document and the definition as consistently applied
by the Company in practice. Management is currently
exploring options for resolution of the discrepancy and is analyzing any
potential participant and / or financial statement impact.   At the time of
this filing, the impact of this discrepancy could not be reasonably estimated.  15.Derivative
Financial Instruments and Hedging Activities  At June 30, 2007, the Companys derivative instruments
consisted of forward sales commitments relating to the Companys commitments to
originate certain residential loans held for sale.  Outstanding commitments on mortgage loans not yet closed
(primarily single-family loan commitments) amounted to approximately $1.6
million at June 30, 2007 compared to approximately $3.8 million at December 31,
2006.  The fair market value of derivative assets related to commitments to
originate such residential loans held for sale was not significant at June 30,
2007.  The fair market value of derivative assets related to forward sales
commitments did not significantly differ from the carrying amount at June 30,
2007. The decrease in forward sales commitments during the first six months was
the result of the Companys decision to retain more residential loans in its
in-house portfolio during the period.  16.Regulatory
Capital Requirements  At
June 30, 2007, the most recent notification from federal banking agencies
categorized the Company and the Bank as well capitalized under United States
federal banking regulations. To be categorized as well capitalized, minimum
total risk-based capital, Tier 1 capital, and Tier 1 leverage ratios
must be maintained as set forth in the following table (dollars in thousands).
Since June 30, 2007, there have been no events or conditions that management
believes would change these categories.    To be well capitalizedunder promptFor capital adequacy
  corrective actionActual
  purposes
  provisionsamount
  ratio
  amount
  ratio
  amount
  ratioAt June 30, 2007Total capital
  to risk-weighted assetsCompany
  
  
  $
  111,320
  10.43%
  85,404
  8.00
  n/a
  n/aBank
  
  
  
  113,353
  10.60
  85,576
  8.00
  106,970
  10.00Tier 1 capital
  to risk-weighted assetsCompany
  
  
  
  102,805
  9.63
  42,702
  4.00
  n/a
  n/aBank
  
  
  
  104,838
  9.80
  42,788
  4.00
  64,182
  6.00Tier 1 capital
  to average assetsCompany
  
  
  
  102,805
  8.85
  46,490
  4.00
  n/a
  n/aBank
  
  
  
  104,838
  9.02
  46,511
  4.00
  58,139
  5.00At June 30, 2006Total capital
  to risk-weighted assetsCompany
  
  
  $
  100,119
  10.34%
  77,457
  8.00
  n/a
  n/aBank
  
  
  
  98,902
  10.21
  77,457
  8.00
  96,821
  10.00Tier 1 capital
  to risk-weighted assetsCompany
  
  
  
  91,240
  9.42
  38,728
  4.00
  n/a
  n/aBank
  
  
  
  90,023
  9.30
  38,728
  4.00
  58,093
  6.00Tier 1 capital
  to average assetsCompany
  
  
  
  91,240
  8.22
  44,416
  4.00
  n/a
  n/aBank
  
  
  
  90,023
  8.10
  44,429
  4.00
  55,537
  5.00
     22 
   Table of Contents     ITEM 2.  Managements
Discussion and Analysis of Financial Condition and Results of Operations  Discussions
of certain matters contained in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
and Exchange Act of 1934, as amended (the Exchange Act), and as such, may
involve risks and uncertainties. These forward-looking statements relate to,
among other things, expectations of the business environment in which the
Company operates, projections of future performance, perceived opportunities in
the market, and statements regarding the Companys mission and vision. The Company
cautions readers that a number of factors could cause actual results,
performance, and achievements to differ materially from the results,
performance, and achievements expressed or implied in such forward-looking
statements. For a discussion of some of the factors that might cause such a
difference, see Part 1, Item 1A in the Companys Annual Report on Form
10-K for the year ended December 31, 2006 and Part II, Item IA in this
Quarterly Report on Form 10-Q for the quarter ended June 30, 2007. The Company
does not undertake and specifically disclaims any obligation to update such
forward-looking statements to reflect occurrences or unanticipated events or
circumstances after the date of such statements except as required by law.  The following discussion and analysis is presented to assist
the reader with understanding the financial condition and results of operations
of the Company.  The information presented in the following discussion of
financial condition and results of operations of the Company results from the
activities of its subsidiary, the Bank, which comprises the majority of the
consolidated net income, revenues, and assets of the Company.  This discussion
should be read in conjunction with the Consolidated Financial Statements and
related notes and other financial data appearing in this report as well as in
the Companys Annual Report on Form 10-K for the year ended December 31, 2006. 
Results of operations for the three and six month periods ended June 30, 2007
are not necessarily indicative of results that may be attained for any other
period.  Percentage calculations contained herein have been calculated based on
rounded results presented herein.  Overview  Who
is Palmetto Bancshares, Inc?  Palmetto Bancshares, Inc. is a regional financial services
holding company headquartered in Laurens, South Carolina and organized in 1982
under the laws of South Carolina. Through its wholly owned subsidiary, The
Palmetto Bank (the "Bank"), Palmetto Bancshares, Inc. engages in the
general banking business through 32 retail banking offices in the Upstate,
South Carolina markets of Laurens, Greenville, Spartanburg, Greenwood,
Anderson, Cherokee, Abbeville, Pickens, and Oconee counties (the Upstate). 
The Companys primary market area is located within the Upstate. In addition to
retail offices, at June 30, 2007, the Company had 39 automatic teller machine
(ATM) locations (including nine at nonretail office locations) and
five-limited service offices located in retirement centers in the Upstate. The
Bank was organized and chartered under South Carolina law in 1906. The Bank has
one active subsidiary, Palmetto Capital, Inc.
(Palmetto Capital), that provides investment products. Throughout this
report, the "Company" shall refer to Palmetto Bancshares, Inc. and
its subsidiary, the Bank, which includes Palmetto Capital, Inc.  Mission and Strategic Vision  The Companys mission as an independent Upstate financial
institution is to achieve superior long-term shareholder value, exercise
exemplary corporate citizenship, and create an environment which promotes and
rewards employee development and the consistent delivery of quality service to
our customers.  From a strategic vision perspective, the Company strives to
be widely recognized as Upstate South Carolinas premier independent community
banking organization.  Through a variety of delivery channels, the Company
provides a full range of high-quality financial products and services
throughout its extended trade area.  The Company and its personnel strive to
provide a level of consistently superior personal service setting the Company
apart from other bank and nonbank competitors.  Financial Highlights  The following tables
summarize the Companys financial highlights at and for the dates indicated
(dollars in thousands).  23 
   Table of Contents  (dollars in
  thousands, except common and per share data)At and for the three month
  
  
  
  At and for the six monthperiods ended June 30,
  Variance
  
  periods ended June 30,
  Variance2007
  
  2006
  $
  
  %
  
  2007
  2006
  
  $
  %(unaudited)
  
  
  
  
  (unaudited)RESULTS OF
  OPERATIONSInterest income
  $
  20,696
  
  18,769
  
  1,927
  10.3
  %
  40,894
  36,717
  
  4,177
  11.4Interest expense
  
  7,988
  
  6,601
  
  1,387
  21.0
  
  15,723
  12,454
  
  3,269
  26.2Net interest
  income
  
  12,708
  
  12,168
  
  540
  4.4
  
  25,171
  24,263
  
  908
  3.7Provision for
  loan losses
  
  433
  
  525
  
  (92)
  (17.5)
  
  800
  1,050
  
  (250)
  (23.8)Net interest
  income after provision for loan losses
  
  12,275
  
  11,643
  
  632
  5.4
  
  24,371
  23,213
  
  1,158
  5.0Noninterest
  income
  
  3,865
  
  3,976
  
  (111)
  (2.8)
  
  7,697
  7,879
  
  (182)
  (2.3)Noninterest
  expense
  
  9,871
  
  10,085
  
  (214)
  (2.1)
  
  20,013
  20,151
  
  (138)
  (0.7)Income before
  provision for income taxes
  
  6,269
  
  5,534
  
  735
  13.3
  
  12,055
  10,941
  
  1,114
  10.2Provision for
  income taxes
  
  2,204
  
  1,803
  
  401
  22.2
  
  4,229
  3,560
  
  669
  18.8Net
  income
  $
  4,065
  
  3,731
  
  334
  9.0
  %
  7,826
  7,381
  
  445
  6.0COMMON SHARE DATANet income:Basic
  $
  0.64
  
  0.59
  
  0.05
  8.5
  %
  1.23
  1.17
  
  0.06
  5.1Diluted
  
  0.63
  
  0.58
  
  0.05
  8.6
  
  1.21
  1.15
  
  0.06
  5.2Cash dividends
  
  0.19
  
  0.18
  
  0.01
  5.6
  
  0.38
  0.36
  
  0.02
  5.6Book value
  
  16.49
  
  14.73
  
  1.76
  11.9
  
  16.49
  14.73
  
  1.76
  11.9Outstanding
  shares
  
  6,389,660
  
  6,356,635
  
  33,025
  0.5
  
  6,389,660
  6,356,635
  
  33,025
  0.5Weighted average
  outstanding - basic
  
  6,385,483
  
  6,354,888
  
  30,595
  0.5
  
  6,382,019
  6,349,099
  
  32,920
  0.5Weighted average
  outstanding - diluted
  
  6,499,649
  
  6,429,759
  
  33,229
  0.5
  
  6,480,454
  6,423,970
  
  35,554
  0.6Dividend payout
  ratio
  
  29.87
  %
  30.67
  
  (0.80)
  (2.6)
  
  31.01
  30.99
  
  0.02
  0.1PERIOD-END
  BALANCESAssets
  $
  1,179,869
  
  1,116,073
  
  63,796
  5.7
  %
  1,179,869
  1,116,073
  
  63,796
  5.7Investment securities
  available for sale, at fair market value
  
  104,708
  
  115,440
  
  (10,732)
  (9.3)
  
  104,708
  115,440
  
  (10,732)
  (9.3)Loans (1)
  
  987,822
  
  892,364
  
  95,458
  10.7
  
  987,822
  892,364
  
  95,458
  10.7Deposits and
  borrowings
  
  1,066,207
  
  1,016,342
  
  49,865
  4.9
  
  1,066,207
  1,016,342
  
  49,865
  4.9Shareholders'
  equity
  
  105,391
  
  93,626
  
  11,765
  12.6
  
  105,391
  93,626
  
  11,765
  12.6AVERAGE BALANCESAssets
  $
  1,166,247
  
  1,114,489
  
  51,758
  4.6
  %
  1,161,523
  1,100,971
  
  60,552
  5.5Interest-earning
  assets
  
  1,098,323
  
  1,034,089
  
  64,234
  6.2
  
  1,091,709
  1,025,236
  
  66,473
  6.5Investment
  securities available for sale, at fair market value
  
  107,759
  
  121,053
  
  (13,294)
  (11.0)
  
  110,585
  123,472
  
  (12,887)
  (10.4)Loans (1)
  
  968,985
  
  880,061
  
  89,838
  10.3
  
  960,302
  874,118
  
  86,895
  10.0Deposits and
  borrowings
  
  917,615
  
  880,344
  
  37,271
  4.2
  
  916,459
  869,382
  
  47,077
  5.4Shareholders'
  equity
  
  105,223
  
  93,625
  
  11,598
  12.4
  
  103,680
  92,439
  
  11,241
  12.2SIGNIFICANT
  OPERATING RATIOS BASED ON EARNINGSReturn on average
  assets
  
  1.40
  %
  1.34
  
  0.06
  4.5
  %
  1.36
  1.35
  
  0.01
  0.7Return on average
  shareholders' equity
  
  15.50
  
  15.98
  
  (0.48)
  (3.0)
  
  15.22
  16.10
  
  (0.88)
  (5.5)Net interest
  margin
  
  4.64
  
  4.72
  
  (0.08)
  (1.7)
  
  4.65
  4.77
  
  (0.12)
  (2.5)(1) Calculated
  using loans including mortgage loans held for sale, net of unearned,
  excluding the allowance for loan losses
  Results of Operations. Unlike many companies that
manufacture goods or provide services, virtually all of the assets and
liabilities of the Company are monetary in nature and, as a result, the
Companys operations are impacted by interest rate fluctuations.  The Company
actively manages the gap between its interest-sensitive assets and
liabilities.  The actions of the Federal
Reserve influence the growth of loans, investments, and deposits and impact the
interest rates charged on loans and paid on deposits. The Federal Reserves
policies have had a significant impact on the operating results of the Bank and
are expected to continue to do so in the future.  Since the second quarter of 2004, the federal funds rate has
increased from 1.0% to 5.25% in a series of seventeen moves. Moreover, since
January 2006, the federal funds rate has increased 100 basis points from 4.25%
to 5.25% in a series of four moves the last two of which occurred during the
second quarter of 2006.  These actions of the Federal Reserve Open Market
Committee impacted net interest income during the three month period ended June
30, 2007 over the same periods of 2006.  Net interest income for the second quarter
of 2007 was $12.7 million, an increase of 4.4% compared to the second quarter
of 2006. During the three month period ended June 30, 2007 compared with the
same period of 2006, the Company experienced increases in both average yield on
interest-earning assets and average cost of interest-bearing liabilities. The
average yield on interest-earning assets increased 28 basis points to 7.56%
during the second quarter of 2007 from 7.28% during the same period of 2006.
The average cost of interest-bearing liabilities increased 48 basis points to
3.49% from 3.01% when comparing the same periods. Average interest-earning
assets increased $64.2 million during the quarter ended June 30, 2007 over the
same quarter of 2006, primarily within the loan portfolio, while
interest-bearing liabilities increased $37.3 million over the same period.  The following analysis
summarizes the dollar amount of changes in interest income and interest expense
attributable to changes in volume and the amount attributable to changes in
rate when comparing the three month period ended June 30, 2007 to the three
month period ended June 30, 2006 (in thousands).  24 
   Table of Contents      Volume
  
  Rate
  
  TotalTotal
  interest-earning assets
  $
  1,479
  
  
  448
  
  
  1,927Total
  interest-bearing liabilities
  
  276
  
  
  1,111
  
  
  1,387Net interest
  income
  $
  1,203
  
  
  (663)
  
  
  540
  Noninterest expenses as a percentage of total revenue has
decreased from 44.3% in the second quarter of 2006 to 40.2% in the second
quarter of 2007.  Period-End Balances.  At
June 30, 2007, the investment security portfolio represented 8.9% of total
assets, a decline from 10.1% at December 31, 2006. The decline in the total
investment securities portfolio from December 31, 2006 to June 30, 2007
resulted primarily from short-term taxable securities issued by
government-sponsored enterprises not being reinvested but instead being used to
fund loan growth and repay borrowings during the six month period ended June
30, 2007. Approximately 75% of the investment securities portfolio was pledged
to secure public deposits as of June 30, 2007 as compared with 62% at December
31, 2006 and 94% at June 30, 2006.  Approximately 42.6% of investment securities
portfolio secured public deposits as of June 30, 2007 as compared with 38% at
December 31, 2006 and 74% at June 30, 2006.  Of the Companys $104.7 million
available for sale investment securities balance at June 30, 2007, $25.9
million was unpledged and, therefore, available as a liquidity source. The
fluctuation in pledged securities between these periods was the result of a
diversification of assets pledged to secure public deposits, securities sold
under agreements to repurchase, and for other purposes as required or permitted
by law.  Loans represent the most significant component of the
Companys interest-earning assets with average loans accounting for 88.2% of
average interest-earning assets during the three month periods ended June 30,
2007. Total loans, including mortgage loans held for sale, increased $40.2
million, during the first six months of 2006.  During this period, increases
were experienced in the commercial business, commercial real estate, and
residential mortgage loan portfolios when analyzing the loan portfolio by loan
purpose.  During this period, mortgage loans held for sale decreased $382
thousand to $1.3 million at June 30, 2007. During 2006, the Company introduced
business credit scoring and began placing an emphasis on small commercial
loans.  Management believes that these changes continued to result in increases
in commercial business loans as a percentage of the total portfolio during the
first six months of 2007. Management anticipates that aggressive commercial real
estate building in recent years may indicate an upcoming period of oversupply. 
In order to avoid an excess supply of commercial limited-service properties,
the Company has tightened underwriting standards with regard to such loans
resulting in little change in commercial real estate loans as a percentage of
the total portfolio. The Company experienced an increase in residential
mortgage loans and a decrease in mortgage loans held for sale during the first
six months of 2007 as a result of the Companys decision to retain more
residential loans in its in-house portfolio during the period.  The Allowance totaled
$8.5 million, at both December 31, 2006 and June 30, 2007, respectively
representing 0.90% and 0.86% of loans, calculated using loans excluding mortgage
loans held for sale and the allowance for loan losses, net of unearned income.
Management believes that the declining trend of the Allowance as a percentage
of ending loans results from several factors including, but not limited to,
managements conservative philosophy regarding its lending mix which impacts
risk grades assigned at loan origination, the ongoing management of asset
quality, and growth within the portfolio being primarily loans secured by real
estate which generally involve less risk that other types of lending, all of
which impact Allowance allocations.  25 
   Table of Contents     The Company experienced an
increase of $8.2 million in traditional deposit accounts during the first six
months of 2007 as a result of an increase in transaction deposit accounts
totaling $53.2 million offset by declines in money market, savings, and time
deposit accounts.  The increase in transaction deposit accounts resulted from
the Companys continued ability to attract deposits through pricing
adjustments, expansion of its geographic market area, level of quality customer
service, and through the Companys reputation in the communities served.
Additionally, the Company has made efforts to enhance its deposit mix by
working to attract lower cost deposit accounts.  The Company believes that the growth in traditional deposit continues to be
enhanced by the introduction, continuation, and enhancement of product
programs and promotions.  During the first six months of 2007, approximately $8
million of the public funds deposited within a Company money market deposit
account was transferred from the Bank, and, money market funds of the Banks
trust department declined approximately $3 million, which together comprised
the majority of the decline in the Companys money market deposit accounts over
the periods noted.  Time deposit accounts
decreased by $28.7 million, or 7.5% during the first six months of 2007. Prior
promotional certificate of deposit accounts offered by the Company
matured during the first six months of 2007.  During this time, the Company
offered a specifically targeted time deposit program in an effort to retain
maturing funds.   Management believes that the Companys time deposit accounts
declined during the first six months of 2007 as a result of returns currently
available from alternative investments.  Although the Bank has historically directly competed for
deposits with commercial banks and other financial institutions, in recent
years, money market, stock, and fixed income mutual funds have attracted an
increasing share of household savings.  Consequently, the Company considers
these funds to be competitors of the Bank. Competition among various financial
institutions is based on interest rates offered on deposit accounts, service
charges, the quality of service rendered, and the convenience of banking
offices. The Bank feels that it sets itself apart from its competitors by
providing superior personal service through a variety of delivery channels and
a full range of high quality financial products and services.  In addition to traditional deposit funding, the Company
utilized borrowings to support interest-earning asset growth during the first
six months of 2006, which increased $13.0 million during the period.  During the first six months of 2007, shareholders equity
was increased through the retention of net income, stock option activity, and
compensation expense related to stock options granted.  These increases were
offset by an increase in cash dividends and in accumulated other comprehensive
loss over the six month period.  Other Highlights  In conjunction with the
     Companys 100th anniversary celebration on September 21, 2006,
     the Company announced its plan to relocate its corporate headquarters to
     downtown Greenville in 2008. Tentative plans project construction of the
     new leased facility to begin in 2007 with a projected completion date in
     2008.  On May 2, 2007, The Bank entered into a Commercial Lease
     (Build-to-Suit) (the "Lease Agreement") with Charles E. Howard
     and Doris H. Howard ("Lessor").  Pursuant to the Lease
     Agreement, the Lessor will complete site work, construct an approximately
     42,000 square foot building, and lease the combined parcels and building
     to the Company to be used as the Companys new corporate headquarters.
     During construction of the new corporate headquarters, branch operations
     will be temporarily housed and conducted within the existing building and
     parking facilities owned by the Bank and located at 105 North Church
     Street. In conjunction with the demolition of the current downtown Greenville
     banking office, the Company anticipates an immaterial write off in
     leasehold improvements during the third quarter of 2007.  The Company is
     currently analyzing the accounting treatment of this lease agreement. The
     Company filed a Current Report on Form 8-K on June 26, 2007 to announce
     its entry into this material definitive agreement.  During the second quarter of 2007, the Company executed a
     ground lease contract for a nonretail office ATM location at Woodmont
     Village Shopping Center on Highway 25 in Moonville, South Carolina.  The
     Company plans to have this location in service by January 2008.  As reported in the Companys Annual Report on Form 10-K
     for the Year Ended Dec ember 31, 2006, during February 2007, the Bank
     purchased real estate in Anderson County on which to construct and
     relocate its existing Pendleton banking office.  Ground was broken on this
     site in July 2007.  During the second quarter of 2007, the Company contracted
     to purchase property at the intersection of West Wade Hampton Boulevard
     and Middleton Way in Greenville County on which to construct and relocate
     its existing Greer banking office.  The Company expects to close on this
     property during the third quarter of 2007.  During April 2007, Nexity Bank extended to the Bank a
     federal funds accommodation in the amount of $10 million for a period
     beginning on April 25, 2007 and ending April 30, 2008 subject to specified
     terms and conditions. Advances under this Accommodation are advances of
     federal funds with a maturity of the next Banking Day (the next day other
     than Saturday or Sunday on which banking business is conducted in South
     Carolina). This additional federal funds accommodation in the amount of
     $10 million increased the Companys accessible funding sources from $40 million
     to $50 million.  26 
   Table of Contents     At June 30, 2007, of its approximately $102.0 million
     available credit based on qualifying loans to serve as collateral against
     borrowings and letters of credit from the FHLB, the Company employed $9.5
     million in borrowings, all of which was determined to be short-term when
     employed, and employed $69.0 million in a letter of credit used to secure
     public deposits as required or permitted by law.  At June 30, 2007, the
     Company had approximately $23.5 million available credit based on qualifying
     loans to serve as collateral against short-term borrowings, long-term
     borrowings, and / or letters of credit from the FHLB.  The Companys remaining $10.0 million in long-term FHLB
     borrowings matured on June 14, 2007.  At June 30, 2007 and 2006, Palmetto Bancshares and the
     Bank were each categorized as well capitalized under the regulatory
     framework for prompt corrective regulatory action.  Critical Accounting Policies  The
Companys accounting and financial reporting policies are in conformity with
generally accepted accounting principles (GAAP).  The preparation of
financial statements in conformity with such principles requires management to
make estimates and assumptions that impact the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities during the
reporting period, and the reported amounts of revenue and expense during the
reporting period.  The Companys
significant accounting policies are discussed in Item 8, Note 1 to the
Consolidated Financial Statements of the Annual Report on Form 10-K for the
year ended December 31, 2006.  Of
these significant accounting policies, the Company has determined that its
most critical accounting estimates include the accounting for its allowance for loan losses,
pension plan, mortgage-servicing rights portfolio, past acquisitions, and
income taxes to be its most critical accounting policies due to the valuation
techniques used and the sensitivity of these financial statement amounts to the
methods, assumptions, and estimates underlying these balances.  Accounting for
these critical areas requires a significant degree of judgment that could be
subject to revision as newer information becomes available. In order to
determine the Companys critical accounting policies, management considers if the accounting estimate requires assumptions about
matters that were highly uncertain at the time the accounting estimate was made
and if different estimates that reasonably could have been used in the current
period or changes in the accounting estimate that are reasonably likely to
occur from period to period would have a material impact on the presentation of
financial condition, changes in financial condition, or results of operations.
In conjunction with the filing of the Companys Annual Report on Form 10-K for
the year ended December 31, 2006, management
and the Companys independent registered public accounting firm discussed the
development and selection of the critical accounting estimates discussed herein
with the Audit Committee of the Companys Board of Directors.  Other Information  Impact of InflationThe Consolidated Financial Statements and
related financial data presented herein have been prepared in accordance with
generally accepted accounting principles.  These principles require the
measurement of financial condition and results of operations in terms of
historical dollars without considering changes in relative purchasing power
over time due to inflation.  Securities and Exchange Commission  The public may read and copy any materials
filed in hard copy by the Company with the Securities and Exchange Commission
(the SEC) at the SECs Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C.  20549.  The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The Company
files reports electronically with the SEC.  The SEC maintains an Internet site
that contains reports, proxy and information statements, and other information
regarding issuers that file reports electronically.  This site may be accessed
at www.sec.gov.  Filings filed by the Company electronically with the SEC may
be accessed through this website.  The Company currently
makes reports filed with the Securities and Exchange Commission available, free
of charge, through its website (www.palmettobank.com) through a link to the
SECs website as noted above.  The Company is currently exploring options to
make such reports available through its website without having to navigate from
its main website.  Such reports may also be requested through sending written
correspondence directed to 301 Hillcrest Drive, Laurens, South Carolina 29360
Attention: Senior Vice President, Finance and Accounting.  27 
   Table of Contents     Financial Condition  The following information is
intended to supplement any information relating to the Consolidated Balance
Sheets contained within Part I, Item 1 of this Quarterly Report on Form
10-Q.  Overview  PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Balance Sheets(dollars in thousands, except common and
  per share data)June 30,
  
  December 31,
  
  Variance2007
  
  2006
  
  $
  
  %ASSETSCash and cash
  equivalentsCash and due from
  banks
  
  
  $
  33,286
  
  43,084
  
  (9,798)
  
  (22.7)
  %Federal funds
  sold
  
  
  
  9,972
  
  3,582
  
  6,390
  
  178.4Total cash and
  cash equivalents
  
  
  43,258
  
  46,666
  
  (3,408)
  
  (7.3)Federal Home Loan
  Bank ("FHLB") stock, at cost
  
  
  2,527
  
  2,599
  
  (72)
  
  (2.8)Investment
  securities available for sale, at fair market value
  
  104,708
  
  116,567
  
  (11,859)
  
  (10.2)Mortgage loans
  held for sale
  
  
  
  1,293
  
  1,675
  
  (382)
  
  (22.8)Loans
  
  
  
  
  
  986,529
  
  945,913
  
  40,616
  
  4.3Less: allowance
  for loan losses
  
  
  (8,515)
  
  (8,527)
  
  12
  
  (0.1)Loans, net
  
  
  
  978,014
  
  937,386
  
  40,628
  
  4.3Premises and
  equipment, net
  
  
  
  24,952
  
  24,494
  
  458
  
  1.9Goodwill
  
  
  
  
  
  3,691
  
  3,691
  
  -
  
  -Other intangible
  assets
  
  
  
  102
  
  127
  
  (25)
  
  (19.7)Accrued interest
  receivable
  
  
  
  6,201
  
  6,421
  
  (220)
  
  (3.4)Other
  
  
  
  
  
  15,123
  
  13,510
  
  1,613
  
  11.9Total assets
  
  
  $
  1,179,869
  
  1,153,136
  
  26,733
  
  2.3
  %LIABILITIES AND
  SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
  
  
  $
  137,182
  
  133,623
  
  3,559
  
  2.7
  %Interest-bearing
  
  
  
  864,643
  
  859,958
  
  4,685
  
  0.5Total deposits
  
  
  
  1,001,825
  
  993,581
  
  8,244
  
  0.8Retail repurchase
  agreements
  
  
  
  12,145
  
  14,427
  
  (2,282)
  
  (15.8)Commercial paper
  (Master notes)
  
  
  27,737
  
  20,988
  
  6,749
  
  32.2Other short-term
  borrowings
  
  
  
  24,500
  
  6,000
  
  18,500
  
  308.3Long-term
  borrowings
  
  
  
  -
  
  10,000
  
  (10,000)
  
  (100.0)Accrued interest
  payable
  
  
  
  1,523
  
  1,584
  
  (61)
  
  (3.9)Other
  
  
  
  
  
  6,748
  
  6,180
  
  568
  
  9.2Total liabilities
  
  
  
  1,074,478
  
  1,052,760
  
  21,718
  
  2.1Shareholders'
  EquityCommon stock
  
  
  
  
  31,948
  
  31,837
  
  111
  
  0.3Capital surplus
  
  
  
  
  1,391
  
  1,102
  
  289
  
  26.2Retained earnings
  
  
  
  73,531
  
  68,132
  
  5,399
  
  7.9Accumulated other
  comprehensive loss, net of tax
  
  
  (1,479)
  
  (695)
  
  (784)
  
  112.8Total
  shareholders' equity
  
  
  105,391
  
  100,376
  
  5,015
  
  5.0Total liabilities
  and shareholders' equity
  $
  1,179,869
  
  1,153,136
  
  26,733
  
  2.3
  %
   Investment Securities Available for Sale  The following table
summarizes the composition of the Companys investment securities available for
sale portfolio at the dates indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalGovernment-sponsored
  enterprises
  $
  29,579
  28.3%
  
  42,383
  36.4State and
  municipal
  
  51,624
  49.3
  
  48,014
  41.2Mortgage-backed
  
  23,505
  22.4
  
  26,170
  22.4Total investment
  securitiesavailable for
  sale
  $
  104,708
  100.0%
  
  116,567
  100.0
  At June 30, 2007, the investment
security portfolio represented 8.9% of total assets, a decline from 10.1% at
December 31, 2006. The decline in the total investment securities portfolio
from December 31, 2006 to June 30, 2007 resulted primarily from short-term
taxable securities issued by government-sponsored enterprises (GSEs) not
being reinvested but instead being used to fund loan growth and repay
borrowings during the six month period ended June 30, 2007.  See Part I, Item 1. Financial
Statements, Consolidated Statements of Cash Flows contained herein for further discussion regarding
how purchases of and proceeds from the sale, maturities, and / or calls
of investment securities as well as principal paydowns of mortgage-backed
securities impacted the investment securities available for sale portfolio
during the six month period ended June 30, 2007. 28 
   Table of Contents      The following tables summarize the amortized cost and fair market
values of investment securities available for sale at the dates indicated (in
thousands).  June 30, 2007
  
  December 31, 2006Fair
  
  
  FairAmortized
  market
  
  Amortized
  marketcost
  value
  
  cost
  valueGovernment-sponsored
  enterprises
  $
  29,672
  29,579
  
  42,554
  42,383State and
  municipal
  
  53,343
  51,624
  
  48,780
  48,014Mortgage-backed
  
  24,099
  23,505
  
  26,362
  26,170Total investment
  securitiesavailable for
  sale
  $
  107,114
  104,708
  
  117,696
  116,567  Public funds are bank deposits
of state and local municipalities and typically require that the Bank pledge
investment grade securities to the accounts to ensure repayment.  Approximately
75% of the investment securities portfolio was pledged to secure public
deposits as of June 30, 2007 as compared with 62% at December 31, 2006 and 94%
at June 30, 2006.  Approximately 42.6% of investment securities portfolio
secured public deposits as of June 30, 2007 as compared with 38% at December
31, 2006 and 74% at June 30, 2006.  The fluctuation in pledged securities
between these periods was the result of a diversification of assets pledged to
secure public deposits, securities sold under agreements to repurchase, and for
other purposes as required or permitted by law as further discussed in Part I,
Item 1. Financial Statements, Note
10 and Note 11 contained herein with
regard to the Companys borrowings from
the FHLB.  See Part I, Item
1. Financial Statements, Note 3 contained
herein for further discussion regarding the Companys investment securities portfolio.  Concentrations of Credit Risk. The following table summarizes the amortized cost
and fair market value of the securities of issuers that, in the aggregate,
exceed ten percent of shareholders equity at June 30, 2007 (dollars in
thousands).  Amortized
  
  
  Fair marketCost
  % of GSEs
  
  value
  % of GSEsGovernment-sponsored
  enterprisesFHLB
  $
  25,704
  86.7
  %
  25,632
  86.6FHLMC
  
  2,982
  10.0
  
  2,975
  10.1FNMA
  
  986
  3.3
  
  972
  3.3$
  29,672
  100.0
  %
  29,579
  100.0Amortized
  
  
  Fair marketCost
  % of MBSs
  
  value
  % of MBSsMortgage-backedFHLMC
  $
  7,555
  31.3
  %
  7,350
  31.3FNMA
  
  16,544
  68.7
  
  16,155
  68.7$
  24,099
  100.0
  %
  23,505
  100.0% ofportfolio
  
  
  % ofAmortized
  amortized
  
  Fair
  market
  portfolio fairCost
  cost
  
  value
  market valueTotal GSEs and
  MBSsFHLB
  $
  25,704
  24.0
  %
  25,632
  24.5FHLMC
  
  10,537
  9.8
  
  10,325
  9.9FNMA
  
  17,530
  16.4
  
  17,127
  16.4$
  53,771
  50.2
  %
  53,084
  50.8
  The Company places its deposits
and correspondent accounts with, and sells its federal funds to, high quality
institutions.  Management believes credit risk associated with correspondent
accounts is not significant.    29 
   Table of Contents   Loans   General.  Loans represent the most significant
component of the Companys interest-earning assets with average loans
accounting for 88.2% and 85.1% of average interest-earning assets during the
three month periods ended June 30, 2007 and June 30, 2006, respectively and
88.0% and 85.3% of average interest-earning assets during the six month periods
ended June 30, 2007 and June 30, 2006, respectively. The following table summarizes the Companys loan portfolio, by
collateral type, at the dates indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalCommercial and
  industrial
  $
  73,943
  7.4
  %
  126,742
  13.4Real estate - 1 -
  4 family
  
  211,190
  21.4
  
  171,828
  18.1Real estate -
  construction
  
  39,695
  4.0
  
  19,959
  2.1Real estate -
  other
  
  574,516
  58.2
  
  540,869
  57.1Total loans
  secured by real estate
  
  825,401
  83.6
  
  732,656
  77.3General consumer
  
  70,814
  7.2
  
  70,502
  7.4Credit line
  
  5,055
  0.5
  
  4,868
  0.5Bankcards
  
  11,461
  1.2
  
  11,813
  1.3Others
  
  1,148
  0.1
  
  1,007
  0.1Total loans,
  gross
  $
  987,822
  100.0
  %
  947,588
  100.0
  During the first six months of
2007, management performed tasks in order to comply with commercial real estate
regulatory reporting requirements. Specifically, in order to adequately monitor
segments of the loan portfolio, the Company reviewed its stratifications within
the loan portfolio using parameters including, but not limited to, loan type,
loan purpose, geographic distribution, and collateral, if applicable, as management
believes that this stratification assists in the identification of factors that
either heighten or reduce the inherent risk. As a result of this process,
management deemed it necessary to adjust various stratification identifiers of
such loans resulting in fluctuations within loan outstanding balances when
reviewed by such stratification identifiers. These reclassifications may impact
the comparability of 2006 and 2007 balances.  Management is currently
exploring ways in which to improve the comparability of these numbers in the
future.  The following table summarizes
loans by loan purpose at the dates indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalCommercial
  business
  $
  120,916
  12.4
  %
  112,264
  12.0Commercial real
  estate
  
  618,084
  63.1
  
  593,377
  63.2Installment
  
  23,280
  2.4
  
  22,139
  2.4Installment real
  estate
  
  68,633
  7.0
  
  66,161
  7.0Indirect
  
  43,098
  4.4
  
  43,634
  4.6Credit line
  
  1,926
  0.2
  
  1,982
  0.2Prime access
  
  52,272
  5.3
  
  53,883
  5.7Residential
  mortgage
  
  42,920
  4.4
  
  35,252
  3.7Bankcards
  
  11,461
  1.2
  
  11,813
  1.3Business manager
  
  316
  -
  
  370
  -Other
  
  1,623
  0.2
  
  1,793
  0.2Loans, unadjusted
  gross
  
  984,529
  100.6
  
  942,668
  100.3Loans in process
  
  1,279
  0.1
  
  2,587
  0.3Deferred loans
  fees and costs
  
  721
  0.1
  
  658
  0.1Loans, adjusted
  gross
  
  986,529
  100.8
  
  945,913
  100.7Mortgage loans
  held for sale
  
  1,293
  0.1
  
  1,675
  0.2Total loans,
  gross
  
  987,822
  100.9
  
  947,588
  100.9Allowance for
  loan losses
  
  (8,515)
  (0.9)
  
  (8,527)
  (0.9)Total loans, net
  $
  979,307
  100.0
  %
  939,061
  100.0
  During 2006, the Company
introduced business credit scoring and began placing an emphasis on small
commercial loans.  Management believes that these changes continue to result in
increases in commercial business loans as a percentage of the total portfolio.  Management believes that the
aggressive commercial real estate building in recent years may indicate an
upcoming period of oversupply.  In order to avoid an excess supply of
commercial limited-service properties, the Company has tightened underwriting
standards with regard to such loans resulting in little change in commercial
real estate loans as a percentage of the total portfolio.  The increase in residential mortgage loans and the decrease
in mortgage loans held for sale during the first six months was the result of
the Companys decision to retain more residential loans in its in-house
portfolio during the period.  30 
   Table of Contents     See Part I, Item 1. Financial
Statements, Note 4 contained herein for further discussion regarding the
Companys loan portfolio.  Credit Quality.  The following table summarizes
trends in problem assets and other asset quality indicators at the dates indicated
(dollars in thousands). The composition of nonaccrual loans is based on loan
collateral type.  June 30,
  
  December 31,2007
  
  2006Real estate
  $
  12,041
  
  6,271Commercial and
  industrial
  329
  
  549Consumer
  66
  
  179Total nonaccrual
  loans
  
  12,436
  
  6,999Real estate
  acquired in settlement of loans
  
  717
  
  600Repossessed
  automobiles
  
  386
  
  319Total
  nonperforming assets
  $
  13,539
  
  7,918Loans past due 90
  days and still accruing (1)
  $
  290
  
  260Ending loans (2)
  $
  986,529
  
  945,913Nonaccrual loans
  as a percentage of loans (2)
  
  1.26
  %
  0.74Nonperforming
  assets as a percentage oftotal assets
  
  1.15
  %
  0.69Allowance for
  loan losses to nonaccrualloans
  
  0.68
  x
  1.22(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
  Total nonaccrual loans increased $5.4 million from December
31, 2006 to June 30, 2007 primarily due to an increase in nonaccrual loans
secured by real estate.  Management believes that the increase in nonaccrual
loans at June 30, 2007 over December 31, 2006 does not indicate a deterioration
of asset quality as the increase can be attributed, for the most part, to
isolated loan circumstances. During the first quarter of 2007, two loans, both
of which were secured by other real estate, were placed in nonaccrual status. 
At June 30, 2007, the principal balance of these loans totaled $5.3 million.  During
July 2007, foreclosure proceedings were completed with regard to the real
estate collateral securing both loans.  Both properties were placed into the
Banks real estate in settlement of loans portfolio in July at fair market
value.  Management expects that the sale of the collateral securing these loans
will fully cover the Companys investment. Excluding the impact of these loans,
virtually all other nonaccrual comparisons remained relatively unchanged from
December 31, 2006 to June 30, 2007.  In its consideration of collectibility of
nonaccrual loans, management takes into consideration, among other factors,
that 96.8% of nonaccrual loans at June 30, 2007 were secured by real estate. In
the event of foreclosure, any losses would be offset by funds received through
the liquidation of the underlying real estate collateral.  Also included within nonaccrual loans at both December 31,
2006 and June 30, 2007 was a loan secured by other real estate placed in
nonaccrual during the fourth quarter of 2005.  In accordance with the Banks
Lending Policy, the loan was downgraded to
substandard at that time.  At both December 31, 2006 and June 30,
2007, the principal balance of this loan totaled $3.9 million.  $878 thousand
of the loan balance was specifically reserved at both December 31, 2006. 
At the time of this filing, the borrower has filed for protection under the
bankruptcy code placing a stay on the Bank's foreclosure order.  Troubled debt restructurings entered into by the Company
during the three month period ended June 30, 2007 were reviewed by the Company
to ensure loan classifications were in accordance with applicable regulations. 
Any specific allocations identified during the review based on probable losses
have been included in the Companys Allowance for the applicable period.  As of June 30, 2007, management was aware of no other
potential problem loans that were not already categorized as nonaccrual, past
due, or restructured, or that had borrower credit problems causing management
to have serious doubt as to the ability of the borrower to comply with the
present loan repayment terms.  31 
   Table of Contents     The Company regularly reviews its loan portfolio and
management determines whether any loans require classification in accordance
with applicable regulations.  The Companys
believes that loans are appropriately classified.  The following table
summarizes the composition of the Companys classified assets by
collateral type at the dates indicated (in thousands).  June 30, 2007Specialmention
  Substandard
  Doubtful
  Loss
  TotalCommercial and
  industrial
  $
  286
  963
  776
  -
  2,025Real estate
  
  923
  18,358
  809
  -
  20,090General consumer
  
  16
  270
  32
  -
  318Credit line
  
  6
  34
  1
  -
  41Total classified
  loans
  $
  1,231
  19,625
  1,618
  -
  22,474Total classified
  loans, unadjusted, as a percentage of total loans (1)
  2.3%Total classified
  loans, adjusted, as a percentage of total loans (1)
  1.7%December 31, 2006Specialmention
  Substandard
  Doubtful
  Loss
  TotalCommercial and
  industrial
  $
  301
  1,098
  839
  -
  2,238Real estate
  
  1,063
  12,398
  942
  -
  14,403General consumer
  
  2
  321
  36
  -
  359Credit line
  
  6
  47
  1
  -
  54Total classified
  loans
  $
  1,372
  13,864
  1,818
  -
  17,054Total classified
  loans, unadjusted, as a percentage of total loans (1)
  1.8%(1)
  Calculated using
  loans excluding mortgage loans held for sale, net of unearned, excluding the
  Allowance.
   Overall, classified assets increased $5.4 million from
December 31, 2006 to June 30, 2007.  From a portfolio perspective, the increase
was experienced primarily in classified assets secured by real estate.  From a
classification perspective, the increase was experienced primarily in
substandard assets discussed previously in
conjunction with the increase in nonaccrual loans over the same periods.
Management believes that the increase in classified assets, from both the
portfolio and classification perspectives, at June 30, 2007 over December 31,
2006 can be attributed, for the most part, to two loans, secured by other real
estate, which were placed in nonaccrual status during the first quarter of 2007. In accordance with the Companys Lending
Policy, the loans were downgraded to
substandard. At June 30, 2007, the principal balance of these loans
totaled $5.3 million.  During July 2007, foreclosure proceedings were completed
with regard to the real estate collateral securing both loans.  Both properties
were placed into the Banks real estate in settlement of loans portfolio in
July at fair market value.  Management expects that the sale of the collateral
securing these loans will fully cover the Companys investment. Excluding the
impact of these loans, virtually all other comparisons, whether from a
portfolio or classification perspective, remained relatively unchanged from
December 31, 2006 to June 30, 2007.  As noted above in conjunction with the discussion of
nonaccrual loans, also included within nonaccrual loans at both December 31,
2006 and June 30, 2007 was a loan secured by other real estate placed in
nonaccrual during the fourth quarter of 2005.  In accordance with the Banks
Lending Policy, the loan was downgraded to
substandard at that time.  At both December 31, 2006 and June 30,
2007, the principal balance of this loan totaled $3.9 million.  $878 thousand
of the loan balance was specifically reserved at both December 31, 2006.  The following table summarizes the changes in the
Companys real estate acquired in settlement of loans, including the balance at
the beginning and end of each period, provision charged to expense, and losses
charged to the Allowance related to the Companys real estate acquired in
settlement of loans for the periods indicated (in thousands).  32 
   Table of Contents    At and for the three month
  
  At and for the six monthperiods ended June 30,
  
  periods ended June 30,2007
  2006
  
  2007
  2006Real estate
  acquired in settlement of loans, beginning of period
  $
  934
  932
  
  600
  1,954Add: New real
  estate acquired in settlement of loans
  
  81
  31
  
  582
  83Less: Sales /
  recoveries of real estate acquired in settlement of loans
  
  (294)
  (190)
  
  (294)
  (1,121)Less: Provision
  charged to expense
  
  (4)
  (45)
  
  (171)
  (188)Real estate
  acquired in settlement of loans, end of period
  $
  717
  728
  
  717
  728
  When Federal Reserve Chairman Ben
Bernanke testified before the House Financial Services Committee on July 18,
2007, he noted that rising delinquencies and foreclosures are creating
personal, economic and social distress for many homeowners and communities.
Consistent with these trends, the Companys new real estate acquired in
settlement of loans totaled $582 thousand during the first six months of 2007
compared with $83 thousand during the same period of 2006.  Although during the
six month period June 30, 2006, $1.1 million in sales and recoveries from the
portfolio were experienced, the portfolio balance at that time from which sales
were derived (beginning balance plus additions to the portfolio) were
considerably higher than those on which sales were derived for the six month
period ended June 30, 2007.  Management believes that real estate acquired in
settlement of loans is effectively managed by the Company considering the increasing
industry trends with regard to foreclosure evidenced by the relatively
unchanged balance in the portfolio when comparing June 30, 2006 to June 30,
2007.  Management
believes that there will always remain a core level of delinquent loans and
real estate and personal property acquired in settlement of loans from normal
lending operations.  Concentrations of Credit Risk. Financial instruments,
which potentially subject the Company to concentrations of credit risk, consist
principally of loans, investment securities, federal funds sold and due from
bank balances.  The Company makes loans to
individuals and small to medium-sized businesses for various personal and
commercial purposes primarily in Upstate, South
Carolina.  The Companys loan portfolio is not concentrated in loans to any
single borrower or a relatively small number of borrowers.  Additionally,
management is not aware of any concentrations of loans to classes of borrowers
or industries that would be similarly impacted by economic conditions. 
Management has identified, and the following table summarizes at the dates
indicated, concentrations of types of lending that it monitors (dollars in
thousands).  June 30, 2007Outstanding
  
  As a percentage
  
  As a percentage ofbalance
  
  of total equity
  
  total loansLoans secured by:Commercial and
  industrial nonmortgage instruments
  $
  73,943
  
  70
  %
  7
  %Residential
  mortgage instruments
  
  211,190
  
  200
  
  21Nonresidential
  mortgage instruments
  
  574,516
  
  545
  
  58December 31, 2006Outstanding
  
  As a percentage
  
  As a percentage ofbalance
  
  of total equity
  
  total loansLoans secured by:Commercial and
  industrial nonmortgage instruments
  $
  126,742
  
  126
  %
  13
  %Residential
  mortgage instruments
  
  171,828
  
  171
  
  18Nonresidential
  mortgage instruments
  
  540,869
  
  539
  
  57
  As previously discussed, the
fluctuations in outstanding balances during the first six months of 2007 were a
result of the Companys review of stratifications within the loan portfolio and
the resulting adjustments made to various stratification identifiers. These
reclassifications may impact the comparability of 2006 and 2007 balances. 
Management is currently exploring ways in which to improve the comparability of
these numbers in the future.  Management realizes that there
are inherent risks in all loan portfolios and that there is always risk
associated with a lack of diversification.  However, management believes that
risks associated with the concentration of loans secured by nonresidential
mortgage instruments are mitigated through the analysis and underwriting of the
credit requests, the retention of adequate collateral, and the oversight of
development or construction processes, where applicable.  The collateral
associated with such loans ranges from income producing commercial properties
to new residential or commercial development projects. Sources of repayment are
analyzed to determine the degree of risk related to each loan during the
underwriting process.  Additionally, although included in one reporting
category, loans secured by nonresidential mortgage instruments are comprised of
many types of loans to many types of borrowers located in many geographical
areas.  33 
   Table of Contents   In addition to monitoring
potential concentrations of loans to particular borrowers or groups of
borrowers, industries, geographic regions, and loan types, management monitors
whether or not the Company has exposure to credit risk from other lending
practices such as loans that subject borrowers to substantial payment increases
(e.g. principal deferral periods, loans with initial interest-only periods,
etc.) and loans with high loan-to-value ratios.  Management has determined
that, at June 30, 2007, the Company has no concentrations in such loans, as the
Company does not typically engage in such lending practices.  Additionally, there are industry
practices that could subject the Company to increased credit risk should
economic conditions change over the course of a loans life.  For example, the
Company makes adjustable-rate loans and fixed-rate principal-amortizing loans
with maturities prior to the loan being fully paid (i.e. balloon-term loans). 
These loans are underwritten and monitored to manage the associated risks. 
Therefore, management believes that these particular practices do not subject
the Company to unusual credit risk.  Allowance for Loan Losses  The Allowance totaled
$8.5 million, at both December 31, 2006 and June 30, 2007, respectively
representing 0.90% and 0.86% of loans, calculated using loans excluding
mortgage loans held for sale and the allowance for loan losses, net of unearned
income.  The following table indicates managements breakdown of the
allowance for loan losses by loan category and the percentage of loans in each
category to gross loans at the dates indicated (dollars in thousands).
Management believes that the Allowance can be allocated by category only on an
approximate basis.  The allocation of the Allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
Allowance to absorb losses in other categories.  June 30,
  
  December 31,2007
  
  2006% of
  
  
  % ofloans
  
  
  loansTotal
  to total
  
  Total
  to totalallowance
  loans
  
  allowance
  loansCommercial and
  industrial
  $
  845
  7.4
  %
  1,167
  13.4Real estate - 1 -
  4 family
  
  1,287
  21.4
  
  1,344
  18.1Real estate -
  construction
  
  39
  4.0
  
  20
  2.1Real estate -
  other
  
  3,943
  58.2
  
  2,745
  57.1General consumer
  
  1,075
  7.2
  
  1,860
  7.4Credit line
  
  156
  0.5
  
  162
  0.5Bankcards
  
  346
  1.2
  
  382
  1.3Others
  
  824
  0.1
  
  847
  0.1Total
  $
  8,515
  100.0
  %
  8,527
  100.0
  The increase in the allocation of the Allowance
to the portfolio secured by other real estate was due, in large part, to two
loans placed in nonaccrual status during the first three months of 2007 as
discussed in Loans, both of which
were secured by other real estate.  As such, the loans were downgraded to substandard in accordance with the
Companys Lending Policy.  Although it was determined that these loans did not
require specific allocations, general reserves were allocated to these loans.  At
June 30, 2007, the principal balance of these loans totaled $5.3 million.  The
decrease in allocation of the Allowance to
the loan portfolio secured by general consumer collateral was due primarily to
a decrease in the historical loss percentage with regard to this category.  See Loans contained herein for discussion
regarding the composition of the loan portfolio as well as the fluctuations within the portfolio from December
31, 2006 to June 30, 2007.  The following table summarizes activity within the Allowance
at the dates and for the periods indicated (dollars in thousands). Losses and
recoveries are charged or credited to the Allowance at the time realized. 34 
   Table of Contents  At and for the three month
  
  At and for the six monthperiods ended June 30
  
  periods ended June 302007
  
  2006
  
  2007
  
  2006Allowance
  balance, beginning of period
  $
  8,460
  
  8,727
  
  8,527
  
  8,431Provision for
  loan losses
  
  433
  
  525
  
  800
  
  1,050Loans charged-offCommercial and
  industrial
  
  32
  
  98
  
  138
  
  214Real estate - 1 -
  4 family
  
  125
  
  21
  
  212
  
  40Real estate -
  construction
  
  -
  
  -
  
  -
  
  -Real estate -
  other
  
  51
  
  100
  
  158
  
  100Consumer
  
  252
  
  214
  
  482
  
  358Total loans
  charged-off
  
  460
  
  433
  
  990
  
  712RecoveriesCommercial and
  industrial
  
  3
  
  7
  
  21
  
  29Real estate - 1 -
  4 family
  
  30
  
  13
  
  33
  
  13Real estate -
  construction
  
  -
  
  -
  
  -
  
  -Real estate -
  other
  
  2
  
  1
  
  3
  
  3Consumer
  
  47
  
  39
  
  121
  
  65Total recoveries
  
  82
  
  60
  
  178
  
  110Net loans
  charged-off
  
  378
  
  373
  
  812
  
  602Allowance
  balance, end of period
  $
  8,515
  
  8,879
  
  8,515
  
  8,879Average loans (1)
  $
  966,064
  
  876,226
  
  957,630
  
  870,735Ending loans (1)
  
  986,529
  
  889,117
  
  986,529
  
  889,117Net loans
  charged-offs to average loans (1)
  
  0.16
  %
  0.17
  
  0.17
  
  0.14Allowance for loan
  losses to ending loans (1)
  
  0.86
  
  1.00
  
  0.86
  
  1.00(1)
  Calculated using
  loans excluding mortgage loans held for sale, net of unearned income,
  excluding allowance for loan losses.
   See Earnings Review, For
the Three Months Ended June 30, 2007, Provision for Loan Losses and Earnings
Review, For the Six Months Ended June 30, 2007, Provision for Loan Losses
contained herein for discussion regarding the decrease in the provision for
loan losses during the three and six month periods ended June 30, 2007 over the
same periods of 2006.  Total net loans
charged-off remained relatively unchanged when comparing the second quarter of
2006 with the same quarter of 2007. Net loans charged-off during the six month
period ended June 30, 2007 were up $210 thousand from the same period of 2006
due to increased net loans charged-off during the first quarter of 2007 when
compared with the same period of 2006.  In conjunction with the Quarterly
Report on Form 10-Q for the Quarter Ended March 31, 2007, management
reported that net loans charged-off during the first quarter of 2006 were not
believed to necessarily be indicative of historical or future credit trends. 
For the quarters ended March 31, 2006, June 30, 2006, September 30, 2006,
December 31, 2006, and March 31, 2007, net loans charged-offs as a percentage
of average loans were 0.11%, 0.17%, 0.19%, 0.21%, and 0.19%, respectively.  Management believes that
the declining trend of the Allowance as a percentage of ending loans results
from several factors including, but not limited to, managements conservative
philosophy regarding its lending mix which impacts risk grades assigned at loan
origination, the ongoing management of asset quality, and growth within the
portfolio being primarily loans secured by real estate which generally involve
less risk that other types of lending, all of which impact Allowance
allocations.  Based on the current
economic environment and other factors that impact the assessment of the
Companys Allowance as discussed above, management believes that the Allowance
at June 30, 2007 was maintained at a level adequate to provide for estimated
probable losses in the loan portfolio.  However, assessing the adequacy
of the Allowance is a process that requires considerable judgment. Management's
judgments are based on numerous assumptions about current events believed to be
reasonable but which may or may not be valid. Thus, there can be no assurance
that loan losses in future periods will not exceed the current Allowance or
that future increases in the Allowance will not be required. No assurance can
be given that management's ongoing evaluation of the loan portfolio, in light
of changing economic conditions and other relevant circumstances, will not
require future additions to the Allowance, thus adversely impacting the results
of operations of the Company.    35 
   Table of Contents Deposits The following table
summarizes the Companys deposit composition at the dates indicated (dollars in thousands).  June 30,
  
  December 31,2007
  
  2006Total
  % of Total
  
  Total
  % of TotalNoninterest-bearing
  transaction deposit accounts
  $
  136,898
  13.7
  %
  133,623
  13.4Interest-bearing
  transaction deposit accounts
  
  363,500
  36.3
  
  313,613
  31.6Transaction
  deposit accounts
  
  500,398
  50.0
  
  447,236
  45.0Money market
  deposit accounts
  
  108,903
  10.9
  
  124,874
  12.6Savings deposit
  accounts
  
  41,590
  4.1
  
  41,887
  4.2Time deposit
  accounts
  
  350,934
  35.0
  
  379,584
  38.2Total traditional
  deposit accounts
  $
  1,001,825
  100.0
  %
  993,581
  100.0
  The increase in transaction
deposit accounts during the first six months of 2007 was primarily a
result of the Companys continued ability to attract deposits through pricing
adjustments, expansion of its geographic market area, level of quality customer
service, and through the Companys reputation in the communities served.
Additionally, the Company has made efforts to enhance its deposit mix by
working to attract lower cost deposit accounts.  The Company believes that the growth in transaction deposit accounts
continues to be enhanced by the introduction, continuation, and
enhancement of product programs and promotions.  During 2006, the Company reported $14 million of growth
within money market deposit accounts related to temporary public funds from one
entity and an increase in money market funds of the Companys trust department
of approximately $6 million. During the first six months of 2007, approximately
$8 million of the public funds were transferred from the Bank, and, in
addition, money market funds of the Banks trust department declined
approximately $3 million, which together contributed to the decline in money
market deposit accounts over the periods noted.  Time deposit accounts decreased by $28.7 million, or 7.5% during the
first six months of 2007. Prior promotional certificate of deposit
accounts offered by the Company matured during the first six months of 2007. 
During this time, the Company offered a specifically targeted time deposit
program in an effort to retain maturing funds.   Management believes that the
Companys time deposit accounts declined during the first six months of 2007 as
a result of returns currently available from alternative investments.  The table set forth below summarizes the Companys weighted
average deposit costs for the periods indicated.  For the three month
  
  For the six monthperiods ended June 30,
  
  periods ended June 30,2007
  
  2006
  
  2007
  
  2006Average cost of
  core deposit accounts
  2.76
  %
  2.05
  
  2.71
  
  1.87Average cost of
  time deposit accounts
  4.39
  
  3.91
  
  4.35
  
  3.80Average cost of
  total traditional deposit accounts
  3.44
  
  2.95
  
  3.41
  
  2.82
  The table set forth below summarizes the Companys interest
expense on deposit accounts costs for the periods indicated (in thousands).  For the three month periods
  
  For the six month periodsended June 30,
  
  ended June 30,2007
  2006
  
  2007
  2006Transaction
  deposit accounts
  $
  2,532
  1,167
  
  4,732
  1,973Money market
  deposit accounts
  
  915
  983
  
  1,895
  1,772Savings deposit
  accounts
  
  36
  38
  
  70
  73Time deposit
  accounts
  
  3,954
  3,841
  
  7,967
  7,445Total interest
  expense on deposit accounts
  $
  7,437
  6,029
  
  14,664
  11,263
  As summarized in Earnings Review for the applicable period,
the increase in interest expense on deposit accounts when comparing both the
three and six month periods ended June 30, 2007 over the same periods of 2006
was attributable primarily to changes in rate.  36 
   Table of Contents     Management does not
believe that its dependence on traditional deposit account funding changed
materially from December 31, 2006 to June 30, 2007.  At June 30, 2007,
traditional deposit accounts as a percentage of liabilities were 93.2% compared
with 94.4% at December 31, 2006.  Borrowings  In addition to the funds
employed from the decline in the investment security portfolio and the
net growth in traditional deposit accounts, borrowings increased $13.0 million during
the first six months of 2007 to fund loan growth. Borrowings as a percentage of
total liabilities were approximately 6.0% and 4.9% at June 30, 2007 and
December 31, 2006, respectively. The
following table summarizes the Companys borrowings composition at the dates
indicated (dollars in thousands).  June 30, 2007
  
  December 31, 2006Total
  % of Total
  
  Total
  % of TotalRetail repurchase
  agreements
  $
  12,145
  18.9
  %
  14,427
  28.1Commercial paper
  
  27,737
  43.1
  
  20,988
  40.8Other short-term
  borrowings
  
  24,500
  38.0
  
  6,000
  11.7Long-term
  borrowings
  
  -
  -
  
  10,000
  19.4Total borrowings
  $
  64,382
  100.0
  %
  51,415
  100.0
  The following table summarizes
short-term borrowing informationat
and for the periods indicated (dollars in thousands).  At and for the three month
  
  At and for the six monthperiods ended June 30,
  
  periods ended June 30,2007
  
  2006
  
  2007
  
  2006Retail repurchase
  agreementsAmount
  outstanding at period end
  $
  12,145
  
  17,961
  
  12,145
  
  17,961Average amount
  outstanding during period
  
  12,442
  
  17,196
  
  13,154
  
  18,204Maximum amount
  outstanding at any period end
  
  12,145
  
  20,071
  
  12,771
  
  23,344Rate paid at
  period end
  
  3.63
  %
  3.63
  
  3.63
  
  3.63Weighted average
  rate paid during the period
  
  4.19
  
  4.13
  
  4.23
  
  3.89Commercial paperAmount
  outstanding at period end
  $
  27,737
  
  22,104
  
  27,737
  
  22,104Average amount
  outstanding during period
  
  26,804
  
  20,401
  
  24,540
  
  18,221Maximum amount
  outstanding at any period end
  
  27,737
  
  22,104
  
  27,737
  
  22,104Rate paid at
  period end
  
  3.81
  %
  3.81
  
  3.81
  
  3.81Weighted average
  rate paid during the period
  
  4.32
  
  4.05
  
  4.33
  
  3.81Other short-term
  borrowingsAmount
  outstanding at period end
  $
  24,500
  
  -
  
  24,500
  
  -Average amount
  outstanding during period
  
  3,570
  
  1,135
  
  2,807
  
  4,857Maximum amount
  outstanding at any period end
  
  24,500
  
  -
  
  24,500
  
  13,900Rate paid at
  period end
  
  5.63
  %
  -
  
  5.63
  
  -Weighted average
  rate paid during the period
  
  6.07
  
  2.47
  
  5.96
  
  4.73*
  Rates paid are
  tiered based on level of deposit.  Rate presented represents the average rate
  for all tiers offered at year-end.
  If needed, funding sources have been arranged through
federal funds lines at correspondent banks, the Federal Reserve Discount
Window, and the FHLB.  At June 30, 2007, the Company had additional funding sources
at correspondent banks totaling $50 million that were accessible at the
Companys option of which $15 million had been utilized. These additional
sources included the Banks additional federal funds accommodation in the
amount of $10 million from Nexity Bank obtained during the second quarter of
2007.  37 
   Table of Contents     Federal Reserve advances,
commonly referred to as discount window borrowings, are secured borrowings
from Federal Reserve Banks. These borrowings are generally available to any
depository institution that maintains reservable transaction accounts or
nonpersonal time deposits and provide back-up funding for commercial banks.
Such borrowings provide short-term funds to help eligible institutions meet
temporary funding requirements or to cushion a more persistent outflow of funds
while the bank makes an orderly adjustment of its balance sheet. All borrowings
must be secured to the satisfaction of the local Reserve Bank. Satisfactory
collateral generally includes United States government securities, federal
agency securities, and, if they are of acceptable quality, mortgage notes on
one- to four- family residences, state and local government securities, and the
notes of businesses, consumers, and other customers. As such, the acceptable
collateral available to secure such borrowings limits the Companys borrowings
through this funding source.  A collateralized borrowing relationship with the
Federal Reserve was in place for the Bank to meet emergency funding needs at
June 30, 2007, however, no borrowings were outstanding. The Bank has not
historically utilized discount window borrowings from the Federal Reserve and
has no plans to do so in the near term. The Bank would typically only utilize
this funding source to meet emergency funding needs.  At June 30, 2007, of its approximately $102.0 million available
credit based on qualifying loans to serve as collateral against borrowings and
letters of credit from the FHLB, the Company employed $9.5 million in
borrowings, all of which was determined to be short-term when employed, and
employed $69.0 million in a letter of credit used to secure public deposits as
required or permitted by law.  At June 30, 2007, the Company had approximately
$23.5 million available credit based on qualifying loans to serve as collateral
against short-term borrowings, long-term borrowings, and / or letters of credit
from the FHLB.  Long-term borrowings are those having maturities greater
than one year when executed. The Companys remaining $10.0 million in long-term
FHLB borrowings matured on June 14, 2007. The following table summarizes long-term borrowing information, all of
which were obtained through the FHLB,at and for the periods indicated (dollars in thousands).  At and for the three month
  
  At and for the six monthperiods ended June 30,
  
  periods ended June 30,2007
  
  2006
  
  2007
  
  2006Long-term FHLB
  borrowingsAmount
  outstanding at period end
  $
  -
  
  10,000
  
  -
  
  10,000Average amount
  outstanding during period
  
  8,242
  
  20,571
  
  9,116
  
  21,779Maximum amount
  outstanding at any period end
  
  10,000
  
  23,000
  
  10,000
  
  23,000Rate paid at
  period end
  
  -
  %
  3.85
  
  -
  
  3.85Weighted average
  rate paid during the period
  
  3.80
  
  3.55
  
  3.83
  
  3.54
  Capital Resources  Average shareholders equity was $105.2 million for the
three month period ended June 30, 2007, or 9.0% of average assets, compared
with $93.6 million, or 8.4% of average assets, for the same period of 2006. 
For the six month period ended June 30, 2007, average shareholders equity was
$103.7 million, or 8.9% of average assets, compared with $92.4 million, or 8.4%
of average assets, for the same period of 2006.  Total shareholders
equity increased from $100.4 million at December 31, 2006 to $105.4 million at
June 30, 2007. The Companys capital ratio of total shareholders equity to
total assets was 8.9% at June 30, 2007 compared with 8.7% at December 31, 2006.
During the first six months of 2007, shareholders equity was increased
through the retention of net income, stock option activity, and compensation
expense related to stock options granted.  These increases were offset by an
increase in cash dividends and in accumulated other comprehensive loss over the
six month period.  See Part I, Item 1. Financial
Statements, Consolidated Statements of Changes in Shareholders Equity
and Comprehensive Income contained herein
for further discussion regarding the changes in stockholders equity
during the six month period ended June 30, 2007.  Palmetto Bancshares and the Bank are required to meet
regulatory capital requirements that currently include several measures of
capital.  At June 30, 2007 and 2006, both were each categorized as well
capitalized under the regulatory framework for prompt corrective regulatory
action.  See Part I, Item
1. Financial Statements, Note 16 contained
herein for further discussion regarding the Banks and Palmetto Bancshares
capital regulatory requirements.  At June 30, 2007, there were no conditions
or events of which management was aware that would materially change Palmetto
Bancshares or the Banks capitalization status.  38 
   Table of Contents     For the second quarter
of 2007, the Companys cash dividend payout ratio was 29.87% compared with a
payout ratio of 30.67% during the same period of 2006. Cash dividends per
common share during the second quarter of 2007 totaled $0.19, an increase of
5.6% over dividends per common share during the same period of 2006 of $0.18.
For the six month periods ended June 30, 2007 and 2006, respectively, the
Companys cash dividend payout ratio was 31.01% and 30.99%.  During the same
periods, cash dividends per common share totaled $0.38 and $0.36, an increase
of 5.6%. The amount of the dividends declared is dependent upon the Companys
earnings, financial condition, capital position, and such other factors the
Board deems relevant.  South Carolina regulations restrict the amount of
dividends that the Bank can pay to the holding company and may require prior
approval before declaration and payment of any excess dividend.  Liquidity  General  The term liquidity refers to the
Companys ability to timely meet obligations when they come due without
incurring unacceptable losses. The Companys management is charged with
ensuring that sufficient funds are available at a reasonable cost to meet
potential demands from both funds providers and borrowers. Banks generally hold
some liquid assets to supplement liquidity from deposits and other liabilities.
These assets can be quickly and easily converted to cash at a reasonable cost.
Liquid assets include those that can be pledged or used in a repurchase
agreement.  The Company considers its money
market assets to be the most liquid of it assets. Money market assets include
federal funds sold with an overnight maturity or term maturity within 30 days. 
At June 30, 2007, the Company had federal funds sold totaling $10.0 million.  The Company's investment
portfolio can provide liquidity through any of three ways including the
maturity of a security, the sale of securities for cash, or through the use of
securities as collateral in a repurchase agreement or other borrowing. The
Company considers an investment security to be saleable if it is not
encumbered, i.e., the security cannot be sold under a repurchase agreement or
pledged or used as collateral, and it is marketable.  Public funds are bank deposits
of state and local municipalities. Although the funds are usually a low-cost,
relatively stable source of funding for the Bank, availability depends on the
particular government's fiscal policies and cash flow needs. Public funds
typically require that the Bank pledge investment grade securities to the
accounts to ensure repayment.  Of the Companys $104.7 million available for
sale investment securities balance at June 30, 2007, $25.9 million was
unpledged and, therefore, available as a liquidity source.  The following table summarizes the gross unrealized losses,
fair market value, and the number of securities in each category of investment
securities available for sale, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at June 30, 2007 (dollars in thousands).  June 30, 2007Less than 12 months
  
  12 months or longer
  
  TotalFair
  Gross
  
  
  Fair
  Gross
  
  
  Fair
  Grossmarket
  unrealized
  
  
  market
  unrealized
  
  
  market
  unrealized#
  value
  losses
  
  #
  value
  losses
  
  #
  value
  lossesGovernment-sponsored
  enterprises
  7
  $
  18,177
  $
  35
  
  6
  11,402
  58
  
  13
  29,579
  93State and
  municipal
  26
  
  9,474
  
  255
  
  98
  37,802
  1,473
  
  124
  47,276
  1,728Mortgage-backed
  5
  
  8,786
  
  199
  
  25
  13,584
  395
  
  30
  22,370
  594Total investment
  securitiesavailable for
  sale
  38
  $
  36,437
  $
  489
  
  129
  62,788
  1,926
  
  167
  99,225
  2,415
  Management believes that the above summarized unrealized
losses are due to interest rate changes, rather than credit quality, on
investments that the Company classifies to indicate that sale is a possibility
but also for which the Company has the ability to hold until maturity.  If
liquidity is needed, the Company does not automatically chose an impaired or
the most impaired security to sell to provide needed liquidity, but rather
considers many factors including, but not limited to, asset  liability
management. Since the Company has the ability and intent to hold these
investments until a market price recovery or maturity, management does not
consider these investments to be other-than-temporarily impaired.  The following table summarizes the percentage of the
applicable investment segments of the investment securities available for sale
by Moodys credit ratings at June 30, 2007.  39 
   Table of Contents  State and
  
  Mortgage-municipal
  
  backedA3
  
  2
  %
  -Aa1
  4
  
  -Aaa
  78
  
  100Not rated
  16
  
  -Total
  100
  %
  100
  Of the state and municipal investment securities not rated
by Moodys at June 30, 2007, 97% was rated Aaa by Standard and Poors while 3%
was rated Aa+.  The Company generally has ready
access to borrowed funds and generally finds that such borrowings are an
economical way to meet short-term or unanticipated loan demand or deposit
withdrawals. Additionally, the Companys reliance on liability liquidity has
increased during the first six months of 2007, as net funds provided through
traditional deposit accounts have remained relatively unchanged. Traditional
deposit accounts are the Companys primary funding source.  Management believes that through
managing liabilities instead of assets, liabilities can be tailored to fit cash
flow needs instead of apportioning asset types and amounts to a given liability
base. Additionally, management believes that by locking in term funding
liquidity risk can be reduced. By accessing external funding sources, the
Company can obtain funds quickly and in large amounts instead of slowly
accumulating traditional deposit accounts.  If needed, alternative funding sources have been arranged
through federal funds lines at correspondent banks, the Federal Reserve
Discount Window, and the FHLB.  Alternative funding is also used when
traditional deposit funding is not available. The Companys alternative funds
providers are typically other financial institutions.  The federal funds market is the day-to-day unsecured lending
of excess reserve funds between banks. If a bank needs funds to meet either its
reserve requirements or other obligations, it can purchase the excess reserves
of another bank. The primary federal funds market is overnight, but maturities
may extend a few days or weeks. At June 30, 2007, the Company had additional
funding sources at correspondent banks totaling $50 million that were
accessible at the Companys option of which $15 million had been utilized.
These additional sources included the Banks additional federal funds
accommodation in the amount of $10 million from Nexity Bank obtained during the
second quarter of 2007.  Federal Reserve advances,
commonly referred to as discount window borrowings are secured borrowings
from Federal Reserve Banks. These borrowings are generally available to any
depository institution that maintains reservable transaction accounts or
nonpersonal time deposits. Such borrowings provide short-term funds to help
eligible institutions meet temporary funding requirements or to cushion a more
persistent outflow of funds while the bank makes an orderly adjustment of its
balance sheet. All borrowings must be secured to the satisfaction of the local
Reserve Bank. Satisfactory collateral generally includes United States government
securities, federal agency securities, and, if they are of acceptable quality,
mortgage notes on one- to four- family residences, state and local government
securities, and the notes of businesses, consumers, and other customers. As
such, the acceptable collateral available to secure such borrowings limits the
Companys borrowings through this funding source.  The FHLB generally establishes
credit availability for each creditworthy institution. Credit availability is
not a formal commitment to extend credit but an indication of the amount of
credit the FHLB is willing to extend to a member. The FHLB monitors each
members credit availability on a periodic basis and may make adjustments to
the credit availability as needed. The amount of a members credit availability
is contingent upon a number of factors, including, but not limited to,
continued financial soundness of the member, and adequacy of the amount of
qualifying collateral available to secure new and outstanding advances. 
Qualifying collateral may include various types of mortgage loans, securities,
and deposits.  The member has certain obligations to the FHLB for its pledged
collateral. These obligations include periodic reporting on eligible, pledged
collateral and adherence to the FHLBs collateral verification review
procedures.  The FHLB has established an
overall credit limit for each member. Generally, this credit limit is 40
percent of the members total assets. However, a members eligibility to borrow
in excess of 30 percent of assets is subject to its meeting eligibility
criteria.  40 
   Table of Contents     The FHLB may provide funding in
large amounts to banks primarily through two types of funding to commercial
banks: collateralized advances and uncollateralized investments.  At June 30,
2007, the Company had approximately $23.5 million available credit based on
qualifying loans to serve as collateral against short-term borrowings,
long-term borrowings, and / or letters of credit from the FHLB.  See Part I, Item 1. Financial
Statements, Consolidated Statements of Cash Flows contained herein to review factors that impacted
liquidity during the periods presented.  See Borrowings for
further discussion regarding the Companys short-term and long-term borrowings.  Lending Commitments  The Company enters into agreements, in the normal course of
business, to extend credit to meet the financial needs of its customers. See Off-Balance Sheet Arrangements below for
further discussion regarding the potential impact the Companys lending
commitments could have on liquidity at June 30, 2007.  Other  During
the second quarter of 2007, in conjunction with the audit of the Companys
benefit plans, a discrepancy was discovered with regard to a definition in the
benefit plans legal plan document and the definition as consistently applied
by the Company in practice. Management is
currently exploring options for resolution of the discrepancy and is analyzing
any potential participant and / or financial statement impact.   At the time of
this filing, the impact of this discrepancy could not be reasonably estimated.  Off-Balance Sheet
Arrangements  In the normal course of
business, the Company engages in a variety of financial transactions that, in
accordance with generally accepted accounting principles, are not recorded in its
financial statements or are recorded in amounts that differ from the notional
amounts.  These transactions involve elements of credit, interest rate, and
liquidity risk.  The Companys
off-balance sheet arrangements principally include lending commitments,
guarantees, and derivatives.  Lending Commitments  In the normal course of
business, the Company makes contractual commitments to extend credit that are
legally binding agreements to lend money to customers at predetermined interest
rates for a specific period of time. The Company also provides standby letters
of credit. The Companys credit policies and standards are applied when making
these types of commitments. These instruments are not recorded until funds are
advanced under the commitments. The
Companys contractual commitments to extend credit increased slightly
from $265.8 million at December 31, 2006 to $266.6 million at June 30, 2007. The following table summarizes the Companys contractual
commitments to extend credit, by
collateral type, at June 30, 2007 (in thousands).  Commercial and industrial
  $
  25,964Real estate
  
  177,034Credit line
  
  7,663Bankcards
  
  43,508Others
  
  12,406Total contractual
  commitments to extend credit
  $
  266,575
  Guarantees  At June
30, 2007, the Company recorded no liability for the current carrying amount of
the obligation to perform as a guarantor, and no contingent liability was
considered necessary as such amounts were not considered material.  The maximum
potential amount of undiscounted future payments related to standby letters of
credit at June 30, 2007 was $9.2 million compared with $8.3 million at December
31, 2006.  Past experience indicates that these standby letters of credit will
expire unused. However, through its various sources of liquidity, the Company
believes that it has the necessary resources available to meet these
obligations should the need arise.  Additionally,
the Company does not believe that the current fair market value of such
guarantees was material at June 30, 2007.  41 
   Table of Contents     Other Off-Balance Sheet Arrangements  At
June 30, 2007, the Company engaged in no
transactions, agreements, or other contractual arrangements to which an entity
unconsolidated with the Company is a party, under which the Company has:  Any
     obligation under a guarantee contract;  A
     retained or contingent interest in assets transferred to an unconsolidated
     entity or similar arrangement that serves as credit, liquidity or market
     risk support to such entity for such assets;  Any
     obligation under a contract that would be accounted for as a derivative
     instrument considering exceptions; or  Any
     obligation arising out of a variable interest in an unconsolidated entity
     that is held by, and material to, the Company, where such entity provides
     financing, liquidity, market risk or credit risk support to, or engages in
     leasing, hedging or research and development services with, the Company.  Derivatives and Hedging Activities  At June 30, 2007, the Companys derivative instruments
consisted of forward sales commitments relating to the Companys commitments to
originate certain residential loans held for sale.  Outstanding commitments on mortgage loans not yet closed
(primarily single-family loan commitments) amounted to approximately $1.6
million at June 30, 2007 compared to approximately $3.8 million at December 31,
2006.  The fair market value of derivative assets related to commitments to
originate such residential loans held for sale was not significant at June 30,
2007.  The fair market value of derivative assets related to forward sales
commitments did not significantly differ from the carrying amount at June 30,
2007. The decrease in forward sales commitments during the first six months was
the result of the Companys decision to retain more residential loans in its
in-house portfolio during the period.  Earnings Review For the Three Months Ended June 30, 2007  Overview. The following information is intended to supplement
any information relating to the Consolidated Statements of Income contained
within Part I, Item 1 of this Quarterly Report on Form 10-Q. 42 
   Table of Contents  PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Income(dollars in thousands, except common and
  per share data)For the three month periodsended June 30,
  
  Variance2007
  
  2006
  
  $
  
  %(unaudited)Interest incomeInterest and fees
  on loans
  
  $
  19,301
  
  17,115
  
  
  2,186
  
  12.8Interest on
  investment securities available for sale
  
  1,130
  
  1,215
  
  
  (85)
  
  (7.0)Interest on
  federal funds sold
  
  
  227
  
  393
  
  
  (166)
  
  (42.2)Dividends on FHLB
  stock
  
  
  38
  
  46
  
  
  (8)
  
  (17.4)Total interest
  income
  
  
  20,696
  
  18,769
  
  
  1,927
  
  10.3Interest expenseInterest on
  deposits
  
  
  7,437
  
  6,029
  
  
  1,408
  
  23.4Interest on
  retail repurchase agreements
  
  130
  
  177
  
  
  (47)
  
  (26.6)Interest on
  commercial paper
  
  
  289
  
  206
  
  
  83
  
  40.3Interest on other
  short-term borrowings
  
  54
  
  16
  
  
  38
  
  237.5Interest on
  long-term borrowings
  
  78
  
  173
  
  
  (95)
  
  (54.9)Total interest
  expense
  
  
  7,988
  
  6,601
  
  
  1,387
  
  21.0Net interest
  income
  
  12,708
  
  12,168
  
  
  540
  
  4.4Provision for
  loan losses
  
  
  433
  
  525
  
  
  (92)
  
  (17.5)Net interest
  income after provision for loan losses
  
  12,275
  
  11,643
  
  
  632
  
  5.4Noninterest
  incomeService charges
  on deposit accounts
  
  1,991
  
  2,042
  
  
  (51)
  
  (2.5)Fees for trust
  and brokerage services
  
  826
  
  847
  
  
  (21)
  
  (2.5)Mortgage-banking
  income
  
  
  171
  
  275
  
  
  (104)
  
  (37.8)Investment
  securities gains
  
  
  -
  
  1
  
  
  (1)
  
  (100.0)Other
  
  
  
  
  877
  
  811
  
  
  66
  
  8.1Total noninterest
  income
  
  3,865
  
  3,976
  
  
  (111)
  
  (2.8)Noninterest expenseSalaries and
  other personnel
  
  
  6,057
  
  5,709
  
  
  348
  
  6.1Occupancy
  
  
  
  379
  
  371
  
  
  8
  
  2.2Furniture and
  equipment
  
  
  422
  
  438
  
  
  (16)
  
  (3.7)Premises and
  equipment leases and rentals
  
  335
  
  331
  
  
  4
  
  1.2Premises and
  equipment depreciation
  
  480
  
  519
  
  
  (39)
  
  (7.5)Marketing
  
  
  
  219
  
  332
  
  
  (113)
  
  (34.0)Amortization of
  core deposit intangibles
  
  12
  
  12
  
  
  -
  
  -Other
  
  
  
  
  1,967
  
  2,373
  
  
  (406)
  
  (17.1)Total noninterest
  expense
  
  9,871
  
  10,085
  
  
  (214)
  
  (2.1)Net income before
  provision for income taxes
  
  6,269
  
  5,534
  
  
  735
  
  13.3Provision for
  income taxes
  
  
  2,204
  
  1,803
  
  
  401
  
  22.2Net income
  
  $
  4,065
  
  3,731
  
  
  334
  
  9.0Common and Per
  Share DataNet Income -
  basic
  
  $
  0.64
  
  0.59
  
  
  0.05
  
  8.5Net Income -
  diluted
  
  
  0.63
  
  0.58
  
  
  0.05
  
  8.6Cash dividends
  
  
  0.19
  
  0.18
  
  
  0.01
  
  5.6Book value
  
  
  
  16.49
  
  14.73
  
  
  1.76
  
  11.9Weighted average
  common shares outstanding - basic
  
  6,385,483
  
  6,354,888Weighted average
  common shares outstanding - diluted
  
  6,499,649
  
  6,429,759
  Net Interest Income. Net interest income is the difference between
interest and fees on interest-earning assets, primarily loans and investment
securities, and interest paid on interest-bearing deposits and other
interest-bearing liabilities.  This measure represents the largest component of
earnings for the Company. The net interest margin measures how effectively the
Company manages the difference between the yield on interest-earning assets and
the rate paid on funds to support those assets. Balances of interest-earning
assets and successful management of the net interest margin determine the level
of net interest income. Changes in interest rates earned on interest-earning
assets and interest rates paid on interest-bearing liabilities, the rate of
growth of the asset and liability base, the ratio of interest-earning assets to
interest-bearing liabilities, and the management of interest rate sensitivity
factor into changes in net interest income.  The following table summarizes the Companys average balance
sheets and net interest income analysis for the periods indicated (dollars in
thousands). The Company's yield on interest-earning assets and cost of
interest-bearing liabilities shown in the table are derived by dividing
interest income and expense by the average balances of interest-earning assets
or interest-bearing liabilities. The following table does not include a
tax-equivalent adjustment to net interest income adjusting the yield for
interest-earning assets earning tax-exempt income to a comparable yield on a
taxable basis.   43 
   Table of Contents For the three month periods ended June 30,2007
  
  2006Average
  Income/
  Yield/
  
  Average
  Income/
  Yield/Balance
  Expense
  Rate
  
  Balance
  Expense
  RateASSETSInterest-earnings assetsLoans, net of unearned (1)
  $            968,985
  $         19,301
  7.99
  %
  $            880,061
  $     17,115
  7.80
  %Investment securities
  available for sale, nontaxable (2)
  50,729
  452
  3.57
  
  54,751
  496
  3.63Investment securities
  available for sale, taxable (2)
  57,030
  678
  4.77
  
  66,302
  719
  4.35Federal funds sold
  19,054
  227
  4.78
  
  29,869
  393
  5.28FHLB stock
  2,525
  38
  6.04
  
  3,106
  46
  5.94Total interest-earning assets
  1,098,323
  20,696
  7.56
  
  1,034,089
  18,769
  7.28Noninterest-earning assetsCash and due from banks
  29,073
  
  
  
  44,193Allowance for loan losses
  (8,443)
  
  
  
  (8,743)Premises and equipment, net
  24,982
  
  
  
  23,432Goodwill
  3,688
  
  
  
  3,688Other intangible assets
  109
  
  
  
  156Accrued interest receivable
  5,873
  
  
  
  5,049Other
  
  12,642
  
  
  
  12,625Total noninterest-earning
  assets
  67,924
  
  
  
  80,400Total assets
  $         1,166,247
  
  
  
  $         1,114,489LIABILITIES AND
  SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
  liabilitiesTransaction and money
  market deposit accounts
  $            463,322
  $           3,447
  2.98
  %
  $            380,615
  $       2,150
  2.27
  %Savings deposit accounts
  41,950
  36
  0.34
  
  46,535
  38
  0.33Time deposit accounts
  361,285
  3,954
  4.39
  
  393,891
  3,841
  3.91Total interest-bearing deposits
  866,557
  7,437
  3.44
  
  821,041
  6,029
  2.95Retail repurchase
  agreements
  12,442
  130
  4.19
  
  17,196
  177
  4.13Commercial paper (Master
  notes)
  26,804
  289
  4.32
  
  20,401
  206
  4.05Other short-term borrowings
  3,570
  54
  6.07
  
  1,135
  7
  2.47Long-term borrowings
  8,242
  78
  3.80
  
  20,571
  182
  3.55Total interest-bearing
  liabilities
  917,615
  7,988
  3.49
  
  880,344
  6,601
  3.01Noninterest-bearing
  liabilitiesNoninterest-bearing
  deposits
  134,599
  
  
  
  134,161Accrued interest payable
  2,468
  
  
  
  2,212Other
  
  6,342
  
  
  
  4,147Total noninterest-bearing
  liabilities
  143,409
  
  
  
  140,520Total liabilities
  1,061,024
  
  
  
  1,020,864Shareholders' equity
  105,223
  
  
  
  93,625Total liabilities and
  shareholders' equity
  $         1,166,247
  
  
  
  $         1,114,489NET INTEREST INCOME / NET
  YIELD ONINTEREST-EARNING ASSETS
  
  $         12,708
  4.64
  %
  
  $     12,168
  4.72
  %(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 loansand deposits are domestic.(2)
  The average balances for
  investment securities include the unrealized gain or loss recorded for
  available for sale securities.  44
   Table of Contents   During the three month period ended June 30, 2007 compared with
the same period of 2006, the Company experienced increases in both average
yield on interest-earning assets and average cost of interest-bearing
liabilities. The average yield on interest-earning assets increased 28 basis
points to 7.56% during the second quarter of 2007 from 7.28% during the same
period of 2006. The average cost of interest-bearing liabilities increased 48
basis points to 3.49% from 3.01% when comparing the same periods. Average
interest-earning assets increased $64.2 million during the quarter ended June
30, 2007 over the same quarter of 2006, primarily within the loan portfolio,
while interest-bearing liabilities increased $37.3 million over the same
period. Rates paid during the three and six
month periods ended June 30, 2007 increased from those paid for the three and
six month periods ended June 30, 2006. The primary reason for this
change is increases in the federal funds rate by the Federal Reserve Open
Market Committee.  The following rate / volume
analysis summarizes the dollar amount of changes in interest income and
interest expense attributable to changes in volume and the amount attributable
to changes in rate when comparing the three month period ended June 30, 2007 to
the three month period ended June 30, 2006 (in thousands).  The impact of the combination
of rate and volume change has been divided equally between the rate change and
volume change.  For the three month period ended June 30,2007 compared with the three month periodended June 30, 2006Volume
  
  Rate
  
  TotalInterest-earnings
  assetsLoans, net of
  unearned
  $
  1,763
  
  423
  
  2,186Investment
  securities available for sale
  
  (143)
  
  58
  
  (85)Federal funds
  sold
  
  (132)
  
  (34)
  
  (166)FHLB stock
  
  (9)
  
  1
  
  (8)Total
  interest-earning assets
  $
  1,479
  
  448
  
  1,927Interest-bearing
  liabilitiesInterest-bearing
  deposits
  $
  348
  
  1,060
  
  1,408Retail repurchase
  agreements
  
  (50)
  
  3
  
  (47)Commercial paper
  
  68
  
  15
  
  83Other short-term
  borrowings
  
  28
  
  19
  
  47Long-term
  borrowings
  
  (118)
  
  14
  
  (104)Total
  interest-bearing liabilities
  $
  276
  
  1,111
  
  1,387NET INTEREST
  INCOME
  $
  1,203
  
  (663)
  
  540
  Provision
for Loan Losses.
The Companys process for determining an appropriate
level for the Allowance is based on a comprehensive, well-documented, and
consistently applied analysis of its loan portfolio. As discussed in Financial Condition, Allowance
for Loan Losses, all significant factors
that affect the collectibility of the portfolio and support the credit losses
estimated are considered during this process. Once this monthly process is
completed, a provision for loan losses is
charged to earnings in order to maintain the Allowance at a level adequate to provide for estimated probable losses
in the loan portfolio.  The
provision for loan losses was $433 thousand and $535 thousand for the three
month periods ended June 30, 2007 and 2006.  The percentage of allowance for
loan losses was reduced to 0.86% of gross loans, excluding mortgage loans held
for sale, outstanding at June 30, 2007 from 1.00% at June 30, 2006.
See Financial Condition,
Allowance for Loan Losses and Financial Condition, Loans contained herein for a
discussion regarding theCompanys
accounting policies related to, factors impacting, and methodology for
analyzing the adequacy of the Companys Allowance and the related provision for
loan losses.  Noninterest Income.  Noninterest income during the three month period
ended June 30, 2007 decreased $111 thousand, or 2.8%, to $3.9 million from $4.0
million during the three month period ended June 30, 2006 due to decreases in
all noninterest income financial statement line items except other noninterest
income.  The Company sells most of the
residential mortgage loans it originates in the secondary market with servicing
rights retained. Mortgage loans serviced for the benefit of others amounted to
$330.2 million, $325.1 million, and $312.8 million at June 30, 2007, December
31, 2006, and June 30, 2006, respectively.  Mortgage-banking income
decreased $104 thousand, or 37.8%, during the three month period ended June 30,
2007 over the three month period ended June 30, 2006 primarily as a result of
increased amortization, impairment, and recoveries between the periods. The
following table summarizes the components of mortgage-banking income for the
periods indicated (in thousands). 45 
   Table of Contents      For the three monthperiods ended June 30,2007
  2006Mortgage-servicing
  fees
  $
  206
  192Gain on sale of
  loans
  
  157
  132Mortgage-serciving
  right amortization, impairment, and recoveries
  
  (234)
  (104)Other
  mortgage-banking income
  
  42
  55Total
  mortgage-banking income
  $
  171
  275
  See Part I, Item 1. Financial
Statements, Note 6 contained herein for a further discussion regarding
the Companys mortgage-servicing rights portfolio.  Noninterest Expense.  Noninterest expense during the three month period
ended June 30, 2007 decreased $214 thousand, or 2.1%, to $9.9 million from
$10.1 million during the three month period ended June 30, 2006. This decrease
resulted primarily from decreases in marketing and other noninterest expense
offset by an increase in salaries and other personnel expense.  Comprising 61.4% of noninterest
expense during the three month period ended June 30, 2007 and 56.6% of
noninterest expense during the three month period ended June 30, 2006, salaries
and other personnel expense increased by $348 thousand to $6.1 million during
the three month period ended June 30, 2007 from $5.7 million during the three
month period ended June 30, 2006. The majority of the increase in salaries and
other personnel expense resulted from annual merit raises for employees and
officers and the addition of new officer positions including those positions
created in connection with the opening of the new Boiling Springs banking
office during 2006.  Marketing and advertising expense decreased $113
thousand during the three month period ended June 30, 2007 compared with
the three month period ended June 30, 2006 primarily due to marketing costs
during the second quarter of 2006 in preparation of the Companys 100-year anniversary celebration.  Other noninterest expense decreased $406 thousand during
second quarter of 2007 when compared with the same quarter of 2006.  This
decrease was the result of an accumulation of changes in several accounts, none
of which were determined to be unusual or infrequent events or transactions or
due to any significant economic changes that materially impacted the amount of
reported income from continuing operations.  Provision
for Income Taxes. Income tax expense
totaled $2.2 million for the three month period ended June 30, 2007 compared
with $1.8 million for the three month period ended June 30, 2006.  The
Company's effective tax rate was 35.2% during the 2007 period and 32.6% during
the 2006 period.   In the
Companys Annual Report on Form 10-K for the year ended December 31, 2006, the
Company reported that it anticipated the effective income tax rate applicable
to current taxable income to approximate between 34% and 36% for 2007. Since December 31, 2006, there have been no events or
conditions that management believes would change this projection.  For the Six Months Ended June 30, 2007  Overview. The following information is intended to supplement
any information relating to the Consolidated Statements of Income contained
within Part I, Item 1 of this Quarterly Report on Form 10-Q. 46 
   Table of Contents      PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Income(dollars in thousands, except common and
  per share data)For the six month periodsended June 30,
  
  Variance2007
  
  2006
  
  $
  
  %(unaudited)Interest incomeInterest and fees
  on loans
  
  $
  38,067
  
  33,568
  
  4,499
  
  13.4Interest on
  investment securities available for sale
  
  2,301
  
  2,464
  
  (163)
  
  (6.6)Interest on
  federal funds sold
  
  
  451
  
  586
  
  (135)
  
  (23.0)Dividends on FHLB
  stock
  
  
  75
  
  99
  
  (24)
  
  (24.2)Total interest
  income
  
  
  40,894
  
  36,717
  
  4,177
  
  11.4Interest expenseInterest on
  deposits
  
  
  14,664
  
  11,263
  
  3,401
  
  30.2Interest on
  retail repurchase agreements
  
  276
  
  351
  
  (75)
  
  (21.4)Interest on
  commercial paper
  
  
  527
  
  344
  
  183
  
  53.2Interest on other
  short-term borrowings
  
  83
  
  114
  
  (31)
  
  (27.2)Interest on
  long-term borrowings
  
  173
  
  382
  
  (209)
  
  (54.7)Total interest
  expense
  
  
  15,723
  
  12,454
  
  3,269
  
  26.2Net interest
  income
  
  25,171
  
  24,263
  
  908
  
  3.7Provision for
  loan losses
  
  
  800
  
  1,050
  
  (250)
  
  (23.8)Net interest
  income after provision for loan losses
  
  24,371
  
  23,213
  
  1,158
  
  5.0Noninterest
  incomeService charges
  on deposit accounts
  
  3,899
  
  4,028
  
  (129)
  
  (3.2)Fees for trust
  and brokerage services
  
  1,522
  
  1,628
  
  (106)
  
  (6.5)Mortgage-banking
  income
  
  
  519
  
  497
  
  22
  
  4.4Investment
  securities gains
  
  
  -
  
  3
  
  (3)
  
  (100.0)Other
  
  
  
  
  1,757
  
  1,723
  
  34
  
  2.0Total noninterest
  income
  
  7,697
  
  7,879
  
  (182)
  
  (2.3)Noninterest
  expenseSalaries and
  other personnel
  
  
  12,194
  
  11,484
  
  710
  
  6.2Occupancy
  
  
  
  749
  
  754
  
  (5)
  
  (0.7)Furniture and
  equipment
  
  
  903
  
  935
  
  (32)
  
  (3.4)Premises and
  equipment leases and rentals
  
  625
  
  646
  
  (21)
  
  (3.3)Premises and
  equipment depreciation
  
  986
  
  1,022
  
  (36)
  
  (3.5)Marketing
  
  
  
  487
  
  738
  
  (251)
  
  (34.0)Amortization of
  core deposit intangibles
  
  24
  
  24
  
  -
  
  -Other
  
  
  
  
  4,045
  
  4,548
  
  (503)
  
  (11.1)Total noninterest
  expense
  
  20,013
  
  20,151
  
  (138)
  
  (0.7)Net income before
  provision for income taxes
  
  12,055
  
  10,941
  
  1,114
  
  10.2Provision for
  income taxes
  
  
  4,229
  
  3,560
  
  669
  
  18.8Net income
  
  $
  7,826
  
  7,381
  
  445
  
  6.0Common and Per
  Share DataNet Income -
  basic
  
  $
  1.23
  
  1.17
  
  0.06
  
  5.1Net Income -
  diluted
  
  
  1.21
  
  1.15
  
  0.06
  
  5.2Cash dividends
  
  
  0.38
  
  0.36
  
  0.02
  
  5.6Book value
  
  
  
  16.49
  
  14.73
  
  1.76
  
  11.9Weighted average
  common shares outstanding - basic
  
  6,382,019
  
  6,349,099Weighted average
  common shares outstanding - diluted
  
  6,480,454
  
  6,423,970
  Net Interest Income.  The following
table summarizes the Companys average balance sheets and net interest income
analysis for the periods indicated (dollars in thousands).   47 
   Table of Contents  For the six month periods ended June 30,2007
  
  2006Average
  Income/
  Yield/
  
  Average
  Income/
  Yield/Balance
  Expense
  Rate
  
  Balance
  Expense
  RateASSETSInterest-earnings assetsLoans, net of unearned (1)
  $          960,302
  $     38,067
  7.99
  %
  $            874,118
  $            33,568
  7.74
  %Investment securities
  available for sale, nontaxable (2)
  49,251
  876
  3.59
  
  54,979
  993
  3.64Investment securities
  available for sale, taxable (2)
  61,334
  1,425
  4.69
  
  68,493
  1,471
  4.33Federal funds sold
  18,262
  451
  4.98
  
  24,377
  586
  4.85FHLB stock
  2,560
  75
  5.91
  
  3,269
  99
  6.11Total interest-earning assets
  1,091,709
  40,894
  7.55
  
  1,025,236
  36,717
  7.22Noninterest-earning assetsCash and due from banks
  30,332
  
  
  
  39,463Allowance for loan losses
  (8,435)
  
  
  
  (8,638)Premises and equipment, net
  24,925
  
  
  
  23,255Goodwill
  3,688
  
  
  
  3,688Other intangible assets
  115
  
  
  
  163Accrued interest receivable
  5,916
  
  
  
  5,078Other
  
  13,273
  
  
  
  12,726Total noninterest-earning
  assets
  69,814
  
  
  
  75,735Total assets
  $       1,161,523
  
  
  
  $         1,100,971LIABILITIES AND
  SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
  liabilitiesTransaction and money
  market deposit accounts
  $          455,404
  $       6,627
  2.93
  %
  $            365,361
  $              3,745
  2.07
  %Savings deposit accounts
  42,066
  70
  0.34
  
  46,138
  73
  0.32Time deposit accounts
  369,372
  7,967
  4.35
  
  394,822
  7,445
  3.80Total interest-bearing deposits
  866,842
  14,664
  3.41
  
  806,321
  11,263
  2.82Retail repurchase
  agreements
  13,154
  276
  4.23
  
  18,204
  351
  3.89Commercial paper (Master
  notes)
  24,540
  527
  4.33
  
  18,221
  344
  3.81Other short-term borrowings
  2,807
  83
  5.96
  
  4,857
  114
  4.73Long-term borrowings
  9,116
  173
  3.83
  
  21,779
  382
  3.54Total interest-bearing
  liabilities
  916,459
  15,723
  3.46
  
  869,382
  12,454
  2.89Noninterest-bearing
  liabilitiesNoninterest-bearing
  deposits
  132,857
  
  
  
  132,898Accrued interest payable
  2,469
  
  
  
  2,097Other
  
  6,058
  
  
  
  4,155Total noninterest-bearing
  liabilities
  141,384
  
  
  
  139,150Total liabilities
  1,057,843
  
  
  
  1,008,532Shareholders' equity
  103,680
  
  
  
  92,439Total liabilities and
  shareholders' equity
  $       1,161,523
  
  
  
  $         1,100,971NET INTEREST INCOME / NET
  YIELD ONINTEREST-EARNING ASSETS
  
  $     25,171
  4.65
  %
  
  $            24,263
  4.77
  %(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 loansand deposits are domestic.(2)
  The average balances for
  investment securities include the unrealized gain or loss recorded for
  available for sale securities.  48 
   Table of Contents    During the six month period ended June 30, 2007 compared with the
same period of 2006, the Company experienced increases in both average yields
on interest-earning assets and average cost of interest-bearing liabilities.
The average yield on interest-earning assets increased 33 basis points to 7.55%
during the six month period ended June 30, 2007 from 7.22% during the same
period of 2006. The average cost of interest-bearing liabilities increased 57
basis points to 3.46% from 2.89% when comparing the same periods. Average
interest-earning assets increased $66.5 million during the six month period
ended June 30, 2007 over the same period of 2006, primarily within the loan
portfolio, while interest-bearing liabilities increased $47.1 million over the
same period. Rates paid during the three
and six month periods ended June 30, 2007 increased from those paid for the
three and six month periods ended June 30, 2006. The primary reason for
this change is increases in the federal funds rate by the Federal Reserve Open
Market Committee.  The following rate / volume
analysis summarizes the dollar amount of changes in interest income and
interest expense attributable to changes in volume and the amount attributable
to changes in rate when comparing the six month period ended June 30, 2007 to
the six month period ended June 30, 2006 (in thousands).  The impact of the
combination of rate and volume change has been divided equally between the rate
change and volume change.  For the six month period ended June 30,2007 compared with the six month periodended June 30, 2006Volume
  
  Rate
  
  TotalInterest-earnings
  assetsLoans, net of
  unearned
  $
  3,390
  
  1,109
  
  4,499Investment
  securities available for sale
  
  (276)
  
  113
  
  (163)Federal funds
  sold
  
  (151)
  
  16
  
  (135)FHLB stock
  
  (21)
  
  (3)
  
  (24)Total
  interest-earning assets
  $
  2,942
  
  1,235
  
  4,177Interest-bearing
  liabilitiesInterest-bearing
  deposits
  $
  892
  
  2,509
  
  3,401Retail repurchase
  agreements
  
  (110)
  
  35
  
  (75)Commercial paper
  
  131
  
  52
  
  183Other short-term
  borrowings
  
  (83)
  
  52
  
  (31)Long-term
  borrowings
  
  (243)
  
  34
  
  (209)Total
  interest-bearing liabilities
  $
  587
  
  2,682
  
  3,269NET INTEREST
  INCOME
  $
  2,355
  
  (1,447)
  
  908
  Provision
for Loan Losses.
The provision for loan losses was $800 thousand and
$1.1 million for the six-month periods ended June 30, 2007 and 2006.  The
percentage of allowance for loan losses was reduced to 0.86% of gross loans,
excluding mortgage loans held for sale, outstanding at June 30, 2007 from 1.00%
at June 30, 2006. See
Financial Condition, Allowance for Loan Losses and Financial Condition, Loans
contained herein for a discussion regarding theCompanys accounting policies related to, factors impacting, and
methodology for analyzing the adequacy of the Companys Allowance and the
related provision for loan losses.  Noninterest Income. Noninterest income during the six
month period ended June 30, 2007 decreased $182 thousand, or 2.3%, to $7.7
million from $7.9 million during the six month period ended June 30, 2006 due
to changes in several accounts, none of which constituted material
fluctuations.  Noninterest Expense.  Noninterest expense during the six month period
ended June 30, 2007 decreased $138 thousand, or 0.7%, to $20.0 million from
$20.2 million during the six month period ended June 30, 2006. This decrease
resulted primarily from decreases in marketing and other noninterest expense
offset by an increase in salaries and other personnel expense.  Comprising 60.9% of noninterest
expense during the six month period ended June 30, 2007 and 57.0% of
noninterest expense during the six month period ended June 30, 2006, salaries
and other personnel expense increased by $710 thousand to $12.2 million during
the six month period ended June 30, 2007 from $11.5 million during the six
month period ended June 30, 2006. The majority of the increase in salaries and
other personnel expense resulted from annual merit raises for employees and
officers and the addition of new officer positions including those positions
created in connection with the opening of the new Boiling Springs banking
office during 2006.  Marketing and advertising expense decreased $251
thousand during the six month period ended June 30, 2007 compared with
the six month period ended June 30, 2006 primarily due to marketing costs
during the second quarter of 2006 in preparation of the Companys 100-year anniversary celebration.  49 
   Table of Contents      Other noninterest expense decreased $503 thousand during the
six month period ended June 30, 2007 when compared with the same period of
2006.  During the second quarter of 2006, as a result of a software upgrade, the Company experienced a temporary delay in check processing and electronic check processing.  At December 31, 2006, the Bank had exposure of, and reserved for in Other Noninterest Expense in the Consolidated Statements of Income, approximately $174 thousand related to items uncollected at that date.  At the end of the first quarter of 2007, the Bank believed it had collected virtually all of these items.  As such, this reserve was reversed within other noninterest expense during the first quarter of 2007. Although items have continued to settle since the first quarter of 2007, the Company believes that the items will net to an immaterial amount when settlement is completed.  As such, no reserve was recorded in its financial statements at June 30, 2007.  The remaining decrease in other noninterest expense was the
result of an accumulation of changes in several accounts, none of which were
determined to be unusual or infrequent events or transactions or due to any
significant economic changes that materially impacted the amount of reported
income from continuing operations.  Provision
for Income Taxes. Income tax expense
totaled $4.2 million for the six month period ended June 30, 2007 compared with
$3.6 million for the six month period ended June 30, 2006.  The Companys
effective tax rate was 35.1% during the 2007 period and 32.5% during the 2006
period.In the Companys Annual Report on Form 10-K for the
year ended December 31, 2006, the Company reported that it anticipated the
effective income tax rate applicable to current taxable income to approximate
between 34% and 36% for 2007. Since December
31, 2006, there have been no events or conditions that management believes
would change this projection.  Accounting and Reporting Matters  See Part I, Item
1. Financial Statements, Note 1 contained
herein for further discussion regarding recently adopted and recently
issued accounting pronouncements and their expected impact on the Company.  Item 3.  Quantitative
and Qualitative Disclosures about Market Risk  The Company has risk management
policies and systems which attempt to monitor and limit exposure to interest
rate risk. Specifically, the Company manages its exposure to fluctuations in
interest rates through policies established by its Asset / Liability Committee
and approved by its Board of Directors. The primary goal of the Asset /
Liability Committee is to monitor and limit exposure to interest rate risk
through implementation of various strategies. While the Asset / Liability
Committee considers these strategies to ultimately position the balance sheet to minimize fluctuations in
income associated with interest rate risk, it also monitors the Companys
liquidity and capital positions to ensure that its strategies result in
adequate capital positions. The Companys primary source of capital has
been the retention of net income. In order to ensure adequate levels of
capital, an ongoing assessment is conducted of projected sources and uses of
capital in conjunction with projected increases in assets and the level of
risk. Management believes it has adequate capital to meet its needs without
entering capital markets.  Market risk sensitive
instruments are generally defined as derivatives and other financial
instruments. At June 30, 2007, the Company had not used any derivatives to
alter its interest rate risk profile. The Companys financial instruments
include loans, federal funds sold, FHLB stock, investment securities, deposits,
and borrowings. At June 30, 2007, the Companys interest-sensitive assets
totaled approximately $1.1 billion while interest-sensitive liabilities totaled
approximately $929.0 million. At December 31, 2006, the Companys
interest-sensitive assets totaled approximately $1.1 billion while
interest-sensitive liabilities totaled approximately $911.4 million.  The yield on interest-sensitive
assets and the cost of interest-sensitive liabilities for the three month
period ended June 30, 2007 was 7.58% and 3.49%, respectively, compared to 7.28%
and 3.01%, respectively, for the same period of 2006. The yield on
interest-sensitive assets and the cost of interest-sensitive liabilities for
the six month period ended June 30, 2007 was 7.57% and 3.46%, respectively,
compared to 7.22% and 2.89%, respectively, for the same period of 2006. The
increase in the yield on interest-sensitive assets and the cost of interest-sensitive
liabilities during both the three and six month periods ended June 30, 2007
over the same periods of 2006 resulted primarily from  increases in the federal
funds rate by the Federal Reserve Open Market Committee. 50 
   Table of Contents      The
Company evaluated the results of its net interest income simulation prepared as
of June 30, 2007 for interest rate risk management purposes. Overall, the model
results indicate that the Companys interest rate risk sensitivity is within
limits set by the Companys guidelines and the
Companys balance sheet is liability sensitive. A liability sensitive balance
sheet suggests that in falling interest rate environment, net interest margin
would increase and during an increasing interest rate environment, net interest
margin would decrease.  Net Interest Income Simulation  The following table summarizes
forecasted net interest income and net interest margin as of June 30, 2007
using a base market rate and the estimated change to the base scenario given
upward and downward movement in interest rates of 100 basis points and 200
basis points (dollars in thousands).  NetinterestmarginAdjusted
  Percentage
  
  Net
  
  changenet interest
  change from
  
  interest
  
  (in basisInterest rate
  scenario
  income
  base
  
  margin
  
  points)Up 200 basis
  points
  $
  49,930
  (4.27)
  %
  4.52
  %
  (0.20)Up 100 basis
  points
  
  52,111
  (0.08)
  
  4.72
  
  -BASE CASE
  
  52,155
  -
  
  4.72
  
  -Down 100 basis
  points
  
  56,086
  7.54
  
  5.08
  
  0.36Down 200 basis
  points
  
  57,860
  10.94
  
  5.24
  
  0.52
   The simulation results as of
June 30, 2007 indicate the Companys interest rate risk position was liability
sensitive as the simulated impact of a downward movement in interest rates of
100 basis points would result in a 7.54% increase in net interest income over
the subsequent 12 month period while an upward movement in interest rates of
100 basis points would result in a 0.08% decrease in net interest income over
the next 12 months. The simulation results indicate that a 100 basis point
downward shift in interest rates would result in a 36 basis point increase in
net interest margin, assuming all other variables remained unchanged.
Conversely, a 100 basis point increase in interest rates would cause no change
in net interest margin. The projected negative impact on the Companys net
interest income for the twelve month period does not exceed the 20% threshold
prescribed by the Asset  Liability Committees policy.  Item 4. Controls and Procedures  Evaluation of
Disclosure Controls and Procedures  An evaluation of the Companys disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities
Exchange Act of 1934) was carried out under the supervision and with the
participation of the Companys Chief Executive Officer, the President and Chief
Operating Officer (Principal Financial Officer) and several other members of
the Companys senior management as of June 30, 2007, the last day of the period
covered by this Quarterly Report. The Companys Chief Executive Officer and the
President and Chief Operating Officer (Principal Financial Officer) concluded
that the Companys disclosure controls and procedures were effective as of June
30, 2007 in ensuring that the information required to be disclosed by the
Company in 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 Chief Executive Officer and the President and Chief Operating Officer
(Principal Financial Officer)) in a timely manner, and is (ii) recorded,
processed, summarized, and reported within the time periods specified in the
SECs rules and forms.  During the second quarter of 2007, the Company did not make any changes
in its internal controls over financial reporting that has materially affected
or is reasonably likely to materially affect those controls.  51 
   Table of Contents     PART II  OTHER
INFORMATION  Any item which is inapplicable or to which the answer is
negative has been omitted and no reference thereto has been made in this
report.  Item 1. Legal Proceedings  See Part I, Item 1. Financial
Statements, Note 14 contained herein for a discussion of the information
required by this item.  Item 4. 
Submission of Matters to a Vote of Security Holders  The Company'sAnnual
	Meeting of Shareholders was held on April 17, 2007.  4,591,962 shares
	were voted of the 6,379,805 shares of $5 par value common stock entitled to
	vote at the Annual Shareholders' Meeting.  Proposal #1 - Election of Directors. 
	The Board of Directors is divided into three classes. At each Annual Meeting
	of Shareholders, the Company's shareholders elect the members of one of the
	three classes to three-year terms. At this Annual Meeting, four directors
	were nominated for reelection for terms expiring at the 2010 Annual Meeting
	of Shareholders and three Directors were nominated for terms expiring ateach of the 2008, 2009, and 2010 Annual Meeting of
	Shareholders. The nominees included Jane S. Sosebee who was appointed to a
	Board term expiring at the 2008 Meeting by action of the Board of Directors
	in September 2006, L. Stewart Spinks who was appointed to a Board term
	expiring at the 2009 Meeting by action of the Board of Directors in June
	2006 to fill the vacancy created by the death of
	William S. Moore, II during the first
	quarter of 2005,and
	Albert V. Smithwho
	was appointed to a Board term expiring at the 2010 Meeting by action of the
	Board of Directors in September 2006.  Annual Meeting of Shareholders at Which TermExpires
			Number of Votes
			For
			Number of Votes
			WithheldJane S. Sosebee
			2008
			4,591,662
			300L. Stewart Spinks
			2009
			4,591,062
			900Albert V. Smith
			2010
			4,443,799
			148,163Michael D. Glenn
			2010
			4,590,428
			1,534Ann B. Smith
			2010
			4,591,662
			300W. Fred Davis, Jr.
			2010
			4,577,637
			14,325David P. George, Jr.
			2010
			4,586,278
			5,684  The following directors' term of office
	continued after the meeting: John T. Gramling, II, John D. Hopkins, Jr., L.
	Leon Patterson, Sam B. Phillips, Jr., E. Keith Snead, III, Paul W. Stringer,
	and J. David Wasson, Jr.
   Item 6.  Exhibits  10.1         Lease
Agreement dated as of May 2, 2007, by and between The Palmetto Bank and Charles
E. Howard and Doris H. Howard (incorporated by reference from Exhibit 10.1 of
Palmetto Bancshares Inc.s Current Report on Form 8-K filed on June 26, 2007)
(File no. 000-26016). 31.1         L.
Leon Patterson's Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 31.2         Paul
W. Stringer's Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 32            Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  Exhibits 31.1, 31.2, and 32 have been filed with
the Securities and Exchange Commission in conjunction with this Quarterly
Report on Form 10-Q. Copies of these exhibits are available upon written
request to Lauren S. Greer, The Palmetto Bank, Post Office Box 49, Laurens,
South Carolina 29360.    52 
       SIGNATURES    Pursuant to
the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.    PALMETTO
BANCSHARES, INC.    /s/     
L. Leon Patterson L. Leon
Patterson Chairman and
Chief Executive Officer    /s/     
Paul W. Stringer Paul W.
Stringer President
and Chief Operating Officer (Principal
Financial Officer)   Dated:   August 9, 2007    53