|U. S. SECURITIES AND EXCHANGE COMMISSION                                                                                                                                                                                                                                                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|WASHINGTON, D.C. 20549                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                 
|FORM 10-Q                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                 
|(X)                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                 
|For the quarterly period ended March 31, 2007                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                 
|OR                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                 
|(  )                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                 
|For the transition period from __________ to
  __________                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                 
|Commission file number  0-26016                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                 
|PALMETTO BANCSHARES, INC.                                                                                                                                                                                                                                                                                                                                                        
|(Exact name of registrant as specified in its
  charter)                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                 
|South Carolina                                                                                                                                                                                                                                                                                                                                                                   
|(State or other jurisdiction of incorporation or
  organization)                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
|301 Hillcrest Drive, Laurens, South Carolina                                                                                                                                                                                                                                                                                                                                     
|(Address of principal executive offices)                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                 
|(864) 984-4551                                                                                                                                                                                                                                                                                                                                                                   
|(Registrant's telephone number)                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                 
|Indicate by check mark
  whether the registrant (1) has filed all reports required to be filed by
  Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
	preceding 12 months (or for such shorter period that the registrant was
  required to file such reports), and (2) has been subject to such filing
  requirements for the past 90 days. Yes
  X   No __
|                                                                                                                                                                                                                                                                                                                                                                                 
|Indicate by check mark
  whether the registrant is a large accelerated filer, an accelerated filer, or
  a non-accelerated filer. 
  See definition of "accelerated filer and large accelerated filer"
  in Rule 12b-2 of the Exchange Act.                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
|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.                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
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PALMETTO
  BANCSHARES, INC. AND SUBSIDIARYTable of
  ContentsPART I.  FINANCIAL INFORMATIONItem 1.
  Financial Statements
  1Item 2.
  Management's Discussion and Analysis of Financial
  Condition andResults of Operations
  19Item 3.
  Quantitative and Qualitative Disclosures about Market Risk
  42Item 4.
  Controls and Procedures
  42PART II.  OTHER INFORMATIONItem 1.
  Legal Proceedings
  43Item 1a.
  Risk Factors
  43Item 2.
  Unregistered Sales of Equity Securities and Use of
  Proceeds
  43Item 3.
  Defaults Upon Senior Securities
  43Item 4.
  Submission of Matters to a Vote of Security Holders
  43Item 5.
  Other Information
  43Item 6.
  Exhibits
  43SIGNATURES
  44







PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

PALMETTO BANCSHARES, INC. AND
			SUBSIDIARYConsolidated Balance Sheets(dollars in thousands, except common
			and per share data)March 31,
			
			December 31,2007
			
			2006(unaudited)ASSETSCash and cash equivalentsCash and due from banks
			$
			30,463
			
			43,084Federal funds sold
			
			35,090
			
			3,582Total cash and cash equivalents
			
			65,553
			
			46,666Federal Home Loan Bank ("FHLB") stock,
			at cost
			
			2,527
			
			2,599Investment securities available for
			sale, at fair market value
			107,072
			
			116,567Mortgage loans held for sale
			
			4,211
			
			1,675Loans
			
			954,221
			
			945,913Less: allowance for loan losses
			
			(8,460)
			
			(8,527)Loans, net
			
			945,761
			
			937,386Premises and equipment, net
			
			25,002
			
			24,494Goodwill
			
			3,691
			
			3,691Other intangible assets
			
			114
			
			126Accrued interest receivable
			
			5,960
			
			6,421Other
			
			13,606
			
			13,511Total assets
			$
			1,173,497
			
			1,153,136LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
			$
			138,771
			
			133,623Interest-bearing
			
			878,931
			
			859,958Total deposits
			
			1,017,702
			
			993,581Retail repurchase agreements
			
			9,905
			
			14,427Commercial paper (Master notes)
			
			24,275
			
			20,988Federal funds purchased
			
			-
			
			6,000FHLB borrowings - long-term
			
			10,000
			
			100,000Accrued interest payable
			
			1,551
			
			1,584Other
			
			6,889
			
			6,180Total liabilities
			
			1,070,322
			
			1,052,760Commitments and contingencies (Note 14)Shareholders' EquityCommon stock - par value $5.00 per
			share;  authorized 10,000,000shares; issued and outstanding 6,381,960
			and 6,367,450at March 31, 2007 and December 31, 2006,
			respectively
			31,910
			
			31,837Capital surplus
			
			1,248
			
			1,102Retained earnings
			
			70,680
			
			68,132Accumulated other comprehensive loss,
			net of tax
			
			(663)
			
			(695)Total shareholders' equity
			
			103,175
			
			100,376Total liabilities and shareholders'
			equity
			$
			1,173,497
			
			1,153,136See Notes to Consolidated Interim
			Financial Statements.




1




|PALMETTO BANCSHARES, INC. AND SUBSIDIARY                  
|----------------------------------------------------------
|Consolidated Statements of Income                         
|(dollars in thousands, except common and
		per share data)
|                                                          
|                                                          
|                                                          
|                                                          
|Interest income                                           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
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|                                                          
|                                                          
|                                                          
|Interest expense                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Provision for loan losses                                 
|                                                          
|                                                          
|                                                          
|Noninterest income                                        
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Noninterest expense                                       
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Provision for income taxes                                
|                                                          
|                                                          
|                                                          
|Common and Per Share Data                                 
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|See Notes to Consolidated Interim Financial
		Statements. 

2


|PALMETTO
		BANCSHARES, INC. AND SUBSIDIARY                                           
|-------------------------------------------------------------------------------------
|Consolidated Statements of Changes in
		Shareholders' Equity and Comprehensive Income
|(dollars in thousands, except common and
		per share data)                           
|(unaudited)                                                                          
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Balance at December 31, 2005                                                         
|                                                                                     
|Net income                                                                           
|Other comprehensive income, net of tax:                                              
|Unrealized holding
		gains arising during period, net                                
|of tax effect of $127                                                                
|Plus: 
		reclassification adjustment included                                        
|in net income, net of tax effect of $1                                               
|Net unrealized
		gains on securities                                                 
|                                                                                     
|Comprehensive income                                                                 
|                                                                                     
|Cash dividend declared and paid ($0.18 per
		share)                                  
|Compensation expense related to stock
		options                                      
|Exercise of stock options                                                            
|                                                                                     
|Balance at March 31, 2006                                                            
|                                                                                     
|Balance at December 31, 2006                                                         
|                                                                                     
|Net income                                                                           
|Other comprehensive income, net of tax:                                              
|Unrealized holding
		gains arising during period, net                                
|of tax effect of $20                                                                 
|Plus: 
		reclassification adjustment included                                        
|in net income, net of tax effect of $0                                               
|Net unrealized
		gains on securities                                                 
|                                                                                     
|Comprehensive income                                                                 
|                                                                                     
|Cash dividend declared and paid ($0.19 per
		share)                                  
|Compensation expense related to stock
		options                                      
|Exercise of stock options                                                            
|                                                                                     
|Balance at March 31, 2007                                                            
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|See Notes to Consolidated Interim Financial
		Statements.                            

3


PALMETTO
  BANCSHARES, INC. AND SUBSIDIARYConsolidated
  Statements of Cash Flows(in thousands)For the three
  month periods 
	ended March 31,2007
  
  2006(unaudited)Cash flows from operating activitiesNet income
  $      3,761
  
  3,650Adjustments to reconcile net income to net cashprovided by operating activitiesDepreciation, amortization, and accretion, net
  551
  
  487Investment securities gains
  -
  
  (2)Provision for loan losses
  367
  
  525Origination of mortgage loans held for sale
  (15,513)
  
  (13,487)Proceeds from sale of mortgage loans held for sale
  13,155
  
  15,620Gain on sale of mortgage loans
  (178)
  
  (158)Compensation expense related to stock options granted
  33
  
  24Loss on disposition of other real estate owned
  166
  
  114Increase (decrease) of other assets, net
  700
  
  (1,610)Increase (decrease) of other liabilities, net
  656
  
  (1,405)Net cash provided by operating activities
  3,698
  
  3,758Cash flows from investing activitiesPurchase of investment securities available for sale
  (5,659)
  
  (8,544)Maturities, redemption, calls, and principal repayment of
  investment securities available for sale
  15,173
  
  5,182Proceeds from sales of investment securities available for
  sale
  -
  
  4,128Redemption of FHLB stock, net
  72
  
  602Origination of loans, net
  (9,243)
  
  4,942Proceeds on sale of other real estate owned
  1
  
  931Purchases of premises and equipment
  (1,014)
  
  (930)Net cash used in investing activities
  (670)
  
  6,311Cash flows from financing activitiesDeposits, net
  24,121
  
  45,677(Decrease) increase of retail repurchase agreements, net
  (4,522)
  
  997Increase in commercial paper, net
  3,287
  
  231(Decrease) of federal funds purchased, net
  (6,000)
  
  (1,000)(Decrease) of other short-term borrowings, net
  -
  
  (16,900)Other common stock activity
  186
  
  291Cash dividends paid on common stock
  (1,213)
  
  (1,143)Net cash provided by financing activities
  15,859
  
  28,153Net increase of cash and cash equivalents
  18,887
  
  38,222Cash and cash equivalents, beginning of the period
  46,666
  
  37,976Cash and cash equivalents, end of the period
  $     65,553
  
  76,198Supplemental Cash Flow DataCash paid during the period forInterest expense
  $      7,768
  
  5,727Income taxes
  8
  
  1,649Significant noncash investing and financing activities(Decrease) increase of unrealized loss on investment
  securities available for sale
  $         (52)
  
  332Loans transferred to other real estate owned, at fair
  market value
  501
  
  52See Notes to
  Consolidated Interim Financial Statements.




4




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 month period ended March 31, 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 2006, but subsequent to the first quarter
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.

The following table summarizes the Company's
Consolidated Statements of Income for the three month period ended March 31,
2006 as reported prior to these reclassifications (in thousands).



5




Noninterest incomeService charges on deposit accounts
			$
			2,058Fees for trust and brokerage services
			
			781Mortgage-banking income
			
			222Investment securities gains
			
			2Other
			
			
			919Total noninterest income
			
			3,982Noninterest expenseSalaries and other personnel
			
			5,775Net occupancy
			
			692Furniture and equipment
			
			1,006Marketing and advertising
			
			456Postage and supplies
			
			389Telephone
			
			213Professional services
			
			221Other
			
			
			1,393Total noninterest expense
			
			10,145Net noninterest expense
			$
			6,163


Recently Adopted Accounting Pronouncements

In March 2006, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No.
156, "*Accounting for Servicing of Financial Assets-an amendment of FASB
Statement No. 140."*This Statement amends SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," with respect to the accounting for separately recognized servicing
assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a servicing contract; requires all
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable; permits an entity to choose its
subsequent measurement methods for each class of separately recognized servicing
assets and servicing liabilities; at its initial adoption, permits a one-time
reclassification of available-for-sale securities to trading securities by
entities with recognized servicing rights, without calling into question the
treatment of other available-for-sale securities under SFAS No. 115, provided
that the available-for-sale securities are identified in some manner as
offsetting the entity's exposure to changes in fair value of servicing assets or
servicing liabilities that a servicer elects to subsequently measure at fair
value; and requires separate presentation of servicing assets and servicing
liabilities subsequently measured at fair value in a Company's statement of
financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. The required adoption date for SFAS
No. 156 was January 1, 2007. The adoption of SFAS No. 156 did not have a
material impact on the Company's financial position, results of operations, or
cash flows.

In July 2006, the FASB issued FASB Interpretation
No. ("FIN") 48, "Accounting for Uncertainty in Income Taxes." FIN No. 48
clarifies accounting for uncertainty in income taxes recognized in enterprises'
financial statements in accordance with SFAS No. 109, "Accounting for Income
Taxes." FIN No. 48 prescribes a recognition threshold and measurement
attributable for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN No. 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transitions. FIN No. 48 was effective for
fiscal years beginning after December 15, 2006. The adoption of FIN No. 48 did
not have a material impact on the Company's financial position, results of
operations, or cash flows.

Other 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 have a material impact on the
Company's financial position, results of operations or cash flows.

Recently Issued Accounting Pronouncements

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.

6




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.

In February 2007, the FASB issued SFAS No. 159,
"The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115." This statement permits, but
does not require, entities to measure many financial instruments at fair value.
The objective of this 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 that are
explicitly excluded as qualifying for fair value. With respect to SFAS No. 115,
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 a 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. The Company is
currently analyzing the fair value option that is permitted, but not required,
under SFAS No. 159.

Other accounting
standards have been issued or proposed by the FASB or other standards-setting
bodies that are not applicable to the Company's business.

2.       Cash and Cash Equivalents

The following table summarizes the composition of
cash and cash equivalents at the dates indicated (in thousands).

March 31,
			December 31,2007
			2006Cash working funds
			$
			8,112
			9,190Noninterest-earning demand deposits in
			other banks
			
			11,237
			23,511In-transit funds
			
			11,114
			10,383Interest-earning federal funds sold
			
			35,090
			3,582Total cash and cash equivalents
			$
			65,553
			46,666


The average outstanding federal funds sold for
the three month periods ended March 31, 2007 and 2006 were $17.5 million and
$18.8 million, respectively.  The average outstanding federal funds sold
for the year ended December 31, 2006 was $20.9 million. The maximum amount of
federal funds sold at any month-end during the three month periods ended March
31, 2007 and 2006 were $24.1 million and $28.6 million, respectively. The
maximum amount of federal funds sold at any month-end during the year ended
December 31, 2006 was $45.5 million.



7




The Company is
required to maintain average reserve balances computed by applying prescribed
percentages to its various types of deposits.  At March 31, 2007, the
Federal Reserve required that the Company maintain $9.7 million in reserve
balances.  These required reserves were met through vault cash.

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).

March 31, 2007Amortized 
			cost
			Gross 
			unrealized 
			gains
			Gross 
			unrealized 
			losses
			Fair
			market 
			valueGovernment-sponsored enterprises
			$
			33,394
			-
			(89)
			33,305State and municipal
			
			49,292
			36
			(908)
			48,420Mortgage-backed
			
			25,464
			105
			(222)
			25,347Total investment securities available
			for sale
			$
			108,150
			141
			(1,219)
			107,072December 31, 2006Amortized 
			cost
			Gross 
			unrealized 
			gains
			Gross 
			unrealized 
			losses
			Fair
			market 
			valueGovernment-sponsored enterprises
			$
			42,554
			-
			(171)
			42,383State and municipal
			
			48,780
			56
			(822)
			48,014Mortgage-backed
			
			26,362
			72
			(264)
			26,170Total investment securities available
			for sale
			$
			117,696
			128
			(1,257)
			116,567


During the three month period ended March 31,
2007, the Company had immaterial realized gains and losses on sales of
investment securities available for sale compared with realized gains of $24
thousand and realized losses amounting to $22 thousand during the three month
period ended March 31, 2006.  During the year ended December 31, 2006, the
Company had realized gains of $92 thousand and realized losses amounting to $58
thousand on sales of investment securities available for sale.

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 March 31, 2007 and December 31, 2006 (dollars in
thousands).

March 31, 2007Less than 12 months
			
			12 months or longer
			
			Total#
			Fair 
			market 
			value
			Gross 
			unrealized 
			losses
			
			#
			Fair 
			market 
			value
			Gross 
			unrealized 
			losses
			
			#
			Fair 
			market 
			value
			Gross 
			unrealized 
			lossesGovernment-sponsored enterprises
			5
			$   6,952
			$            
			3
			
			8
			26,353
			85
			
			13
			33,305
			88State and municipal
			5
			2,455
			19
			
			98
			37,734
			890
			
			103
			40,189
			909Mortgage-backed
			-
			-
			-
			
			30
			15,541
			222
			
			30
			15,541
			222Total investment securities available
			for sale
			10
			$   9,407
			$         
			22
			
			136
			79,628
			1,197
			
			146
			89,035
			1,219


December 31, 2006Less than 12 months
			
			12 months or longer
			
			Total#
			Fair 
			market 
			value
			Gross 
			unrealized 
			losses
			
			#
			Fair 
			market 
			value
			Gross 
			unrealized 
			losses
			
			#
			Fair 
			market 
			value
			Gross 
			unrealized 
			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 securities available
			for sale
			13
			$   7,878
			$         
			55
			
			131
			90,166
			1,202
			
			144
			98,044
			1,257




8


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.

Approximately 80% of the investment securities
portfolio was pledged to secure public deposits as of March 31, 2007 as compared
with 62% at December 31, 2006 and 86% at March 31, 2006.  Of the Company's
$107.1 million available for sale investment securities balance at March 31,
2007, $21.1 million was available as a liquidity source.

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).

March 31, 2007
			
			December 31, 2006Total
			
			% of Total
			
			Total
			
			% of TotalCommercial business
			$
			121,056
			
			12.7
			%
			112,264
			
			12.0Commercial real estate
			
			592,295
			
			62.4
			
			593,377
			
			63.2Installment
			
			22,221
			
			2.3
			
			22,139
			
			2.4Installment real estate
			
			66,391
			
			7.0
			
			66,161
			
			7.0Indirect
			
			45,392
			
			4.8
			
			43,634
			
			4.6Credit line
			
			1,906
			
			0.2
			
			1,982
			
			0.2Prime access
			
			52,294
			
			5.5
			
			53,883
			
			5.7Residential mortgage
			
			36,227
			
			3.8
			
			35,252
			
			3.7Bankcards
			
			11,191
			
			1.2
			
			11,813
			
			1.3Business manager
			
			275
			
			-
			
			370
			
			-Other
			
			1,657
			
			0.2
			
			1,793
			
			0.2Loans, unadjusted gross
			
			950,905
			
			100.1
			
			942,668
			
			100.3Loans in process
			
			2,658
			
			0.3
			
			2,587
			
			0.3Deferred loans fees and costs
			
			658
			
			0.1
			
			658
			
			0.1Loans, adjusted gross
			
			954,221
			
			100.5
			
			945,913
			
			100.7Mortgage loans held for sale
			
			4,211
			
			0.4
			
			1,675
			
			0.2Total loans, gross
			
			958,432
			
			100.9
			
			947,588
			
			100.9Allowance for loan losses
			
			(8,460
			)
			(0.9
			)
			(8,527
			)
			(0.9
			)Total loans, net
			$
			949,972
			
			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
$329.2 million, $325.1 million, and $310.0 million at March 31, 2007, December
31, 2006, and March 31, 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 $178 thousand and $158 thousand for
the three month periods ended March 31, 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).

March 31,
			December 31,
			March 31,2007
			2006
			2006Nonaccrual loans
			$
			12,137
			6,999
			7,526Loans past due 90 days and still
			accruing (1)
			
			243
			260
			159$
			12,380
			7,259
			7,685(1) Substantially all of these loans are
			bankcard loans


9


The following table summarizes the activity
impacting the allowance for loan losses ("Allowance") for the periods indicated
(in thousands).

|                               |                       | For the three month periods
|------------------------------ | --------------------- | ---------------------------
|                               |                       | ended March 31,            
|                               |                       |                            
|Allowance, beginning of period | $                     | 8,527                      
|Provision for loan losses      |                       | 367                        
|                               |                       |                            
|Loans charged-off              |                       | (530)                      
|Loan recoveries                |                       | 96                         
|                               | Net loans charged-off |                            
|                               |                       |                            
|Allowance, end of period       | $                     | 8,460                      
|                               |                       |                            

Troubled debt restructurings entered into by the
Company during the three month period ended March 31, 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 March 31, 2007, of its approximately $93
million qualifying loans available to serve as collateral against borrowings and
letters of credit from the FHLB, the Company pledged as collateral $79.0
million.

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).

|                  |                                                     | March 31, 2007   
|----------------- | --------------------------------------------------- | -----------------
|                  |                                                     |                  
|Loans secured by: |                                                     |                  
|                  | Commercial and industrial nonmortgage
		instruments | $                
|                  | Residential mortgage instruments                    |                  
|                  | Nonresidential mortgage instruments                 |                  
|                  |                                                     |                  
|                  |                                                     | December 31, 2006
|                  |                                                     |                  
|Loans secured by: |                                                     |                  
|                  | Commercial and industrial nonmortgage
		instruments | $                
|                  | Residential mortgage instruments                    |                  
|                  | Nonresidential mortgage instruments                 |                  
|                  |                                                     |                  

During the first
quarter of 2007, management performed several preliminary 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.

10




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 March 31,
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.

5.      
Premises and Equipment, Net

The following table summarizes the Company's
premises and equipment balances at the dates indicated (in thousands).

|                                          |                               |          | March 31, | December 31,
|----------------------------------------- | ----------------------------- | -------- | --------- | ------------
|                                          |                               |          | 2007      | 2006        
|Land                                      | $                             | 6,685    | 6,305    
|Buildings                                 |                               | 17,448   | 17,124   
|Leasehold impovements                     |                               | 2,848    | 2,847    
|Furniture and equipment                   |                               | 17,931   | 17,762   
|Software                                  |                               | 3,234    | 3,194    
|Bank automobiles                          |                               | 886      | 859      
|                                          | Premises and equipment, gross |          | 49,032    | 48,091      
|                                          |                               |          |           |             
|Accumulated depreciation and amortization |                               | (24,030) | (23,597) 
|                                          | Premises and equipment, net   | $        | 25,002    | 24,494      

At March 31, 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 quarter of 2007, the Company
added a new nonbanking office ATM location at Batesville Plaza Shopping Center
in Greenville County.

During 2006, the Company began an expansion of
its Greenwood county Montague banking office.  Construction on this office
was completed during the first quarter of 2007.

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
|----------------------------------------------- | ----------------------- | ------------------ | ---------------------------
|                                                |                         |                    | ended March 31,            
|                                                |                         |                    |                            
|Accumulated depreciation, beginning of
		period | $                       | 23,597             | 21,759                     
|                                                |                         |                    |                            
|Depreciation                                    |                         |                    |                            
|                                                | Buildings               |                    | 112                        
|                                                | Leasehold improvements  |                    | 40                         
|                                                | Furniture and equipment |                    | 247                        
|                                                | Software                |                    | 61                         
|                                                | Bank automobiles        |                    | 46                         
|                                                |                         | Total depreciation |                            
|                                                |                         |                    |                            
|Disposals                                       |                         | (73)               | -                          
|                                                |                         |                    |                            
|Accumulated depreciation, end of period         | $                       | 24,030             | 22,262                     
|                                                |                         |                    |                            

11


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 $329.2 million, $325.1 million, and $310.0 million
at March 31, 2007, December 31, 2006, and March 31, 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 periodsended March 31,2007
			
			2006Mortgage-servicing rights portfolio, net
			of valuationallowance, beginning of period
			$
			2,648
			
			2,626Capitalized mortgage-servicing rights
			
			203
			
			170Mortgage-servicing rights portfolio
			amortization
			
			(67)
			
			(282)Change in mortgage-servicing rights
			portfolio valuation allowance
			
			1
			
			114Mortgage-servicing rights portfolio, net
			of valuationallowance, end of period
			$
			2,785
			
			2,628Mortgage-servicing rights portfolio
			amortization as a percentage of themortgage-servicing rights portfolio,
			beginning of period, andcapitalized mortgage-servicing rights
			during the period
			
			9.5
			%
			10.7


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 March 31, 2007, December 31, 2006, and
March 31, 2006 was $2.8 million, $2.7 million, and 2.7 million , respectively.

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 periodsended March 31,2007
		2006Valuation allowance, beginning of period
		$
		4
		148Aggregate additions charged and reductions
		credited to operations
		
		(1)
		(114)Valuation allowance, end of period
		$
		3
		34


See Consolidated Statements of Cash Flows for a
further discussion of the activity impacting the Company's mortgage-servicing
rights portfolio.  12




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).

March 31,
			December 31,2007
			2006Goodwill
			$
			3,691
			3,691Customer list intangibles
			
			114
			127Total intagible assets
			$
			3,805
			3,818


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 periodsended March 31,2007
			2006Balance, at beginning of period
			$
			126
			175Less:
			amortization
			
			(12)
			(12)Balance, at end of period
			$
			114
			163


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

March 31,
		December 31,2007
		2006Customer list intangibles, gross
		$
		1,779
		1,779Less: accumulated
		amortization
		
		(1,665)
		(1,653)Customer list intangibles, net
		$
		114
		126


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, 2006
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,
2006 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).

March 31,
		December 31,2007
		2006Real estate acquired in settlement of loans
		$
		934
		600Repossessed automobiles acquired in
		settlement of loans
		
		332
		319Total property
		acquired in settlement of loans
		$
		1,266
		919


13


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 monthperiods ended March 31,2007
		2006Real estate acquired in settlement of loans,
		beginning of period
		$
		600
		1,954Add: New real estate acquired in settlement
		of loans
		
		501
		52Less: Sales / recoveries of real estate
		acquired in settlement of loans
		
		-
		(931)Less: Provision charged to expense
		
		(167)
		(143)Real estate acquired in settlement of loans,
		end of period
		$
		934
		932


Based on the Company's policies and procedures
regarding the regular review of fair market values of real estate acquired in
settlement of loans and writedowns taken accordingly, management believes that
the properties within the portfolio were properly valued at March 31, 2007.

9.      
Deposits

The following table summarizes the Company's
deposit composition at the dates indicated (in thousands).

March 31,
			December 31,2007
			2006Transaction deposit accounts
			$
			492,744
			447,236Money market deposit accounts
			
			113,689
			124,874Savings deposit accounts
			
			42,752
			41,887Time deposit accounts $100,000 and
			greater
			
			129,594
			126,880Time deposit accounts less than $100,000
			
			238,923
			252,704Total deposit accounts
			$
			1,017,702
			993,581


At March 31, 2007, $538 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 periodsended March 31,2007
			2006Transaction and money market deposit
			accounts
			$
			3,180
			1,595Savings deposit accounts
			
			34
			35Time deposit accounts
			
			4,013
			3,604Total interest expense on deposit
			accounts
			$
			7,227
			5,234


10.    Borrowings from the
Federal Home Loan Bank

At March 31, 2007, of its approximately $93
million available credit based on qualifying loans to serve as collateral
against short-term or long-term borrowings from the FHLB, the Company employed
$10.0 million in borrowings, all of which was determined to be long-term when
employed, and employed $69.0 million in a letter of credit used to secure public
deposits as required or permitted by law.

14




The following table summarizes FHLB
borrowing informationat and for the periods indicated (dollars in
thousands).

At and for the three monthperiods ended March 31,2007
			
			2006Short-term FHLB borrowingsAmount outstanding at period end
			$            
			-
			
			-Average amount outstanding during period
			-
			
			8,454Maximum amount outstanding at any period
			end
			-
			
			10,900Rate paid at period end
			-
			%
			-Weighted average rate paid during the
			period
			-
			
			5.04Long-term FHLB borrowingsAmount outstanding at period end
			$      10,000
			
			23,000Average amount outstanding during period
			10,000
			
			23,000Maximum amount outstanding at any period
			end
			10,000
			
			23,000Rate paid at period end
			3.85
			%
			3.53Weighted average rate paid during the
			period
			3.85
			
			3.53


Long-term borrowings are those having maturities
greater than one year when executed. The remaining long-term FHLB borrowing of
$10.0 million is scheduled to mature during the second quarter of 2007.

Management was not
aware of any circumstances at March 31, 2007 that would require prepayment of
any of the Company's FHLB advances. Additionally, none of the Company's
long-term FHLB advances outstanding at March 31, 2007 had embedded call options.

11.    Other Borrowings

The following table summarizes short-term
borrowing informationat and for the periods indicated (dollars in
thousands).

At and for the three monthperiods ended March 31,2007
			
			2006Retail repurchase agreementsAmount outstanding at period end
			$       
			9,905
			
			17,725Average amount outstanding during period
			13,874
			
			19,223Maximum amount outstanding at any period
			end
			12,771
			
			23,344Rate paid at period end
			3.63
			%
			3.13Weighted average rate paid during the
			period
			4.27
			
			3.67Commercial paperAmount outstanding at period end
			$      24,275
			
			18,146Average amount outstanding during period
			22,251
			
			16,017Maximum amount outstanding at any period
			end
			24,275
			
			18,146Rate paid at period end
			3.81
			%
			3.31Weighted average rate paid during the
			period
			4.34
			
			3.49Federal funds purchasedAmount outstanding at period end
			$            
			-
			
			-Average amount outstanding during period
			2,035
			
			166Maximum amount outstanding at any period
			end
			14,000
			
			3,000Rate paid at period end
			-
			%
			-Weighted average rate paid during the
			period
			5.78
			
			4.89*
			Rates paid are tiered based on level of
			deposit.  Rate presented represents the average rate for all
			tiers offered at year-end.


If needed, alternative funding sources have been
arranged through federal funds lines at correspondent banks and through the
Federal Reserve Discount Window.  At March 31, 2007, the Company had
additional funding sources totaling of $40 million that were accessible at the
Company's option.

15




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 periodsended March 31,2007
			2006Service cost
			$
			193
			141Interest cost
			
			226
			165Expected return on plan assets
			
			(314)
			(229)Amortization of prior service cost
			
			4
			3Amortization of loss
			
			27
			20Postretirement benefit expense, net
			$
			136
			100


Expected
Contributions. Contributions to Plan assets totaling $1.1 million are
expected during fiscal year 2007. Contributions during the first three months of
2007 totaled $275 thousand compared with $308 thousand during the first three
months of 2006.

Stock Option Plan

Stock Option Compensation
Expense.The compensation cost that was charged against pretax net income
during the first three months of 2007 for stock options was $33 thousand.

Stock
Option Activity. 14,510 stock options
with a weighted average exercise price of $12.81 were exercised during the
first three months of 2007.  Cash received from stock option exercises under
the Company's stock option plan for the three month period ended March 31, 2007
was $186 thousand.

401(k) Retirement Plan

During the three month periods ended March 31,
2007 and 2006, the Company made matching contributions to employee 401(k)
retirement plans totaling $78 thousand, and $69 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 periodsended March 31,2007
		2006Weighted average common shares outstanding -
		basic
		6,378,516
		6,343,247Dilutive impact resulting from potential
		common share issuances
		77,289
		100,755Weighted average common shares outstanding -
		diluted
		6,455,805
		6,444,002Per Share DataNet income - basic
		$           
		0.59
		0.58Net income - diluted
		0.58
		0.57


At March 31, 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 March 31, 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 January 2007,
the Company entered into a ground lease agreement for leased property at which
the Company will house a new ATM.  This ground lease is located in a market
area that the Company currently serves.

16




Lending Commitments

The Company's
contractual commitments to extend credit increased slightly from $265.8 million
at December 31, 2006 to $277.8 million at March 31, 2007.

Guarantees

At March 31, 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 March 31, 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 March 31, 2007.

Other Off-Balance Sheet Arrangements

At March 31, 2007,
the Company had no interest in unconsolidated special purpose entities nor was
it involved in other off-balance sheet contractual relationships, unconsolidated
related entities that have off-balance sheet arrangements, or transactions that
could result in liquidity needs (other than those discussed herein).

At March 31, 2007, of its approximately $93
million available credit based on qualifying loans to serve as collateral
against short-term or long-term borrowings from the FHLB, the Company employed
$10.0 million in borrowings, all of which was determined to be long-term when
employed and employed $69.0 million in a letter of credit. 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.

15.    Derivative Financial
Instruments and Hedging Activities

At March 31, 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 $8.8
million at March 31, 2007.  The fair market value of derivative assets
related to commitments to originate such residential loans held for sale and
forward sales commitments was not significant at March 31, 2007.

16.    Regulatory Capital
Requirements



At March 31, 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 March 31, 2007, there have been no events or
conditions that management believes would change these categories.





17






Actual
			For capital adequacy 
			purposes
			To be well capitalized under 
			prompt corrective 
			action provisionsamount
			ratio
			amount
			ratio
			amount
			ratioAt March 31, 2007Total capital to risk-weighted assetsCompany
			$
			108,215
			10.27%
			84,303
			8.00
			n/a
			n/aBank
			
			108,197
			10.27
			84,303
			8.00
			105,378
			10.00Tier 1 capital to risk-weighted
			assetsCompany
			
			99,755
			9.47
			42,151
			4.00
			n/a
			n/aBank
			
			99,737
			9.46
			42,151
			4.00
			63,227
			6.00Tier 1 capital to average assetsCompany
			
			99,755
			8.65
			46,107
			4.00
			n/a
			n/aBank
			
			99,737
			8.65
			46,121
			4.00
			57,651
			5.00At March 31, 2006Total capital to risk-weighted assetsCompany
			$
			97,278
			10.31%
			75,447
			8.00
			n/a
			n/aBank
			
			96,098
			10.19
			75,447
			8.00
			94,309
			10.00Tier 1 capital to risk-weighted
			assetsCompany
			
			88,551
			9.39
			37,724
			4.00
			n/a
			n/aBank
			
			87,371
			9.26
			37,724
			4.00
			56,586
			6.00Tier 1 capital to average assetsCompany
			
			88,551
			8.18
			43,310
			4.00
			n/a
			n/aBank
			
			87,371
			8.06
			43,338
			4.00
			54,173
			5.00


17.    Subsequent Events

During May 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 a write off of
approximately $400 thousand in leasehold improvements during the second 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.



18




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

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
month period ended March 31, 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.

General

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").  In
addition to retail offices, at March 31, 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.
Additionally, during the first quarter of 2007, the Company added a new
nonbanking office ATM location at Batesville Plaza Shopping Center in Greenville
County.  The Bank was organized and chartered under South Carolina law in
1906. Throughout this report, the "Company" shall refer to Palmetto Bancshares,
Inc. and its subsidiary, the Bank, which includes its brokerage subsidiary,
Palmetto Capital, Inc. ("Palmetto Capital"), except where the context requires
otherwise.

Forward-Looking Statements

The Company makes forward-looking statements in this
report and in other reports and proxy statements filed with the SEC.  In
addition, certain statements in future filings by the Company with the SEC, in
press releases, and in oral and written statements made by or with the approval
of the Company, which are not statements of historical fact, constitute
forward-looking statements. Because such statements discuss future events or
conditions, forward-looking statements often include words such as "anticipate,"
"believe," "estimate," "expect," "intend," "plan," "project," "target," "can,"
"could," "may," "should," "will," "would," or similar expressions.  Do not
unduly rely on forward-looking statements.  Such statements give
expectations about the Company's future and are not guarantees. 
Forward-looking statements speak only as of the date for which they are made,
and the Company might not update them to reflect changes that occur after the
date they are made.

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.

Other Information

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.



19




Impact of Inflation

The 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.

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 could be
significantly impacted by interest rate fluctuations.  Interest rates do
not necessarily move in the same direction or in the same magnitude as the price
of goods and services since such changes in interest rates are impacted by
inflation.  The Company intends to continue to actively manage the gap
between its interest-sensitive assets and liabilities.  See Disclosures
Regarding Market Risk contained herein for discussion regarding the relationship
of the Company's interest-sensitive assets and liabilities.

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.  In conjunction with that filing, 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.

Highlights

The following tables summarize the Company's
financial highlights at and for the dates indicated (dollars in thousands).









20




(dollars in thousands, except common and
			per share data)At and for the three monthperiods ended March 31,
			
			Dollar
			
			Percent2007
			
			2006
			
			Variance
			
			Variance(unaudited)SUMMARY OF EARNINGSInterest income
			$
			20,198
			
			17,948
			
			2,250
			
			12.5
			%Interest expense
			
			7,735
			
			5,853
			
			1,882
			
			32.2Net interest income
			
			12,463
			
			12,095
			
			368
			
			3.0Provision for loan losses
			
			367
			
			525
			
			(158)
			
			(30.1)Net interest income after provision for
			loan losses
			
			12,096
			
			11,570
			
			526
			
			4.5Noninterest income
			
			3,832
			
			3,903
			
			(71)
			
			(1.8)Noninterest expense
			
			10,142
			
			10,066
			
			76
			
			0.8Income before provision for income taxes
			
			5,786
			
			5,407
			
			379
			
			7.0Provision for income taxes
			
			2,025
			
			1,757
			
			268
			
			15.3Net income
			$
			3,761
			
			3,650
			
			111
			
			3.0
			%COMMON SHARE DATANet income:Basic
			$
			0.59
			
			0.58
			
			0.01
			
			1.7
			%Diluted
			
			0.58
			
			0.57
			
			0.01
			
			1.8Cash dividends
			
			0.19
			
			0.18
			
			0.01
			
			5.6Book value
			
			16.17
			
			14.42
			
			1.75
			
			12.1Outstanding shares
			
			6,381,960
			
			6,350,635
			
			31,325
			
			0.5Weighted average outstanding - basic
			
			6,378,516
			
			6,343,247
			
			35,269
			
			0.6Weighted average outstanding - diluted
			
			6,455,805
			
			6,444,002
			
			11,803
			
			0.2Dividend payout ratio
			
			32.24
			%
			31.32
			
			0.92
			
			2.9PERIOD-END BALANCESAssets
			$
			1,173,497
			
			1,153,136
			
			20,361
			
			1.8
			%Investment securities available for
			sale, at fair market value
			
			107,072
			
			116,567
			
			(9,495)
			
			(8.1)Loans (1)
			
			958,432
			
			947,588
			
			10,844
			
			1.1Deposits and borrowings
			
			1,061,882
			
			1,044,996
			
			16,886
			
			1.6Shareholders' equity
			
			103,175
			
			100,376
			
			2,799
			
			2.8AVERAGE BALANCESAssets
			$
			1,156,747
			
			1,087,303
			
			69,444
			
			6.4
			%Interest-earning assets
			
			1,085,022
			
			1,016,285
			
			68,737
			
			6.8Investment securities available for
			sale, at fair market value
			
			113,443
			
			125,918
			
			(12,475)
			
			(9.9)Loans (1)
			
			951,523
			
			868,109
			
			83,414
			
			9.6Deposits and borrowings
			
			1,046,386
			
			131,621
			
			914,765
			
			695.0Shareholders' equity
			
			102,120
			
			91,240
			
			10,880
			
			11.9SIGNIFICANT OPERATING RATIOS BASED ON
			EARNINGSReturn on average assets
			
			1.32
			%
			1.36
			
			(0.04)
			
			(2.9)
			%Return on average shareholders' equity
			
			14.94
			
			16.22
			
			(1.28)
			
			(7.9)Net interest margin
			
			4.66
			
			4.83
			
			(0.17)
			
			(3.5)(1) Calculated using loans including
			mortgage loans held for sale, net of unearned, excluding the
			allowance for loan losses




21




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)March 31,
			
			December 31,
			
			Dollar
			
			Percent2007
			
			2006
			
			variance
			
			varianceASSETSCash and cash equivalentsCash and due from banks
			$             
			30,463
			
			43,084
			
			(12,621)
			
			(29.3)
			%Federal funds sold
			35,090
			
			3,582
			
			31,508
			
			879.6Total cash and cash equivalents
			65,553
			
			46,666
			
			18,887
			
			40.5Federal Home Loan Bank ("FHLB") stock,
			at cost
			2,527
			
			2,599
			
			(72)
			
			(2.8)Investment securities available for
			sale, at fair market value
			107,072
			
			116,567
			
			(9,495)
			
			(8.1)Mortgage loans held for sale
			4,211
			
			1,675
			
			2,536
			
			151.4Loans
			
			
			954,221
			
			945,913
			
			8,308
			
			0.9Less: allowance for loan losses
			(8,460)
			
			(8,527)
			
			67
			
			(0.8)Loans, net
			945,761
			
			937,386
			
			8,375
			
			0.9Premises and equipment, net
			25,002
			
			24,494
			
			508
			
			2.1Goodwill
			
			
			3,691
			
			3,691
			
			-
			
			-Other intangible assets
			114
			
			127
			
			(13)
			
			(10.2)Accrued interest receivable
			5,960
			
			6,421
			
			(461)
			
			(7.2)Other
			
			
			13,606
			
			13,510
			
			96
			
			0.7Total assets
			$          
			1,173,497
			
			1,153,136
			
			20,361
			
			1.8
			%LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
			$              
			138,771
			
			133,623
			
			5,148
			
			3.9
			%Interest-bearing
			878,931
			
			859,958
			
			18,973
			
			2.2Total deposits
			1,017,702
			
			993,581
			
			24,121
			
			2.4Retail repurchase agreements
			9,905
			
			14,427
			
			(4,522)
			
			(31.3)Commercial paper (Master notes)
			24,275
			
			20,988
			
			3,287
			
			15.7Federal funds purchased
			-
			
			6,000
			
			(6,000)
			
			(100.0)FHLB borrowings - long-term
			10,000
			
			10,000
			
			-
			
			-Accrued interest payable
			1,551
			
			1,584
			
			(33)
			
			(2.1)Other
			
			
			6,889
			
			6,180
			
			709
			
			11.5Total liabilities
			1,070,322
			
			1,052,760
			
			17,562
			
			1.7Shareholders' EquityCommon stock
			31,910
			
			31,837
			
			73
			
			0.2Capital surplus
			1,248
			
			1,102
			
			146
			
			13.2Retained earnings
			70,680
			
			68,132
			
			2,548
			
			3.7Accumulated other comprehensive loss,
			net of tax
			(663)
			
			(695)
			
			32
			
			(4.6)Total shareholders' equity
			103,175
			
			100,376
			
			2,799
			
			2.8Total liabilities and shareholders'
			equity
			$          
			1,173,497
			
			1,153,136
			
			20,361
			
			1.8
			%


Federal Home Loan Bank ("FHLB") System

The Bank, as a member of the Federal Home Loan
Bank, is required to acquire and hold shares of capital stock in that Federal
Home Loan Bank.   A member's FHLB capital stock requirement is an
amount equal to the sum of a membership requirement and an activity-based
requirement as described in the FHLB's Capital Plan.  The Bank was in
compliance with this requirement with an investment in Federal Home Loan Bank
stock at March 31, 2007 of $2.5 million. Dividends on FHLB capital stock have
yielded returns of 5.8% and 6.3% for the three month periods ended March 31,
2007 and 2006, respectively.  Although it does not provide borrowing
capacity, a member's capital stock is pledged to the FHLB as additional
collateral to secure the member's indebtedness.

Investment Securities Available for Sale

Investment securities available for sale totaled
$107.1 million at March 31, 2007, a decrease of $9.5 million, or 8.1%, when
compared with December 31, 2006.  Average balances of available for sale
investment securities decreased from $125.9 million during the three months
ended March 31, 2006 to $113.4 million during the same period of 2007. The
following table summarizes the composition of the Company's investment
securities available for sale portfolio at the dates indicated (dollars in
thousands).

March 31, 2007
			
			December 31, 2006Total
			% of Total
			
			Total
			% of TotalGovernment-sponsored enterprises
			$
			33,305
			31.1%
			
			42,383
			36.4State and municipal
			
			48,420
			45.2
			
			48,014
			41.2Mortgage-backed
			
			25,347
			23.7
			
			26,170
			22.4Total investment securities available
			for sale
			$
			107,072
			100.0%
			
			116,567
			100.0


At March 31, 2007,
the investment security portfolio represented 9.1% of total assets, a decline
from 10.1% at December 31, 2006. The decline in the total investment securities
portfolio of approximately 8.1% from December 31, 2006 to March 31, 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 three month period
ended March 31, 2007.



22




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 three month period ended March 31, 2007.

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 March 31, 2007 (dollars in thousands).

Amortized 
			Cost
			% of GSEs
			
			Fair market
 value
			% of GSEsGovernment-sponsored enterprisesFHLB
			$
			20,442
			61.2
			%
			20,384
			61.2FHLMC
			
			11,970
			35.9
			
			11,951
			35.9FNMA
			
			982
			2.9
			
			970
			2.9$
			33,394
			100.0
			%
			33,305
			100.0Amortized 
			Cost
			% of MBSs
			
			Fair market 
			value
			% of MBSsMortgage-backedFHLMC
			$
			8,538
			33.5
			%
			8,415
			33.2FNMA
			
			16,926
			66.5
			
			16,932
			66.8$
			25,464
			100.0
			%
			25,347
			100.0Amortized Cost
			% of portfolio 
			amortized cost
			
			Fair market 
			value
			% of portfolio 
			fair market 
			valueTotal GSEs and MBSsFHLB
			$
			20,442
			18.9
			%
			20,384
			19.0FHLMC
			
			20,508
			19.0
			
			20,366
			19.0FNMA
			
			17,908
			16.5
			
			17,902
			16.7$
			58,858
			54.4
			%
			58,652
			54.7


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.

Loans

General.  Loans represent the most
significant component of the Company's interest-earning assets with average
loans accounting for 87.7% and 85.4% of average interest-earning assets during
the first three months of 2007 and 2006, respectively.  The following table
summarizes the Company's loan portfolio, by collateral type, at the dates
indicated (dollars in thousands).

March 31, 2007
		
		December 31, 2006Total
		% of Total
		
		Total
		% of TotalCommercial and industrial
		$
		135,004
		14.1
		%
		126,742
		13.4Real estate - 1 - 4 family
		
		201,320
		21.0
		
		171,828
		18.1Real estate - construction
		
		26,469
		2.8
		
		19,959
		2.1Real estate - other
		
		505,623
		52.7
		
		540,869
		57.1Total loans secured by real estate
		
		733,412
		76.5
		
		732,656
		77.3General consumer
		
		72,917
		7.6
		
		70,502
		7.4Credit line
		
		4,961
		0.5
		
		4,868
		0.5Bankcards
		
		11,191
		1.2
		
		11,813
		1.3Others
		
		947
		0.1
		
		1,007
		0.1Total loans
		$
		958,432
		100.0
		%
		947,588
		100.0


23


During the first
quarter of 2007, management performed several preliminary 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.

The following table summarizes loans, by loan
purpose, excluding those mortgage loans held for sale, by classification at the
dates indicated (dollars in thousands).

March 31, 2007
		
		December 31, 2006Total
		% of Total
		
		Total
		% of TotalCommercial business
		$
		121,056
		12.7
		%
		112,264
		12.0Commercial real estate
		
		592,295
		62.4
		
		593,377
		63.2Installment
		
		22,221
		2.3
		
		22,139
		2.4Installment real estate
		
		66,391
		7.0
		
		66,161
		7.0Indirect
		
		45,392
		4.8
		
		43,634
		4.6Credit line
		
		1,906
		0.2
		
		1,982
		0.2Prime access
		
		52,294
		5.5
		
		53,883
		5.7Residential mortgage
		
		36,227
		3.8
		
		35,252
		3.7Bankcards
		
		11,191
		1.2
		
		11,813
		1.3Business manager
		
		275
		-
		
		370
		-Other
		
		1,657
		0.2
		
		1,793
		0.2Loans, unadjusted gross
		
		950,905
		100.1
		
		942,668
		100.3Loans in process
		
		2,658
		0.3
		
		2,587
		0.3Deferred loans fees and costs
		
		658
		0.1
		
		658
		0.1Loans, adjusted gross
		
		954,221
		100.5
		
		945,913
		100.7Mortgage loans held for sale
		
		4,211
		0.4
		
		1,675
		0.2Total loans, gross
		
		958,432
		100.9
		
		947,588
		100.9Allowance for loan losses
		
		(8,460)
		(0.9)
		
		(8,527)
		(0.9)Total loans, net
		$
		949,972
		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 a decline in commercial real
estate loans as a percentage of the total portfolio.

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.



24






March 31,
		
		December 31,2007
		
		2006Real estate
		$
		11,507
		
		6,271Commercial and industrial
		
		530
		
		549Credit cards
		
		-
		
		-Other consumer
		
		100
		
		179Total nonaccrual loans
		
		12,137
		
		6,999Real estate acquired in settlement of loans
		
		934
		
		600Repossessed automobiles
		
		332
		
		319$
		13,403
		
		7,918Loans past due 90 days and still accruing
		(1)
		$
		243
		
		260Ending loans (2)
		$
		954,221
		
		945,913Nonaccrual loans as a percentage of loans
		(2)
		
		1.27
		%
		0.74Nonperforming assets as a percentage oftotal assets
		
		1.14
		%
		0.69Allowance for loan losses to nonaccrualloans
		
		0.70
		%
		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


Overall, nonaccrual loans increased $5.1 million
from December 31, 2006 to March 31, 2007 primarily with regard to loans secured
by real estate.  Management believes that the increase in nonaccrual loans
at March 31, 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
March 31, 2007, the principal balance of these loans totaled $5.3 million. 
Management believes the collateral securing these loans is sufficient to cover
the Company's exposure.  Excluding the impact of these loans, virtually all
other nonaccrual comparisons remained relatively unchanged from December 31,
2006 to March 31, 2007.  In its consideration of collectibility of
nonaccrual loans, management takes into consideration, among other factors, that
94.8% of nonaccrual loans at March 31, 2007 were secured by real estate. In the
event of foreclosure, management believes losses would be offset by funds
received through the liquidation of the underlying real estate collateral.

Troubled debt
restructurings entered into by the Company for the years ended December 31, 2006
and December 31, 2005 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 loan losses ("Allowance") for the
applicable period.

As of March 31, 2007, management was aware of no
other potential problem loans that were not already categorized as nonaccrual,
past due, or restructured, 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.

Through the Company's regular reviews of the
facets of its loan portfolio, management determines whether any loans require
classification in accordance with applicable regulations.  As such, the
Company's believes that loans are appropriately classified.



25




The following table summarizes the composition of
the Company's classified assets by collateral type at the dates indicated (in
thousands).

March 31, 2007Special 
		mention
		Substandard
		Doubtful
		Loss
		TotalCommercial and industrial
		$
		320
		1,115
		838
		-
		2,273Real estate
		
		1,584
		17,940
		842
		-
		20,366General consumer
		
		17
		300
		34
		-
		351Credit line
		
		6
		30
		1
		-
		37Total classified
		loans
		$
		1,927
		19,385
		1,715
		-
		23,027Total classified loans, unadjusted, as a percentage of total loans (1)
		2.4%Total classified loans, adjusted, as a percentage of total loans (1)
		1.9%December 31, 2006Special 
		mention
		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 $6.0 million
from December 31, 2006 to March 31, 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. Management believes that the increase in
classified assets, from both the portfolio and classification perspectives, at
March 31, 2007 over December 31, 2006 does not indicate a deterioration of asset
quality as the increase 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 as discussed previously in conjunction with the increase
in nonaccrual loans over the same periods. In accordance with the Company's
Lending Policy, the loans were downgraded to "substandard." At March 31, 2007,
the principal balance of these loans totaled $5.3 million.  Management
believes the collateral securing these loans is sufficient to cover the
Company's exposure.  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 March 31, 2007.

The following table summarizes the changes in the
allowances, 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 monthperiods ended March 31,2007
		2006Real estate acquired in settlement of loans,
		beginning of period
		$
		600
		1,954Add: New real estate acquired in settlement
		of loans
		
		501
		52Less: Sales / recoveries of real estate
		acquired in settlement of loans
		
		-
		(931)Less: Provision charged to expense
		
		(167)
		(143)Real estate acquired in settlement of loans,
		end of period
		$
		934
		932


See Part I, Item 1. Financial Statements, Note 8
contained herein for further discussion regarding the Company's real estate and
personal property acquired in settlement of loans.

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).



26




March 31, 2007Outstanding 
		balance
		
		As a percentage 
		of total equity
		
		As a percentage 
		of total loansLoans secured by:Commercial and industrial nonmortgage
		instruments
		$
		135,004
		
		131
		%
		14
		%Residential mortgage instruments
		
		201,320
		
		195
		
		21Nonresidential mortgage instruments
		
		505,623
		
		490
		
		53December 31, 2006Outstanding 
		balance
		
		As a percentage 
		of total equity
		
		As a percentage 
		of 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 three
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.

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 March 31,
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 for loan losses is established as
losses are estimated to have occurred through a provision for loan losses
charged to earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed. 
Subsequent recoveries, if any, are credited to the Allowance.

The Allowance is analyzed on a monthly basis by
management using an internal analysis model.  This evaluation is inherently
subjective, as it requires estimates that are susceptible to significant
revision as more information becomes available. On a quarterly basis, the
Company's Allowance model and conclusions are reviewed and approved by senior
management.

The Allowance consists of specific, general, and
unallocated components.  The specific component related to loans that are
classified as doubtful, substandard, or special mention.  For such loans
that are also classified as impaired, an allowance is established when the
discounted case flows of the impaired loan is lower that the carrying value of
that loan. The general component covers nonclassified loans and is based on
historical loss experience adjusted for qualitative factors.  An
unallocated component is maintained to cover uncertainties that could impact
management's estimate of probable losses.  The unallocated component of the
Allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.

In evaluating the adequacy of the allowance for loan
losses and determining the related provision for loan losses, if any, management
may consider, though not intended to be an all-inclusive list, collectibility of
loans in light of historical experience, change in the size and mix of the
overall portfolio composition, specific allocations based on probable losses
identified during the review of the portfolio, delinquency trends in the
portfolio and the composition of nonperforming loans, including the percent of
nonperforming loans with supplemental mortgage insurance or secured by real
estate, and subjective factors, including local and general economic business
factors and trends, industry and interest rate trends, new lending products,
changes in underwriting criteria, and portfolio concentrations. Management is
currently using a five year lookback period when computing historical loss rates
to determine the allocated component of the Allowance.



27




The Allowance totaled $8.5 million, at both
December 31, 2006 and March 31, 2007, respectively representing 0.90% and 0.89%
of loans, calculated using loans excluding mortgage loans held for sale and the
allowance for loan losses, net of unearned income.

The following table summarizes the allocation by
collateral type of the Allowance and the percentage of loans to total loans,
excluding net of unearned balances, 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.

|                           |       | March 31, |                 | December 31,                
|-------------------------- | ----- | --------- | --------------- | ----------------------------
|                           |       | 2007      |                 | 2006                        
|                           |       |           | Total allowance | % of loans to 
		total loans
|Commercial and industrial  | $     | 1,073     | 14.1            | %                           
|Real estate - 1 - 4 family |       | 1,275     | 21.0            |                             
|Real estate - construction |       | 32        | 2.8             |                             
|Real estate - other        |       | 3,679     | 52.7            |                             
|General consumer           |       | 1,060     | 7.6             |                             
|Credit line                |       | 147       | 0.5             |                             
|Bankcards                  |       | 324       | 1.2             |                             
|Others                     |       | 870       | 0.1             |                             
|                           | Total | $         | 8,460           | 100.0                       
|                           |       |           |                 |                             

Fluctuations within the allocation of the Allowance
from December 31, 2006 to March 31, 2007 result from changes in historical loss
experience and changes in the size and mix of the overall portfolio composition.
The increase in 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.  Such
downgrades resulted in increased Allowance coverage.  At March 31, 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 March 31, 2007.

28






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.

At and for the three month
		
		At and for the yearperiods ended March 31,
		
		ended December 31,2007
		
		2006
		
		2006Allowance balance, beginning of period
		$
		8,527
		
		8,431
		
		8,431Provision for loan losses
		
		367
		
		525
		
		1,625Loans charged-offCommercial and industrial
		
		106
		
		116
		
		453Real estate - 1 - 4 family
		
		87
		
		19
		
		247Real estate - construction
		
		-
		
		-
		
		-Real estate - other
		
		107
		
		-
		
		191Consumer
		
		230
		
		144
		
		791Total loans charged-off
		
		530
		
		279
		
		1,682RecoveriesCommercial and industrial
		
		18
		
		22
		
		37Real estate - 1 - 4 family
		
		3
		
		-
		
		15Real estate - construction
		
		-
		
		-
		
		-Real estate - other
		
		1
		
		2
		
		6Consumer
		
		74
		
		26
		
		95Total recoveries
		
		96
		
		50
		
		153Net loans charged-off
		
		434
		
		229
		
		1,529Allowance balance, end of period
		$
		8,460
		
		8,727
		
		8,527Average loans (1)
		$
		949,102
		
		865,183
		
		895,062Ending loans (1)
		
		954,221
		
		860,958
		
		945,913Net loans charged-offs to average loans (1)
		
		0.19
		%
		0.11
		
		0.17Allowance for loan losses to ending loans
		(1)
		
		0.89
		
		1.01
		
		0.90(1)
		Calculated using loans excluding mortgage
		loans held for sale, net of unearned income, excluding allowance for
		loan losses


See Earnings Review, Provision for Loan Losses
contained herein for discussion regarding the decrease in the provision for loan
losses from the first three months of 2006 to the same period of 2007.

Total net loans charged-off totaled $434 thousand
during the first three months of 2007 up from $229 thousand during the same
period of 2006. Management believes 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.  The majority of the increase in net loans
charged-off from the three month period ended March 31, 2006 to the same period
of 2007 was related to loans secured by real estate.

The level of the Allowance during the first three
months of 2007 was also impacted by growth within the loan portfolio during the
period.

Management believes that the declining trend of
the Allowance to 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 March 31, 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.



29




Deposits

The following table summarizes the Company's
deposit composition at the dates indicated (dollars in thousands).

|                                                   |                                    | March 31, |           | December 31,
|-------------------------------------------------- | ---------------------------------- | --------- | --------- | ------------
|                                                   |                                    | 2007      |           | 2006        
|                                                   |                                    |           | Total     | % of Total  
|Noninterest-bearing transaction deposit
		accounts | $                                  | 138,771   | 13.6      | %           
|Interest-bearing transaction deposit
		accounts    |                                    | 353,973   | 34.8      |             
|                                                   | Transaction deposit accounts       |           | 492,744   | 48.4        
|                                                   |                                    |           |           |             
|Money market deposit accounts                      |                                    | 113,689   | 11.2      |             
|Savings deposit accounts                           |                                    | 42,752    | 4.2       |             
|Time deposit accounts                              |                                    | 368,517   | 36.2      |             
|                                                   | Total traditional deposit accounts | $         | 1,017,702 | 100.0       
|                                                   |                                    |           |           |             

Core traditional deposit accounts, which include
checking, money market, and savings accounts, grew by $35.2 million during
the first three months of 2007, or 5.7%.

The increase in transaction
deposit accounts core traditional during both the period 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 core traditional deposit continues
to be enhanced by the introduction, continuation, and enhancement of
programs and promotions, such as the Seniority Club checking product, a health
savings account product, and new business investment money market account, as
well as by the Bank's new customer referral program.

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 three months of 2007,
$6 million of the public funds were transferred from the Bank, and, in addition,
money market funds of the Bank's trust department declined $7 million, which
together contributed to the decline in money market deposit accounts over the
periods noted.

Time deposit
accounts decreased by $11.1 million, or 2.9% during the first three months of
2007. 15 month certificate of deposit accounts offered by the Company during
December 2005 began to mature during the first thee months of 2007.  The
Company typically offers specifically targeted time deposit programs in an
effort to retain maturing funds.   The decline in time deposit
accounts during this period was due in large part to the funds that the Company
was unable to retain and the maturing funds that were reinvested by customers
into different Company deposit products.

The table set forth below summarizes the
Company's weighted average deposit costs for the periods indicated.

|                                                     | For the three month    
|---------------------------------------------------- | -----------------------
|                                                     | periods ended March 31,
|                                                     | 2007                   
|Average cost of core deposit accounts                | 2.66                   
|Average cost of time deposit accounts                | 4.31                   
|Average cost of total traditional deposit
		accounts | 3.38                   

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 ended March 31,
|                              |                                            |                        
|Transaction deposit accounts  | $                                          | 2,200                  
|Money market deposit accounts |                                            | 980                    
|Savings deposit accounts      |                                            | 34                     
|Time deposit accounts         |                                            | 4,013                  
|                              | Total interest expense on deposit accounts | $                      
|                              |                                            |                        

Management does not believe that its dependence
on traditional deposit account funding changed materially from December 31, 2006
to March 31, 2007.  At March 31, 2007, traditional deposit accounts as a
percentage of liabilities were 95.1% compared with 94.4% at December 31, 2006.
Due to the level of funding provided by traditional deposit, the Company has not
had to rely as heavily on alternative funding sources from which to fund a
portion of loan demand.



30




Borrowings

Borrowings decreased $7.2 million at the end of
the first three months of 2007 when compared with the end of 2006. 
Borrowings as a percentage of total liabilities were approximately 4.1% and 4.9%
at March 31, 2007 and December 31, 2006, respectively. The following table
summarizes the Company's borrowings composition at the dates indicated (dollars
in thousands).

|                               |                  | March 31, 2007 |        | December 31, 2006
|------------------------------ | ---------------- | -------------- | ------ | -----------------
|                               |                  |                | Total  | % of Total       
|Retail repurchase agreements   | $                | 9,905          | 22.4   | %                
|Commercial paper               |                  | 24,275         | 55.0   |                  
|Federal funds purchased        |                  | -              | -      |                  
|FHLB borrowings - short - term |                  | -              | -      |                  
|FHLB borrowings - long - term  |                  | 10,000         | 22.6   |                  
|                               | Total borrowings | $              | 44,180 | 100.0            
|                               |                  |                |        |                  

At March 31, 2007, of its approximately $93
million available credit based on qualifying loans to serve as collateral
against short-term or long-term borrowings from the FHLB, the Company employed
$10.0 million in borrowings, all of which was determined to be long-term when
employed, and employed $69.0 million in a letter of credit used to secure public
deposits as required or permitted by law. 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.

The following table summarizes short-term
borrowing informationat and for the periods indicated (dollars in
thousands).

|                             |                                                                                                                                     | At and for the three month
|---------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | --------------------------
|                             |                                                                                                                                     | periods ended March 31,   
|                             |                                                                                                                                     |                           
|Retail repurchase agreements |                                                                                                                                     |                           
|                             | Amount outstanding at period end                                                                                                    | $                         
|                             | Average amount outstanding during period                                                                                            |                           
|                             | Maximum amount outstanding at any period end                                                                                        |                           
|                             | Rate paid at period end                                                                                                             |                           
|                             | Weighted average rate paid during the period                                                                                        |                           
|                             |                                                                                                                                     |                           
|Commercial paper             |                                                                                                                                     |                           
|                             | Amount outstanding at period end                                                                                                    | $                         
|                             | Average amount outstanding during period                                                                                            |                           
|                             | Maximum amount outstanding at any period end                                                                                        |                           
|                             | Rate paid at period end                                                                                                             |                           
|                             | Weighted average rate paid during the period                                                                                        |                           
|                             |                                                                                                                                     |                           
|Federal funds purchased      |                                                                                                                                     |                           
|                             | Amount outstanding at period end                                                                                                    | $                         
|                             | Average amount outstanding during period                                                                                            |                           
|                             | Maximum amount outstanding at any period end                                                                                        |                           
|                             | Rate paid at period end                                                                                                             |                           
|                             | Weighted average rate paid during the period                                                                                        |                           
|                             |                                                                                                                                     |                           
|*                            | Rates paid are tiered based on level of
		deposit.  Rate presented represents the average rate for all tiers
		offered at year-end.

31




The following table summarizes FHLB
borrowing informationat and for the periods indicated (dollars in
thousands).

At and for the three monthperiods ended March 31,2007
		
		2006Short-term FHLB borrowingsAmount outstanding at period end
		$
		-
		
		-Average amount outstanding during period
		
		-
		
		8,454Maximum amount outstanding at any period end
		
		-
		
		10,900Rate paid at period end
		
		-
		%
		-Weighted average rate paid during the period
		
		-
		
		5.04Long-term FHLB borrowingsAmount outstanding at period end
		$
		10,000
		
		23,000Average amount outstanding during period
		
		10,000
		
		23,000Maximum amount outstanding at any period end
		
		10,000
		
		23,000Rate paid at period end
		
		3.85
		%
		3.53Weighted average rate paid during the period
		
		3.85
		
		3.53


Long-term borrowings are those having maturities
greater than one year when executed. The remaining long-term FHLB borrowing of
$10.0 million is scheduled to mature during the second quarter of 2007.

Management was not
aware of any circumstances at March 31, 2007 that would require prepayment of
any of the Company's FHLB advances. Additionally, none of the Company's
long-term FHLB advances outstanding at December 31, 2006 had embedded call
options.

Rates paid during the three month period ended
March 31, 2007 increased from those paid for the three month period ended March
31, 2006. The primary reason for this change is the action of the Federal
Reserve Open Market Committee. Since the second quarter of 2004, the federal
funds rate has increased from 1.0% to 5.25% in a series of seventeen moves.

Capital Resources

Average shareholders' equity was $102.1 million
for the three month period ended March 31, 2007, or 8.8% of average assets,
compared with $91.2 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 $103.2 million at March 31, 2007. The Company's
capital ratio of total shareholders' equity to total assets was 8.8% at March
31, 2007 compared with 8.7% at December 31, 2006. During the first three months
of 2007, shareholders' equity was increased through the retention of net income,
stock option activity, compensation expense related to stock options granted and
a slight improvement in accumulated other comprehensive income.  These
increases were offset by an increase in cash dividends when comparing the three
month period ended March 31, 2007 with the same period of 2006.  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 three month
period ended March 31, 2007.

Palmetto Bancshares and the Bank are required to
meet regulatory capital requirements that currently include several measures of
capital.  At March 31, 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 the Palmetto
Bancshares' capital regulatory requirements.  At March 31, 2007, there were
no conditions or events of which management was aware that would materially
change Palmetto Bancshares' or the Bank's status.

For the first three months of 2007, the Company's
cash dividend payout ratio was 32.25% compared with a payout ratio of 31.32%
during the same period of 2006. Cash dividends per common share during the first
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. 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.



32






Management continually reviews opportunities for
Upstate expansion that are believed to be in the best interest of the Company,
its customers, and its shareholders. During 2006, the Company began an expansion
of its Greenwood county Montague banking office.  Construction on this
office was completed during the first quarter of 2007.

Disclosures Regarding 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 March 31, 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 March 31, 2007, the Company's interest-sensitive assets
totaled approximately $1.1 billion while interest-sensitive liabilities totaled
approximately $923.1 million. At December 31, 2006, the Company's
interest-sensitive assets totaled approximately $1.0 billion while
interest-sensitive liabilities totaled approximately $879.5 million.

The yield on
interest-sensitive assets and the cost of interest-sensitive liabilities for the
three month period ended March 31, 2007 was 7.55% and 3.43%, respectively,
compared to 7.16% and 2.77%, respectively, for the same period of 2006. The
increase in the yield on interest-sensitive assets and the cost of
interest-sensitive liabilities resulted from the rising interest rate
environment.

The Company
evaluated the results of its net interest income simulation prepared as of March
31, 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 March
31, 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).

Interest rate scenario
		
		Adjusted net 
		interest 
		income
		Percentage 
		change from 
		base
		
		Net interest 
		margin
		
		Net interest 
		margin 
		change
		in 
		basis
		points)Up 200 basis points
		$
		49,706
		(8.50)
		%
		4.50
		%
		(0.42)Up 100 basis points
		
		52,452
		(3.45)
		
		4.75
		
		(0.17)BASE CASE
		
		54,325
		-
		
		4.92
		
		-Down 100 basis points
		
		57,353
		5.57
		
		5.20
		
		0.27Down 200 basis points
		
		59,489
		9.51
		
		5.39
		
		0.47




33






The simulation
results as of March 31, 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 5.57% 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 3.45% 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 27 basis
point increase in net interest margin, assuming all other variables remained
unchanged. Conversely, a 100 basis point increase in interest rates would cause
an 17 basis point decrease 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.

Liquidity

General

Approximately 80% of the investment securities
portfolio was pledged to secure public deposits as of March 31, 2007 as compared
with 62% at December 31, 2006 and 86% at March 31, 2006.  Of the Company's
$107.1 million available for sale investment securities balance at March 31,
2007, $21.1 million was 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 as further
discussed in Part I, Item 1. Financial Statements, Note 10 contained herein with
regard to the Company's borrowings from the FHLB. Management believes that cash
flows from investments, in addition to its available borrowing capacity and
efforts to grow deposits, are sufficient to provide the necessary funding for
2007.

Each of the Company's sources of liquidity is
subject to various uncertainties beyond the control of the Company. As a measure
of protection, additional funding sources have been arranged through federal
funds lines at correspondent banks, through the Federal Reserve Discount Window,
and through the FHLB.  FHLB borrowings are an alternative to other funding
sources with similar maturities. At March 31, 2007, of its approximately $93
million available credit based on qualifying loans to serve as collateral
against short-term or long-term borrowings from the FHLB, the Company employed
$10.0 million in borrowings, all of which was determined to be long-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 March 31, 2007, the Company had
additional funding sources totaling $40 million that were accessible at the
Company's option.

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 for further discussion regarding
such agreements. Increased demand for funds under these agreements would reduce
the Company's available liquidity and could require additional sources of
liquidity.

See Part I, Item 1. Financial Statements,
Consolidated Statements of Cash Flows contained herein to review factors that
impacted liquidity during the periods presented.

Borrowings

At March 31, 2007, the Company employed $10.0
million in FHLB borrowings, all of which was determined to be long-term when
employed. See Borrowings for further discussion regarding the Company's long-tem
borrowings, and Part I, Item 1. Financial Statements, Notes 10 and 11 also
contained herein for further discussion regarding the Company's borrowings.

Lending Commitments

See Off-Balance Sheet Arrangements and Part I,
Item 1. Financial Statements, Note 14 all contained herein for further
discussion regarding the potential impact the Company's lending commitments
could have on liquidity at March 31, 2007.

Palmetto Bancshares

At March 31, 2007, the holding company had $24.3
million in commercial paper compared with a balance of $21.0 million at December
31, 2006, respectively. The table set forth below summarizes the Company's
weighted average borrowing costs with respect to commercial paper for the
periods indicated.



34




|                                 |      |   | For the three month    
|-------------------------------- | ---- | - | -----------------------
|                                 |      |   | periods ended March 31,
|                                 |      |   | 2007                   
|Average cost of commercial paper | 4.34 | % | 3.49                   



Other

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 had collected virtually all of these items.  As such, this reserve
was reversed during the first quarter of 2007.

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. These lending commitments are provided to customers in the normal
course of business, and the Company's credit policies and standards are applied
when making these 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 $277.8 million at March 31, 2007.

Guarantees

At March 31, 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 March 31, 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 March 31, 2007.

Other Off-Balance Sheet Arrangements

At March 31, 2007,
the Company had no interest in nonconsolidated special purpose entities nor was
it involved in other off-balance sheet contractual relationships, unconsolidated
related entities that have off-balance sheet arrangements, or transactions that
could result in liquidity needs (other than those discussed herein).

At March 31, 2007, of its approximately $93
million available credit based on qualifying loans to serve as collateral
against short-term or long-term borrowings from the FHLB, the Company employed
$10.0 million in borrowings, all of which was determined to be long-term when
employed and employed $69.0 million in a letter of credit. 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.



35




Derivatives and Hedging Activities

At March 31, 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 $8.8
million at March 31, 2007.  The fair market value of derivative assets
related to commitments to originate such residential loans held for sale and
forward sales commitments was not significant at March 31, 2007.

Earnings Review

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.







36




PALMETTO BANCSHARES, INC. AND SUBSIDIARYConsolidated Statements of Income(dollars in thousands, except common and
		per share data)For the three month periodsended March 31,
		
		Dollar
		
		Percent2007
		
		2006
		
		variance
		
		variance(unaudited)Interest incomeInterest and fees on loans
		$
		18,766
		
		16,453
		
		2,313
		
		14.1Interest on investment securities available
		for sale
		1,171
		
		1,249
		
		(78)
		
		(6.2)Interest on federal funds sold
		
		224
		
		193
		
		31
		
		16.1Dividends on FHLB stock
		
		37
		
		53
		
		(16)
		
		(30.2)Total interest income
		
		20,198
		
		17,948
		
		2,250
		
		12.5Interest expenseInterest on deposits
		
		7,227
		
		5,234
		
		1,993
		
		38.1Interest on retail repurchase agreements
		146
		
		174
		
		(28)
		
		(16.1)Interest on commercial paper
		
		238
		
		138
		
		100
		
		72.5Interest on federal funds purchased
		29
		
		2
		
		27
		
		1,350.0Interest on FHLB borrowings - short-term
		-
		
		105
		
		(105)
		
		(100.0)Interest on FHLB borrowings - long-term
		95
		
		200
		
		(105)
		
		(52.5)Total interest expense
		7,735
		
		5,853
		
		1,882
		
		32.2Net interest income
		12,463
		
		12,095
		
		368
		
		3.0Provision for loan losses
		
		367
		
		525
		
		(158)
		
		(30.1)Net interest income after provision for loan
		losses
		12,096
		
		11,570
		
		526
		
		4.5Noninterest incomeService charges on deposit accounts
		1,908
		
		1,986
		
		(78)
		
		(3.9)Fees for trust and brokerage services
		696
		
		781
		
		(85)
		
		(10.9)Mortgage-banking income
		
		348
		
		222
		
		126
		
		56.8Investment securities gains
		
		-
		
		2
		
		(2)
		
		(100.0)Other
		
		880
		
		912
		
		(32)
		
		(3.5)Total noninterest income
		3,832
		
		3,903
		
		(71)
		
		(1.8)Noninterest expenseSalaries and other personnel
		
		6,137
		
		5,775
		
		362
		
		6.3Occupancy
		
		370
		
		383
		
		(13)
		
		(3.4)Furniture and equipment
		
		481
		
		497
		
		(16)
		
		(3.2)Premises and equipment leases and rentals
		290
		
		315
		
		(25)
		
		(7.9)Premises and equipment depreciation
		506
		
		503
		
		3
		
		0.6Marketing
		
		
		268
		
		406
		
		(138)
		
		(34.0)Amortization of core deposit intangibles
		12
		
		12
		
		-
		
		-Other
		
		2,078
		
		2,175
		
		(97)
		
		(4.5)Total noninterest expense
		10,142
		
		10,066
		
		76
		
		0.8Net income before provision for income taxes
		5,786
		
		5,407
		
		379
		
		7.0Provision for income taxes
		
		2,025
		
		1,757
		
		268
		
		15.3Net income
		$
		3,761
		
		3,650
		
		111
		
		3.0Common and Per Share DataNet Income - basic
		$
		0.59
		
		0.58
		
		0.01
		
		1.7Net Income - diluted
		
		0.58
		
		0.57
		
		0.01
		
		1.8Cash dividends
		
		0.19
		
		0.18
		
		0.01
		
		5.6Book value
		
		
		16.17
		
		14.42
		
		1.75
		
		12.1Weighted average common shares outstanding -
		basic
		6,378,516
		
		6,343,247Weighted average common shares outstanding -
		diluted
		6,455,805
		
		6,444,002


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.



37




For the three month periods ended March 31,2007
			
			2006Average
			Income/
			Yield/
			
			Average
			Income/
			Yield/Balance
			Expense
			Rate
			
			Balance
			Expense
			RateASSETSInterest-earnings assetsLoans, net of unearned (1)
			$    951,523
			$   
			18,766
			8.00
			%
			$   
			868,109
			$   
			16,453
			7.69
			%Investment securities available
			for sale, nontaxable (2)
			47,757
			424
			3.60
			
			55,210
			497
			3.65Investment securities available
			for sale, taxable (2)
			65,686
			747
			4.61
			
			70,708
			752
			4.31Federal funds sold
			17,461
			224
			5.20
			
			18,824
			193
			4.16FHLB stock
			2,595
			37
			5.78
			
			3,434
			53
			6.26Total interest-earning assets
			1,085,022
			20,198
			7.55
			
			1,016,285
			17,948
			7.16Noninterest-earning assetsCash and due from banks
			31,605
			
			
			
			34,680Allowance for loan losses
			(8,427)
			
			
			
			(8,532)Premises and equipment, net
			24,867
			
			
			
			23,076Goodwill
			3,688
			
			
			
			3,688Other intangible assets
			121
			
			
			
			170Accrued interest receivable
			5,959
			
			
			
			5,107Other
			
			13,912
			
			
			
			12,829Total noninterest-earning assets
			71,725
			
			
			
			71,018Total assets
			$ 
			1,156,747
			
			
			
			$ 
			1,087,303LIABILITIES AND SHAREHOLDERS'
			EQUITYLiabilitiesInterest-bearing liabilitiesTransaction and money market
			deposit accounts
			$   
			447,398
			$    
			3,180
			2.88
			%
			$   
			349,938
			$    
			1,595
			1.85
			%Savings deposit accounts
			42,183
			34
			0.33
			
			45,737
			35
			0.31Time deposit accounts
			377,549
			4,013
			4.31
			
			395,763
			3,604
			3.69Total interest-bearing deposits
			867,130
			7,227
			3.38
			
			791,438
			5,234
			2.68Retail repurchase agreements
			13,874
			146
			4.27
			
			19,223
			174
			3.67Commercial paper (Master notes)
			22,251
			238
			4.34
			
			16,017
			138
			3.49Federal funds purchased
			2,035
			29
			5.78
			
			166
			2
			4.89FHLB borrowings - short-term
			-
			-
			-
			
			8,454
			105
			5.04FHLB borrowings - long-term
			10,000
			95
			3.85
			
			23,000
			200
			3.53Total interest-bearing
			liabilities
			915,290
			7,735
			3.43
			
			858,298
			5,853
			2.77Noninterest-bearing liabilitiesNoninterest-bearing deposits
			131,096
			
			
			
			131,621Accrued interest payable
			2,470
			
			
			
			1,981Other
			
			5,771
			
			
			
			4,163Total noninterest-bearing
			liabilities
			139,337
			
			
			
			137,765Total liabilities
			1,054,627
			
			
			
			996,063Shareholders' equity
			102,120
			
			
			
			91,240Total liabilities and
			shareholders' equity
			$ 
			1,156,747
			
			
			
			$ 
			1,087,303NET INTEREST INCOME / NET YIELD
			ON
			
			$   
			12,463
			4.66
			%
			
			$   
			12,095
			4.83
			%INTEREST-EARNING ASSETS(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.




38




During the first three months of 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 39 basis
points to 7.55% during the first three months of 2007 from 7.16% during the
first three months of 2006. The average cost of interest-bearing liabilities
increased 66 basis points to 3.43% during the first three months of 2007 from
2.77% during the first three months of 2006. Average interest-earning assets
increased $68.7 million during the twelve month period ended March 31, 2007,
primarily within the loan portfolio, while interest-bearing liabilities
increased $57.0 million. Rates earned and paid during the first three months of
2007 increased from those during the first three months of 2006 primarily due to
the action of the Federal Reserve Open Market Committee. Since the second
quarter of 2004, the federal funds rate has increased from 1.0% to 5.25% in a
series of seventeen moves.

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 March 31, 2007 to
the three month period ended March 31, 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 March
		31, 2007 
		compared with the three month period ended March 31, 2006Volume
		
		Rate
		
		TotalInterest-earnings assetsLoans, net of unearned
		$
		1,626
		
		687
		
		2,313Investment securities available for sale
		
		(132)
		
		54
		
		(78)Federal funds sold
		
		(12)
		
		43
		
		31FHLB stock
		
		(12)
		
		(4)
		
		(16)Total interest-earning assets
		$
		1,470
		
		780
		
		2,250Interest-bearing liabilitiesInterest-bearing deposits
		$
		536
		
		1,457
		
		1,993Retail repurchase agreements
		
		(67)
		
		39
		
		(28)Commercial paper
		
		62
		
		38
		
		100Federal funds purchased
		
		27
		
		-
		
		27FHLB borrowings - short-term
		
		(52)
		
		(52)
		
		(104)FHLB borrowings - long-term
		
		(127)
		
		21
		
		(106)Total interest-bearing liabilities
		$
		379
		
		1,503
		
		1,882NET INTEREST INCOME
		$
		1,091
		
		(723)
		
		368


Provision for Loan Losses

The following table summarizes the Company's
allowance for loan losses and selected percentages for the periods indicated
(dollars in thousands) which support the decrease in the provision for loan
losses during the three month period ended March 31, 2007 from the same period
of 2006.



March 31,
		
		December 31,2007
		
		2006Allowance for loan losses
		$
		8,460
		
		8,527Allowance as a percentage of loans (1)
		
		0.89
		%
		0.90Adjusted nonaccrual loans as a percentage of
		loans (1) (2)
		
		0.72
		
		0.74Adjusted classified assets as a percentage
		of loans (1) (3)
		
		1.86
		
		1.80Allowance to adjusted nonaccrual loans (2)
		
		1.2
		x
		1.2Allowance to adjusted classified assets (3)
		
		0.5
		
		0.5(1) Calculated using loans excluding
		mortgage loans held for sale, net of unearned, excluding the Allowance(2) Nonaccrual loans calculated excluding
		the special circumstance loans discussed in Financial Condition - Loans(3) Classified assets calculated excluding
		the special circumstance loans discussed in Financial Condition - Loans


See Financial Condition, Allowance for Loan
Losses contained herein for further discussion regarding net loans charged-off
during the periods noted.  See Financial Condition, Loans contained herein
for further discussion regarding the growth in the loan portfolio during the
first three months of 2007.  Also see Financial Condition, Loans and
Allowance for Loan Losses contained herein for further discussion regarding the
Company's accounting policies related to, factors impacting, and methodology for
analyzing the adequacy of the Company's Allowance.



39




Noninterest Income

Noninterest income during the three month period
ended March 31, 2007 decreased $71 thousand, or 1.8%, to $3.8 million from $3.9
million during the three month period ended March 31, 2006. The decrease in
noninterest income during the three month period ended March 31, 2007 over the
same period of 2006 resulted from slight decreases in all financial statement
line items except mortgage-banking 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 $329.2 million and $310.0 million at March 31, 2007 and March
31, 2006, respectively. Mortgage-banking income increased $126 thousand, or
56.8%, during the three month period ended March 31, 2007 over the three month
period ended March 31, 2006 primarily as a result of decreased amortization,
impairment, and recoveries between the periods.

Amortization, impairment, and recoveries within the
mortgage-servicing rights portfolio continued to decline during 2007. 
Since the second quarter of 2004, the federal funds rate has increased from 1.0%
to 5.25% in a series of seventeen moves.  As interest rates have risen over
this period, refinancing activity slowed.  As such, the component of
mortgage-servicing rights amortization, impairment, and recoveries relative to
refinancing activity (prepayment speeds) slowed as well thereby positively
impacting the amortization, impairment, and recoveries within the Company's
mortgage-servicing rights portfolio.

For purposes of
measuring impairment, the mortgage-servicing rights portfolio is reviewed for
impairment based upon quarterly external valuations. Such valuations are based
on projections using a discounted cash flow method that includes assumptions
regarding prepayments, interest rates, servicing costs, and other factors. The
Company's established impairment valuation allowance records estimated
impairment for the mortgage-servicing rights portfolio. Subsequent increases in
value are recognized by the Company to the extent of the impairment valuation
allowance.  In a rising interest rate environment, prepayments typically
slow thereby resulting in recoveries of previously established valuation
allowances.

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 March 31, 2007 increased $76 thousand, or 0.1%, to $10.142 million from
$10.066 million during the three month period ended March 31, 2006. The increase
in noninterest expense during the three month period ended March 31, 2007
compared with the same period of 2006 resulted primarily from an increase in
salaries and other personnel expenses, offset by slight decreases in all other
financial statement line items.

Comprising 60.5% of
noninterest expense during the three month period ended March 31, 2007 and 57.4%
of noninterest expense during the three month period ended March 31, 2006,
salaries and other personnel expense increased by $362 thousand to $6.1 million
during the three month period ended March 31, 2007 from $5.8 million during the
three month period ended March 31, 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 $138
thousand during the three month period ended March 31, 2007 compared with the
three month period ended March 31, 2006 primarily due to marketing costs during
the first three months of 2006 in preparation of the Company's 100-year
anniversary celebration.

40




Provision for Income Taxes

Income tax expense totaled $2.0 million for the
three month period ended March 31, 2007 compared with $1.8 million for the three
month period ended March 31, 2006.  The Company's effective tax rate was
35.0% during the 2007 period and 32.5% during the 2006 period.  The Company
anticipates the effective income tax rate applicable to current taxable income
will approximate between 34% and 36% for
2007.

Accounting and Reporting Matters

Recently Adopted Accounting Pronouncements

In March 2006, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No.
156, "*Accounting for Servicing of Financial Assets-an amendment of FASB
Statement No. 140."*This Statement amends SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," with respect to the accounting for separately recognized servicing
assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a servicing contract; requires all
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable; permits an entity to choose its
subsequent measurement methods for each class of separately recognized servicing
assets and servicing liabilities; at its initial adoption, permits a one-time
reclassification of available-for-sale securities to trading securities by
entities with recognized servicing rights, without calling into question the
treatment of other available-for-sale securities under SFAS No. 115, provided
that the available-for-sale securities are identified in some manner as
offsetting the entity's exposure to changes in fair value of servicing assets or
servicing liabilities that a servicer elects to subsequently measure at fair
value; and requires separate presentation of servicing assets and servicing
liabilities subsequently measured at fair value in a Company's statement of
financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. The required adoption date for SFAS
No. 156 was January 1, 2007. The adoption of SFAS No. 156 did not have a
material impact on the Company's financial position, results of operations, or
cash flows.

In July 2006, the FASB issued FASB Interpretation
No. ("FIN") 48, "Accounting for Uncertainty in Income Taxes." FIN No. 48
clarifies accounting for uncertainty in income taxes recognized in enterprises'
financial statements in accordance with SFAS No. 109, "Accounting for Income
Taxes." FIN No. 48 prescribes a recognition threshold and measurement
attributable for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN No. 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transitions. FIN No. 48 was effective for
fiscal years beginning after December 15, 2006. The adoption of FIN No. 48 did
not have a material impact on the Company's financial position, results of
operations, or cash flows.

Other 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 have a material impact on the
Company's financial position, results of operations or cash flows.

Recently Issued Accounting Pronouncements

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.



41




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.

In February 2007, the FASB issued SFAS No. 159,
"The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115." This statement permits, but
does not require, entities to measure many financial instruments at fair value.
The objective of this 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 that are
explicitly excluded as qualifying for fair value. With respect to SFAS No. 115,
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 a 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. The Company is
currently analyzing the fair value option that is permitted, but not required,
under SFAS No. 159.

Other accounting
standards have been issued or proposed by the FASB or other standards-setting
bodies that are not applicable to the Company's business.

Item 3.  Quantitative and Qualitative
Disclosures about Market Risk

See Part I, Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations, Disclosures Regarding
Market Risk contained herein for discussion regarding the Company's quantitative
and qualitative disclosure about market risk.

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 (Chief Accounting Officer) and several
other members of the Company's senior management as of March 31, 2007, the last
day of the period covered by this Annual Report. The Company's Chief Executive
Officer and the President and Chief Operating Officer (Chief Accounting Officer)
concluded that the Company's disclosure controls and procedures were effective
as of March 31, 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 (Chief Accounting 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
fourth quarter of 2006, the Company did not make any changes in its internal
controls over financial reporting that has materially affected is reasonably
likely to materially affect those controls.



42






PART
II - OTHER INFORMATION

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 1A. Risk Factors

There have been no material changes from the risk
factors previously disclosed in Item 1a to Part I of the Company's Annual Report
on Form 10-K for the year ended December 31, 2006.

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

None

Item 3.  Defaults Upon Senior Securities

None

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

None

Item 5.  Other Information

None.

Item 6.  Exhibits

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

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

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

The exhibits noted above 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.



43








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
 (Chief Accounting Officer)



Dated:  
May 10, 2007