| **U. S. SECURITIES AND EXCHANGE  COMMISSION	WASHINGTON, D.C. 20549**                        |
|---------------------------------------------------------------------------------------------|
| **FORM 10-Q**                                                                               |
|                                                                                             |  |  |  |  |  |  |  |  |  |  |  |  |
|  (X)                                                                              | QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934 |  |
|                                                                                             | For the quarterly period ended  March 31, 2006 |
| OR                                                                                          |
|  (  )                                                                             | TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|                                                                                             | For the transition period from  __________ to __________ |
|                                                                                             |  |  |  |  |  |  |  |  |  |  |  |  |
| Commission file number   0-26016                                                       |
|                                                                                             |  |  |  |  |  |  |  |  |  |  |  |  |
| **PALMETTO BANCSHARES, INC.**(Exact name of registrant as  specified in its charter)        |
|                                                                                             |  |  |  |  |  |  |  |  |  |  |  |  |
| **South Carolina	(State or other jurisdiction of  incorporation or organization)**          |  | **74-2235055	(IRS Employer Identification No.)** |
|                                                                                        |  |   |
|                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |  | ** ** | ** ** | ** ** | ** ** |  |
| **301 Hillcrest Drive, Laurens,  South Carolina	(Address of principal executive  offices)** |  | **29360	(Zip Code)** |
|                                                                                        |  |   |
| ** **                                                                                  |  | ** ** | ** ** | ** ** | ** ** |  |  | ** ** | ** ** | ** ** | ** ** |  |
| **(864) 984-4551	(Registrant's telephone number)**                                          |  | **www.palmettobank.com	(Registrant's web site)** |
|                                                                                        |  |   |

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

        Indicate  by check mark whether the registrant is a large accelerated filer, an  accelerated filer, or a non-accelerated filer.  See definition of "accelerated filer  and large accelerated filer" in Rule 12b-2 of the Exchange  Act.

        Large accelerated filer [ ]         Accelerated filer [x]          Non-accelerated filer [ ]

        Indicate  by check mark whether the registrant is a shell company (as defined by Rule  12b-2 of the Exchange  Act).  Yes [ ] No [x]

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

|  |  | Class                               |  | Outstanding at April 27, 2006           |  |  |
|--|--|-------------------------------------|--|-----------------------------------------|--|--|
|  |  |  ----------------------------- |  |    ------------------------------- |  |  |
|  |  | Common stock, $5.00 par value       |  | 6,355,635                               |  |  |

 

----

 

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY** |
|-----------------------------------------------|
| **Table of  Contents**                        |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |
| PART I.  FINANCIAL INFORMATION           |  |  |  |
|                                               | Item 1. | Financial Statements | 2 |  |  |
|                                               | Item 2. | Management's Discussion and Analysis of Financial  Condition and Results of Operations | 19 |  |  |
|                                               | Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 41 |  |  |
|                                               | Item 4. | Controls and Procedures | 41 |  |  |
|                                               |  |  |  |  |  |
| PART II.  OTHER INFORMATION              |  |  |  |
|                                               | Item 1. | Legal Proceedings | 42 |  |  |
|                                          | Item 1a. | Risk Factors | 42 |   |   |
|                                               | Item 2. | Unregistered Sales of Equity Securities and Use of  Proceeds | 42 |  |  |
|                                               | Item 3. | Defaults Upon Senior Securities | 42 |  |  |
|                                               | Item 4. | Submission of Matters to a Vote of Security Holders | 42 |  |  |
|                                               | Item 5. | Other Information | 42 |  |  |
|                                               | Item 6. | Exhibits | 42 |  |  |
|                                               |  |  |  |  |  |
| SIGNATURES                                    | 43 |  |  |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |
|                                               |  |  |  |  |  |

 1

----

| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY**                          |
|-----------------------------------------------------------------------|
| **Consolidated  Balance Sheets**                                      |
| **(dollars in  thousands, except common and per share data)**         |
|                                                                  |   |   |   |   |   |   |   |   |
| ** **                                                            |   |   |   |   |   | **March 31,** |   | **December 31,** |
|                                                                  |   |   |   |   |   | **2006** | ** ** | **2005** |
|                                                                  |   |   |   |   |   | (unaudited) |   |   |
| ASSETS                                                                |   |   |   |   |   |   |   |
| Cash and cash equivalents                                             |   |   |   |   |   |
|                                                                  | Cash and due from banks |   |   |  $ | 46,762  |   | 36,978  |
|                                                                  | Federal funds sold |   |   | 29,436  |   | 998  |
|                                                                  |   | Total cash and cash equivalents |   | 76,198  |   | 37,976  |
|                                                                  |   |   |   |   |   |   |   |   |
| Federal Home Loan Bank ("FHLB") stock, at cost              |   | 3,184  |   | 3,786  |
| Investment securities available for sale, at fair market  value       | 124,920  |   | 125,988  |
| Mortgage loans held for sale                                          |   |   | 2,846  |   | 4,821  |
|                                                                  |   |   |   |   |   |   |   |   |
| Loans                                                                 |   |   |   |   | 860,958  |   | 866,181  |
|                                                                  | Less allowance for loan losses |   |   | (8,727) |   | (8,431) |
|                                                                  |   | Loans, net |   |   | 852,231  |   | 857,750  |
|                                                                  |   |   |   |   |   |   |   |   |
| Premises and equipment, net                                           |   |   | 23,103  |   | 22,676  |
| Accrued interest receivable                                           |   |   | 5,054  |   | 5,226  |
| Other assets                                                          |   |   |   | 17,569  |   | 16,792  |
|                                                                  |   |   | Total assets |   |   |  $ | 1,105,105  |   | 1,075,015  |
|                                                                  |   |   |   |   |   |   |   |   |
| LIABILITIES AND SHAREHOLDERS' EQUITY                                  |   |   |   |   |
| Liabilities                                                           |   |   |   |   |   |   |   |
| Deposits                                                              |   |   |   |   |   |   |   |
|                                                                  | Noninterest-bearing |   |   |  $ | 137,060  |   | 131,157  |
|                                                                  | Interest-bearing |   |   | 812,000  |   | 772,226  |
|                                                                  |   | Total deposits |   |   | 949,060  |   | 903,383  |
|                                                                  |   |   |   |   |   |   |   |   |
| Retail repurchase agreements                                          |   |   | 17,725  |   | 16,728  |
| Commercial paper (Master notes)                                       |   |   | 18,146  |   | 17,915  |
| Federal funds purchased                                               |   |   | -    |   | 1,000  |
| Federal Home Loan Bank borrowings                                     |   |   | 23,000  |   | 39,900  |
| Other liabilities                                                     |   |   |   | 5,615  |   | 7,148  |
|                                                                  |   | Total liabilities |   |   | 1,013,546  |   | 986,074  |
|                                                                  |   |   |   |   |   |   |   |   |
| Commitments and contingencies (Note 13)                               |   |   |   |   |
|                                                                  |   |   |   |   |   |   |   |   |
| Shareholders' Equity                                                  |   |   |   |   |   |
| Common stock - par value $5.00 per share;  authorized 10,000,000 |   |   |   |
|                                                                  | shares; issued and outstanding 6,350,635 and 6,331,335 |   |   |   |
|                                                                  | at March 31, 2006 and December  31, 2005, respectively. | 31,753  |   | 31,656  |
| Capital surplus                                                       |   |   |   | 877  |   | 659  |
| Retained earnings                                                     |   |   | 60,039  |   | 57,532  |
| Accumulated other comprehensive loss, net of tax                      |   | (1,110) |   | (906) |
|                                                                  |   | Total shareholders' equity |   |   | 91,559  |   | 88,941  |
|                                                                  |   |   |   |   |   |   |   |   |
|                                                                  |   |   | Total liabilities and shareholders' equity |  $ | 1,105,105  |   | 1,075,015  |
|                                                                  |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements.              |

 2

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| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                 |
|---------------------------------------------------------------|
| **Consolidated  Statements of Income**                        |
| **(dollars in  thousands, except common and per share data)** |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   | **For the three  months ended March 31,** |
|                                                          |   |   |   |   |   |   | **2006** | ** ** | **2005** | ** ** |
|                                                          |   |   |   |   |   |   | (unaudited) | ** ** |
| Interest income                                          |   |   |   |   |   |   |
|                                                          | Interest and fees on loans |   |   |  $ | 16,453  |   | 12,891  |   |
|                                                          | Interest and dividends on investment securities available  for sale: |   |   |   |   |
|                                                          |   | U.S. Government agencies | 530  |   | 82  |   |
|                                                          |   | State and municipal |   |   | 497  |   | 618  |   |
|                                                          |   | Mortgage-backed securities |   | 222  |   | 634  |   |
|                                                          | Interest on federal funds sold |   |   | 193  |   | 26  |   |
|                                                          | Dividends on FHLB stock |   |   | 53  |   | 38  |   |
|                                                          |   |   | Total interest income |   | 17,948  |   | 14,289  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Interest expense                                              |   |   |   |   |   |   |   |
|                                                          | Interest on deposits including retail repurchase  agreements | 5,408  |   | 3,088  |   |
|                                                          | Interest on federal funds purchased |   | 2  |   | 25  |   |
|                                                          | Interest on FHLB borrowings |   | 305  |   | 297  |   |
|                                                          | Interest on commercial paper (Master notes) | 138  |   | 66  |   |
|                                                          |   |   | Total interest expense |   | 5,853  |   | 3,476  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income |   | 12,095  |   | 10,813  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Provision for loan losses                                     |   |   | 525  |   | 600  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income after provision for loan losses | 11,570  |   | 10,213  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Noninterest income                                            |   |   |   |   |   |   |
|                                                          | Service charges on deposit accounts |   | 2,058  |   | 1,847  |   |
|                                                          | Fees for trust and brokerage services |   | 781  |   | 803  |   |
|                                                          | Mortgage-banking income |   |   | 222  |   | 282  |   |
|                                                          | Investment securities gains |   |   | 2  |   | 54  |   |
|                                                          | Other income |   |   |   | 919  |   | 779  |   |
|                                                          |   |   | Total noninterest income |   | 3,982  |   | 3,765  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Noninterest expense                                           |   |   |   |   |   |   |
|                                                          | Salaries and other personnel |   |   | 5,775  |   | 4,964  |   |
|                                                          | Net occupancy |   |   |   | 692  |   | 600  |   |
|                                                          | Furniture and equipment |   |   | 1,006  |   | 885  |   |
|                                                          | Marketing and advertising |   |   | 456  |   | 262  |   |
|                                                          | Postage and supplies |   |   | 389  |   | 317  |   |
|                                                          | Telephone |   |   |   |   | 213  |   | 183  |   |
|                                                          | Professional services |   |   | 221  |   | 181  |   |
|                                                          | Other expense |   |   |   | 1,393  |   | 1,458  |   |
|                                                          |   |   | Total noninterest expense |   | 10,145  |   | 8,850  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income before provision for income taxes | 5,407  |   | 5,128  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Provision for income taxes                                    |   |   | 1,757  |   | 1,717  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income |   |   |  $ | 3,650  |   | 3,411  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Common Share Data                                             |   |   |   |   |   |   |
|                                                          | Net Income - basic |   |   |  $ | 0.58  |   | 0.54  |   |
|                                                          | Net Income - diluted |   |   | 0.57  |   | 0.53  |   |
|                                                          | Cash dividends |   |   |   | 0.18  |   | 0.16  |   |
|                                                          | Book value |   |   |   | 14.42  |   | 13.00  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          | Weighted average common shares outstanding - basic | 6,343,247  |   | 6,309,527  |   |
|                                                          | Weighted average common shares outstanding - diluted | 6,444,002  |   | 6,407,359  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| See Notes to Consolidated Interim Financial	Statements.       |

 

 3

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| **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)                                                                                     |
|                                                                                            |   | **Shares of	common	stock** | ** ** | ** ** | ** ** | **Accumulated	other	comprehensive	income 	(loss),  net** | **   ****Total** |
|                                                                                            |   | ** ** | ** ** | ** ** |
|                                                                                            |   | **Common	stock** | **Capital	surplus** | **Retained	earnings** |
|                                                                                            |   |
| Balance at December 31, 2004                                                                    |   | 6,297,285  |  $ | 31,486  |  $ | 448  |  $ | 47,923  |  $ | 905  |  $ | 80,762  |
|                                                                                            |   |   |   |   |   |   |   |
| Net income                                                                                      |   |   |   |   | 3,411  |   | 3,411  |
| Other comprehensive income, net of tax:                                                         |   |   |   |   |   |   |
|     Unrealized holding losses arising during  period, net                   |   |   |   |   |   |   |
|           of tax  effect of $804                   |   |   |   |   |   | (1,285) |   |
|      Less:  reclassification adjustment included                       |   |   |   |   |   |   |
|           in net  income, net of tax effect of $21 |   |   |   |   | 33  |   |
|      Net unrealized  losses on securities                                   |   |   |   |   |   | (1,252) |
|                                                                                            |   |   |   |   |   |   |   |
| Comprehensive income                                                                            |   |   |   |   |   |   | 2,159  |
|                                                                                            |   |   |   |   |   |   |   |
| Cash dividend declared and paid ($0.16 per share)                                               |   |   |   | (1,010) |   | (1,010) |
| Exercise of stock options                                                                       |   | 16,250  | 81  | 107  |   |   | 188  |
|                                                                                            |   |  |  |  |  |  |  |
| Balance at March 31, 2005                                                                       |   | 6,313,535  |  $ | 31,567  |  $ | 555  |  $ | 50,324  |  $ | (347) |  $ | 82,099  |
|                                                                                            |   |   |   |   |   |   |   |
|                                                                                            |   |   |   |   |   |   |   |
| Balance at December 31, 2005                                                                    |   | 6,331,335  |  $ | 31,656  |  $ | 659  |  $ | 57,532  |  $ | (906) |  $ | 88,941  |
|                                                                                            |   |   |   |   |   |   |   |
| Net income                                                                                      |   |   |   |   | 3,650  |   | 3,650  |
| Other comprehensive income, net of tax:                                                         |   |   |   |   |   |   |
|      Unrealized  holding losses arising during period, net                  |   |   |   |   |   |   |
|           of tax  effect of $128                   |   |   |   |   |   | (205) |   |
|      Less:  reclassification adjustment included                       |   |   |   |   |   |   |
|           in net  income, net of tax effect of $1  |   |   |   |   | 1  |   |
|      Net unrealized  losses on securities                                   |   |   |   |   |   | (204) |
|                                                                                            |   |   |   |   |   |   |   |
| Comprehensive income                                                                            |   |   |   |   |   |   | 3,446  |
|                                                                                            |   |   |   |   |   |   |   |
| Cash dividend declared and paid ($0.18 per share)                                               |   |   |   | (1,143) |   | (1,143) |
| Expense of stock option vesting                                                                 |   |   |   | 24  |   |   | 24  |
| Exercise of stock options                                                                       |   | 19,300  | 97  | 194  |   |   | 291  |
|                                                                                            |   |  |  |  |  |  |  |
| Balance at March 31, 2006                                                                       |   | 6,350,635  |  $ | 31,753  |  $ | 877  |  $ | 60,039  |  $ | (1,110) |  $ | 91,559  |
|                                                                                            |   |   |   |   |   |   |   |

See Notes to Consolidated Interim Financial	Statements.

 4

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| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY******                        |
|-------------------------------------------------------------------------|
| **Consolidated  Statements of Cash Flows**                              |
| **(in thousands)**                                                      |
|                                                                    |   |   |   |   |   |   |   |   |   |
|                                                                    |   |   |   |   |   | **For the three  months ended March 31,** |
|                                                                    |   |   |   |   |   | **2006** | ** ** | **2005** | ** ** |
|                                                                    |   |   |   |   |   | (unaudited) | ** ** |
| Cash flows from operating activities                                    |   |   |   |   |
|                                                                    | Net income |   |  $ | 3,650  |   | 3,411  |   |
|                                                                    | Adjustments to reconcile net income to net cash |   |   |   |   |
|                                                                    |   | provided by operating activities |   |   |   |   |
|                                                                    |   |   | Depreciation and amortization | 654  |   | 800  |   |
|                                                                    |   |   | Investment securities gains | (2) |   | (54) |   |
|                                                                    |   |   | Provision for loan losses | 525  |   | 600  |   |
|                                                                    |   |   | Origination of mortgage loans held for sale | (13,005) |   | (15,353) |   |
|                                                                    |   |   | Proceeds from sale of mortgage loans held for sale | 15,138  |   | 16,075  |   |
|                                                                    |   |   | Gain on sale of mortgage loans | (158) |   | (203) |   |
|                                                                    |   |   | Decrease (increase) in accrued interest receivable | 172  |   | (167) |   |
|                                                                    |   |   | Compensation expense related to stock options granted | 24  |   |  -- |   |
|                                                                    |   |   | Decrease (increase) in other assets, net | (776) |   | 316  |   |
|                                                                    |   |   | Change in other liabilities, net | (1,533) |   | (1,407) |   |
|                                                                    |   |   |   |   |   |  |   |   |   |
|                                                                    |   |   |   | Net cash provided by operating activities | 4,689  |   | 4,018  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Cash flows from investing activities                                    |   |   |   |   |
|                                                                    | Purchase of investment securities available for sale | (8,544) |   | (23,641) |   |
|                                                                    | Proceeds from maturities of investment securities  available for sale | 3,545  |   | 325  |   |
|                                                                    | Proceeds from sales of investment securities available for  sale | 4,128  |   | 21,402  |   |
|                                                                    | Proceeds from calls of investment securities available for  sale | 458  |   | 955  |   |
|                                                                    | Principal paydowns on mortgage-backed  securities available for sale | 1,179  |   | 4,149  |   |
|                                                                    | Redemption (purchase) of FHLB stock | 602  |   | (465) |   |
|                                                                    | Net decrease (increase) in loans outstanding | 4,942  |   | (30,329) |   |
|                                                                    | Purchases of premises and equipment, net | (930) |   | (711) |   |
|                                                                    |   |   |   |   |   |  |   |  |   |
|                                                                    |   |   |   | Net cash used in investing activities | 5,380  |   | (28,315) |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Cash flows from financing activities                                    |   |   |   |   |
|                                                                    | Net increase in deposit accounts | 45,677  |   | 3,726  |   |
|                                                                    | Net increase in retail repurchase agreements | 997  |   | 4,584  |   |
|                                                                    | Net increase in commercial paper | 231  |   | 1,942  |   |
|                                                                    | Net increase (decrease) in federal funds purchased | (1,000) |   | 13,320  |   |
|                                                                    | Net increase (decrease) in FHLB borrowings | (16,900) |   | 6,000  |   |
|                                                                    | Proceeds from stock option activity | 291  |   | 188  |   |
|                                                                    | Dividends paid |   | (1,143) |   | (1,010) |   |
|                                                                    |   |   |   |   |   |  |   |  |   |
|                                                                    |   |   |   | Net cash provided by financing activities | 28,153  |   | 28,750  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Net increase in cash and cash equivalents                               | 38,222  |   | 4,453  |   |
| Cash and cash equivalents, beginning of the period                      | 37,976  |   | 33,445  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents, end of the period                            |  $ | 76,198  |   | 37,898  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Supplemental Information                                                |   |   |   |   |   |
| Cash paid during the period for:                                        |   |   |   |   |
|                                                                    | Interest expense |   |  $ | 5,979  |   | 3,498  |   |
|                                                                    | Income taxes |   | 1,684  |   | 1,867  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| Supplemental schedule of non-cash investing and financing  transactions |   |   |   |   |
|                                                                    | Change in unrealized loss on investment securities  available |   |   |   |   |
|                                                                    |   | for sale, net of income tax |  $ | (204) |   | (1,252) |   |
|                                                                    | Loans transferred to other real estate owned, at fair  market value | 52  |   | 154  |   |
|                                                                    | Loans charged-off |   | 279  |   | 403  |   |
|                                                                    |   |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements.                |
|                                                                    |   |   |   |   |   |   |   |   |   |

 

5

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| **PALMETTO BANCSHARES, INC. ANDSUBSIDIARY**                       |
|-------------------------------------------------------------------|
| **Notes To Consolidated InterimFinancial Statements (Unaudited)** |

Palmetto Bancshares, Inc. is a regional financialservices company headquartered in Laurens, South Carolina and organized in 1982under the laws of South Carolina. Through its wholly owned subsidiary, ThePalmetto Bank (the "Bank"), Palmetto Bancshares, Inc. engages in the generalbanking business through 31 retail banking offices in the upstate South Carolinamarkets of Laurens, Greenville, Spartanburg, Greenwood, Anderson, Cherokee,Abbeville, Pickens, and Oconee counties (the "Upstate").  Brokerageoperations are conducted through the Bank's wholly owned subsidiary, PalmettoCapital, Inc. ("Palmetto Capital"). The Bank was organized and chartered underSouth Carolina law in 1906.  Throughout this report, the "Company" shallrefer to Palmetto Bancshares, Inc. and its subsidiary, the Bank, which includesits subsidiary, Palmetto Capital, except where the context requires otherwise.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies followed bythe Company for interim financial reporting are consistent with the accountingpolicies followed for annual financial reporting.  The unauditedConsolidated Interim Financial Statements and footnotes are presented inaccordance with the instructions for the Quarterly Report on Form 10-Q. The information contained in the footnotes included in the Company's latestAnnual Report on Form 10-K should be referred to in connection with the readingof these unaudited Consolidated Interim Financial Statements.  

Principles ofConsolidationThe accompanying Consolidated Interim Financial Statements include theaccounts of the Company, which includes its wholly owned subsidiary, the Bank,and the Bank's wholly owned subsidiary, Palmetto Capital.  In management'sopinion, all significant intercompany accounts and transactions have beeneliminated in consolidation, and all adjustments necessary for a fairpresentation of the financial condition and results of operations for periodspresented have been included. Any such adjustments are of a normal and recurringnature. Assets held by the Company or its subsidiary in a fiduciary or agencycapacity for customers are not included in the Company's Consolidated InterimFinancial Statements as such items do not represent assets of the Company or itssubsidiary.

Use of EstimatesThe accounting and reporting policies of the Company conform to accountingprinciples generally accepted in the United States of America and to generalpractices within the banking industry. In preparing its Consolidated FinancialStatements, the Company's management makes estimates and assumptions that impactthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities as of the date of the Consolidated Financial Statementsfor the periods presented. Actual results could differ from these estimates andassumptions. As such, the results of operations for the three months ended March31, 2006 are not necessarily indicative of the results of operations that may beexpected in future periods.

ReclassificationsCertain amounts previously presented in the Company's Consolidated FinancialStatements for prior periods have been reclassified to conform to currentclassifications.  All such reclassifications had no impact on the priorperiods' net income or retained earnings as previously reported. During thefirst quarter of 2006, due to the nature of the account, the Company beganclassifying its interest bearing overnight investment account at the FederalHome Loan Bank as federal funds sold.  Prior to 2006, this account had beenclassified within the cash and due from banks financial statement line item. As such, this change resulted in an asset reclassification within theConsolidated Balance Sheets.

Stock Option PlansIn an effort to provide investors and other users of financial statementswith more complete and consistent financial information, the FinancialAccounting Standards Board ("FASB") published Statement of Financial AccountingStandards ("SFAS") No. 123 (revised 2004), "Share-Based Payment," which requiresthat the compensation cost relating to stock-based payment transactions bemeasured based on the fair value of the equity or liability instruments issuedand recognized in financial statements. Prior to its revision, SFAS No. 123,"Accounting for Stock-Based Compensation," allowed a company to adopt either thefair value method of valuation or the intrinsic valuation method presented underAPB Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB No. 25")to account for stock-based compensation. SFAS No. 123 permitted companies torecognize as expense over the instrument's vesting period the fair value of allstock-based awards on the date of grant. In management's opinion, the existingstock option valuation models did not provide a reliable measure of stock optionfair value. Therefore, as permitted, the Company applied the accounting rulespermitted under APB No. 25 and provided pro forma net income and pro forma netincome per common share disclosures for stock option grants as if the fair valuebased method defined in SFAS No. 123 had been applied. The provisions of APB No.25 and related interpretations required compensation cost for options berecognized only if the market price of the underlying stock exceeded theexercise price on the date of grant. As such, no stock-based compensation costhas typically been reflected in net income of the Company, as all stock-basedawards granted under current and past plans have historically had an exerciseprice equal to the fair value of the underlying common stock on the date ofgrant.

6

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On January1, 2006, the Company adopted the fair value recognition provisions ofSFAS No. 123(R) to account for compensation costs under its current stockoption plan.  In conjunction with the adoption of SFAS No. 123(R), theCompany elected to use the modified prospective method to account for thetransition from the intrinsic value method to the fair value recognition method. Under the modified prospective method, compensation cost is recognized from theadoption date forward for all new stock options granted and for any outstandingunvested awards as if the fair value method had been applied to those awards asof the date of grant. The following table illustrates the impact on net incomeand net income per share as if the fair value method had been applied to alloutstanding and unvested awards for the periods indicated (in thousand, exceptcommon share data).

|  |  | **For the three months ended March 31,** 
**2006**
**2005**Net income, as reported$3,650 3,411 Add: stock-based compensation expense		included in reported net income, net  		 of related tax effects 24  - Deduct: stock-based compensation expense		determined under fair market  value based method for all awards, net of		related tax effects (24)(25)Pro forma net income including stock-based		compensation expense based on  fair market value method $3,650 3,386  Common Share Data Net income - basic, as reported $0.58 0.54 Net income - basic, pro forma 0.58 0.54  Net income - diluted, as reported $0.57  0.53 Net income - diluted, pro forma 0.57 0.53 
The following table summarizes the stock-basedawards granted by the Company, the fair market value of each award granted asestimated on the date of grant using the Black-Scholes option-pricing model, andthe weighted average assumptions used for such grants for the periods indicated.

**For awards granted during the 		three months ended March 31,**
**2006**
** **
**2005**Awards granted
10,000 
33,000   
** **
** **
** **Dividend yields2.45  % 2.48 Expected volatility11  % 16 Risk-free interest rate4  % 4 Expected term (years) 9  9 Vesting period (years)5 5 
See Note 11 containedherein for further discussion regarding the Company's stock option plan.

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Concentrations of Credit RiskThe Company makes loans to individuals and small to medium-sized businessesfor various personal and commercial purposes primarily in Upstate, SouthCarolina.  The Company's loan portfolio is not concentrated in loans to anysingle borrower or a relatively small number of borrowers.  Additionally,management is not aware of any concentrations of loans to classes of borrowersor industries that would be similarly impacted by economic conditions. Management has identified, and the following table summarizes at the datesindicated, concentrations of types of lending that it monitors (dollars inthousands).

**March 31, 2006** 
**Outstanding 		balance**
** **
**As a percentage of 		total equity**
**As a percentage of 		total loans**Loans secured by: Commercial and industrial nonmortgage		instruments$125,112 137 %15 %Residential mortgage instruments 164,797 180 19 Nonresidential mortgage instruments 474,843 519 55  
**December 31, 2005** 
**Outstanding 		balance**
** **
**As a percentage of 		total equity**
**As a percentage of 		total loans**Loans secured by: Commercial and industrial nonmortgage		instruments$143,334 161 %17 %Residential mortgage instruments 167,693 189 19 Nonresidential mortgage instruments 458,154 515 53  
In addition to monitoring potentialconcentrations of loans to particular borrowers or groups of borrowers,industries, geographic regions, and loan types, management monitors whether ornot the Company has exposure to credit risk from other lending practices such asloans that subject borrowers to substantial payment increases (e.g. principaldeferral periods, loans with initial interest-only periods, etc.) and loans withhigh loan-to-value ratios.  Management has determined that, at March 31,2006, the Company has no concentrations in such loans, as the Company does nottypically engage in such lending practices.  

Additionally, there are industry practices thatcould subject the Company to increased credit risk should economic conditionschange over the course of a loan's life.  For example, the Company makesadjustable-rate loans and fixed-rate principal-amortizing loans with maturitiesprior to the loan being fully paid (i.e. balloon-term loans).  These loansare underwritten and monitored to manage the associated risks.  Therefore,management believes that these particular practices do not subject the Companyto unusual credit risk. 

The Company's investment portfolio consistsprincipally of obligations of the United States, its agencies, and / or itscorporations and general obligation municipal securities.  In the opinionof management, there is no concentration of credit risk in its investmentportfolio.  The Company places its deposits and correspondent accountswith, and sells its federal funds to, high quality institutions. Management believes credit risk associated with correspondent accounts is notsignificant.

Recently Issued Accounting PronouncementsThe following is a summary of recent authoritative pronouncements that couldimpact the accounting, reporting, and / or disclosure of financial informationby the Company.

In December 2004, the FASB issued SFAS No. 123(revised 2004), "Share-Based Payment."  SFAS No. 123(R) requires companiesto measure all employee stock-based compensation awards using a fair valuemethod and record such expense in its financial statements.  In addition,SFAS No. 123(R) requires additional accounting and disclosures related to theincome tax and cash flow impacts resulting from share-based paymentarrangements.  SFAS No. 123(R) was effective, and the Company adopted SFASNo. 123(R) using the modified prospective method, beginning as of the firstannual reporting period beginning after December 15, 2005.  

8

 

In January 2006, theFASB issued a proposed statement regarding the fair value option for financialassets and financial liabilities.  The FASB believes that the proposedStatement would create a fair value option under which an entity may irrevocablyelect fair value as the initial and subsequent measurement attribute for certainfinancial assets and financial liabilities, with changes in fair valuerecognized in earnings as those changes occur. An entity would be permitted toelect the fair value option at initial recognition of a financial asset orfinancial liability or upon an event that gives rise to new-basis accounting forthat item. The election of the fair value option would be made on acontract-by-contract basis and would need to be supported by concurrentdocumentation or a preexisting documented policy. This proposed Statement wouldrequire an entity to report its financial assets and financial liabilities that,pursuant to electing the fair value option, would be subsequently measured atfair value in a manner that separates those reported fair values from thecarrying amounts of assets and liabilities subsequently measured using anothermeasurement attribute on the face of the statement of financial position. Thisproposed Statement would amend FASB No. 115, "Accounting for Certain Investmentsin Debt and Equity Securities," to require that securities reported at fairvalue in accordance with FASB No. 115 satisfy this financial statementpresentation requirement. This proposed Statement would also require an entityto provide information that would allow users to understand the impact onearnings of changes in the fair values of assets and liabilities subsequentlymeasured at fair value as a result of a fair value election. Adoption of thisproposed statement would be required as of the beginning of an entity's firstfiscal year that begins after December 15, 2006, with earlier adoption permittedas of the beginning of an entity's earlier fiscal year that begins afterissuance of the final statement.

In February 2006, the FASB issued SFAS No. 155,"Accounting for Certain Hybrid Financial Instruments-an amendment of FASBStatements No. 133 and 140." This Statement amends SFAS No. 133, "Accounting forDerivative Instruments and Hedging Activities," and SFAS No. 140, "Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities." This Statement resolves issues addressed in SFAS No. 133Implementation Issue No. D1, "Application of Statement 133 to BeneficialInterests in Securitized Financial Assets." SFAS No. 155 is effective for allfinancial instruments acquired or issued after the beginning of an entity'sfirst fiscal year that begins after September 15, 2006. The Company does notbelieve that the adoption of SFAS No. 155 will have a material impact on itsfinancial position, results of operations and cash flows. 

In March2006, the FASB issued SFAS No. 156, "*Accounting for Servicing of FinancialAssets-an amendment of FASB Statement No. 140." *This Statement amendsFASB No. 140, "Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities," with respect to the accounting for separatelyrecognized servicing assets and servicing liabilities. SFAS No. 156 requires anentity to recognize a servicing asset or servicing liability each time itundertakes an obligation to service a financial asset by entering into aservicing contract; requires all separately recognized servicing assets andservicing liabilities to be initially measured at fair value, if practicable;permits an entity to choose its subsequent measurement methods for each class ofseparately recognized servicing assets and servicing liabilities; at its initialadoption, permits a one-time reclassification of available-for-sale securitiesto trading securities by entities with recognized servicing rights, withoutcalling into question the treatment of other available-for-sale securities underStatement 115, provided that the available-for-sale securities are identified insome manner as offsetting the entity's exposure to changes in fair value ofservicing assets or servicing liabilities that a servicer elects to subsequentlymeasure at fair value; and requires separate presentation of servicing assetsand servicing liabilities subsequently measured at fair value in the statementof financial position and additional disclosures for all separately recognizedservicing assets and servicing liabilities. An entity should adopt SFAS No. 156as of the beginning of its first fiscal year that begins after September 15,2006. The Company is currently evaluating the impact that the adoption of SFASNo. 156 will have on its financial position, results of operations and cashflows.  

In March2006, the FASB issued an Exposure Draft designed to improve accounting forpostretirement benefit plans including pensions. The FASB believes that theproposed statement would increase transparency and completeness of financialstatements by requiring employers to recognize the overfunded or underfundedpositions of defined benefit postretirement plans, including pension plans, intheir balance sheets. The proposal would also require that employers measureplan assets and obligations as of the date of their financial statements. TheFASB is seeking written comments on the proposal by May 31, 2006.

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Other accounting standards that have been issuedor proposed by the FASB or other standards-setting bodies are not expected tohave a material impact on the Company's financial position, results ofoperations and cash flows.

2.       NATURE OF OPERATIONS

The industry in which the Bank operates existsprimarily to provide an intermediary service to the general public with funds todeposit and, by using these funds, to originate loans in the markets served. TheBank provides a full range of banking activities, including, but not limited to,such services as checking, savings, money market, and time deposits for a widerange of consumer and commercial depositors; loans for business, real estate,and personal uses; safe deposit box rental; electronic funds transfer services;telephone banking; and bankcard services. The Bank's indirect lending departmentestablishes relationships with Upstate automobile dealers to provide customerfinancing on qualifying automobile purchases, and the Bank's mortgage-bankingoperation meets a range of its customers' financial service needs byoriginating, selling, and servicing mortgage loans. The Bank also offers bothindividual and commercial trust services through its trust department. Palmetto Capital, the brokerage subsidiary of the Bank, offers customersbrokerage services relating to stocks, treasury and municipal bonds, mutualfunds, and insurance annuities, as well as college and retirement planning.

3.       INVESTMENT SECURITIES AVAILABLE FOR SALE

The following tables summarize the amortizedcost, gross unrealized gains, gross unrealized losses, and fair market values ofinvestment securities available for sale at the dates indicated (in thousands).

**March 31, 2006**		 
**Amortized 		cost**
**Gross unrealized 		gains**
**Gross unrealized 		losses**
**Fair market 		value**Investment securities available for sale		 U.S. Government agencies$51,323   		-    (375)50,948 State and municipal		 54,803 106 (1,066)53,843 Mortgage-backed		 20,599   		-     		(470)20,129 Total investment securities available 		for sale $126,725 106 (1,911)124,920 		 
**December 31, 2005**		 
**Amortized 		cost**
**Gross unrealized 		gains**
**Gross unrealized 		losses**
**Fair market 		value**Investment securities available for sale		 U.S. Government agencies$50,257 -   (297)49,960 State and municipal		 56,766 185 (945)56,006 Mortgage-backed		 20,438 1		(417)20,022 Total investment securities available 		for sale $127,461 186 (1,659)125,988 		 
See ConsolidatedStatements of Cash Flows for a further discussion of the activity impacting theCompany's investment securities available for sale portfolio during the threemonths ended March 31, 2006.

During the quarter ended March 31, 2006, theCompany had realized gains of $24 thousand and realized losses amounting to $22thousand on sales of investment securities available for sale compared withrealized gains of $118 thousand and realized losses amounting to $64 thousandduring the same quarter of 2005.  Specific identification is the basis onwhich cost is determined in computing realized gains and losses.

The following table summarizes the grossunrealized losses, fair market value, and the number of securities in eachcategory of investment securities available for sale, aggregated by investmentcategory and length of time that individual securities have been in a continuousunrealized loss position, at March 31, 2006 (dollars in thousands).

10

**Less 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 		losses**U.S. Government agencies           		19 		 $45,070				 $(276)             		3 5,878 (99)          		22 50,948 (375)State and municipal          		43 		           		19,554 		                     		(383)          		59 20,590 (683)         		102 40,144 (1,066)Mortgage-backed             		9 		            		3,900 		                       		(55)          		24 16,131 (415)          		33 20,031 (470)   Total investment securities   available for		sale            		71 		 $68,524				 $(714)          		86 42,599 (1,197)         		157 111,123 (1,911)
As summarized in the preceding table, totalunrealized losses within the Company's investment securities portfolio are theresult of an accumulation of a high volume of such securities in relatively lowunrealized loss positions.   Since the Company has the ability andintent to hold these investments until a market price recovery or maturity,management does not consider these investments to be other-than-temporarilyimpaired. 

Investment securities available for sale with anaggregate carrying value totaling $108.0 million and $104.9 million at March 31,2006 and December 31, 2005, respectively, were pledged to secure publicdeposits, securities sold under agreements to repurchase, and for other purposesas required or permitted by law.

4.       LOANS 

The following tablesummarizes loans, by loan purpose, excluding those mortgage loans held for sale,by classification at the dates indicated (dollars in thousands). 
** **** **
**March 31, 2006**
** **
**December 31, 2005**** **** **		 
**Total**
**% of Total**
** **
**Total**
**% of Total**Commercial business$90,907 
		10.6%90,345 10.5 Commercial real estate		 553,893 64.8		561,574 65.1 Installment		 19,220 2.2 18,677 2.2 Installment real estate		 57,013 6.7 55,682 6.5 Indirect		 34,166 4.0 30,481 3.5 Credit line		 1,929 0.2  		2,022 0.2 Prime access		 54,538 6.4 54,296 6.3 Residential mortgage		 33,824 4.0 34,453 4.0 Bankcards		 11,087 1.3 11,744 1.4 Business manager		 232  		-   230  -   Other		 1,667 0.2 2,059 0.2 Loans in process		 1,697 0.2 3,857 0.4 Deferred loans fees and costs		 785 0.1 761 0.1 Loans		 860,958 100.7 866,181 100.4 		 Mortgage loans held for sale		 2,846 0.3 4,821  0.6 Total loans, gross		 863,804 101.0 871,002 101.0 		 Allowance for loan losses		 (8,727)(1.0)(8,431)(1.0)Total loans, net$855,077		
		100.0%862,571 100.0 		 
Loans included in thepreceding table are net of participations sold and mortgage loans sold andserviced for others.  Mortgage loans serviced for the benefit of othersamounted to $310.0 million and $304.2 million at March 31, 2006 and December 31,2005, respectively. The majority of these mortgage loans sold and serviced forothers are serviced for the Federal Home Loan Mortgage Corporation. See Note 5contained herein for further discussion regarding mortgage loans serviced by theCompany for others. Net gains on the sale of mortgage loans included in MortgageBanking Income in the Company's Consolidated Statements of Income totaled $158thousand and $203 thousand for the quarters ending March 31, 2006 and 2005,respectively. 

See Note 1 containedherein for discussion regarding the Company's concentration of credit risk.

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The following table summarizes nonaccrual loansand loans past due 90 days and still accruing interest at the dates indicated(in thousands).
		 
**March 31,**
**December 31,**		 
**2006**
**2005**Nonaccrual loans$7,526		9,913 Loans past due 90 days and still accruing		(1)		 159 207 $7,685		10,120 		 (1) Substantially all of these loans are		bankcard loans
During the fourth quarter of 2005, two loans,both of which were secured by other real estate, were placed in nonaccrualstatus.  In accordance with the Bank's lending policy, the loans weredowngraded to substandard. At December 31, 2005, the principal balance of theseloans totaled $7.2 million, and management believed the collateral securingthese loans is sufficient to cover the Bank's exposure.  Payment wasreceived during the first quarter of 2006 on one of these loans (balance ofapproximately $3.3 million) that warranted the removal of nonaccrual status atthat time. Additionally, current payments have been received since the loan wasbrought current and removed from nonaccrual status.  Offsetting this decline in nonaccrual loans during the first threemonths of 2006 was the addition of a few moderate sized loans that were placedin nonaccrual status during the quarter.  Management is aware of nomaterial relationships or specific events or trends that led to the increase innonaccrual loans, after taking into consideration the removal of the loan notedabove from nonaccrual during the first quarter of 2006, at March 31, 2006 overDecember 31, 2005.  

The table set forthbelow summarizes the activity impacting the allowance for loan losses (the"Allowance") for the periods indicated (in thousands).
** **** **
**For the three months ended**** **** **
**March 31,**** **** **		 
**2006**
**2005**Allowance, beginning of period$8,431 7,619 Provision for loan losses		 525 600 		 Loans charged-off		  (279)(403)Loan recoveries		 50 22 Net loans charged-off		 (229)(381)		 Allowance, end of period$8,727 7,838 		 
As of March 31, 2006,management was aware of no potential problem loans that were not alreadycategorized as nonaccrual, past due, or restructured, that had borrower creditproblems causing management to have serious doubt as to the ability of theborrower to comply with the present loan repayment terms.  

Any troubled debtrestructurings entered into by the Company for the quarters ended March 31, 2006and 2005 were immaterial when considered individually, or in the aggregate, withregard to the Company's Consolidated Financial Statements.

The Bank makescontractual commitments to extend credit that are legally binding agreements tolend money to customers at predetermined interest rates for a specific period oftime.  The Bank also provides standby letters of credit. See Note 13contained herein for further discussion regarding the Company's commitments.

5.       MORTGAGE-SERVICING RIGHTS

The Company sells aportion of its originated fixed-rate and adjustable-rate mortgage loansservicing retaining. All of the Company's loan sales have been without provisionfor recourse. Mortgage loans serviced for the benefit of others amounted to$310.0 million and $304.2 million at March 31, 2006 and December 31, 2005,respectively. The majority of these mortgage loans sold and serviced for othersare serviced for the Federal Home Loan Mortgage Corporation. 

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The following table summarizes the changes in thethe Company's mortgage-servicing right portfolio for the periods indicated (inthousands). 

** For the three months ended**
** March 31,** 
**2006**
**2005**Mortgage-servicing right portfolio, net of		valuation allowance, beginning of period$2,626 2,316 Capitalized mortgage-servicing rights 89 
		175 Mortgage-servicing right portfolio		amortization              		(167)
             		(138)Change in mortgage-servicing right valuation		allowance 80 
		18 Mortgage-servicing right portfolio, net of		valuation allowance, end of period$2,628 2,371  
Mortgage-servicingright amortization and valuation allowances are included in Mortgage-BankingIncome on the Consolidated Statements of Income.

The aggregate fairmarket value of mortgage-servicing rights at March 31, 2006 and 2005 was $2.7million and $2.3 million, respectively. 

The decline inmortgage-servicing rights capitalized is primarily due to the lower level ofmortgage loan sales during the first three months of 2006 when compared with thesame period of 2005. The increase in mortgage-servicing right portfolioamortization from the three months ended March 31, 2005 to the same period of2006 is due primarily to the increase in mortgage loans serviced for the benefitof others over the same periods.  As a percentage of the mortgage-servicingright portfolio, this amortization remained relatively unchanged when comparingthe two periods. Over the last several years the Company was required to recordreserves for impairment as declining interest rates caused the estimated fairvalue of its mortgage-servicing right portfolio to fall below recorded values.Recent increases in market interest rates for mortgage loans resulted inincreases in the estimated fair value of the Company's mortgage-servicing rightportfolio, allowing the Company to recover a portion of previously recordedimpairment reserves.

The following table summarizes the activityimpacting the valuation allowance for impairment of the mortgage-servicing rightportfolio for the periods indicated (in thousands).

** For the three months ended**
** March 31,** 
**2006**
**2005**Valuation allowance, beginning of period$114 132 Aggregate additions charged and reductions		credited to operations                   		(80)                  		(18)Valuation allowance, end of period$34 114  
Activity impactingthe Company's mortgage-servicing rights portfolio, including mortgage loansoriginated to be sold and sales, are reflected in the Consolidated Statement ofCash Flows. 

As reported in theCompany's Annual Report on Form 10-K for the year ended December 31, 2005, theCompany estimates amortization expense related to its mortgage-servicing rightportfolio of $628 thousand for the year ended December 31, 2006, $513 thousandfor the year ended December 31, 2007, $417 thousand for the year ended December31, 2008, $337 thousand for the year ended December 31, 2009, $270 thousand forthe year ended December 31, 2010, and $461 thousand thereafter.  Managementis aware of no material events or uncertainties that would cause reportedprojected amortization related to its mortgage-servicing right portfolio not tobe indicative of future financial condition or results of operations or thatwould cause future financial condition or results of operations to differmaterial from these projections. However, amortization expense is calculatedbased on current available information regarding loan payments and prepaymentsand could change in future periods based on changes in volume of prepayments andother economic factors.

See Consolidated Statements of Cash Flows for afurther discussion of the activity impacting the Company's mortgage-servicingright portfolio.

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6.       INTANGIBLE ASSETS 

The following tablesummarizes intangible assets, which are included in Other Assets on theConsolidated Balance Sheets, net of accumulated amortization, at the datesindicated (in thousands). 
 
**March 31,**
**December 31,**
**March 31,** 
**2006**
**2005**
**2005**Goodwill$          		3,691             		3,691             		3,691 Customer list intangibles                		163                		175                		283 Total intangible assets$          		3,854             		3,866  $         		3,974  
The following tablesummarizes the activity of intangible assets with finite lives, which arecomprised of customer list intangibles, and the related amortization, which isincluded in Other Noninterest Expense in the Consolidated Statements of Income,for the periods indicated (in thousands).  

**For the three months**
**ended March 31,** 
**2006**
**2005**Balance, at beginning of period$        		175           		320      Less: amortization             		12             		37 Balance, at end of period$        		163           		283  
The following tablesummarizes the gross carrying amount and accumulated deprecation of intangibleassets with finite lives at the dates indicated (in thousands).

**March 31,** 
**2006**
**2005**Customer list intangibles, gross$      1,779        		1,779      Less: accumulated		amortization        		1,616        		1,496 Customer list intangibles, net$        		163           		283  
As reported in theCompany's Annual Report on Form 10-K for the year ended December 31, 2005, theCompany estimates amortization expense related to intangible assets with finitelives of $48 thousand for the years ended December 31, 2006 and 2007, $45thousand for the year ended December 31, 2008, and $34 thousand for the yearended December 31, 2009.  Management is aware of no material events oruncertainties that would cause amortization expense related to the Company'sintangible assets with finite lives not to be indicative of future financialcondition or results of operations or that would cause future financialcondition or results of operations to differ materially from these projections.

The Company's intangible assets with finite lives(goodwill) are subject to periodic impairment tests that are performed by theCompany as of June 30 annually, or more often, if events or circumstancesindicate that there may be impairment. Management is aware of no material eventsor uncertainties that have occurred since June 30, 2005 that would indicate thatthere might be impairment. As such, no changes were made to the carrying amountof goodwill for the three months ended March 31, 2006.

7.       REAL ESTATE AND PERSONAL PROPERTY ACQUIRED IN SETTLEMENT OF LOANS

The following tablesummarizes real estate and personal property acquired in settlement of loans atthe dates indicated (in thousands).                         
 
**March 31,**
**December 31,**
**March 31,** 
**2006**
**2005**
**2005**Real estate acquired in settlement of loans
$         		932              		1,954         		2,346 Repossessed automobiles acquired in		settlement of loans            		182                 		167            		229      Total property		acquired in settlement of loans
$       1,114              		2,121         		2,575  
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The following tablesummarizes the changes in the allowances, including the balance at the beginningand end of each period, provision charged to expense, and losses charged to theAllowance related to the Company's real estate acquired in settlement of loansfor the periods indicated (in thousands).

**At and for the three months**
**ended March 31,** 
**2006**
**2005**Real estate acquired in settlement of loans,		beginning of period
$1,954 2,413 Add: New real estate acquired in settlement		of loans 52 154 Less: Sales / recoveries of real estate		acquired in settlement of loans              		(931)             		(161)Less: Provision charged to expense              		(143)               		(60)Real estate acquired in settlement of loans,		end of period
$932 2,346  
8.       DEPOSITS

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

**March 31, 2006**** **
**December 31, 2005** 
**Total**
**% of Total**** **
**Total**
**% of Total**Transaction deposit accounts$386,379 40.7 
%351,629 38.9 Money market deposit accounts 121,413 12.8 111,380 12.4 Savings deposit accounts 46,948 5.0 45,360 5.0 Time deposit accounts 394,320 41.5 395,014 43.7 Total traditional deposit accounts$949,060 100.0 
%903,383 100.0  
9.       FEDERAL HOME LOAN BANK BORROWINGS 

At March 31, 2006, ofits approximately $182 million available credit based on qualifying loansavailable to serve as collateral against short-term or long-term borrowings fromthe FHLB, the Company employed $23.0 million, all of which was determined to belong-term when employed.  

FHLB advances withfixed interest rates are subject to a prepayment fee in the event of full orpartial repayment prior to maturity or the expiration of any interim interestrate period.  Management was not aware of any circumstances at March 31,2006 that would require prepayment of any of the Company's FHLB advances. 

10.     OTHER BORROWINGS

If needed, alternative funding sources have beenarranged through federal funds lines at correspondent banks and through theFederal Reserve Discount Window.  At March 31, 2006, the Company had unusedshort-term lines of credit at correspondent banks totaling of $40 million (whichwere accessible at the Company's option).  

11.     EMPLOYEE BENEFIT PLANS

PostretirementBenefits The following table summarizes the combined adjusted postretirement benefitexpense components for the Company's defined benefit pension plan, which isincluded in Salaries and Other Personnel Expense on the Consolidated Statementsof Income, at and for the periods indicated (in thousands). 

15

 

**For the three months**
**ended March 31,** 
**2006**
**2005**Service cost$             		141                 		141 Interest cost                		165                		165 Expected return on plan assets              		(229)             		(229)Amortization of prior service cost                    		3                    		3 Amortization of loss                  		20                  		20 Postretirement benefit expense $             		100                		100 
The Company expectsto contribute $1.2 million to the plan during 2006. During the three monthsended March 31, 2006 and 2005, $308 thousand and $300 thousand was contributed,respectively. 

Stock Option PlanAs of March 31, 2006, 424,200 options, net of cancellations, had beengranted that expire at various dates through December 31, 2015. Of these,243,485 remained outstanding at March 31, 2006 at prices ranging from $8.75 to$29.90. These options are not granted in lieu of otherwise payable cashcompensation. All options granted have a vesting term of five years and anexercise period of ten years. At March 31, 2006, there were 25,800 remainingoptions available for grant under this plan. 

The following table summarizes stock optionactivity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan for theperiods indicated.

**Stock 		options** 
**Weighted-average 		exercise price**Outstanding at December 31, 2004257,835 $14.59 Granted33,000  26.60 Forfeited / Cancelled-   - Exercised(16,250) 11.56 Outstanding at March 31, 2005274,585 $16.22  Outstanding at December 31, 2005252,785 $16.63 Granted10,000  29.00 Forfeited / Cancelled-   		 -  Exercised(19,300) 15.05 Outstanding at March 31, 2006243,485 $17.27  
401(k) Retirement PlanDuring the three months ended March 31, 2006 and 2005, the Company madematching contributions to employee 401(k) retirement plans totaling $69 thousandand $66 thousand, respectively.

12.     NET INCOME PERCOMMON SHARE

The following table summarizes the Company'sreconciliation of the numerators and denominators of the basic and diluted netincome per common share computations for the periods indicated (dollars inthousand, except common share data).

**For the three months 		ended March 31,** 
**2006**
**2005**Weighted average common shares outstanding -		basic 
		 6,343,247 
		 6,309,527 Dilutive impact resulting from potential		common share issuances 
   		100,755 
     		97,832 Weighted average common shares outstanding -		diluted 
		 6,444,002 
		 6,407,359    Common Share Data Net income - basic$        0.58		         		0.54 Net income - diluted          		0.57          		0.53 
16

 

At March 31, 2006, there were no option sharesexcluded from the calculation of diluted net income per common share because theexercise price was greater than the average market price as determined by anindependent valuation of common shares.  

The Company paid cash dividends of $0.18 and $0.16 per share for the three months ended March 31, 2006 and 2005,respectively.  

13.     COMMITMENTS AND CONTINGENCIES

LegalProceedingsThe Company is currently subject to various legal proceedings and claimsthat have arisen in the ordinary course of its business. In the opinion ofmanagement, based on consultation with external legal counsel, any reasonablyforeseeable outcome of such current litigation would not materially impact theCompany's financial condition or results of operations.

Lease AgreementsLease payments for rental commitments under noncancelable ground andbuilding operating leases totaled $179 thousand and $159 thousand during thethree months ended March 31, 2006 and 2005, respectively.  Such paymentsare included in Occupancy Expense in the Consolidated Statements of Income.

During the firstquarter of 2006, the Bank completed negotiations with a third party with regardto the sublease of its previous Blackstock Road banking office location. 

LendingCommitmentsThe following table summarizes the Company's contractual commitments toextend credit at March 31, 2006 (in thousands).
Home equity loans$45,768 Credit cards 45,623 Commercial real estate development 54,710 Other unused lines of credit 51,161 Total contractual obligations$197,262		
GuaranteesAt March 31, 2006, the Company recorded no liability for the currentcarrying amount of the obligation to perform as a guarantor, and no contingentliability was considered necessary as such amounts were not considered material. The maximum potential amount of undiscounted future payments related to standbyletters of credit at March 31, 2006 was $5.6 million.  Past experienceindicates that these standby letters of credit will expire unused. However,through its various sources of liquidity, the Company believes that it has thenecessary resources available to meet these obligations should the need arise. Additionally, the Company does not believe that the current fair market value ofsuch guarantees was material at March 31, 2006.

Other Off-BalanceSheet ArrangementsAt March 31, 2006, the Company had no interest in nonconsolidated specialpurpose entities nor was it involved in other off-balance sheet contractualrelationships, unconsolidated related entities that have off-balance sheetarrangements, or transactions that could result in liquidity needs (other thanthose discussed herein).

14.     DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGINGACTIVITIES

At March 31, 2006, the Company's derivativeinstruments consisted of forward sales commitments relating to the Company'scommitments to originate certain residential loans held for sale.

Outstanding commitments on mortgage loans not yetclosed (primarily single-family loan commitments) amounted to approximately $4.6million at March 31, 2006.  The fair market value of derivative assetsrelated to commitments to originate such residential loans held for sale andforward sales commitments was not significant at March 31, 2006.

17

15.     DIVIDEND RESTRICTIONS AND REGULATORY CAPITALREQUIREMENTS

At March31, 2006, the most recent notification from federal banking agencies categorizedthe Company and the Bank as well capitalized under the regulatory framework. Tobe categorized as well capitalized, minimum total risk-based capital, Tier 1capital, and Tier 1 leverage ratios as set forth in the following table (dollarsin thousands) must be maintained. Since March 31, 2006, there have been noevents or conditions that management believes would changed these categories.
** **** **** **** **** **
**Actual**
**For capital 		adequacy purposes**
**To be well capitalized 		under prompt corrective 		action provisions**
**amount**
**ratio**
**amount**
**ratio**
**amount**
**ratio**At March 31,		2006*Total		capital to risk-weighted assets*Company
$       		97,278 
		10.31%       		75,447     		      8.00 
		 n/a 
		n/aBank         		96,098         		10.19        		75,447           		8.00 
       		94,309         		10.00 *Tier 1		capital to risk-weighted assets*Company         		88,551           		9.39        		37,724     		      4.00 
		 n/a 
		n/aBank         		87,371           		9.26        		37,724           		4.00        		56,586           		6.00 *Tier 1		capital to average assets*Company         		88,551           		8.18        		43,310         		  4.00 
		 n/a 
		n/aBank         		87,371           		8.06        		43,338           		4.00        		54,173           		5.00 At March 31,		2005*Total		capital to risk-weighted assets*Company
$       		86,072 
		10.28%       		67,010           		8.00 
		 n/a 
		n/aBank         		85,389         		10.19        		67,010           		8.00        		83,762         		10.00 *Tier 1		capital to risk-weighted assets*Company         		78,234           		9.34        		33,505           		4.00 
		 n/a 
		n/aBank         		77,551           		9.26        		33,505           		4.00        		50,257           		6.00 *Tier 1		capital to average assets*Company         		78,234           		7.81        		40,091           		4.00 
		 n/a 
		n/aBank         		77,551           		7.74        		40,098           		4.00        		50,122           		5.00 	 
 

 

18

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

The following discussion and analysis ispresented to assist the reader with understanding the financial condition andresults of operations of the Company.  The information presented in thefollowing discussion of financial condition and results of operations of theCompany results from the activities of its subsidiary, the Bank, which comprisesthe majority of the consolidated net income, revenues, and assets of theCompany.  This discussion should be read in conjunction with theConsolidated Financial Statements and related notes and other financial dataappearing in this report as well as in the Company's Annual Report on Form 10-Kfor the year ended December 31, 2005.  Results of operations for the threemonths ended March 31, 2006 are not necessarily indicative of results that maybe attained for any other period.  

WEBSITE AVAILABILITY OF REPORTS FILED WITH THESECURITIES AND EXCHANGE COMMISSION

The Bank's website, www.palmettobank.com,includes a link to the Securities and Exchange Commission's Electronic DataGathering, Analysis, and Retrieval ("EDGAR") system which makes various reportsfiled with the Securities and Exchange Commission by the Company, including, butnot limited to, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K, Ownership Reports filed in conjunction with Section16, and amendments to such reports, available, free of charge.  Thesereports are made available as soon as reasonably practicable after these reportsare filed with, or furnished to, the Securities and Exchange Commission. The Securities and Exchange Commission's EDGAR database may also be accessedthrough its website, www.sec.gov.

FORWARD-LOOKING STATEMENTS

TheCompany makes forward-looking statements in this report and in other reports andproxy statements filed with the Securities and Exchange Commission ("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 theapproval of the Company, which are not statements of historical fact, constituteforward-looking statements. Broadly speaking, forward-looking statementsinclude, but are not limited to, projections of the Company's revenues, income,earnings per common share, capital expenditures, dividends, capital structure,or other financial items, descriptions of plans or objectives of management forfuture operations, products or services, forecasts of the Company's futureeconomic performance, and descriptions of assumptions underlying or relating toany of the foregoing.  

Forward-looking statements discuss matters thatare not historical facts.  Because such statements discuss future events orconditions, 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 notunduly rely on forward-looking statements.  Such statements giveexpectations 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 thedate they are made.

CRITICAL ACCOUNTING POLICIES

TheCompany's significant accounting policies are discussed in Item 8, Note 1 to theConsolidated Financial Statements of the Annual Report on Form 10-K for the yearended December 31, 2005.  Of these significant accounting policies, theCompany considers its policies regarding the accounting for its allowance forloan losses (the "Allowance"), pension plan, mortgage-servicing right portfolio,past acquisitions, and income taxes to be its most critical accounting policiesdue to the valuation techniques used and the sensitivity of these financialstatement amounts to the methods, assumptions, and estimates underlying thesebalances.  Accounting for these critical areas requires a significantdegree of judgment that could be subject to revision as newer informationbecomes available. 

19

COMPANY OVERVIEW

Palmetto Bancshares, Inc. is a regional financialservices company headquartered in Laurens, South Carolina and organized in 1982under the laws of South Carolina. Through its wholly owned subsidiary, ThePalmetto Bank (the "Bank"), Palmetto Bancshares, Inc. engages in the generalbanking business through 31 retail banking offices in the upstate South Carolinamarkets of Laurens, Greenville, Spartanburg, Greenwood, Anderson, Cherokee,Abbeville, Pickens, and Oconee counties (the "Upstate").  In addition toretail offices, at March 31, 2006, the Bank had 33 automatic teller machine("ATM") locations (including four at nonretail office locations) andfive-limited service offices located in retirement centers in the Upstate.Brokerage operations are conducted through the Bank's wholly owned subsidiary,Palmetto Capital, Inc. ("Palmetto Capital"). The Bank was organized andchartered 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 subsidiary, Palmetto Capital, except where the contextrequires otherwise. 

The industry in which the Bank operates existsprimarily to provide an intermediary service to the general public with funds todeposit and, by using these funds, to originate loans in the markets served. TheBank provides a full range of banking activities, including, but not limited to,such services as checking, savings, money market, and time deposits for a widerange of consumer and commercial depositors; loans for business, real estate,and personal uses; safe deposit box rental; electronic funds transfer services;telephone banking; and bankcard services. The Bank's indirect lending departmentestablishes relationships with Upstate automobile dealers to provide customerfinancing on qualifying automobile purchases, and the Bank's mortgage-bankingoperation meets a range of its customers' financial service needs byoriginating, selling, and servicing mortgage loans. The Bank also offers bothindividual and commercial trust services through its trust department. Palmetto Capital, the brokerage subsidiary of the Bank, offers customersbrokerage services relating to stocks, treasury and municipal bonds, mutualfunds, and insurance annuities, as well as college and retirement planning.

 

 

 

 

 

 

20

FIRST QUARTER HIGHLIGHTS
(dollars in		thousands, except common and per share data)
**At and for the three months**
**At and for the year**
**ended March 31,**
**ended December 31,**		 
**2006**
** **
**2005**
**2005**
		(unaudited)
** ** SUMMARY OF		OPERATIONS Interest income		$17,948 14,289 62,783 Interest		expense		 5,853 3,476 17,279 Net interest income 12,095 10,813 45,504 Provision for		loan losses		 525 600 2,400 Net interest income after provision		for loan losses 11,570 10,213 43,104 Noninterest		income 3,982 3,765 15,719 Noninterest		expense		 10,145 8,850 38,101 Income before		provision for income taxes 5,407 5,128 20,722 Provision for		income taxes		 1,757 1,717   6,942      Net income		$3,650 3,411 13,780  COMMON SHARE		DATA Net income per		common share: Basic		$ 0.58 0.54 2.18 Diluted 0.57 0.53 2.15 Cash dividends		per common share 0.18 0.16 0.66 Book value per		common share 14.42 13.00 14.05 Outstanding		common shares 6,350,635 6,313,535 6,331,335 Weighted		average common shares outstanding - basic  6,343,247 6,309,527 6,317,110 Weighted		average common shares outstanding - diluted 6,444,002 6,407,359 6,417,358 Dividend payout		ratio 31.32 %29.61       30.27  YEAR-END		BALANCES Assets		$1,105,105 1,022,604 1,075,015 Investment		securities available for sale, at fair market value 124,920 138,385   		125,988 Loans (1) 863,804 808,283   		871,002 Deposits and		other borrowings 1,007,931 936,467   		978,926 Shareholders'		equity 91,559 82,099     		88,941  AVERAGE		BALANCES Assets		$1,087,303 1,006,498 1,043,897 		Interest-earning assets 1,016,285 940,552   		977,679 Investment		securities available for sale, at fair market value 125,918 141,878   		132,709 Loans (1) 868,109 790,453   		833,353 Deposits and		other borrowings 989,919 919,289   		952,623 Shareholders'		equity  91,240 82,593      85,790 
21
 SIGNIFICANT		OPERATING RATIOS BASED ON EARNINGS Return on		average assets 1.36 %1.37 1.32 Return on		average shareholders' equity 16.22 16.74 16.06 Net interest		margin 4.83 4.66 4.65  SIGNIFICANT		CAPITAL RATIOS  Average		shareholders' equity to average assets 8.39  % 8.21  8.22 Equity to		assets at year-end  8.29 8.03 8.27 Tier 1		risk-based capital 9.39 9.34 9.36 Total		risk-based capital 10.31 10.28 10.28 Tier 1 leverage		ratio 8.18 7.81 8.08  SIGNIFICANT		CREDIT QUALITY RATIOS  Nonaccrual		loans to total assets 0.68 %0.22  0.92 Net loans		charged-offs to average loans (2)   0.11  0.20 0.19  (1) Calculated		using loans including mortgage loans held for sale, net of unearned,		excluding the allowance for loan losses(2) Calculated		using loans excluding mortgage loans held for sale, net of unearned,		excluding the allowance for loan losses
FINANCIAL CONDITION

The followinginformation is intended to supplement any information relating to theConsolidated Balance Sheets contained within Part I, Item 1 of this QuarterlyReport on Form 10-Q.    

Overview

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**
**Consolidated Balance Sheets**
**(dollars in thousands, except common and per share data)**** **** **** **
**March 31,**
**December 31,**
**Dollar**
**Percent**
**2006**
**2005**
**Variance**
**Variance**
		(unaudited)** **** **ASSETS** **** **Cash		and cash equivalents** **** **Cash and due		from banks
		$46,762 36,978 9,784 26.5  %Federal funds		sold29,436 998 28,438 2,849.5  Total		cash and cash equivalents76,198 37,976 38,222 100.6 Federal		Home Loan Bank ("FHLB") stock, at cost3,184 3,786 (602)(15.9)Investment		securities available for sale, at fair market value124,920 125,988 (1,068)(0.8)		Mortgage loans held for sale 2,846 4,821 (1,975)(41.0)Loans 860,958 866,181 (5,223)(0.6)Less allowance		for loan losses(8,727)(8,431)(296)3.5 Loans, net852,231 857,750 (5,519)(0.6)		Premises and equipment, net23,103 22,676 427 1.9 Accrued		interest receivable5,054 5,226 (172)(3.3)Other assets17,569 16,792 777 4.6 Total assets 
$1,105,105 1,075,015 30,090 2.8 %
22
 		LIABILITIES AND SHAREHOLDERS' EQUITY** **** **Liabilities** **** **Deposits** **** **Noninterest-bearing
		$137,060 131,157 5,903 4.5 %		Interest-bearing 812,000 772,226 39,774 5.2 Total deposits949,060 903,383 45,677 5.1 Retail		repurchase agreements17,725 16,728  997 6.0 		Commercial paper (Master notes)18,146 17,915 231 1.3 Federal		funds purchased -  1,000 (1,000)(100.0)Federal		Home Loan Bank borrowings23,000 39,900 (16,900)(42.4)Other		liabilities5,615 7,148 (1,533)(21.4)Total		liabilities1,013,546 986,074 27,472 2.8 ** **** **		Shareholders' Equity** **** **Common		stock 31,753 31,656 97 0.3 Capital		surplus877 659 218 33.1 		Retained earnings 60,039 57,532 2,507 4.4 		Accumulated other comprehensive loss, net of tax(1,110)(906)(204)22.5 Total		shareholders' equity 91,559 88,941 2,618 2.9 ** **** **Total		liabilities and shareholders' equity
$1,105,105 1,075,015 30,090 2.8 %** **** **
Cash and CashEquivalentsThe following table summarizes the composition ofcash and cash equivalents at the dates indicated (in thousands).
		 
**March 31,**
**December 31,**		 
**2006**
**2005**Cash working		funds		$7,734 8,377 Noninterest-earning demand deposits		in other banks 31,826 18,911 In-transit		funds 7,202 9,690 Federal funds		sold		 29,436 998 Total cash and cash equivalents$76,198 37,976  
23

As interest ratescontinue to rise, liability management continues to be a critical key toenhancing the Company's profitability. Understanding the balance in costsbetween asset-based and liability-based liquidity and knowing which fundingalternatives are most effective are factors the Company considers with regard toits liquidity and funds management.  The increase in cash and cashequivalents during the first three months of 2006 is a result of the growth ininterest-bearing deposits outpacing the growth in the Company's loan andinvestment securities portfolios during the same period.   Excessbalances of cash and cash equivalents will be employed by the Company to fundfuture interest-earning asset growth as adequate liquidity allows the Company tomeet asset and liability obligations without delay. 

The Company'sliquidity is impacted by its ability to attract and retain deposit accounts,activity within and sales from its investment securities and loan portfolios,alternative sources of funds, and current earnings. The increase in cash andcash equivalents summarized above is attributed to the growth in depositsoutpacing the growth in the investment securities and loan portfolios over theperiods noted. 

InvestmentSecurities Available For SaleThe following table summarizes the composition ofthe Company's investment securities available for sale portfolio at the datesindicated (dollars in thousands).
** **** **
**March 31, 2006**** **
**December 31, 2005**   ** **** **		 
**Total**
**% of Total**** **
**Total**
**% of Total**   U.S. Government agencies		$50,948 
		40.8%49,960 39.7    State and		municipal  53,843 43.1 56,006 44.4    		Mortgage-backed  20,129 16.1 20,022 15.9    Total investment securities		available for sale		$124,920 
		100.0%125,988 100.0        Total investment securities		available for sale as a percentage of total assets		 
		11.3%11.7    
 See Consolidated Statements of Cash Flowscontained within Part I, Item 1 of this Quarterly Report on Form 10-Q for afurther discussion of the activity impacting the Company's investment securitiesavailable for sale portfolio during the three months ended March 31, 2006.

The following table summarizes the amortizedcosts and fair market values with regard to the Company's investment securitiesportfolio at the dates indicated (dollars in thousands). 
** **** **
**March 31, 2006**** **
**December 31, 2005**** **** **** **		 
**Amortized 		cost**
**Fair market 		value**** **
**Amortized 		cost**
**Fair market 		value**** **U.S. Government agencies		$51,323 50,948 50,257 49,960 State and		municipal  54,803 53,843 56,766  56,006 		Mortgage-backed  20,599 20,129		20,438 20,022 Total investment securities		available for sale		$126,725 124,920		127,461 125,988		
 See Note 3 contained within Part I, Item 1 ofthis Quarterly Report on Form 10-Q for further discussion regarding theCompany's investment securities portfolio.

LoansGeneral. Loans represent the most significantcomponent of the Company's interest-earning assets with average loans accountingfor 85.4%, 85.2%, and 84.0% of average interest-earning assets for the threemonths ended March 31, 2006, the year ended December 31, 2005, and the threemonths ended March 31, 2005, respectively.  The Company strives to maintaina diversified loan portfolio in an effort to spread risk and reduce exposure toeconomic downturns that may occur within different segments of the economy,geographic locations, or in particular industries.  Although the Companymay originate loans outside of its market area, the Company originates themajority of its loans in its primary market area of Upstate, South Carolina. 

 

24
 
The following tablesummarizes the Company's loan portfolio, by collateral type, at the datesindicated (dollars in thousands).

**March 31, 2006**
**December 31, 2005**** **** **		 
**Total**
**% of Total**** **
**Total**
**% of Total**Commercial and		industrial		$		125,112 14.4 
** %**143,334 16.5 Real estate -		1 - 4 family 164,797		19.1 167,693		19.3 Real estate -		construction 25,569 3.0 29,731 3.4 Real estate -		other 474,843		55.0 458,154		 52.6 General		consumer 57,380 6.6 55,008 6.3 Credit line 4,401 0.5 4,465  0.5 Bankcards 11,087 1.3 11,744 1.3 Others		 615 0.1 873  0.1 Total loans$863,804 100.0 
**%**871,002 100.0  
The following tablesummarizes the Company's loan portfolio, by loan purpose, net of the allowancefor loan losses, at the dates indicated (dollars in thousands). 
** **** **
**March 31, 2006**
** **
**December 31, 2005**** **** **** **		 
**Total**
**% of Total**
** **
**Total**
**% of Total**** **Commercial		business		$        		90,907 
		10.6%          		90,345         		 10.5 Commercial		real estate         		553,893          		64.8         		561,574          		65.1 Installment           		19,220            		2.2           		18,677            		2.2 Installment		real estate           		57,013            		6.7     		      55,682            		6.5 Indirect           		34,166            		4.0           		30,481            		3.5 Credit line             		1,929            		0.2             		2,022            		0.2 Prime access           		54,538            		6.4           		54,296            		6.3 Residential		mortgage           		33,824            		4.0           		34,453            		4.0 Bankcards           		11,087            		1.3           		11,744            		1.4 Business		manager                		232              		-                  		230              		-   Other             		1,667            		0.2             		2,059            		0.2 Loans in		process             		1,697            		0.2             		3,857            		0.4 Deferred loans		fees and costs		                		785            		0.1                		761            		0.1 Loans         		860,958        		100.7         		866,181        		100.4  Mortgage loans		held for sale		             		2,846            		0.3           		  4,821            		0.6 Total loans         		863,804        		101.0         		871,002        		101.0  Allowance for		loan losses           		(8,727)          		(1.0)          		(8,431)          		(1.0)Total loans, net		$      		855,077 
		100.0%        		862,571        		100.0  
At March 31, 2006, the Company's net loanportfolio approximated $852.2 million, or 77.1%, of the Company's total assetscompared with $857.8 million, or 79.8%, at December 31, 2005. Mortgage loansheld for sale decreased $2.0 million from December 31, 2005 to March 31, 2006. 

During the firstthree months of 2006, the Company's commercial real estate portfolio declined by$7.7 million, or 1.4%.  Although this portfolio experienced loan growthduring the quarter, this growth was offset by the payoff of approximately $10million of commercial real estate loans in which the Company participated.

Also during the firstthree months of 2006, the Company's indirect lending portfolio increased by $3.7million, or 12.1%.  Management attributes this indirect loan growth to anew program offered by the Company that targets high credit scoring consumers atcompetitive rates. The goal of this program is to introduce the Company and itsproducts to reputable automobile dealers.  Once introduced, the Company'sgoal is to continue to build and maintain relationships with these dealers andtheir customers.  

See Note 4 containedwithin Part I, Item 1 of this Quarterly Report on Form 10-Q for furtherdiscussion regarding the Company's loan portfolio.

Credit Quality. The following table summarizesthe composition of the Company's classified assets by collateral type at thedates indicated (in thousands). 

25

**March 31, 2006**		 
**Special 		mention**
**Substandard**
**Doubtful**
**Loss**
**Total**Commercial and		industrial		$73 2,694        		1,009       -  		    3,776 Real estate - 1		- 4 family          		151 4,933           		375       -  		    5,459 Real estate -		construction            		-                      -  		            		-         -  		         		-   Real estate -		other            		14 12,710           		221       -  		12,945 General		consumer            		15                  		317             		62       -  		      		394 Credit line		              		6                    		58             		-         -  		        		64 Total classified assets$        259		            		20,712        		1,667       -  		 22,638  
**December 31, 2005**		 
**Special 		mention**
**Substandard**
**Doubtful**
**Loss**
**Total**Commercial and		industrial		$230               		2,925           		851       -  		    4,006 Real estate - 1		- 4 family 1,147 4,023           		239       -  		    5,409 Real estate -		construction            		-                      		-               		-         -  		         		-   Real estate -		other            		82             		11,400             		58       -  		11,540 General		consumer            		25                  		287          		   68       -  		      		380 Credit line		              		6                    		54               		1         1		        		62 Total classified assets$     1,490             		18,689        		1,217         1		 21,397  
During the fourth quarter of 2005, two loans,both of which were secured by other real estate, were placed in nonaccrualstatus.  In accordance with the Bank's lending policy, the loans weredowngraded to substandard. At December 31, 2005, the principal balance of theseloans totaled $7.2 million.  At year-end 2005, management believed thecollateral securing these loans to be sufficient to cover the Bank's exposure. Although one such loan has since been brought current, in accordance with thedefinition of substandard as defined by the Bank's lending policy, the loanremains classified as substandard. These isolated loan circumstances haveresulted in classified asset balances since the third quarter of 2005 higherthan the Company's typical historical balances.   Management is awareof no material relationships or specific events or trends that led to theincrease in classified assets during the first three months of 2006 and believesthat the increase does not indicate a deterioration of asset quality as theincrease can be attributed, in most part, to isolated loan circumstances. 

The Company's loan portfolio is periodicallyreviewed and loans are, in the opinion of management, appropriately classified.Allowances have been established against all assets requiring classification.

The following table summarizes trends in problemassets and other asset quality indicators at the dates indicated (dollars inthousands).
		 
**March 31,**
**December 31,**		 
**2006**** **
**2005**		 
** **** **
** **Nonaccrual		loans$7,526 9,913 Total nonperforming loans 7,526 9,913  Real estate		acquired in settlement of loans 932 1,954 Repossessed		automobiles		 182 167 Total nonperforming assets$8,640 12,034  Loans past due 90 days and still		accruing (1)$159 207  Ending loans		(2)		$860,958 866,181 Nonaccrual loans as a percentage of		loans (2)  0.87 %1.14 Nonperforming assets as a		percentage of total assets 0.78%1.12Allowance for loan losses to		nonaccrual loans 1.16		x0.85   		    (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
26

The following tablesummarizes the composition of nonaccrual loans at the dates indicated (dollarsin thousands).
** **** **
**March 31, 2006**
** **
** **
**December 31, 2005**
** **** **** **** **		 
**Total**
**% of Total**
** **
** **
**Total**
**% of 		Total**
** **** **Loans secured by		real estate		$6,847 91.0  % 9,165 92.4 Commercial and		industrial 531 7.1 631 6.4 Credit cards  -   -    -    -   Other consumer		 148 1.9 117                 		1.2 Total nonaccrual loans$7,526 100.0  % 9,913 100.0 
During the fourth quarter of 2005, two loans,both of which were secured by other real estate, were placed in nonaccrualstatus.  In accordance with the Bank's lending policy, the loans weredowngraded to substandard. At December 31, 2005, the principal balance of theseloans totaled $7.2 million, and management believed the collateral securingthese loans is sufficient to cover the Bank's exposure.  Payment wasreceived during the first quarter of 2006 on one of these loans (balance ofapproximately $3.3 million) that warranted the removal of nonaccrual status atthat time. Offsetting this decline in nonaccrual loans during the first threemonths of 2006 was the addition of a few moderate sized loans that were placedin nonaccrual status during the quarter.  Management is aware of nomaterial relationships or specific events or trends that led to the increase innonaccrual loans, after taking into consideration the removal of the loan notedabove from nonaccrual during the first quarter of 2006, at March 31, 2006 overDecember 31, 2005.  

The following tablesummarizes the changes in the allowances, including the balance at the beginningand end of each period, provision charged to expense, and losses charged to theAllowance related to the Company's real estate acquired in settlement of loansfor the periods indicated (in thousands).

**At and for the three months**
**ended March 31,**		 
**2006**
**2005**Real estate		acquired in settlement of loans, beginning of period		$          		1,954             		2,413 Add: New real estate acquired in		settlement of loans                  		52                		154 Less: Sales / recoveries of real		estate acquired in settlement of loans              		(931)             		(161)Less: Provision charged to expense		              		(143)               		(60)Real estate		acquired in settlement of loans, end of period$             		932             		2,346  
Activity in realestate acquired in settlement of loans is correlated to current economicconditions that impact the borrower's ability to service their debt. Management believes that the decrease in property added to the portfolio duringthe first three months of 2006 was a direct reflection of continued generaleconomic improvement gauged by factors including, but not limited to, consumerexpectations, real money supply, a decline in initial unemployment claims,interest rate conditions, and manufacturing new orders. Management believes thatthe increase in sales over the periods presented is the result of increasingconsumer confidence, which is directly correlated to consumer spending, andreflects the marketability of the properties within the portfolio.  Basedon the Company's policies and procedures regarding the regular review of fairmarket values of real estate acquired in settlement of loans and writedownstaken accordingly, management believes that the properties within the portfoliowere properly valued at March 31, 2006. Additionally, management believes thatthe excess of sales from the portfolio during the three months ended March 31,2006 over additions during the same period indicate that the properties withinthe portfolio are marketable. 

See Note 7 contained within Part I, Item 1 ofthis Quarterly Report on Form 10-Q for further discussion regarding theCompany's real estate acquired in settlement of loans portfolio.  

As of March 31, 2006,management was aware of no potential problem loans that were not alreadycategorized as nonaccrual, past due, or restructured, that had borrower creditproblems causing management to have serious doubt as to the ability of theborrower to comply with the present loan repayment terms.  

Any troubled debtrestructurings entered into by the Company for the quarters ended March 31, 2006and 2005 were immaterial when considered individually, or in the aggregate, withregard to the Company's Consolidated Financial Statements.

27

 

The Company believes that recent economicconditions have had a short-term impact on consumer confidence, especially onconsumer expectations. Though consumer confidence appears to be improved fromlevels in recent years, management believes that higher than historical fuelcosts combined with job market uncertainty continues to curb both consumerconfidence and spending, when compared with past levels, in the short-term. Asprojected in the Company's Annual Report on Form 10-K, as rebuilding effortshave taken hold and job growth has gained momentum, management believes thatconsumer confidence has shown signs of and will continue to show signed ofrebound during 2006. Management believes that because the Company's loanportfolio is closely monitored, any changes within the Company's loan portfolioare promptly addressed in its Allowance model. Additionally, management believesthat there will always remain a core level of delinquent loans and real estateand personal property acquired in settlement of loans from normal lendingoperations. 

Allowance for Loan Losses The Allowance totaled $8.7 million and $8.4million, at March 31, 2006 and December 31, 2005, respectively representing1.01% and 0.97% of loans, calculated using loans excluding mortgage loans heldfor sale, net of unearned income, excluding allowance for loan losses.

The following table summarizes the allocation ofthe Allowance and the percentage of loans to total loans, excluding net ofunearned balances, both by collateral type, at the dates indicated (dollars inthousands). Management believes that the Allowance can be allocated by categoryonly on an approximate basis.  The allocation of the Allowance to eachcategory is not necessarily indicative of future losses and does not restrictthe use of the Allowance to absorb losses in other categories. 

**March 31,**
**December 31,**** **** **
**2006**** **
**2005**** **** **		 
**Total allowance**
**% of loans 		to total loans**** **
**Total 		allowance**
**% of loans 		to total loans**Commercial and		industrial		$
		1,828 
14.4 %
1,897 
16.5 Real estate - 1		- 4 family 1,521 19.1 1,267 19.3 Real estate -		construction    		26  		3.0     26  		3.4 Real estate -		other 2,574 55.0 2,044 52.6 General consumer 1,582   6.6 2,153  		6.3 Credit line   		154  		0.5   		130  		0.5 Bankcards   		355  		1.3   		310  		1.3 Others		   		687  		0.1   		604  		0.1 Total $8,727 100.0 %8,431 100.0  
 

 

28

The following table summarizes activity withinthe Allowance at the dates and for the periods indicated (dollars in thousands).Losses and recoveries are charged or credited to the Allowance at the timerealized. 

**At and for the three**
**At and for the year**
**months ended March 31,**
**ended December 31,**** **** **** **		 
**2006**** **
**2005**** **
**2005**** **** **Allowance		balance, beginning of period		$          		8,431             		7,619                             		7,619 ** ** Provision for		loan losses                		525                		600                             		2,400  Loans		charged-off Commercial and		industrial                		116                  		82                                		244 Real estate -		1 - 4 family                  		19                  		70                                		415 Real estate -		construction                   		-                     		-                                    		-   Real estate -		other                   		-                      		3                                		242 Consumer		        		        144                		248                                		891 Total loans charged-off                		279                		403                             		1,792  Recoveries Commercial and		industrial                  		22                    		2                                  		35 Real estate -		1 - 4 family                   		-                     		-                                    		-   Real estate -		construction                   		-                     		-                                    		-   Real estate -		other                    		2                   		-                                    		35 Consumer		                  		26      		            20                                		134 Total recoveries		                  		50                  		22                                		204  Net loans charged-off		                		229                		381                             		1,588  Allowance		balance, end of period		$          		8,727             		7,838                             		8,431  Average loans		(1)		$      		865,183         		785,755                         		828,545 Ending loans		(1)         		860,958         		802,948                         		866,181 Net loans		charged-offs to average loans (1)               		0.11 %              		0.20                          		     0.19 Allowance for		loan losses to ending loans (1)                     		1.01               		0.98                               		0.97  (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 for a discussion of the fluctuation in the provisionfor loan losses when comparing the three months ended March 31, 2005 with thesame period of 2006.

Total net loans charged-off totaled $229 thousandduring the three months ended March 31, 2006 down from $381 thousand during thesame period of 2005. When comparing net loans charged-off during the periods themajority of the decline was experienced within the consumer portfolio primarilyas a result of the recent gradual overall economic improvements as compared withrecent years.  Management attributes the overall decline in net loanscharged-off to the careful management of the Company's loan portfolio and theresulting impact such management has had on asset quality as well as overalleconomic improvements that generally increase the likelihood of consumerrepayment of debt.  

Although levels of classified assets increasedfrom both March 31, 2005 and December 31, 2005, management believes that theseincreases were not necessarily the result of deterioration in asset quality. Instead, management believes that such trends are the result of isolated eventsthat are not necessarily indicative of historical or future credit trends. 

During the fourth quarter of 2005, two loans,both of which were secured by other real estate, were placed in nonaccrualstatus.  In accordance with the Bank's lending policy, the loans weredowngraded to substandard. At December 31, 2005, the principal balance of theseloans totaled $7.2 million, and management believed the collateral securingthese loans is sufficient to cover the Bank's exposure.  Payment wasreceived during the first quarter of 2006 on one of these loans (balance ofapproximately $3.3 million) that warranted the removal of nonaccrual status atthat time. Offsetting this decline in nonaccrual loans during the first threemonths of 2006 was the addition of a few moderate sized loans that were placedin nonaccrual status during the quarter.  Management is aware of nomaterial relationships or specific events or trends that led to the increase innonaccrual loans, after taking into consideration the removal of the loan notedabove from nonaccrual during the first quarter of 2006.

29

Loan growth duringthe three months ended March 31, 2006 had little impact on the Company'sAllowance due to the fact that total loans actually declined $7.2 million duringthe period. See Loans for a discussion of the fluctuation of the loan portfolioduring the first three months of 2006.

In an effort to mitigate any credit deteriorationresulting from economic conditions, management has and continues to emphasizeconservative underwriting in an effort to manage credit quality as evidenced bythe key performance indicators relative to the Allowance discussed herein.

The Company's Allowance as a percentage of endingloans, excluding those mortgage loans held for sale, increased from December 31,2005 to March 31, 2006 primarily as a result of the fluctuations within the mixof classified assets between the periods noted.

Based on the current economic environment andother factors that impact the assessment of the Company's Allowance as discussedabove, management believes that the Allowance at March 31, 2006 was maintainedat a level adequate to provide for estimated probable losses in the loanportfolio.  However, assessing the adequacy of the Allowance is a processthat requires considerable judgment. Management's judgments are based onnumerous assumptions about current events believed to be reasonable but whichmay or may not be valid. Thus, there can be no assurance that loan losses infuture periods will not exceed the current Allowance or that future increases inthe Allowance will not be required. No assurance can be given that management'songoing evaluation of the loan portfolio, in light of changing economicconditions and other relevant circumstances, will not require future additionsto the Allowance, thus adversely impacting the results of operations of theCompany.

DepositsThe following table summarizes the Company'sdeposit composition at the dates indicated (dollars in thousands).

**March 31, 2006**** **
**December 31, 2005**		 
**Total**
**% of Total**** **
**Total**
**% of Total**Transaction		deposit accounts		$386,379 40.7 
%351,629 38.9 Money market		deposit accounts 121,413 12.8 111,380 12.4 Savings		deposit accounts  		46,948   5.0  		45,360  		5.0 Time deposit		accounts		 394,320 41.5 395,014 43.7 Total traditional deposit accounts$949,060 100.0 
%903,383 100.0  
Total traditional deposit accounts increased$45.7 million from December 31, 2005 to March 31, 2006. Management does notbelieve that its dependence on traditional deposit account funding changedmaterially from December 31, 2005 to March 31, 2006.  At March 31, 2006,traditional deposit accounts as a percentage of liabilities were 93.6% comparedwith 91.6% at December 31, 2005.  The percentage of funding provided bytraditional deposit accounts has increased during the three months of 2006, andaccordingly, the Company has not had to rely as heavily on alternative fundingsources from which to fund a portion of loan demand. 

Core traditional deposit accounts, which includetransaction, money market, and savings accounts, grew by $46.4 million duringthe first three months of 2006, or 9.1%.  The increase in core traditionaldeposit accounts during the first three months of 2006 was primarily a result ofthe Company's continued ability to attract traditional deposit accounts throughpricing adjustments, expansion of its geographic market area, level of qualitycustomer service, and through the Company's reputation in the communitiesserved. Additionally, this growth in core traditional deposit accounts wasenhanced by additional marketing efforts directed toward several existingdeposit products.  

Time deposit accountsdecreased by $694 thousand during the first three months of 2006. Promotionalcertificate of deposit accounts offered beginning during the fourth quarter of2004 began to mature during the first three months of 2006.  The Bank hassuccessfully retained a large portion of these maturing funds.  The declinein time deposit accounts during the first three months of 2006 is due in largepart to the funds that the Bank was unable to retain. 

30

Although deposit growth is a top priority of theCompany, such growth is not dependent on targeted programs, and management doesnot believe the Company will lose deposits if it does not continue to offertargeted programs.

The Company's increase in core traditionaldeposit accounts results from its efforts to enhance the deposit mix by workingto attract lower-cost deposit accounts. As noted above, core traditional depositaccounts grew by $46.4 million during the first three months of 2006 whilehigher-cost time deposit accounts decreased by $694 thousand during the sameperiod. The Company's average cost of core traditional deposit accounts for thethree months ended March 31, 2006 was 1.67% compared with 0.94% for the yearended December 31, 2005 and 0.57% for the three months ended March 31, 2005. TheCompany's average cost of time deposit accounts for the three months ended March31, 2006 was 3.69% compared with 2.99% for the year ended December 31, 2005 and2.77% for the three months ended March 31, 2005. The Company's average cost oftotal traditional deposit accounts increased from 1.73% for the three monthsended March 31, 2005 to 1.98% for the year ended December 31, 2005 further to2.68% for the three months ended March 31, 2006.

BorrowingsBorrowings decreased $17.9 million at March 31,2006 when compared with year-end 2005.  Borrowings as a percentage of totalliabilities were approximately 2.3% and 4.1% at March 31, 2006 and December 31,2005, respectively. The following table summarizes the Company's borrowings composition at thedates indicated (dollars in thousands).

**March 31, 2006**** **
**December 31, 2005**		 
**Total**
**% of Total**** **
**Total**
**% of Total**Retail		repurchase agreements		$ 17,725 30.1 %16,728 22.1 Commercial		paper 18,146 30.8 17,915 23.7 Federal funds		purchased  -    -    		1,000  		1.3 FHLB		borrowings - short - term  -    -   16,900 22.4 FHLB		borrowings - long - term		 23,000 39.1 23,000 30.5 Total borrowings$58,871 100.0 %75,543 100.0  
Short and long-termborrowings are a source of funding that the Company utilizes depending on thecurrent level of deposits, the desirability of raising deposits through marketpromotions, the Company's unused FHLB borrowing capacity, and the availabilityof collateral to secure FHLB borrowings. Federal funds purchased and short-termFHLB borrowings represent unsecured overnight borrowings. These borrowings arean important source of funding to the Company as they allow the Company to meetfunding needs without relying on increasing deposits on a short-term basis. Thedecrease in borrowings at March 31, 2006 when compared with December 31, 2005resulted from the Company's ability to meet its funding needs during the periodwith funds generated through deposit account growth.

At March 31, 2006, ofits approximately $182 million available credit based on qualifying loansavailable to serve as collateral against short-term or long-term borrowings fromthe FHLB, the Company employed $23.0 million in long-term borrowings. 

FHLB advances withfixed interest rates are subject to a prepayment fee in the event of full orpartial repayment prior to maturity or the expiration of any interim interestrate period.  Management was not aware of any circumstances at March 31,2006 that would require prepayment of any of the Company's FHLB advances. 

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

 

31
** **
**For the three months ended**** **
**For the year ended**** **
**March 31,**** **
**December 31,**** **
**2006**
** **
**2005**** **
**2005**Retail repurchase agreements 3.37 
%1.63 
2.38 Commercial paper3.49 1.57 
2.33 Federal funds purchased4.89 2.21 
2.71 FHLB borrowings - short-term5.04 1.37 
3.59 FHLB borrowings - long-term3.53 3.24 
3.38 
Rates paid during the three months ended March31, 2006 increased from those paid for the year ended December 31, 2005. Theprimary reason for the changes in the yields paid on interest-bearingliabilities has been 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 4.75% in a series of fifteen moves.  The increases in the Company'sborrowings costs during the first three months of 2006 is attributed to theseincreasing rate trends.

Capital ResourcesAverage shareholders' equity was $91.2 millionfor the three months ended March 31, 2006, or 8.4% of average assets. Averageshareholders' equity was $82.6 million for the year ended December 31, 2005, or8.2% of average assets.

Total shareholders' equity increased from $88.9million at December 31, 2005 to $91.6 million at March 31, 2006. The Company'scapital ratio of total shareholders' equity to total assets was 8.3% at March31, 2006 compared with 8.3% at December 31, 2005. During 2006, shareholders'equity was increased through the retention of earnings and stock optionactivity.  These increases were offset by an increase in cash dividends anda decline in accumulated other comprehensive income when comparing the threemonths ended March 31, 2006 with the year ended December 31, 2005.  SeeConsolidated Statements of Changes in Shareholders' Equity and ComprehensiveIncome contained within Part I, Item 1 of this Quarterly Report on Form 10-Q fora further discussion regarding the changes in stockholders' equity during thethree months ended March 31, 2006.

The Company and the Bank are required to meetregulatory capital requirements that currently include several measures ofcapital.  At March 31, 2006, the Company and the Bank were each categorizedas well capitalized under the regulatory framework for prompt corrective action.See Note 15 contained within Part I, Item 1 of this Quarterly Report on Form10-Q for further discussion regarding the Bank's and the Company's capitalregulatory requirements. At March 31, 2006, there were no conditions or eventsof which management was aware that would materially change the Company's or theBank's status. 

During the first three months of 2006, theCompany's cash dividend payout ratio was 31.32% compared with a payout ratio of30.27% for the year ended December 31, 2005. The Company's cash dividend payoutratio during the first three months of 2005 was 29.61%. Cash dividends percommon share for the first three months of 2006 totaled $0.18, an increase of12.5% over dividends per common share during the same period of 2005 of $0.16. 

DISCLOSURES REGARDING MARKET RISK

The Company evaluatedthe results of its net interest income simulation prepared as of March 31, 2006for interest rate risk management purposes. Overall, the model results indicatethat the Company's interest rate risk sensitivity is within limits set by theCompany's guidelines and the Company's balance sheet is liability sensitive. Aliability sensitive balance sheet suggests that in falling interest rateenvironment, net interest margin would increase and during an increasinginterest rate environment, net interest margin would decrease.

Net Interest Income SimulationAs of March 31, 2006,the following table summarizes forecasted net interest income and net interestmargin using a base market rate and the estimated change to the base scenariogiven upward and downward movement in interest rates of 100 basis points and 200basis points (dollars in thousands).

32

**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		$49,293              		(5.40)
 %         		4.72 
 %        		(0.27)Up 100 basis points 50,768              		(2.57)        		4.86        		(0.13)BASE CASE 52,106                    		-           		4.99             		-   Down 100 basis points 53,102 1.91         		5.09  0.10  Down 200 basis points 53,335 2.36          		5.11 0.12 
The simulationresults as of March 31, 2006 indicate the Company's interest rate risk positionwas liability sensitive as the simulated impact of an downward movement ininterest rates of 100 basis points would result in a 1.91% increase in netinterest income over the subsequent 12 month period while an upward movement ininterest rates of 100 basis points would result in a 2.57% decrease in netinterest income over the next 12 months. The simulation results indicate that a100 basis point downward shift in interest rates would result in a 10 basispoint increase in net interest margin, assuming all other variables remainedunchanged. Conversely, a 100 basis point increase in interest rates would causea 13 basis point decrease in net interest margin. The projected negative impacton the Company's net interest income for the twelve month period does not exceedthe 20% threshold prescribed by the Asset - Liability Committee's policy. 

LIQUIDITY

GeneralThe investmentsecurities portfolio is also an avenue for liquidity through scheduledmaturities, sales of investment securities, and prepayment of principal onmortgage-backed securities.  Approximately 86% of the investment securitiesportfolio was pledged to secure public deposits as of March 31, 2006 as comparedwith 83% at December 31, 2005.   

Each of the Company's sources of liquidity issubject to various uncertainties beyond the control of the Company. As a measureof protection, the Company has back-up sources of funds available. If needed,alternative funding sources have been arranged through federal funds lines atcorrespondent banks and through the Federal Reserve Discount Window.  AtMarch 31, 2006, the Company had unused short-term lines of credit atcorrespondent banks totaling of $40 million (which were accessible at theCompany's option).  

In addition to theseunused short-term lines of credit, the Company may utilize borrowings from theFHLB to fund increases in interest-earning assets in times of declines inalternative funding sources. At March 31, 2006, of its approximately $182million available credit based on qualifying loans available to serve ascollateral against short-term or long-term borrowings from the FHLB, the Companyemployed $23.0 million, all of which was determined to be long-term whenemployed.  

See ConsolidatedStatements of Cash Flows contained within Part I, Item 1 of this QuarterlyReport on Form 10-Q for a discussion regarding the factors impacting liquidityfor the three months ended March 31, 2006.

LendingCommitmentsSee Off-Balance SheetArrangements, Lending Commitments for a discussion of the potential impact onliquidity of the Company's lending commitments at March 31, 2006.

PalmettoBancsharesAt March 31, 2006,the holding company had $18.1 million in commercial paper with a weightedaverage rate paid during the three month period of 3.49% compared with $17.9million outstanding at December 31, 2005 with a weighted average paid during theyear of 2.33%. At March 31, 2005, the holding company had $19.0 million incommercial paper outstanding with a weighted average rate paid during the threemonth period of 1.57%

Potential sources of the holding company'spayment for periodic stock purchases and dividends include dividends from theBank and funds received through stock option exercises. At March 31, 2006, theholding company had cash reserves of $1.2 million compared with $875 thousand atDecember 31, 2005.  The increase between the two periods resulted primarilyfrom the receipt of funds in conjunction with stock option transactions duringthe first three months of 2006.

33

OFF-BALANCE SHEETARRANGEMENTS

The Company'soff-balance sheet arrangements principally include lending commitments,guarantees, and derivatives.

LendingCommitmentsThe following table summarizes the Company'scontractual commitments to extend credit at March 31, 2006 (in thousands).
Home equity		loans		$
		45,768 Credit cards		 
45,623 Commercial		real estate development		 
54,710 Other unused		lines of credit 51,161 Total contractual obligations		$197,262  
GuaranteesAt March 31, 2006, the Company recorded no liabilityfor the current carrying amount of the obligation to perform as a guarantor, andno contingent liability was considered necessary as such amounts were notconsidered material.  The maximum potential amount of undiscounted futurepayments related to standby letters of credit at March 31, 2006 was $5.6million.  Past experience indicates that these standby letters of creditwill expire unused. However, through its various sources of liquidity, theCompany believes that it has the necessary resources available to meet theseobligations should the need arise.  Additionally, the Company does notbelieve that the current fair market value of such guarantees was material atMarch 31, 2006.

Other Off-BalanceSheet ArrangementsAt March 31, 2006, the Company had no interest innonconsolidated special purpose entities nor was it involved in otheroff-balance sheet contractual relationships, unconsolidated related entitiesthat have off-balance sheet arrangements, or transactions that could result inliquidity needs (other than those discussed herein).

DerivativesAt March 31, 2006, the Company's derivativeinstruments consisted of forward sales commitments relating to the Company'scommitments to originate certain residential loans held for sale.

Outstanding commitments on mortgage loans not yetclosed (primarily single-family loan commitments) amounted to approximately $4.6million at March 31, 2006.  The fair market value of derivative assetsrelated to commitments to originate such residential loans held for sale andforward sales commitments was not significant at March 31, 2006.

EARNINGS REVIEW

The followinginformation is intended to supplement any information relating to theConsolidated Statements of Income contained within Part I, Item 1 of thisQuarterly Report on Form 10-Q.    

34
Overview
**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**
**Consolidated Statements of Income**
**(dollars in thousands, except common and per share data)**** **** **
**For the three months ended**** **** **** **
**March 31,**
**Dollar**
**Percent**
**2006**
**2005**
**Variance**
**Variance**
		(unaudited)** **** **Interest income** **** **Interest and		fees on loans
		$
		16,453 
12,891 3,562  27.6 %Interest and		dividends on investment securities available for sale1,249 1,334  (85) 		(6.4)Interest on		federal funds sold193 26 167 642.3 Dividends on		FHLB stock 		53 38 15  39.5 Total interest		income17,948 14,289 3,659  25.6 Interest expenseInterest on		deposits including retail repurchase agreements5,408  		3,088 2,320  75.1 Interest on		federal funds purchased2 25 (23)(92.0)Interest on FHLB		borrowings305 297  8  2.7 Interest on		commercial paper (Master notes)138  		66 72 109.1 Total interest		expense 5,853 3,476 2,377  68.4 ** **** **Net		interest income12,095 10,813 1,282  11.9 ** **** **Provision for		loan losses525  600 (75)(12.5)** **Net		interest income after provision for loan losses11,570 10,213 1,357  13.3 Noninterest		incomeService charges		on deposit accounts2,058 1,847 211  11.4 Fees for trust		and brokerage services781  803  (22) 		(2.7)Mortgage-Banking		Income222  282  (60)(21.3)Investment		securities gains  		2   		54  (52)(96.3)Other income919  779 140 18.0 Total		noninterest income3,982 3,765 217 5.8 ** **** **Noninterest		expenseSalaries and		other personnel 5,775 4,964 811 16.3 Net occupancy  		692  600  		92 15.3 Furniture and		equipment1,006  885 121 13.7 Marketing and		advertising  		456  262 194 74.0 Postage and		supplies  		389  317  72 22.7 Telephone  		213  183  30 16.4 Professional		services  		221  181  40 22.1 Other expense1,393 1,458 (65)(4.5)		Total noninterest expense10,145 8,850 1,295 14.6 ** **** **		Net income before provision for income taxes 5,407 5,128 279 5.4 
35
		Provision for income taxes1,757 1,717 40 2.3 ** **** **		Net income
$3,650 3,411 239 7.0 		%** **** **		Common Share Data** **** **		Net Income - basic
$0.58 0.54  0.04 7.4 		%		Net Income - diluted0.57 0.53  0.04 7.5 		Cash dividends		0.18 0.16  0.02 12.5 		Book value14.42 13.00  1.42 10.9 ** **** **		Weighted average common shares outstanding - basic6,343,247 6,309,527 ** **		Weighted average common shares outstanding - diluted
 6,444,002 
6,407,359 ** **
Net interest marginfor the three months ended March 31, 2006 was 4.83% compared with 4.66% for thesame period of 2005. Over these periods average interest-earning assetsincreased $75.7 million, or 8.1%, while interest-bearing liabilities increased$65.6 million, or 8.3%. The yield on interest-earning assets and the cost ofinterest-bearing liabilities for the three months ended March 31, 2006 was 7.16%and 2.77%, respectively, up from 6.42% and 2.10%, respectively, for the yearended December 31, 2005 and 6.16% and 1.78%, respectively, for the three monthsended March 31, 2005.

Earnings resulted in a return on averageshareholders' equity of 16.22%, 16.06% and 16.74% for the three months endedMarch 31, 2006, the year ended December 31, 2005, and the three months endedMarch 31, 2005, respectively. Return on average assets was 1.36%, 1.32%, and1.37% for the same periods.

Net Interest IncomeNet interest income for the three months ended March 31, 2006 increased $1.3million, or 11.9%, to $12.1 million from $10.8 million for the three monthsended March 31, 2005. During the first three months of 2006, the Companyexperienced increases in average yields on interest-earning assets consistentwith the increase in the average cost of interest-bearing liabilities. Theaverage yield on interest-earning assets increased 100 basis points to 7.16%during the three months ended March 31, 2006 from 6.16% during the three monthsended March 31, 2005. The average cost of interest-bearing liabilities increased99 basis points to 2.77% during the three months ended March 31, 2006 from 1.78%during the three months ended March 31, 2005. Net interest income for the threemonths ended March 31, 2006 was $12.1 million, and the net yield oninterest-earning assets was 4.83%. Average interest-earning assets increased$75.7 million over the same periods, while interest-bearing liabilitiesincreased $65.6 million. The primary reason for the increase in the yieldsearned and paid on interest-earnings assets and interest-bearing liabilities,respectively, has been 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 4.75% in a series of fifteen moves.  

The following table summarizes the Company'saverage balance sheets and net interest income analysis for the periodsindicated (dollars in thousands). It also presents the dollar amount of changesin interest income and interest expense attributable to changes in volume andthe amount attributable to changes in rate. The impact of the combination ofrate and volume change has been divided equally between the rate change andvolume change. The Company's yield on interest-earning assets and cost ofinterest-bearing liabilities shown in the table are derived by dividing interestincome and expense by the average balances of interest-earning assets orinterest-bearing liabilities. 

36

**For the three months ended March 31,**
**2006**** **
**2005**** **		 
**Average**		 
**Income/**
**Yield/**
** **		 
**Average**		 
**Income/**
**Yield/**** **		 
**Balance**		 
**Expense**
**Rate**
** **		 
**Balance**		 
**Expense**
**Rate**** **ASSETS  		 		 Interest-earnings assets  		 		 Federal funds sold$
18,824 $
193 
4.16 
%$
4,235 $
26 
2.49 
%FHLB stock 		 
3,434		 
53
6.26		 
3,986 		 
38 
3.87 Investment securities, nontaxable (1)		 
55,210		 
497
3.65 		 
66,679 		 
618 
3.76 Investment securities, taxable (1)		 
70,708		 
752
4.31 		 
75,199 		 
 716 
3.86 Loans, net of unearned (2)		 
 868,109 		 
16,453 
7.69 		 
790,453 		 
12,891 
6.61 Total interest-earning assets		 
1,016,285 		 
17,948
7.16 		 
940,552 		 
14,289 
6.16   		 		 Noninterest-earning assets  		 		 Cash and due from banks		 
34,680  		 
31,649 		 Allowance for loan losses		 
(8,532) 		 
(7,648)		 Premises and equipment, net		 
23,076  		 
22,274 		 Accrued interest receivable		 
5,107 		 
4,321 		 Other		 
16,687 		 
15,350 		 Total noninterest-earning assets		 
71,018 		 
65,946 		   		 		 Total assets$
1,087,303 		 $
1,006,498 		 		 		 		    		 		    		 		 		 		 		 		 		 LIABILITIES AND SHAREHOLDERS' EQUITY  		 		 Liabilities    		 		 Interest-bearing liabilities  		 		 Transaction and money market deposit		accounts$
349,938$
1,595 
1.85 
%$
284,638 $
431 
0.61 
% |
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