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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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FORM 10-Q





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




For the quarterly period ended September 30, 2002





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





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PALMETTO BANCSHARES, INC.


(Exact name of registrant as specified in its charter)





South Carolina

74-2235055(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer Identification
No.)





301 Hillcrest Drive


Laurens, South Carolina


29360


(Address of principal executive offices)


(Zip Code)





(864) 984-4551


(Registrant's telephone number, including area code)





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





Class

Outstanding at November 14, 2002Common stock, $5.00 par value

6,303,778





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PALMETTO BANCSHARES, INC.


Index





Quarterly Report on Form 10-Q


For the Quarter Ended September 30, 2002





Page No.PART I.    FINANCIAL INFORMATIONItem 1.

Financial StatementsConsolidated Balance Sheets at September 30, 2002 and 2001 and December 31, 2001

1Consolidated Statements of Income for the three months ended September 30, 2002 and 2001

2Consolidated Statements of Income for the nine months ended September 30, 2002 and 2001

3Consolidated Statements of Changes in Shareholders Equity and Comprehensive Income for the nine months ended September 30, 2002 and 2001

4Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001

5Notes to the Consolidated Interim Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

8Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28Item 4.

Controls and Procedures

30PART II.    OTHER INFORMATIONItem 1.

Legal Proceedings

31Item 2.

Changes in Securities and Use of Proceeds

31Item 3.

Defaults Upon Senior Securities

31Item 4.

Submission of Matters to a Vote of Security Holders

31Item 5.

Other Information

31Item 6.

Exhibits and Reports on Form 8-K

31SIGNATURES

32CERTIFICATIONS PURSUANT TO 15 U.S.C. SECTION 7241

33




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PART I.  FINANCIAL INFORMATION





Item 1.  Financial Statements





PALMETTO
BANCSHARES, INC.


Consolidated Balance Sheets


(Dollars in thousands, except share data)





September 30, 2002


September 30, 2001


December 31, 2001(unaudited)


(unaudited)ASSETSCash and due from banks

$
40,120


$
31,985


$
27,742Federal funds sold


29,840



1,760



17,949Federal Home Loan Bank (FHLB) stock, at cost


1,733



1,733



1,733Investment securities available for sale


97,074



97,266



95,095Loans held for sale


8,747



5,346



10,054Loans


599,594



546,626



553,821Less allowance for loan losses


(6,252
)


(5,611
)


(5,658
)Loans, net


602,089



546,361



558,217Premises and equipment, net


19,726



18,551



19,175Accrued interest receivable


4,535



5,043



4,947Other assets


14,104



11,257



10,421Total assets

$
809,221


$
713,956


$
735,279LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing

$
113,887


$
100,606


$
102,679Interest-bearing


590,333



522,850



542,621Total deposits


704,220



623,456



645,300Securities sold under agreements to repurchase


17,314



14,605



15,313Commercial paper (Master notes)


16,226



12,907



11,076Other liabilities


5,314



4,812



4,522Total liabilities


743,074



655,780



676,211Shareholders' EquityCommon stockpar value $5.00 per share; authorized 10,000,000 shares; issued and outstanding 6,303,778, 6,264,734,
and 6,283,623 shares, respectively


31,519



31,324



31,418Capital surplus


84



47



26Retained earnings


32,577



25,628



27,386Accumulated other comprehensive income


1,967



1,177



238Total shareholders' equity


66,147



58,176



59,068Total liabilities and shareholders' equity

$
809,221


$
713,956


$
735,279





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.


Consolidated Statements of Income


(Dollars in thousands, except share data) (Unaudited)





For the three months ended September 30,2002


2001Interest incomeInterest and fees on loans

$
10,584


$
11,126Interest and dividends on investment securities available for sale:U.S. Treasury and U.S. Government agencies


470



146State and municipal


412



674Mortgage-backed securities


89



284Interest on federal funds sold


96



82Dividends on FHLB stock


22



29Total interest income


11,673



12,341Interest expenseInterest on deposits


2,898



4,600Interest on securities sold under agreements to repurchase


48



82Interest on federal funds purchased






5Interest on commercial paper (Master notes)


44



80Total interest expense


2,990



4,767Net interest income


8,683



7,574Provision for loan losses


1,200



900Net interest income after provision for loan losses


7,483



6,674Noninterest incomeService charges on deposit accounts


2,052



1,911Fees for trust services


415



427Gains on sales of loans


146



204Investment securities gains


114



Other income


715



690Total noninterest income


3,442



3,232Noninterest expenseSalaries and other personnel


3,854



3,562Net occupancy


563



523Furniture and equipment


698



614FDIC assessment


19



28Postage and supplies


397



293Marketing and advertising


180



201Telephone


204



196Cardholder processing expense


132



135Sales finance losses


(1
)


2Other expense


1,366



1,278Total noninterest expense


7,412



6,832Income before income taxes


3,513



3,074Income tax provision


1,184



882Net income

$
2,329


$
2,192Net income per share-basic

$
0.37


$
0.35Net income per share-dilutive


0.36



0.34Cash dividends declared per share


0.11



0.10





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.


Consolidated Statements of Income


(Dollars in thousands, except share data) (Unaudited)





For the nine months ended September 30,2002

2001Interest incomeInterest and fees on loans

$
31,409

$
33,135Interest and dividends on investment securities available for sale:U.S. Treasury and U.S. Government agencies


1,218


569State and municipal


1,545


2,039Mortgage-backed securities


327


939Interest on federal funds sold


307


299Dividends on FHLB stock


72


96Total interest income


34,878


37,077Interest expenseInterest on deposits


9,150


14,532Interest on securities sold under agreements to repurchase


139


502Interest on federal funds purchased


1


48Interest on commercial paper (Master notes)


115


314Total interest expense


9,405


15,396Net interest income


25,473


21,681Provision for loan losses


3,100


3,138Net interest income after provision for loan losses


22,373


18,543Noninterest incomeService charges on deposit accounts


5,859


5,422Fees for trust services


1,346


1,372Gains on sales of loans


564


403Investment securities gains


349


Other income


2,250


2,114Total noninterest income


10,368


9,311Noninterest expenseSalaries and other personnel


11,210


9,797Net occupancy


1,672


1,552Furniture and equipment


2,002


1,768FDIC assessment


84


82Postage and supplies


1,107


986Marketing and advertising


710


714Telephone


594


567Cardholder processing expense


420


410Sales finance losses


65


16Other expense


4,030


3,542Total noninterest expense


21,894


19,434Income before income taxes


10,847


8,420Income tax provision


3,578


2,468Net income

$
7,269

$
5,952Net income per share-basic

$
1.15

$
0.95Net income per share-dilutive


1.12


0.92Cash dividends declared per share


0.33


0.30





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.


Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income


(Dollars in thousands, except share data)
(Unaudited)





Common Stock

Capital Surplus

Retained Earnings


Accumulated Other Comprehensive Income (Loss), Net


TotalBalance at December 31, 2000

$
31,279

$
23

$
21,555


$
(264
)

$
52,593Net income








5,952







5,952Other comprehensive income, net of tax:Unrealized holding gains arising during period, net of tax effect of $902












1,441Less: reclassification adjustment for gains included in net income, net of tax effect of $0












0Net unrealized gains on securities
















1,441Comprehensive income
















7,393Cash dividend declared and paid








(1,879
)






(1,879
)Issuance of 9,000 shares in connection with stock options


45


24










69Balance at September 30, 2001

$
31,324

$
47

$
25,628


$
1,177


$
58,176Balance at December 31, 2001

$
31,418

$
26

$
27,386


$
238


$
59,068Net income








7,269







7,269Other comprehensive income, net of tax:Unrealized holding gains arising during period, net of tax effect of $1,217












1,944Less: reclassification adjustment for gains included in net income, net of tax effect of $134












(215
)Net unrealized gains on securities
















1,729Comprehensive income
















8,998Cash dividend declared and paid








(2,078
)






(2,078
)Issuance of 20,155 shares in connection with stock options


101


58










159Balance at September 30, 2002

$
31,519

$
84

$
32,577


$
1,967


$
66,147





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.


Consolidated Statements of Cash Flows


(Dollars in thousands) (Unaudited)





For the nine months ended September 30,2002


2001Cash flows from operating activitiesNet income

$
7,269


$
5,952Adjustments to reconcile net income to net cash provided by (used in) operating activitiesDepreciation and amortization


1,358



1,981(Gain) on sale of investment securities


(349
)


Provision for loan losses


3,100



3,138Origination of loans held for sale


(65,546
)


(64,875
)Sale of loans held for sale


67,417



60,543(Gain) on sale of loans


(564
)


(403
)Change in accrued interest receivable


412



186Change in other assets


(1,295
)


(1,247
)Change in other liabilities, net


(291
)


1,061Net cash provided by operating activities


11,511



6,336Cash flows from investing activitiesPurchase of investment securities available for sale


(50,123
)


(18,432
)Proceeds from maturities of investment securities available for sale


23,202



16,239Proceeds from sale of investment securities available for sale


24,039



Principal paydowns on mortgage-backed securities available for sale


3,696



5,822Net increase in loans outstanding


(50,351
)


(52,369
)Purchases of premises and equipment, net


(1,857
)


(3,245
)Net cash used in investing activities


(51,394
)


(51,985
)Cash flows from financing activitiesNet increase in deposit accounts


58,920



50,790Net increase (decrease) in securities sold under agreements to repurchase


2,001



(5,318
)Net increase (decrease) in commercial paper


5,150



(2,452
)Proceeds from issuance of common stock


159



69Dividends paid


(2,078
)


(1,879
)Net cash provided by financing activities


64,152



41,210Net increase (decrease) in cash and cash equivalents


24,269



(4,439
)Cash and cash equivalents at beginning of the period


45,691



38,184Cash and cash equivalents at end of the period

$
69,960


$
33,745Supplemental InformationCash paid during the period for:Interest expense

$
9,733


$
15,692Income taxes


3,555



2,328Supplemental schedule of non-cash investing and financing transactionsChange in unrealized gain on investment securities available for sale, pre-tax

$
2,811


$
2,343Loans transferred to other real estate owned


2,072



1,012Loans charged-off


2,689



3,125





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.


Notes To Consolidated Interim Financial Statements





1.  GENERAL





Principles of Consolidation


The foregoing unaudited consolidated financial
statements include accounts of the Palmetto Bancshares, Inc. (defined collectively with its subsidiaries as the Company), its wholly owned subsidiary, The Palmetto Bank (the Bank), and Palmetto Capital, Inc., the Banks
wholly owned subsidiary. In managements opinion, all significant intercompany accounts and transactions have been eliminated, and all adjustments necessary for a fair presentation of the results for interim periods presented have been
included. Any such adjustments are of a normal and recurring nature.





Basis of Presentation


The unaudited consolidated interim financial statements are presented in accordance with the instructions for Form 10-Q. Accordingly, certain information and footnotes required by generally accepted
accounting principles for complete financial statements are not included herein. The interim statements should be read in conjunction with the financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for
the year ended December 31, 2001.





Summary of Significant Accounting Policies


The significant accounting policies used by the Company are described in Note 1 to the Companys Annual Report on Form 10-K for the year ended December 31, 2001. There have been no changes in these policies subsequent
to the year ended December 31, 2001.





Accounting Estimates and Assumptions





Certain policies require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could
differ significantly from these estimates and assumptions.





2.  PER SHARE INFORMATION





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





For the three months ended September 30,2002

2001BASICAverage common shares outstanding (denominator)

6,301,974

6,263,125DILUTEDAverage common shares outstanding

6,301,974

6,263,125Dilutive potential common shares

167,467

174,206Average diluted shares outstanding (denominator)

6,469,441

6,437,331




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For the nine months ended September 30,2002

2001BASICAverage common shares outstanding (denominator)

6,294,386

6,261,335DILUTEDAverage common shares outstanding

6,294,386

6,261,335Dilutive potential common shares

169,662

173,564Average diluted shares outstanding (denominator)

6,464,048

6,434,899




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





The following
discussion and analysis is presented to assist in understanding the financial condition and results of operations of Palmetto Bancshares, Inc. (defined collectively with its subsidiaries as the Company). This discussion should be read in
conjunction with the consolidated financial statements and related notes and other financial data appearing in this report as well as the Annual Report of Palmetto Bancshares, Inc. on Form 10-K for the year ended December 31, 2001. Results of
operations for the three month period ended September 30, 2002 are not necessarily indicative of results that may be attained for any other period. Percentage calculations contained herein have been calculated based upon actual, not rounded,
results.





The holding company was organized in 1982 under the laws of South Carolina. Through its wholly-owned subsidiary, The Palmetto
Bank (the Bank), and the Banks wholly-owned subsidiary, Palmetto Capital, Inc. (Palmetto Capital), the Company engages in the general banking business in the upstate South Carolina market of Laurens, Greenville,
Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, and Oconee counties (the Upstate). The Bank was organized and chartered under South Carolina law in 1906.





The Bank performs a full range of banking activities, including such services as checking, savings, money market, and other time deposits of various types of consumer and commercial depositors; loans
for business, real estate, and personal uses; safe deposit box rental and various electronic funds transfer services. The Bank also offers both individual and commercial trust services through an active trust department. Palmetto Capital is a
brokerage subsidiary of the Bank, which offers customers stocks, treasury and municipal bonds, mutual funds and insurance annuities, as well as college and retirement planning.





FORWARD LOOKING STATEMENTS





This report contains certain forward-looking
statements (as defined in the Private Securities Litigation Reform Act of 1995) to assist in the understanding of anticipated future operating and financial performance, growth opportunities, growth rates, and other similar forecasts and statements
of expectations. These forward-looking statements reflect current views, but are based on assumptions and are subject to risks, uncertainties, and other factors, which may cause actual results to differ materially from those in such statements.
These factors include, but are not limited to, the following:





| |  |  | risks from changes in economic, monetary policy and industry conditions;
| | - |  | ------------------------------------------------------------------------

| |  |  | changes in interest rates, deposit rates, the net interest margin and funding sources;
| | - |  | --------------------------------------------------------------------------------------

| |  |  | market risk and inflation;
| | - |  | --------------------------

| |  |  | risks inherent in making loans including repayment risks and value of collateral;
| | - |  | ---------------------------------------------------------------------------------

| |  |  | loan growth, the adequacy of the allowance for loan losses and the assessment of problem loans;
| | - |  | -----------------------------------------------------------------------------------------------

| |  |  | fluctuations in consumer spending;
| | - |  | ----------------------------------

| |  |  | competition in the banking industry and demand for our products and services;
| | - |  | -----------------------------------------------------------------------------

| |  |  | dependence on senior management;
| | - |  | --------------------------------

| |  |  | technological changes;
| | - |  | ----------------------

| |  |  | ability to increase market share;
| | - |  | ---------------------------------

| |  |  | expense projections;
| | - |  | --------------------

| |  |  | risks associated with income taxes, including the potential for adverse adjustments;
| | - |  | ------------------------------------------------------------------------------------

| |  |  | changes in accounting policies and practices;
| | - |  | ---------------------------------------------

| |  |  | costs and effects of litigation; and
| | - |  | ------------------------------------

| |  |  | recently-enacted or proposed legislation.
| | - |  | -----------------------------------------



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Such forward-looking statements speak only as of the date on which such statements are made. We
undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings by
the Company with the Securities Exchange Commission, in press releases and in oral and written statements made by or with the approval of Palmetto Bancshares Inc., which are not statements of historical fact, constitute forward-looking statements.




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BALANCE SHEET REVIEW





Overview





Total assets increased by $73.9 million, or 10%, at September 30, 2002
as compared to December 31, 2001 and increased by $95.3 million, or 13%, at September 30, 2002 as compared to September 30, 2001. Liquid assets, which include cash, federal funds sold, and investments available for sale, increased by $26.2 million,
or 18%, at September 30, 2002 over December 31, 2001 and $36.0 million or 27% at September 30, 2002 over September 30, 2001. Total liabilities increased $66.9 million, or 10%, at September 30, 2002 over December 31, 2001 and reported an $87.3
million increase, or 13%, at September 30, 2002 over September 30, 2001. Total shareholders equity increased $7.1 million, or 12%, at September 30, 2002 over December 31, 2001 and reported an $8.0 million increase, or 14%, at September 30,
2002 over September 30, 2001.





Securities





At September 30, 2002, the Companys investment portfolio totaled $97.1 million compared to $95.1 million and $97.3 million at December 31, 2001 and September 30, 2001, respectively. This represents an increase of 2%
over December 31, 2001 and a minute decrease over September 30, 2001. The composition of the investment portfolio at September 30, 2002 follows: agencies 43%, municipalities 35%, treasuries 16%, and mortgage-backed securities 6%.





During the first nine months of 2002, the Bank purchased $50.1 million of investment securities (available for sale), $47.2 million of the investment
portfolio matured or was sold resulting in a gain of $349 thousand, and $3.7 million was paid down on mortgage backed securities held for sale. The September 30, 2002 securities balance included $3.2 million in pre-tax unrealized gains in the
portfolio.





During the first nine months of 2001, the Bank purchased $18.4 million of investment securities (available for sale), $16.2
million of the investment portfolio matured, and $5.8 million was paid down on mortgage backed securities held for sale. No securities were sold from the portfolio during the nine month period ended September 30, 2001. The September 30, 2001
securities balance included $2.3 million in pre-tax unrealized gains in the portfolio.





Loans





At September 30, 2002, the Company had total loans outstanding of $602.1 million, which equaled 85% of total deposits and 74% of total assets. Loans are the
largest category of earning assets and generally produce higher yields than other earning assets. The loan portfolio consists principally of commercial loans, commercial real estate loans, consumer loans, sales finance loans, and mortgage loans.





Loans held for sale were $8.7 million at September 30, 2002 compared to $10.1 million and $5.3 million at December 31, 2001 and
September 30, 2001, respectively. This represents a decrease of 13% over December 31, 2001 and an increase of 64% over September 30, 2001. As a result of the favorable interest rate environment for mortgage loans and refinances, the Bank originated
approximately $74.9 million in mortgage loans during the first nine months of 2002, with substantially all being sold during the same period.





Loans excluding those held for sale, net of unearned income, were $599.6 million at September 30, 2002 compared to $553.8 million and $546.6 million at December 31, 2001 and September 30, 2001, respectively. This represents increases
of 8% over December 31, 2001 down from an increase of 10% over September 30, 2001. Management believes that the recent downturn in the economy has contributed to the decreased percentage of loan growth over the periods presented. The Companys




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strategy is to allow for lower loan growth in times of economic downturn as opposed to attracting growth at the expense of low interest rate
positions.





See Credit Quality for additional discussion of loan portfolio performance.





Allowance for Loan Losses





The adequacy
of the allowance is analyzed on a monthly basis. For purposes of this analysis, adequacy is defined as a level sufficient to absorb probable losses in the portfolio. The Bank uses an allowance model that takes into account loan risk grades,
delinquency trends, and charge-off ratios as well as loan growth. Assessing the adequacy of the allowance requires considerable judgment. Managements judgments are based on numerous assumptions about current events, which we believe to be
reasonable. The allowance is subject to examination and adequacy testing by regulatory agencies.





The allowance for loan losses totaled
$6.3 million at September 30, 2002 compared to $5.7 million and $5.6 million at December 31, 2001 and September 30, 2001, respectively. This represents an increase of 10% over December 31, 2001 and 11% over September 30, 2001. Table 1 summarizes the
changes in the allowance.





Table 1


Summary of Loan
Loss and Recovery Experience


(Dollars in thousands)





At and for the nine months ended September 30,


At and for the year ended December 31, 20012002


2001Allowance at beginning of period

$
5,658


$
5,446


$
5,446Net charge-offs:Loans charged-off


2,689



3,125



4,033Less: loans recovered


183



152



2072,506



2,973



3,826Additions to reserves through provision


3,100



3,138



4,038Allowance at end of period

$
6,252


$
5,611


$
5,658Average loans excluding held for sale

$
567,341


$
526,417


$
534,034Loans excluding held for sale, net unearned


599,594



546,626



553,821Net charge-offs as a % of average loans excluding held for sale (annualized, where applicable)


0.59
%


0.75
%


0.72
%Allowance as a % of loans excluding held for sale, net unearned


1.04



1.03



1.02




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The allowance for loan losses as a percentage of loans excluding held for sale increased to 1.04% at
September 30, 2002 from 1.02% and 1.03% at December 31, 2001 and September 30, 2001, respectively. During mid-1999 management noted deterioration in the performance of the sales finance portfolio resulting in increased charge-offs during 2000 and
2001. The sales finance portfolio includes loans with more inherent risk than the loans in the Banks direct lending portfolio. Annualized (where applicable) net charge-offs as a percentage of average loans excluding held for sale have declined
from 75 basis points at September 30, 2001 to 72 basis points at December 31, 2001 to 59 basis points at September 30, 2002. Additionally, it was noted that the sales finance portfolio has decreased to $14.8 million at September 30, 2002 from $15.9
at December 31, 2001 and $17.4 million at September 30, 2001.





See Credit Quality for additional discussion of factors
contributing to the allowance for loan losses.





Other Assets





At September 30, 2002, other assets totaled $14.1 million compared to $10.4 million and $11.3 million at December 31, 2001 and September 30, 2001, respectively.
This represents an increase of 35% over December 31, 2001 and 25% over September 30, 2001.





At September 30, 2002 major components of
other assets included the Travelers Express reserve (described below) totaling $1.9 million, mortgage servicing rights which totaled $1.9 million, pension plan assets totaling $2.1 million, other real estate owned totaling $1.5 million, and $4.1
million of intangible assets.





In August 2002, the Bank established a reserve account with Travelers Express, its third party official
check vendor. In the past, Travelers Express has paid checks and the Bank remitted the forwarded balance the following day which resulted in payment of one days interest to Travelers Express on the forwarded monies. Establishing this reserve
account has eliminated the need for forwarded monies and therefore the interest payments to Travelers Express.





At December 31, 2001
other assets was comprised primarily of mortgage servicing rights totaling $1.6 million, pension plan assets totaling $1.7 million, other real estate owned totaling $217 thousand, and $4.4 million of intangible assets.





At September 30, 2001 large components contributing to the balance of $11.3 million included mortgage servicing rights totaling $1.5 million, pension plan assets
totaling $1.7 million, other real estate owned totaling $1.0 million, and $4.5 million of intangible assets.





The recent favorable
interest rate environment as well as the addition of mortgage loan originators has contributed to the increase in the loan portfolio at September 30, 2002 over December 31, 2001 as well as September 30, 2001. As noted in the Loans
section above, originations of loans held for sale thus far in 2002 have totaled $74.9 million. Since loans are typically sold servicing retained, the increase in these loans has caused the increase in the Banks mortgage servicing portfolio
described above.





Due to the low volume of properties within the other real estate owned portfolio, the foreclosure of new property or
the sale of an existing property can cause the balance to fluctuate greatly on a monthly basis. From September 30, 2001 to December 31, 2001 other real estate owned declined from $1.0 million to $217 thousand. At December 31, 2001, five
relationships were included in the other real estate owned portfolio. Between December 31, 2001 and September 30, 2002 the balance increased from $217 thousand to $1.5 million. This increase was the result of eight new relationships being added to
the portfolio over the period offset by six relationships being removed from the portfolio through property sale. Since December 31, 2001, the portfolio saw $2.1 million of additions offset by writedowns and sales totaling $816 thousand. 84% of the
additions were contained within four




12




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##### Table of Contents




relationships with one relationship constituting 41%.





As noted above in the Allowance for Loan Losses section, during mid-1999 management noted deterioration in the performance of the sales finance
portfolio. In the periods following these findings, charge-offs increased and collateral was repossessed, in some cases, in conjunction with a portion of these sales finance loans. During the nine month period ended September 30, 2002, the Bank has
begun to experience a decrease in charge-offs (in part related to this portfolio). In addition, the balance of repossessed automobiles has begun to decline. Resulting from the review of the loans within the portfolio, the sales finance portfolio has
decreased to $14.8 million at September 30, 2002 from $15.9 at December 31, 2001 and $17.4 million at September 30, 2001.





The decline in
the intangible asset balances is attributed to related amortization. Amortization for the nine month period ended September 30, 2002 was $328 thousand compared to $329 thousand for the same period ended September 30, 2001. Amortization for the
twelve month period ended December 31, 2001 was $377 thousand.





Deposits





At September 30, 2002, total deposits totaled $704.2 million compared to
$645.3 million and $623.5 million at December 31, 2001 and September 30, 2001, respectively. This represents an increase of 9% over December 31, 2001 and 13% over September 30, 2001. Deposits remain the Banks primary source of funds for loans
and investments. Deposits provided funding for 100% and 98% of average earning assets for the nine month periods ended September 30, 2002 and 2001, respectively. Deposit pricing remains very competitive. The composition of the deposit portfolio at
September 30, 2002 follows: time deposits 47%, interest-bearing demand deposits 32%, noninterest-bearing deposits 16%, and savings 5%.





Borrowed Funds





At September 30, 2002, total securities sold under agreement to
repurchase totaled $17.3 million compared to $15.3 million and $14.6 million at December 31, 2001 and September 30, 2001, respectively. This represents an increase of 13% over December 31, 2001 and 19% over September 30, 2001.





At September 30, 2002, total commercial paper totaled $16.2 million compared to $11.1 million and $12.9 million at December 31, 2001 and September 30,
2001, respectively. This represents an increase of 46% over December 31, 2001 and 26% over September 30, 2001.





As noted above in the
Deposits section, deposits provided funding for 100% and 98% of average earning assets for the nine month periods ended September 30, 2002 and 2001, respectively. The increase in borrowed funds can be attributed to the higher balances of
cash and due from banks, federal funds sold, and total loans only partially offset by the increase in deposits.





Other Liabilities





At September 30, 2002, other liabilities totaled $5.3 million compared to $4.5 million and $4.8
million at December 31, 2001 and September 30, 2001, respectively. This represents an increase of 18% over December 31, 2001 and 10% over September 30, 2001.





The increase in other liabilities at September 30, 2002 compared to December 31, 2001 of $792 thousand is the result of fluctuations in several accounts. Accrued income taxes decreased approximately $703 thousand at
September 30, 2002 compared to December 31, 2001 based on the amount of income earned as of both periods in time. At December 2001 twelve months of income was taxable, while at September 2002, only nine months of income was taxable contributing to
the




13




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##### Table of Contents




decrease. Taxes relating to the unrealized gain on available for sale securities increased approximately
$1.1 million due to an increase in the unrealized gains on available for sale securities at September 30, 2002 over December 31, 2001. At September 30, 2002 the Company was in a deferred tax liability position of $722 thousand while at December 31,
2001 we were in a deferred tax asset position thereby leaving the liability account with a zero balance resulting in an increase in this account of $722 thousand. The final large fluctuation affecting the increase in other liabilities at September
30, 2002 over December 31, 2001 was a decrease in accrued interest payable of approximately $328 thousand. The fluctuation of this account results from the average balances of interest-bearing balances for the respective month as well as the cost of
the interest-bearing balances for the month. Although average interest-earning liabilities increased 7% from the month ended December 31, 2001 to the month ended September 30, 2002, the cost of the interest-earning liabilities decreased from 2.33%
for the month ended December 31, 2001 to 1.64% for the month ended September 30, 2002. The effect of this decrease of 69 basis points offsets the 7% increase in average interest-earning balances resulting in an overall decrease in accrued interest
payable at September 30, 2002 over December 31, 2001.





The increase in other liabilities at September 30, 2002 compared to September 30,
2001 of $502 thousand results from the fluctuations of several accounts. Accrued income taxes decreased approximately $871 thousand at September 30, 2002 compared to September 30, 2001. This decrease is due to the timing of the prior year third
quarter payment of $600 thousand that was not remitted until October 3, 2001. In the current year this payment was made prior to the closing of the month end balances. Taxes relating to the unrealized gain on available for sale securities increased
approximately $495 thousand due to an increase in the unrealized gain on available for sale securities at September 30, 2002 over September 30, 2001. At September 30, 2002 the Company was in a deferred tax liability position of $722 thousand while
at September 30, 2001 we were in a deferred tax asset position thereby leaving the liability account with a zero balance resulting in an increase in this account of $722 thousand. The final large fluctuation contributing to the increase in other
liabilities at September 30, 2002 over September 30, 2001 was a decrease in accrued interest payable of approximately $502 thousand. The fluctuation of this account is a result of the average balances of interest-bearing balances for the respective
month as well as the cost of the interest-bearing balances for the month. Although average interest-earning liabilities increased 11% from the month ended September 30, 2001 to the month ended September 30, 2002, the cost of the interest-earning
liabilities decreased from 2.71% for the month ended September 30, 2001 to 1.64% for the month ended September 30, 2002. The effect of this decrease of 107 basis points offsets the 11% increase in average interest-earning balances resulting in an
overall decrease in accrued interest payable at September 30, 2002 over September 30, 2001.





Capital Resources and Dividends





Shareholders equity totaled $66.1 million, $59.1 million, and $58.2 million
at September 30, 2002, December 31, 2001, and September 30, 2001, respectively. Shareholders equity as a percentage of total assets was 8% for each of the above periods in time. Increases in shareholders equity result from retention of
earnings, unrealized gains in the available for sale security portfolio, and stock option exercises offset by dividends paid.





Book value
per share was $10.49 at September 30, 2002 compared to $9.40 and $9.29 at December 31, 2001 and September 30, 2001, respectively.





As of
September 30, 2002, the Company and the Bank were in compliance with each of the applicable regulatory capital requirements and met or exceeded the well-capitalized regulatory guidelines. Table 2 sets forth various capital ratios for the
Company and the Bank. The Company and the Bank are subject to certain regulatory restrictions on the amount of dividends they are permitted to pay. Based on the Banks current total risk-based capital ratio at September 30, 2002, the Bank had
$5.7 million of excess retained earnings available for dividend payout and still be considered well-capitalized.




14




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##### Table of Contents




Table 2


Capital Ratios





As of 9/30/02


Adequately Capitalized
Requirement


Well-Capitalized RequirementCompany:Total Risk-based Capital

10.93
%

8.00
%

10.00
%Tier 1 Risk-based Capital

9.90


4.00


6.00Tier 1 Leverage Ratio

7.79


4.00


5.00Bank:Total Risk-based Capital

10.82
%

8.00
%

10.00
%Tier 1 Risk-based Capital

9.79


4.00


6.00Tier 1 Leverage Ratio

7.70


4.00


5.00





Off-Balance Sheet Arrangements





The Companys off-balance sheet arrangements, which principally include lending commitments, are described below.





Lending commitments include loan commitments, standby letters of credit, and unused credit card lines. These instruments are not recorded in the
consolidated balance sheet until funds are advanced under the commitments. The Company provides these lending commitments to customers in the normal course of business.





For commercial customers, loan commitments generally take the form of revolving credit arrangements to finance customers working capital requirements. For retail customers, loan commitments are
generally lines of credit secured by residential property. Unused credit card lines are generally used for short-term borrowings. At September 30, 2002, these commitments totaled $102.8 million. Standby letters of credit are conditional commitments
to guarantee performance, typically contract or financial integrity, of a customer to a third party and totaled $1.5 million at September 30, 2002. The Company applies essentially the same credit policies and standards as it does in the lending
process when making these commitments.




15




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##### Table of Contents




Liquidity





Liquidity management ensures that adequate funds are available to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve
requirements, pay operating expenses, provide funds for dividends, and manage operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, loan sales, securities
available for sale, maturities of securities, and earnings.





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





Investment securities are an important tool to our liquidity management. Securities classified as available for sale may be sold in response to changes in
interest rates, liquidity needs, and/or significant prepayment risk.





Net cash provided by operations and deposits from customers have
been the primary sources of liquidity for the Company. Liquidity is also enhanced by the ability to acquire new deposits through the Banks established branch network of 30 branches in South Carolina.





The Bank has access to borrowings from the FHLB and maintains short-term lines of credit. At September 30, 2002, the Bank had approximately $76 million of unused
borrowing capacity from the FHLB. The Bank has pledged assets to be used as collateral if the Bank takes advantage of the FHLB line of credit. At September 30, 2002, the Bank had unused short-term lines of credit totaling approximately $37 million
(which are withdrawable at the lenders option). Management believes that these sources are adequate to meet its liquidity needs and to maintain the liquidity ratio within policy guidelines.





The Company has certain cash needs including general operating expenses and the payment of dividends and interest on borrowings. The Company currently has no long-term debt outstanding and
has declared and paid cash dividends totaling $.33 per share in the nine month period ended September 30, 2002. Although there can be no guarantee that additional dividends will be paid in 2002, the Company plans to continue its quarterly dividend
payments.





In the normal course of business, to meet the financial needs of its customers, the Company, principally through the Bank,
enters into agreement to extend credit. For amounts and types of such agreements at September 30, 2002, see Off-Balance Sheet Arrangements. Increased demand for funds under these agreements would reduce the Companys liquidity and
could require additional sources of liquidity.





Credit Quality





A willingness to take credit risk is inherent in the decision to grant credit. Prudent risk-taking requires a credit risk management system based on sound policies and control processes that ensure
compliance with those policies. Adherence to underwriting standards is managed through a multi-layered credit approval process and review of loans approved by lenders. Through loan review, reviews of exception reports, and ongoing analysis of asset
quality trends, compliance with loan monitoring policies is managed.





Table 3 presents information pertaining to nonperforming assets.




16




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##### Table of Contents




Table 3


Nonperforming Loans and Assets


(Dollars in thousands)








September 30,


December 31, 20012002


2001Nonaccrual loans

$
3,593


$
2,518


$
3,399Loans past due 90 days still accruing interest


277



765



630Total nonperforming loans


3,870



3,283



4,029Other real estate owned


1,473



1,017



217Repossessed automobiles


337



794



581Total nonperforming assets

$
5,680


$
5,094


$
4,827Total nonperforming loans as a percentage of loans (1)


.65
%


.60
%


.73
%Total nonperforming assets as a percentage of loans, other real estate owned, and repossessed automobiles
(1)


.94



.93



.87Allowance for loan losses as a percentage of nonperforming loans


1.62x



1.71x



1.40x


---

(1) Calculated using loans excluding held for sale





Until the economy improves, credit quality indicators will remain volatile. While current economic data seems to be signaling improvement, the outlook
remains uncertain. Management believes, however, that loss exposure in its loan portfolio is identified, adequately reserved in a timely manner, and closely monitored to ensure that changes are promptly addressed in its analysis of allowance
adequacy. Accordingly, management believes the allowance as of September 30, 2002 is adequate, based on its assessment of probable losses, and available facts and circumstances then prevailing.




17




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##### Table of Contents




EARNINGS REVIEW





COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED


SEPTEMBER 30, 2002 AND 2001





Overview





Net income for the three months ended September 30, 2002 totaled $2.3 million, up 6% compared
with $2.2 million for the third quarter 2001. Earnings per diluted share for the third quarter 2002 were $0.36, a 6% increase from $0.34 per diluted share in the third quarter 2001. Earnings per basic share for the third quarter 2002 were $0.37, a
6% increase from $0.35 per basic share in the third quarter 2001.





Average common shares outstanding on a diluted basis were 6.5 million
in the third quarter 2002, up 0.50% from 6.4 million for third quarter 2001. Average common shares outstanding on a basic basis were 6.3 million in the third quarter 2002, relatively unchanged from 6.3 million in the third quarter 2001.





Noninterest income for the three months ended September 30, 2002 totaled $3.4 million, up 6% compared with $3.2 million for the third
quarter 2001. Noninterest expense for the three months ended September 30, 2002 totaled $7.4 million, up 8% compared with $6.8 million for the third quarter 2001.





Net Interest Income





Net interest
income is the difference between gross interest and fees on earning assets, primarily loans and investment securities, and interest paid on deposits and other interest-earning liabilities. The net interest margin measures how effectively a company
manages the difference between the yield on earning assets and the rate paid on funds to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax exempt income to a comparable yield on a taxable basis.
Table 4 presents average balance sheets and a net interest income analysis on a tax-equivalent basis for the three months ended September 30, 2002 and 2001.





Fully tax-equivalent net interest income for the third quarter of 2002 increased $1.0 million, or 14%, to $8.9 million from $7.8 million in the third quarter of 2001. The fully tax-equivalent net interest margin increased to
4.93% in the third quarter of 2002 from 4.77% in the third quarter of 2001.





Average earning assets grew $64.8 million, or 10%, to $714.9
million in the third quarter of 2002 from $650.1 million in the third quarter of 2001, primarily from the growth of federal funds sold, loans, and investment securities. Average loans were $591.3 million during the third quarter of 2002 compared
with $551.5 million during the third quarter of 2001. Average investment securities, including the average net unrealized securities gains, increased from $87.9 million in the third quarter of 2001 to $98.9 million in the third quarter of 2002.





Average total deposits increased from $609.0 million during the third quarter of 2001 to $667.6 million during the third quarter of
2002. Average other interest-earning liabilities increased to $35.6 million in the third quarter of 2002 from $28.5 million during the third quarter of 2001.




18




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##### Table of Contents




Table 4


Comparative Average BalanceYields and Costs


(Dollars in thousands)





For the three months ended September 30,2002


2001Average Balance


Income/ Expense

Yield/ Rate


Average Balance


Income/ Expense

Yield/ RateASSETSEarnings assetsFederal funds sold

$
22,551


$
96

1.69
%

$
8,717


$
82

3.73
%Federal Home Loan Bank stock and deposits


2,082



22

4.19



1,971



29

5.84Nontaxable investment securities (2) (3)


36,177



615

6.74



57,694



922

6.34Taxable investment securities (2)


62,697



559

3.54



30,215



430

5.65Taxable loans, net of unearned (1)


591,345



10,584

7.10



551,456



11,126

8.00Total earning assets


714,852



11,876

6.59



650,053



12,589

7.68Nonearning assetsCash and due from banks


28,847









24,336Allowance for loan losses


(6,000
)








(5,683
)Premises and equipment, net


19,785









18,167Accrued interest


4,378









4,860Other assets


13,071









10,765Total nonearning assets


60,081









52,445Total assets

$
774,933








$
702,498LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesEarning liabilitiesDemand deposits

$
226,162


$
421

0.74
%

$
205,299


$
844

1.63
%Savings


38,386



65

0.67



33,496



113

1.34Time


297,734



2,412

3.21



277,564



3,643

5.21Total earning deposits


562,282



2,898

2.04



516,359



4,600

3.53Other earning liabilities


35,552



92

1.03



28,537



167

2.32Total earning liabilities


597,834



2,990

1.98



544,896



4,767

3.47Nonearning liabilitiesNonearning deposits


105,313









92,613Other nonearnings liabilities


6,353









7,702Total nonearning liabilities


111,666









100,315Total liabilities


709,500









645,211Shareholders' equity


65,433









57,287Total liabilities and shareholders' equity

$
774,933








$
702,498NET INTEREST MARGIN (FTE)





$
8,886

4.93
%





$
7,822

4.77
%Tax-equivalent adjustment (3)





$
203








$
248


---

|(1) |  | Nonaccrual loans are included in average balances for yield computations. The effect of foregone interest income as a result of loans on nonaccrual was not
considered in the above analysis. All loans and deposits are domestic.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(3) |  | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. Yields on
nontaxable securities are stated on a fully taxable equivalent basis, assuming the effective rate for the respective period. The adjustments made to convert nontaxable investments to a fully taxable equivalent basis were $203 and $248 for the 2002
and 2001 periods, respectively.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



19




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##### Table of Contents




The underlying factor for the changes in the yields and rates on earning assets and costing liabilities
has been the action of the Federal Reserve Open Market Committee during the past 21 months. From January 2001 through the end of December 2001, the Federal Reserve cut interest rates four hundred and seventy five basis points. Variable rate loans
reprice immediately following changes in interest rates by the Federal Reserve. During the third quarter of 2002 as compared to the third quarter of 2001, the net interest margin improved, primarily from repricing certificates of deposits at lower
rates which was only partially offset by the decreasing yields of the loan and securities portfolios which was a direct result of the interest rate environment. The weighted average yield of the loan portfolio decreased from 8.00% for third quarter
2001 to 7.10% for third quarter 2002. The weighted average yield of the security portfolio decreased from 6.10% for third quarter 2001 to 4.71% for third quarter 2002. As the Company reduced its interest rates during the year, the decline in the
funding source rate outpaced the decline in the earning asset yield.





Provision for Loan
Losses





The provision for loan losses was $1.2 million and $900 thousand for the third quarter of 2002 and 2001, respectively. The
provision is adjusted each month to reflect loan volume growth and allow for loan charge-offs, recoveries and other factors which impact managements assessment of the adequacy of the allowance for loan losses. Managements objective is to
maintain the allowance for loan losses at an adequate level to cover probable losses in the portfolio. Additions to the allowance for loan losses are based on managements evaluation of the loan portfolio under current economic conditions, past
loan loss experience, and such other factors, which in managements judgment deserve recognition in estimating loan losses.





During
mid-1999 management noted deterioration in the performance of the sales finance portfolio that resulted in increased charge-offs during 2000 and 2001. See Allowance for Loan Losses for discussion of this portfolio and the effect on the
allowance for loan losses and, therefore, the provision for loan losses. This portfolio was a contributor to the increase in the provision during recent years as a result of higher charge-offs. However, annualized third quarter net charge-offs as a
percentage of average loans excluding held for sale have begun to decline represented by 80 basis points for the quarter ended September 30, 2001 compared to 57 basis points for the quarter ended September 30, 2002.





While management uses the best information available to make evaluations, future adjustments to the allowance in the form of provisions through the income
statement may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to
adjustment, based upon information that is available to them at the time of their examination.





NonInterest Income and Expense





Noninterest income for the third quarter of 2002 increased $210 thousand, or 6%,
to $3.4 million from $3.2 million in the third quarter of 2001. Noninterest expense for the third quarter of 2002 increased $580 thousand, or 8%, to $7.4 million from $6.8 million in the third quarter of 2001.





Contributing to the increase in noninterest income for the three months ended September 30, 2002 over the same period ended 2001 were increases in service
changes on deposit accounts totaling $142 thousand and gain on sale of securities totaling $114 thousand. These increases were offset by declines in gain on sale of loans totaling $58 thousand.





Contributing to the increase in noninterest expense was an increase in salaries and personnel expense of $292 thousand for the three months ended September 30, 2002 over September 30, 2001.
This increase is due in part to the opening of the Travelers Rest and Seneca branches during the first quarter of 2002 thereby increasing salaries and personnel expense related to the increase in personnel. Also contributing to the noninterest
expense increase was an increase in occupancy and furniture and equipment expense of $123 thousand for the three months ended September 30, 2002




20




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##### Table of Contents

over September 30, 2001 as well as an increase in supplies (specifically forms and printing) of $71 thousand over the same periods, all of which
is due in part to additional expenses related to the new branches. The remaining large fluctuation within the noninterest expense category relates to the writedown of properties within the other real estate owned portfolio. The writedowns increased
$113 thousand for the three month period ended September 30, 2002 over the same three month period of 2001 to a balance of $122 thousand. For discussion concerning the other real estate owned portfolio at September 30, 2002, see Other
Assets within the Balance Sheet Review section of this Form 10-Q.





Income
Taxes





Income tax expense attributable to income from continuing operations increased to $1.2 million for the third quarter of 2002
from $882 thousand for the third quarter of 2001. The effective income tax rate was 34% for the third quarter of 2002 compared to 29% for the third quarter of 2001.




21




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##### Table of Contents




COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001





Overview





Net income for the nine months ended September 30, 2002 totaled $7.3 million, up 22% compared with $6.0 million for the nine months ended September 30, 2001. Earnings per diluted share for the nine
months ended September 30, 2002 were $1.12, a 22% increase from $0.92 per diluted share for the same period in 2001. Earnings per basic share for the nine months ended September 30, 2002 were $1.15, a 21% increase from $0.95 per basic share in the
same period of 2001.





Average common shares outstanding on a diluted basis were 6.5 million for the nine months ended September 30, 2002,
up 0.45% from 6.4 million for the same period of 2001. Average common shares outstanding on a basic basis were 6.3 million for the nine months ended September 30, 2002 and 2001.





Noninterest income for the nine months ended September 30, 2002 totaled $10.4 million, up 11% compared with $9.3 million for the same period of 2001. Noninterest expense for the nine months ended
September 30, 2002 totaled $21.9 million, up 13% compared with $19.4 million for the same period of 2001.





Net Interest Income





Net interest income is the difference between gross interest and fees on earning assets,
primarily loans and investment securities, and interest paid on deposits and other interest-earning liabilities. The net interest margin measures how effectively a company manages the difference between the yield on earning assets and the rate paid
on funds to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax exempt income to a comparable yield on a taxable basis. Table 5 presents average balance sheets and a net interest income analysis on
a tax-equivalent basis for the nine months ended September 30, 2002 and 2001.





Fully tax-equivalent net interest income for the nine
months ended September 30, 2002 increased $3.7 million, or 17%, to $26.2 million from $22.5 million for the nine months ended September 30, 2001. The fully tax-equivalent net interest margin increased to 4.99% for the nine months ended September 30,
2002 from 4.75% for the nine month period ended September 30, 2001.





Average earning assets grew $68.2 million, or 11%, to $702.5 million
for the nine months ended September 30, 2002 from $634.3 million for the same period of 2001, primarily from the growth of federal funds sold, loans, and investment securities. Average loans were $574.9 million during the nine month period
ended September 30, 2002 compared with $533.3 million during the same period of 2001. Average investment securities, including the average net unrealized securities gains, increased from $91.2 million for the nine months ended September 30, 2001 to
$101.4 million in the same period of 2002.





Average total deposits increased from $593.3 million for the nine month period ended
September 30, 2001 to $660.3 million during the same period of 2002. Average other interest-earning liabilities increased to $33.0 million for the nine months ended September 30, 2002 from $31.3 million during the nine month period ended
September 30, 2001.




22




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##### Table of Contents




Table 5


Comparative Average BalanceYields and Costs


(Dollars in thousands)





For the nine months ended September 30,2002


2001Average Balance


Income/ Expense

Yield/Rate


Average Balance


Income/ Expense

Yield/ RateASSETSEarnings assetsFederal funds sold

$
24,182


$
307

1.70
%

$
7,932


$
299

5.04
%Federal Home Loan Bank stock and deposits


2,057



72

4.68



1,936



96

6.63Nontaxable investment securities (2) (3)


44,614



2,306

6.91



57,835



2,872

6.64Taxable investment securities (2)


56,769



1,545

3.64



33,361



1,508

6.04Taxable loans, net of unearned (1)


574,896



31,409

7.30



533,251



33,135

8.31Total earning assets


702,518



35,639

6.78



634,315



37,910

7.99Nonearning assetsCash and due from banks


28,449









24,912Allowance for loan losses


(5,817
)








(5,517
)Premises and equipment, net


19,666









17,426Accrued interest


4,499









4,839Other assets


12,300









10,528Total nonearning assets


59,097









52,188Total assets

$
761,615








$
686,503LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesEarning liabilitiesDemand deposits

$
227,382


$
1,293

0.76
%

$
200,699


$
2,940

1.96
%Savings


37,266



193

0.69



32,235



370

1.53Time


293,446



7,664

3.49



269,025



11,222

5.58Total earning deposits


558,094



9,150

2.19



501,959



14,532

3.87Other earning liabilities


33,031



255

1.03



31,344



864

3.69Total earning liabilities


591,125



9,405

2.13



533,303



15,396

3.86Nonearning liabilitiesNonearning deposits


102,213









91,382Other nonearnings liabilities


5,246









6,190Total nonearning liabilities


107,459









97,572Total liabilities


698,584









630,875Shareholders' equity


63,031









55,628Total liabilities and shareholders' equity

$
761,615








$
686,503NET INTEREST MARGIN (FTE)





$
26,234

4.99
%





$
22,514

4.75
%Tax-equivalent adjustment (3)





$
761








$
833


---

|(1) |  | Nonaccrual loans are included in average balances for yield computations. The effect of foregone interest income as a result of loans on nonaccrual was not
considered in the above analysis. All loans and deposits are domestic.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(3) |  | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. Yields on
nontaxable securities are stated on a fully taxable equivalent basis, assuming the effective rate for the respective period. The adjustments made to convert nontaxable investments to a fully taxable equivalent basis were $761 and $833 for the 2002
and 2001 periods, respectively.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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The underlying factor for the changes in the yields and rates on earning assets and costing liabilities
has been the action of the Federal Reserve Open Market Committee during the past 21 months. From January 2001 through the end of December 2001, the Federal Reserve cut interest rates four hundred and seventy five basis points. Variable rate loans
reprice immediately following changes in interest rates by the Federal Reserve. During the nine month period ended September 30, 2002 as compared to the same period of 2001, the net interest margin improved, primarily from repricing certificates of
deposits at lower rates which was only partially offset by the decreasing yields of the loan and securities portfolios which was a direct result of the interest rate environment. The weighted average yield of the loan portfolio decreased from 8.31%
for the nine month period ended September 30, 2001 to 7.30% for the same period of 2002. The weighted average yield of the security portfolio decreased from 6.42% for the nine month period ended September 30, 2001 to 5.08% for the same period of
2002. As the Company reduced its interest rates during the year, the decline in the funding source rate outpaced the decline in the earning asset yield.





Provision for Loan Losses





The
provision for loan losses was $3.1 million for both the nine month period ending September 30, 2002 and 2001. The provision is adjusted each month to reflect loan volume growth and allow for loan charge-offs, recoveries and other factors which
impact managements assessment of the adequacy of the allowance for loan losses. Managements objective is to maintain the allowance for loan losses at an adequate level to cover probable losses in the portfolio. Additions to the allowance
for loan losses are based on managements evaluation of the loan portfolio under current economic conditions, past loan loss experience, and such other factors, which in managements judgment deserve recognition in estimating loan losses.





During mid-1999 management noted deterioration in the performance of the sales finance portfolio that resulted in increased charge-offs
during 2000 and 2001. See Allowance for Loan Losses for discussion of this portfolio and the effect on the allowance for loan losses and, therefore, the provision for loan losses. This portfolio contributed to the increase in the
provision during recent years as a result of higher charge-offs. However, annualized year-to-date net charge-offs as a percentage of average loans excluding held for sale have begun to decline as evidenced by the 75 basis points for the nine months
ended September 30, 2001 compared to 59 basis points for the nine months ended September 30, 2002.





While management uses the best
information available to make evaluations, future adjustments to the allowance in the form of provisions through the income statement may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation.
The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment, based upon information that is available to them at the time of their examination.





NonInterest Income and Expense





Noninterest income for the nine month period ended September 30, 2002 increased $1.1 million, or 11%, to $10.4 million from $9.3 million for the same period of 2001. Noninterest expense for the nine
month period of 2002 increased $2.5 million, or 13%, to $21.9 million from $19.4 million for the same nine month period of 2001.





Several
factors contributed to the increase in noninterest income for the nine month period ended September 30, 2002 over 2001. Service charges on deposit accounts increased $437 thousand or 8% between the two periods. This increase was primarily due
to the increase in deposit accounts over this period. Also contributing to the increase of noninterest income were increases in gain on sale of loans of $161 thousand and investment security gains of $349 thousand.





Several factors contributed to the increase in noninterest expense for the nine month period ended




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September 30, 2002 over 2001. The Company experienced an increase in salaries and personnel expense of
$1.4 million for the nine months ended September 30, 2002 over September 30, 2001. This increase is due in part to the opening of the Travelers Rest and Seneca branches during the first quarter of 2002 thereby increasing salaries and personnel
expense related to the increase in personnel. Also contributing to the noninterest expense increase was an increase in occupancy and furniture and equipment expense of $354 thousand for the nine months ended September 30, 2002 over September 30,
2001 as well as an increase in supplies (specifically forms and printing) of $77 thousand over the same periods, all of which is due in part to additional expenses related to the new branches. The remaining large fluctuation within the noninterest
expense category relates to the writedown of repossessed properties within the other real estate owned portfolio and repossessed automobiles. The property writedowns increased $146 thousand for the nine month period ended September 30, 2002 over the
same nine month period of 2001 to a balance of $168 thousand. For discussion concerning the other real estate owned portfolio at September 30, 2002, see Other Assets within the Balance Sheet Review section of this Form 10-Q.
The automobile writedowns increased $49 thousand for the nine month period ended September 30, 2002 over the same nine month period of 2001 to a balance of $65 thousand. For discussion concerning repossessed automobiles, see Allowance for Loan
Losses within the Balance Sheet Review section of this Form 10-Q.





Income Taxes





Income tax expense attributable to income from continuing operations increased to $3.6 million for the nine months ended September 30, 2002 from $2.5 million for
the same period of 2001. The effective income tax rate was 33% for the nine month period ended September 30, 2002 and 29% for nine month period ended 2001.




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ACCOUNTING AND REPORTING MATTERS





In July 2001 the Financial Accounting Standards Board (FASB) issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In conjunction with these
releases, the FASB reminded its constituents that SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions applied to bank acquisitions, and these acquisitions were thus excluded from the scope of SFAS No. 142.
As a result, any intangible asset created as a result of a branch acquisition would continue to be amortized in accordance with the provisions of SFAS No. 72.





On October 1, 2002 the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions. The Statement, which provides guidance on the accounting for the acquisition of a financial institution, applies to
all acquisitions except those between two or more mutual enterprises. SFAS No. 147 requires that the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business
combination represents goodwill that should be accounted for under FASB Statement No. 142, Goodwill and Other Intangible Assets. This Statement clarifies that a branch acquisition that meets the definition of a business should be accounted
for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill. The FASB recognizes EITF 98-3,  Determining Whether a Transaction is an
Exchange of Similar Productive Assets or a Business Combination, as guidance for determining if a transaction meets the criteria to be considered a business combination. Thus, the specialized accounting guidance in paragraph 5 of FASB
Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, will not apply after September 30, 2002. Financial institutions meeting conditions outlined in Statement 147 will be required to restate previously
issued 2002 quarterly financial statements, if material. The objective of that restatement requirement is to present the balance sheet and income statement as if the amount accounted for under Statement 72 as an unidentifiable intangible asset had
been reclassified to goodwill as of the date Statement 142 was initially applied. Those transition provisions are effective on October 1, 2002; however, early application is permitted.





At December 31, 2001 the Company had unamortized intangible assets recorded as core deposit premiums purchased of $382 thousand as well as unamortized goodwill defined in SFAS 72 as an unidentifiable
intangible asset (Statement 72 goodwill) of $3.9 million. The Company has continued to amortize these assets in accordance with SFAS No. 72 and also has reviewed for potential impairment in accordance with SFAS No. 142 as if it were
applicable. Based on the results of the test, the Company believes that there is no impairment in 2002 related to these intangible assets.





The Company is currently reviewing past branch acquisitions to determine if they qualify as business combinations and would then be accounted for under the provisions of SFAS No. 147 (and thus SFAS No. 142). Through the third quarter
ended September 30, 2002, Company results include the amortization of these intangible assets as was directed under SFAS No. 72. The Company is currently reviewing its compliance with SFAS No. 147 and in the fourth quarter will restate previously
issued 2002 quarterly financial statements, if deemed material.





On October 4, 2002 the FASB issued an Exposure Draft, Accounting
for Stock-Based CompensationTransition and Disclosure, that would amend FASB Statement No. 123, Accounting for Stock-Based Compensation.The proposed amendment would enable companies that choose to adopt the preferable fair value
based method to report the full effect of employee stock options in their financial statements immediately upon adoption, and make available to investors better and more frequent disclosure about the cost of employee stock options. The proposed
changes would provide




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three methods of transition for companies that voluntarily adopt the fair value method of recording
expenses relating to employee stock options. In addition, the FASB proposes clearer and more prominent disclosures about the cost of stock-based employee compensation and an increase in the frequency of those disclosures to include publication in
quarterly financial statements. Currently, companies are not required to present stock option disclosures in interim financial statements. The FASB plans to issue the amendment to Statement 123 by the end of this year and its provisions would be
effective immediately upon issuance. The proposed disclosures to be provided in annual financial statements would be required for fiscal years ending after December 15, 2002. The proposed disclosures to be provided in interim financial information
would be required as of the first interim period beginning after December 15, 2002, with earlier application encouraged. The Company applies the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, when accounting for stock options which requires compensation expense for options to be recognized only if the market price of the underlying stock exceeds the exercise price on the date of grant. Accordingly, the Company has not
recognized compensation expense for its options granted in 2002. The Company is prepared to comply with all provisions related to stock options as it relates to the extent of disclosure and well as the frequency of this disclosure, however, at this
time, we do not anticipate the adoption of the fair value method of stock option accounting.





Other accounting standards that have been
issued or proposed by the Financial Accounting Standards Board that do not require adoption until a further date are not expected to have a material impact on the consolidated financial statements upon adoption.




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Item 3.  
Quantitative and Qualitative Disclosures about Market Risk





Market risk is the risk of loss from adverse
changes in market prices and rates. The Companys market risk arises principally from interest rate risk inherent in its lending, deposit, borrowing and investing activities. Management actively monitors and manages its inherent rate risk
exposure. Although the Company manages other risks, such as credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk. This risk could potentially have the
largest material effect on the Companys financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Companys
business activities.





The Companys profitability is affected by fluctuations in interest rates. Managements goal is to
maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Companys earnings to the extent that the interest rates on
interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using several tools.





At September 30, 2002, management believes that there have been no significant changes in market risk as disclosed in the Companys
Annual Report on Form 10-K for the year ended December 31, 2001.





The Banks goal is to minimize interest rate risk between
interest-bearing assets and liabilities at various maturities through its Asset-Liability Management (ALM). ALM involves managing the mix and pricing of assets and liabilities in the face of uncertain interest rates and an uncertain
economic outlook. It seeks to achieve steady growth of net interest income with an acceptable amount of interest rate risk and sufficient liquidity. The process provides a framework for determining, in conjunction with the profit planning process,
which elements of the Companys profitability factors can be controlled by management. Understanding the current position and implications of past decisions is necessary in providing direction for the future financial management of the Company.
The Company uses an asset-liability model to determine the appropriate strategy for current conditions.





Interest sensitivity management
is part of the asset-liability management process. Interest sensitivity gap (GAP) is the difference between total rate sensitive assets and rate sensitive liabilities in a given time period. The Companys rate sensitive assets are
those repricing within one year and those maturing within one year. Rate sensitive liabilities include insured money market accounts, savings accounts, interest-bearing transaction accounts, time deposits and borrowings. The profitability of the
Company is influenced significantly by managements ability to manage the relationship between rate sensitive assets and liabilities.





The following table is a summary of the Companys one year gap at September 30, 2002 (amounts in thousands):





September 30, 2002Interest-earning assets maturing or repricing within one year

$
277,184Interest-bearing liabilities maturing or repricing within one year

$
342,761Cumulative gap

$
(65,577
)Gap as a percentage of total assets


-8.10
%





The above analysis does not take in to account any prepayments on mortgages, consumer or
other loans, or securities. All maturities are stated in contractual terms. The Companys current GAP analysis reflects that in periods of increasing or decreasing interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities. The Companys GAP analysis also shows that at the interest repricing of one year, the Companys net interest margin would be adversely impacted by an increase in market interest rates. This analysis, however, does not take
into account the dynamics of the




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marketplace. GAP is a static measurement that assumes that if the prime rate increases by 100 basis
points, all assets and liabilities that are due to reprice will increase by 100 basis points at the next opportunity.





Because the
Companys management feels that GAP analysis is a static measurement, it manages its interest income through its asset/liability strategies that focus on a net interest income model based on managements projections. The Company has a
targeted net interest income range of plus or minus twenty percent based on a 300 basis point change over twelve months. The asset/liability committee meets weekly to address interest pricing issues, and this model is reviewed monthly. Management
will continue to monitor its liability sensitive position in times of increasing interest rates, which might adversely affect its net interest margin.




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Item 4.  
Controls and Procedures





Under the supervision and with the participation of our management, including the
Chief Executive Officer and Chief Accounting Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing date of this quarterly report, and, based on their
evaluation, our Chief Executive Officer and Chief Accounting Officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.





Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange
Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange
Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.




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##### Table of Contents




PART II.  OTHER INFORMATION





Item 1.  
Legal Proceedings





In its annual report on Form 10-K for the fiscal year ended December 31, 2001, the Company
disclosed a legal proceeding between the Bank and M. Snyders, Inc., an automobile dealership, relating to sales finance contracts that M. Snyders sold to the Bank. Please refer to [Item 3 of Part I of] that annual report on Form 10-K for
additional information about this matter.





In addition to the matter described above, from time to time the Bank is involved in legal
proceedings incidental to its normal course of business as a bank. Management believes that none of these proceedings is likely to have a materially adverse effect on the business of the Company or the Bank.





Item 2.  
Changes in Securities and Use of Proceeds





None





Item 3.  
Defaults Upon Senior Securities





None





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





None





Item 5.  
Other Information





None





Item 6.  
Exhibits and Reports on Form 8-K





(a)  Exhibits





None





(b)  Reports on Form 8-K





None




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SIGNATURES





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





PALMETTO BANCSHARES, INC.





By:/s/    L. Leon PattersonL. Leon Patterson Chairman and Chief Executive Officer





/s/    PAUL W.
STRINGERPaul W. Stringer President and Chief Operating Officer (Chief Accounting Officer)





Date: November 14, 2002




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CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF PALMETTO BANCSHARES, INC.


PURSUANT TO 15 U.S.C. SECTION 7241





I, L.  Leon Patterson, hereby certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Palmetto Bancshares, Inc.;
|-- |  | --------------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (Evaluation Date); and
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons fulfilling the equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




By:   /s/    L. Leon PattersonL. Leon Patterson Chairman and Chief Executive Officer Date: November 14, 2002




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CERTIFICATION OF CHIEF ACCOUNTING OFFICER OF PALMETTO BANCSHARES, INC.


PURSUANT TO 15 U.S.C. SECTION 7241





I, Paul W. Stringer, hereby certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Palmetto Bancshares, Inc.;
|-- |  | --------------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (Evaluation Date); and
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons fulfilling the equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




By:   /s/     Paul W. StringerPaul W. Stringer President and Chief Operating Officer (Chief Accounting Officer) Date:  November 14, 2002




34