Item 1. Business
Palmetto Bancshares, Inc. ("Bancshares" or the "Company") is a bank holding company 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"), Bancshares engages in the general banking business in the upstate South Carolina market of Laurens, Greenville, Spartanburg, Greenwood, Anderson, and Cherokee counties. The Bank is a state, non-member bank which was organized and chartered under South Carolina law in 1906. There are 24 full service branch offices in addition to the headquarters located in Laurens, South Carolina.
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. The Bank's Dealer Finance Department establishes relationships with Upstate automobile dealers to provide customer financing of automobile purchases. In the later part of 1995, the Bank started a mortgage banking operation to continue to meet a broader range of its customers' financial service needs. This mortgage banking operation was in full operation by March 1996: originating, selling, and servicing mortgage loans.
At December 31, 1996, Bancshares had total assets of $468.4 million, loans outstanding of $333.0 million and deposits of $412.4 million. This compares with total assets of $376.2 million, loans outstanding of $255.2 million and deposits of $329.7 million, at December 31, 1995; and with total assets of $312.1 million, loans outstanding of $215.4 million and deposits of $274.5 million, at December 31, 1994.
Competition The upstate South Carolina market is a highly competitive banking market in which all of the largest financial institutions in the state are represented. The competition among the various financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of service rendered and the convenience of banking facilities. The Bank believes it has competed effectively in its market.
Interstate Banking In 1986, South Carolina adopted legislation which permits banks and bank holding companies in certain southern states to acquire banks in South Carolina to the extent that such other states have reciprocal legislation applicable to South Carolina banks and bank holding companies. The legislation resulted in a number of the Bank's competitor banks being purchased by large, out-of-state bank holding companies. Size gives the larger banks certain advantages in competing for business from larger corporations. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina and the region. As a result, the Bank does not generally attempt to compete for the banking relationships of larger corporations, but concentrates its efforts on small and medium-size businesses and individuals. The Bank believes it has competed effectively in this market segment by offering quality, personalized service. It is management's intention to remain a locally-based, independent, South Carolina Bank.
Customers The majority of the Bank's customers are individuals and small to medium-sized businesses headquartered within its service area. The Bank is not dependent upon a single or a very few customers, the loss of which would have a material adverse effect on the Bank. No customer accounts for more than 5% of the Bank's total deposits at any time. Management does not believe that the Bank's loan portfolio is dependent on a single customer or group of customers concentrated in a particular industry whose loss or insolvency would have a material adverse effect on the Bank.
Growth On April 15, 1996, the Bank acquired three existing branches of First Union National Bank of South Carolina. These branches are located in Gaffney and Blacksburg in Cherokee County and Ninety-Six in Greenwood County. The bank assumed deposits of approximately $54 million, but assumed no loans. The Bank is leasing the Gaffney branch building. For additional information concerning the branch acquisition, see page 2 of the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Management continually reviews opportunities to expand in the upstate South Carolina market that it believes to be in the best interest of the Bank and its customers.
Systems In November 1996, the Bank began operating its Telephone Banking Center (the "TBC"), an in-house sales and service center. The TBC provides the Bank's customers with more options to do their banking business and offers extended service hours. The telephone bankers are qualified to answer account inquiries, process transactions, and provide updated rate and service information.
In September 1995, the Bank successfully completed a conversion of their data processing software. This software enables the Bank to deliver more sophisticated user friendly financial services to its customers. The Bank incurred conversion costs of approximately $1 million.
Employees At December 31, 1996, the Bank had 257 full-time equivalent employees, none of whom are subject to a collective bargaining agreement. Management believes its relationship with its employees is excellent.
Monetary Policy The results of operations of Bancshares and the Bank are affected by credit policies of monetary authorities, particularly the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against member bank deposits and limitations on interest rates which member banks may pay on time and savings deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of Bancshares and the Bank.
Regulatory Environment
GENERAL
Bancshares and its subsidiaries are extensively regulated under federal and state law. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws may have a material effect on the business and prospects of Bancshares. The operations of Bancshares may be affected by possible legislative and regulatory changes and by the monetary policies of the United States.
Bancshares. As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHCA"), Bancshares is subject to regulation and supervision by the Federal Reserve. Under the BHCA, Bancshares's activities and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity that the Federal Reserve determines to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. The BHCA also restricts the ability of Bancshares to acquire ownership or control of more than 5% of the outstanding voting stock of banks or certain other nonbanking businesses.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation ("FDIC") insurance funds in the event the depository institution becomes in danger of defaulting or in default under its obligations to repay deposits. For
example, under current federal law, to reduce the likelihood of receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become "undercapitalized": with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve also has the authority under the BHCA to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal law grants federal bank regulatory authorities additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution's financial condition.
Bancshares is subject to the obligations and restrictions described above. However, management currently does not expect that any of those provisions will have any material impact on its operations.
As a bank holding company registered under the South Carolina Bank Holding Company Act, Bancshares also is subject to regulation by the State Board. Bancshares must file with the State Board periodic reports with respect to its financial condition and operations, management and intercompany relationships between Bancshares and its subsidiaries.
The Bank. The Bank is a FDIC-insured, South Carolina-chartered banking corporation and is subject to various statutory requirements and rules and regulations promulgated and enforced primarily by the State Board and the FDIC. These statutes, rules and regulations relate to insurance of deposits, required reserves, allowable investments, loans, mergers, consolidations, issuance of securities, payment of dividends, establishment of branches and other aspects of the business of the Bank. The FDIC has broad authority to prohibit the Bank from engaging in what it determines to be unsafe or unsound banking practices. In addition, federal law imposes a number of restrictions on state-chartered, FDIC-insured banks and their subsidiaries. These restrictions range from prohibitions against engaging as a principal in certain activities to the requirement of prior notification of branch closings. The Bank also is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit and equal credit and fair credit reporting laws. The Bank is not a member of the Federal Reserve System.
Dividends. The holders of Bancshares common stock are entitled to receive dividends when and if declared by the Board of Directors out of funds legally available therefor. Bancshares is a legal entity separate and distinct from the Bank and Palmetto Capital, Inc. and depends for its revenues on the payment of dividends from the Bank. Current federal law would prohibit, except under certain circumstances and with prior regulatory approval, an insured depository institution, such as the Bank, from paying dividends or making any other capital distribution if, after making the payment or distribution, the institution would be considered "undercapitalized," as that term is defined in applicable regulations. In addition, as a South Carolina-chartered bank, the Bank is subject to legal limitations on the amount of dividends it is permitted to pay. In particular, the Bank must receive the approval of the South Carolina Commissioner of Banking prior to paying dividends to Bancshares.
CAPITAL ADEQUACY
Bancshares. The Federal Reserve has adopted risk-based capital guidelines for bank holding companies. Under these guidelines, the minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be "Tier 1 capital," principally consisting of common shareholders' equity, noncumulative preferred stock, a limited amount of cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries, less certain goodwill items. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier 1 (leverage) capital ratio under which a bank holding company must maintain a minimum level of Tier
1 capital (as determined under applicable rules) to average total consolidated assets of at least 3% in the case of bank holding companies which have the highest regulatory examination ratios and are not contemplating significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 100 to 200 basis points above the stated minimum. At December 31, 1996, Bancshares was in compliance with both the risk-based capital guidelines and the minimum leverage capital ratio.
The Bank. As a state-chartered, FDIC-insured institution which is not a member of the Federal Reserve System, the Bank is subject to capital requirements imposed by the FDIC. The FDIC requires state-chartered nonmember banks to comply with risk-based capital standards substantially similar to those required by the Federal Reserve, as described above. The FDIC also requires state-chartered nonmember banks to maintain a minimum leverage ratio similar to that adopted by the Federal Reserve. Under the FDIC's leverage capital requirement, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth are required to maintain a minimum leverage ratio of 3% of Tier 1 capital to total assets; all other banks are required to maintain a minimum leverage ratio of not less than 4%. As of December 31, 1996, the Bank was in compliance with both the risk-based capital guidelines and the minimum leverage capital ratio. For further discussion on the Bank's current capital rating, see pages 8 through 9 of the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
INSURANCE
As an FDIC-insured institution, the Bank is subject to insurance assessments imposed by the FDIC. Under current law, the insurance assessment to be paid by insured institutions shall be as specified in a schedule required to be issued by the FDIC that specifies, at semiannual intervals, target reserve ratios designed to increase the FDIC insurance fund's reserve ratio to 1.25% of estimated insured deposits (or such higher ratio as the FDIC may determine in accordance with the statute) in 15 years. Further, the FDIC is authorized to impose one or more special assessments in any amount deemed necessary to enable repayment of amounts borrowed by the FDIC from the United States Department of the Treasury (the "Treasury Department").
Effective January 1, 1993, the FDIC implemented a risk-based assessment schedule, having assessments ranging from 0.23% to 0.31% of an institution's average assessment base. The actual assessment to be paid by each FDIC-insured institution is based on the institution's assessment risk classification, which is determined based on whether the institution is considered "well capitalized," "adequately capitalized" or "undercapitalized," as such terms have been defined in applicable federal regulations adopted to implement the prompt corrective action provisions of FEDERAL DEPOSIT INSURANCE CORPORATION INSURANCE ACT ("FDICIA") (see "Other Safety and Soundness Regulations -- Prompt Corrective Action" below), and whether such institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. In August 1995, the FDIC approved a reduction in the insurance assessments for Bank Insurance Fund ("BIF") deposits. This reduction decreased the Bank's insurance assessment for BIF deposits from 0.26% to 0.04% of the average assessment base. During 1996, the insurance assessment for the Bank's BIF deposits was set at zero (although banks pay a $2,000 annual fee) due to the fact that it was "well capitalized." Because the Bank is now "adequately capitalized," it will pay insurance premiums in 1997, ranging from 0.00% to 0.27% of the average assessment base.
Under the recently enacted DEPOSIT INSURANCE FUND ACT, BIF-assessable deposits are subject to assessment for payment on the $780 million annual Financing Corporation ("FICO") bond obligation at 1/5 the rate of Savings Association Insurance Fund-assessable deposits. Accordingly, the FDIC has estimated that the annual FICO rate will be 1.30 basis points per $100 of BIF-assessable deposits in the years 1997 -- 1999. Starting in the year 2000 until the FICO bonds are retired, banks and thrifts will pay the assessment on a pro rata basis (estimated at 2.5 basis points for banks).
OTHER SAFETY AND SOUNDNESS REGULATIONS
Prompt Corrective Action. Current law provides the federal banking agencies with broad powers to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Under uniform regulations defining such capital levels issued by each of the federal banking agencies, a bank is considered "well capitalized" if it has (i) a total risk-based capital ratio
of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" bank is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL rating of 1). A bank is considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with a composite CAMEL rating of 1); (B) "significantly undercapitalized" if the bank has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier 1 risk-based capital ratio of less than 3%, or (iii) a leverage ratio of less than 3%; and (C) "critically undercapitalized" if the bank has a ratio of tangible equity to total assets equal to or less than 2%. Bancshares and the Bank each currently meet the definition of adequately capitalized.
Brokered Deposits. Current federal law also regulates the acceptance of brokered deposits by insured depository institutions to permit only a "well capitalized" depository institution to accept brokered deposits without prior regulatory approval. Under FDIC regulations, "well capitalized" insured depository institutions may accept brokered deposits without restriction, "adequately capitalized" insured depository institutions may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions on payments of interest rates), while "undercapitalized" insured depository institutions may not accept brokered deposits. The regulations provide that the definitions of "well capitalized," "adequately capitalized" and "undercapitalized" are the same as the definitions adopted by the agencies to implement the prompt corrective action provisions of FDICIA (as described in the previous paragraph). Bancshares does not believe that these regulations will have a material adverse effect on its current operations.
Other FDICIA Regulations. To facilitate the early identification of problems, FDICIA required the federal banking agencies to prescribe more stringent reporting requirements. The FDIC final regulations implementing those provisions, among other things, require that management report on the institution's responsibility for preparing financial statements and establishing and maintaining an internal control structure and procedures for financial reporting and compliance with designated laws and regulations concerning safety and soundness, and that independent auditors attest to and report separately on assertions in management's reports concerning compliance with such laws and regulations, using FDIC approved audit procedures. These regulations apply to financial institutions with greater than $500 million in assets at the beginning of their fiscal year.
COMMUNITY REINVESTMENT ACT
The Bank is subject to the requirements of the COMMUNITY REINVESTMENT ACT ("CRA"). The CRA requires that financial institutions have an affirmative and ongoing obligation to meet the credit needs of their local communities, including low-income and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution's efforts in meeting community credit needs are evaluated as part of the examination process pursuant to twelve assessment factors. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The Bank received an "outstanding" rating in its most recent evaluation dated April 15, 1996.
TRANSACTIONS BETWEEN BANCSHARES, ITS SUBSIDIARIES AND AFFILIATES
Bancshares' subsidiaries are subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons; and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Aggregate limitations on extensions of credit also may apply. Bancshares' subsidiaries also are subject to certain lending limits and restrictions on overdrafts to such persons.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or its nonbank subsidiary, on investments in their securities and on the use of their securities as collateral for loans to any borrower. Such restrictions may limit Bancshares' ability to obtain funds from its bank subsidiary for its cash needs, including funds for acquisitions, interest and operating expenses.
In addition, under the BHCA and certain regulations of the Federal Reserve, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, a subsidiary may not generally require a customer to obtain other services from any other subsidiary or Bancshares, and may not require the customer to promise not to obtain other services from a competitor, as a condition to an extension of credit to the customer.
Item 2.

Item 2. Properties
The corporate headquarters, the telephone banking center, and the finance, operations, data processing, trust, human resources, loan administration, internal audit and marketing departments are located in a facility at 301 Hillcrest Drive, Laurens, South Carolina ("Corporate Center"). The main office of the Bank is located in a facility at 101 West Main Street, Laurens, South Carolina which also contains a three lane drive-in facility.
The Bank has twenty-four full-service branches in the Upstate region of South Carolina in the following locations: Laurens (3), Duncan, Clinton, Greenwood (2), Ninety-Six, Fountain Inn, Hodges, Simpsonville, Anderson (2), Greenville (4), Pendleton, Spartanburg (3), Inman, Blacksburg and Gaffney.
The Bank has automatic teller machines at the following branches: Church Street (Laurens), Clinton, Montague Street (Greenwood), Ninety-Six, Fountain Inn, Simpsonville, Haywood Road (Greenville), Howell Road (Greenville), Grove Road (Greenville), Blackstock Road (Spartanburg), Fernwood Drive (Spartanburg), Duncan, Blacksburg, Gaffney, Pendleton, Anderson and North Anderson branches. The Bank also has ATM's at two non-branch locations: the Flour Daniel office complex (Greenville) and the Clemson University campus (Clemson). In addition, the Bank owns five limited service branches in various retirement centers located in the Upstate region of South Carolina.
The Bank owns all of its facilities except the following leased facilities, which have annual rental expenses from $1,400 to $99,100:
East North Street, Haywood Road, East North Street at Howell Road offices - Greenville
Spartan Centre, Blackstock Road, Fernwood Drive offices - Spartanburg
Gaffney office - Gaffney
South Main Street and Ninety-Six offices - Greenwood
North Main office - North Anderson
Offices range in size from branch locations of approximately 800 to 10,000 square feet, to the Corporate Center location of approximately 55,000 square feet. The Corporate Center underwent renovations in the current year totalling approximately $700,000. Because of the renovations, this location now houses the corporate offices, finance department, and telephone banking center. All facilities are protected by alarm and security systems which meet or exceed regulatory standards. Each facility is in good condition and capable of handling increased volume. All of the locations are considered suitable and adequate for their intended purposes.
Item 3.

Item 3. Legal Proceedings
Bancshares is not engaged in any legal proceedings. From time to time the Bank is involved in legal proceedings incidental to its normal course of business as a bank. Management believes none of these proceedings is likely to have a materially adverse effect on the business of Bancshares or the Bank.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
At a Special Meeting of Shareholders held on October 15, 1996, the holders of the Company's Common Stock, $5.00 par value (the "Common Stock"), approved a proposal to adopt an amendment to the Company's Articles of Incorporation to increase the number of authorized shares of the Common Stock from 2,000,000 to 10,000,000 shares, as follows:
Votes For Against Abstain Broker Non-Votes 885,585 shares 0 shares 8,470 shares 0 shares
The proposal was adopted principally to permit a three-for-one stock split effected in the form of a 200% stock dividend to each holder of Common Stock on September 12, 1996 (the "Stock Split"), which was conditioned upon shareholder approval of the proposal to amend the Company's Articles of Incorporation. Prior to such amendment, the number of shares of Common Stock authorized and available for issuance was insufficient to permit the Company to effect the Stock Split.
PART II
Item 5.

Item 5. Market for Registrant's Common Stock and Related Shareholder Matters
There is no public market for the common stock of Bancshares or the Bank. The last known selling price of Bancshares' common stock, based on information available to Bancshares' management, was $20 per share on March 11, 1997.
Bancshares, or its predecessor, the Bank, has paid regular dividends on common stock since 1909. For the years ended December 31, 1996, 1995, and 1994, Bancshares paid total cash dividends per share of $0.28, $0.22, and $0.18, respectively. Certain other information concerning dividends and historical trading prices is set forth on page 43 of the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
The ability of Bancshares to pay dividends depends upon the amount of dividends that is received from the Bank. The only restrictions on the amount of dividends available for payment to Bancshares are guidelines established by the state regulatory authorities for primary capital to asset ratios. The South Carolina Board of Financial Institutions guideline suggests a ratio of at least seven percent (7%). As of December 31, 1996, the Bank's primary capital to asset ratio was 7.35%.
As of December 31, 1996, approximately $1,643,000 was available for payment of dividends by the Bank. Prior approval of the Office of the Commissioner of Banking, State Board of Financial Institutions is required for any payment of dividends by a state bank. As of December 31, 1996, there were 540 shareholders of record.
Item 6.

Item 6. Selected Financial Data
The information required by this item is set forth on page 5 of the Company's Annual Report 1996, which is incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Certain information required by this item is set forth on pages 2 through 11 of the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Distribution of Assets and Liabilities
(Table 1 goes here)
Table 1 Distribution of Assets and Liabilities (DOLLARS IN THOUSANDS)
INVESTMENT PORTFOLIO
The following table shows, as of December 31, 1996, 1995 and 1994, the book value and market values of investments in obligations of (i) the U.S. Government and its agencies, (ii) states, counties, and municipalities, and (iii) mortgage-backed securities. TABLE 2 Investment Portfolio (Dollars in Thousands)
INVESTMENTS HELD TO MATURITY
The following table indicates the maturities and respective yields by investment category as of December 31, 1996. Yields on tax exempt securities are stated on a tax equivalent basis using a federal tax rate of 34%. TABLE 3 Investment Portfolio Maturity Schedule (Par Value -- Dollars in Thousands) December 31, 1996
INVESTMENTS HELD TO MATURITY
INVESTMENTS AVAILABLE FOR SALE
LOAN PORTFOLIO
Management of the Company believes that the loan portfolio is adequately diversified. The table below summarizes loans by classification for the five year period ended December 31, 1996.
TABLE 4 Loan Portfolio Composition (Dollars in Thousands)
Commercial loans are spread through numerous types of businesses with no particular industry concentrations. Loans to individuals are made primarily to finance consumer goods purchased. At December 31, 1996, total loans, net of unearned discounts, were 79% of total earning assets. Loans secured by real estate accounted for 58% of total loans as of December 31, 1996. Most of the loans classified as real estate-mortgage are commercial loans where real estate provides additional collateral.
The table below shows the amounts of loans at December 31, 1996, except for real estate mortgage and installment loans to individuals, due to mature and available for repricing within the time period stated.
TABLE 5 Maturities and Sensitivity of Loans to Changes in Interest Rates (Dollars in Thousands)
The amounts of the preceding loans with a maturity over one year which have a predetermined interest rate or a floating or adjustable interest rate are as follows:
December 31, 1996
Predetermined interest rate $ 45,242 Floating or adjustable interest rate -
Total $ 45,242 ========
Thirty-two percent of total loans are repricable within one year.
Non-accrual loans are those loans which management, through its continuing evaluation of loans, has determined offer a more than normal risk of collectability of future interest. Interest income on non-accrual loans is recognized only as received. Interest on past due loans continues to accrue until such time that the loans are either charged-off or placed in non-accrual status. The non-accrual loan policy provides that it is the responsibility of the chief credit officer to administer the placing of loans on non-accrual status. Loans which become ninety days past due will be placed on non-accrual. Loans on which bankruptcy notices are received will also be placed on non-accrual. In addition, other loans on which repayment appears doubtful may be placed on non-accrual at the discretion of the chief credit officer.
The following table sets forth, for each loan category, the amounts of total loans 90 days or more past due and on non-accrual, the amounts of total loans 90 days or more past due and accruing, total loans outstanding, the percentage of each type of loan 90 days or more past due and the amount of foregone interest income for each of the five years for December 31, 1992 through December 31, 1996.
In addition to the non-performing loans disclosed below, the Company had approximately $193,000 in impaired loans at December 31, 1995. During 1995, the average recorded investment in impaired loans was approximately $211,000. Included in the allowance for loan losses at December 31, 1995 is approximately $97,000 related to these impaired loans.
During 1996, the Company charged-off some of the loans previously considered impaired and was able to reclassify others due to improved credit conditions; so that at December 31, 1996 there were no impaired loans. During 1996, the average recorded investment in impaired loans was approximately $76,000, and there is no allowance for loan losses related to impaired loans at December 31, 1996.
TABLE 6 Nonperforming Loans (Dollars in Thousands)
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TABLE 7 Summary of Loan Loss and Recovery Experience (Dollars in Thousands)
The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically, included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans which are past due more than 60 days and loans which are in a non-accrual status. In addition, based on past experience, an unallocated portion of the reserve is established which does not relate to any specific loan or category of loans. Based on the above analysis, management makes a provision for possible loan losses which will bring the allowance for loan losses to an adequate level.
The following table summarizes the activity in the allowance for loan losses for the years indicated:
Losses and recoveries are charged or credited to the allowance at the time realized.
The following table summarizes the allocation of the allowance for loan losses at December 31:
DEPOSITS
The following table presents average balances and average rates paid by category of deposit for the years ended December 31, 1996, 1995 and 1994:
The following table sets forth, by time remaining to maturity, domestic certificates of deposit over $100,000 as of December 31, 1996, 1995 and 1994.
The company has no foreign deposits.
RETURN ON EQUITY AND ASSETS
The table below illustrates the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), dividend payout ratio (dividends declared divided by net income), and average equity to average assets ratio (average equity divided by average total assets) for the years indicated:
TABLE 9 Return on Equity and Assets (Dollars in thousands, except per share data)
(1) Excluding an accounting reclassification for shares held as ESOP stock of $3,313,474 and $2,770,528 at December 31, 1996 and 1995, respectively.
(2) These numbers have been restated to reflect the three-for-one stock split in 1996.
(3) Based on weighted average shares outstanding not subject to put call of 2,732,305; 3,010,320 and 3,000,690 for 1996, 1995 and 1994, respectively.
SHORT - TERM BORROWINGS
The following table sets forth certain information regarding short term borrowings at December 31:
TABLE 10 Short-Term Borrowings (Dollars in thousands)
1996 1995 1994 ---- ---- ----
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Amount outstanding at year-end $ 11,636 7,546 5,252 Average amount outstanding during year 11,601 10,228 8,596 Maximum amount outstanding at any month end 12,694 11,680 9,551 Weighted average rate paid at year end 4.44% 3.05% 2.85% Weighted average rate paid during the year 3.84% 4.31% 2.58%
FEDERAL FUNDS PURCHASED
Amount outstanding at year end $ 3,000 2,900 - Average amount outstanding during year 5,746 2,380 369 Maximum amount outstanding at any month end 17,500 3,000 - Weighted average rate at year end 7.75% 5.50% - Weighted average rate paid during the year 5.45% 5.68% 5.33%
COMMERCIAL PAPER
Amount outstanding at year end $ 7,435 6,187 6,914 Average amount outstanding during year 8,075 8,017 6,312 Maximum amount outstanding at any month end 9,168 9,370 7,601 Weighted average rate paid at year end 4.69% 3.30% 3.10% Weighted average rate paid during the year 3.88% 4.28% 2.72%
RATE / VOLUME ANALYSIS
The following table includes, for the years ended December 31, 1996, 1995 and 1994 interest income on earning assets and related average yields, as well as interest expense on liabilities and related average rates paid. Also shown are the dollar amounts of change due to rate and volume variances. The effect of the combination of rate and volume change has been divided equally between the rate change and volume change.
Yields on nontaxable securities are stated on a fully taxable equivalent basis, assuming a federal tax rate of 34% for the three years reported on. The adjustments made to convert to a fully taxable equivalent basis were $655,491, $691,030, and $702,961 for 1996, 1995 and 1994, respectively.
The effect of foregone interest income as a result of loans on non-accrual was not considered in the above analysis.
TABLE 11 (CONTINUED)
TABLE 12 Interest Rate Sensitivity (Dollars in Thousands) At December 31, 1996
Notes to Interest Rate Sensitivity table:
(bullet)Interest-earning assets are included in the period in which the balances are expected to be repaid and/or repriced as a result of scheduled rate adjustments and contractual maturities. (bullet)Loans receivable includes non-performing loans and unamortized deferred loan costs, and is reduced by unamortized discounts. (bullet)Interest-bearing liabilities are included in the period in which the balances are expected to be withdrawn as a result of contractural maturities. For accounts with no stated maturities, the balances are included in the one day category. (bullet)The interest rate sensitivity gap represents the difference between total interest-earning assets and total interest-bearing liabilities.
An important aspect of achieving satisfactory net interest income is the composition and maturities of rate sensitive assets and liabilities. The preceding table generally reflects that in periods of rising interest rates, rate sensitive liabilities will reprice slightly faster than rate sensitive assets, thus having a negative effect on net interest income. It must be understood, however, that such an analysis is only a snapshot picture and does not reflect the dynamics of the market place. Therefore, management reviews simulated earnings statements on a monthly basis to more accurately anticipate its sensitivity to changes in interest rates. For further discussion, please see "Net Interest Income" section of Management's Discussion and Analysis in the Company's Supplemental Annual Report 1996 (pages 3 through 5), which is incorporated herein by reference.
NON - INTEREST INCOME
Non-interest income increases have primarily resulted from increased volume and selected fee increases in deposit accounts and trust services. Service charges on deposit accounts were responsible for 55% of other operating income in 1996, as compared to 56% in both 1995 and 1994. The following table sets forth the components of other operating income:
TABLE 13 Non-Interest Income (Dollars in thousands) Years Ended December 31, 1996 1995 1994
Service charges on deposit accounts $ 2,863 2,494 2,254 Fees for trust services 861 773 670 Gains on sales of loans 148 - - Investment securities gains (losses) 21 (93) (13) Merchant discount income 345 384 325 Other 1,000 905 793 ----------- ---------- -----------
Total non-interest income $ 5,238 4,463 4,029 =========== ========== ===========
NON - INTEREST EXPENSES
Non-interest expense increases have primarily resulted from expenses associated with the acquisition of additional branches and renovations to the Corporate Center. This includes increased salary and other personnel expenses as a result of additional staff and annual pay increases as well as increased depreciation expenses as a result of additional buildings being purchased. Salaries and other personnel expenses account for approximately 48% of total non-interest expenses in 1996, as compared to 53% in 1994, and 54% in 1993. The following table sets forth the components of non-interest expense:
TABLE 14 Non-Interest Expenses (Dollars in thousands)
Item 8.

Item 8. Financial Statements and Supplementary Data
The information required by this item is set forth in the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
The information required by this item is set forth under the headings "Election of Directors" and "Executive Officers" on pages 2 through 5 in the definitive Proxy Statement of the Company filed in connection with its 1997 Annual Meeting of the Shareholders, which is incorporated herein by reference.
Item 11.

Item 11. Executive Compensation
The information required by this item is set forth under the headings "Compensation of Directors and Executive Officers," "Aggregated Option Exercises in Last Fiscal Year and Year-end Option Values" and "Security Ownership of Certain Beneficial Owners and Management" on pages 5 through 14 in the definitive Proxy Statement of the Company filed in connection with its 1997 Annual Meeting of Shareholders, which is incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is set forth under the heading "Security Ownership of Certain Beneficial Owners and Management" on pages 13 through 14 in the definitive Proxy Statement of the Company filed in connection with its 1997 Annual Meeting of Shareholders, which is incorporated herein by reference.
Item 13.

Item 13. Certain Relationships and Related Transactions
The information required by this item is set forth under the heading "Certain Relationships and Related Transactions" on page 15 in the definitive Proxy Statement of the Company filed in connection with its 1997 Annual Meeting of Shareholders, which is incorporated herein by reference.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) The following are filed as a part of this report on Form 10-K: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Report of Independent Certified Public Accountant: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Consolidated Balance Sheets as of December 31, 1996 and 1995: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Consolidated Statements of Changes in Shareholder's Equity for the Years Ended December 31, 1996, 1995 and 1994: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
Notes to Consolidated Financial Statements: Incorporated by reference to the Company's Supplemental Annual Report 1996, which is incorporated herein by reference.
(2) Additional financial statement schedules furnished pursuant to the requirements of Form 10-K
All other schedules have been omitted as the required information is either inapplicable or included in the Notes to the Consolidated Financial Statements.
(3) Exhibits:
Exhibit No. Description
3.1.1 Articles of Incorporation filed on May 13, 1982 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 3 to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the Securities and Exchange Commission on December 30, 1987
3.1.2 Articles of Amendment filed on May 5, 1988 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.2 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20, 1992
3.1.3 Articles of Amendment filed on January 26, 1989 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.3 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20, 1992
3.1.4 Articles of Amendment filed on April 23, 1990 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.4 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20, 1992
3.1.5 Articles of Amendment filed on October 16, 1996 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 3.1.5 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996.
3.2.1^ By-Laws adopted April 10, 1990.
3.2.2^ Amendment to By-Laws dated April 12, 1994.
4.1.1 Articles of Incorporation of the Registrant: Included in Exhibits 3.1.1 - .5
4.2 Bylaws of the Registrant: Included in Exhibit 3.2
4.3 Specimen Certificate for Common Stock: Incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212, filed with the Securities and Exchange Commission on August 20, 1992
10.1* Palmetto Bancshares, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10(a) to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the Securities and Exchange Commission on December 30, 1987
13.1.1^ Page 5 of the Company's Annual Report 1996, mailed to shareholders on March 14, 1997.
13.1.2^ The Company's Supplemental Annual Report 1996, mailed to shareholders on March 14, 1997.
20.1 The Company's Proxy Statement dated March 14, 1997, with respect to an Annual Meeting of Shareholders as filed with the Commission on March 14, 1997.
21.1^ List of Subsidiaries of the Registrant
27.1^ Financial Data Schedule
* Management contract or compensatory plan or arrangement.
^ Filed herewith.
(b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the three months ended December 31, 1996.
(c) Exhibits required to be filed with this Form 10-K by Item 601 of Regulation S-K are filed herewith or incorporated by reference herein.
(d) Certain additional financial statements. Not Applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 Patterson L. Leon Patterson Chairman and Chief Executive Officer
/s/ Paul W. Stringer Paul W. Stringer President (Chief Accounting Officer)
Date: March 18, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below and on the dates by the following persons on behalf of the registrant and in the capacities indicated:
EXHIBIT INDEX
Exhibit No. Description
3.1.1 Articles of Incorporation filed on May 13, 1982 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 3 to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the Securities and Exchange Commission on December 30,
3.1.2 Articles of Amendment filed on May 5, 1988 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.2 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20,
3.1.3 Articles of Amendment filed on January 26, 1989 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.3 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20, 1992
3.1.4 Articles of Amendment filed on April 23, 1990 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 4.1.4 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212 filed with the Securities and Exchange Commission on August 20, 1992
3.1.5 Articles of Amendment filed on October 16, 1996 in the office of the Secretary of State of South Carolina: incorporated by reference to Exhibit 3.1.5 to the Company's quarterly report on Form 10-Q for the fiscal quarter ended September 30, 1996.
3.2.1^ By-Laws adopted April 10, 1990.
3.2.2^ Amendment to By-Laws dated April 12, 1994.
4.1.1 Articles of Incorporation of the Registrant: Included in Exhibits 3.1.1 - .5
4.2 Bylaws of the Registrant: Included in Exhibit 3.2
4.3 Specimen Certificate for Common Stock: Incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8, Commission File No. 33-51212, filed with the Securities and Exchange Commission on August 20, 1992
10.1 Palmetto Bancshares, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10(a) to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the Securities and Exchange Commission on December 30,
13.1.1^ Page 5 of the Company's Annual Report 1996, mailed to shareholders on March 14, 1997.
13.1.2^ The Company's Supplemental Annual Report 1996, mailed to shareholders on March 14, 1997.
20.1 The Company's Proxy Statement dated March 14, 1997, with respect to an Annual Meeting of Shareholders as filed with the Commission on March 14, 1997.
21.1^ List of Subsidiaries of the Registrant
27.1^ Financial Data Schedule
^ Filed herewith.