U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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 March 31, 2015

OR

(  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file number 0-26016

PALMETTO BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

South Carolina	74-2235055
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

306 East North Street, Greenville, South Carolina	29601
(Address of principal executive offices)	(Zip Code)

(800) 725–2265

(Registrant’s telephone number)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

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

Large accelerated filer [ ]	Accelerated filer [ ]
Nonaccelerated filer [ ]	Smaller reporting company [x]

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

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

Class	Outstanding at April 24, 2015
-----------------------------	-------------------------------
Common stock, $0.01 par value	12,814,574

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Quarterly Report on Form 10-Q

Table of Contents

PART I		Financial Information			1
	Item 1.		Financial Statements		1
				Consolidated Balance Sheets	1
				Consolidated Statements of Income	2
				Consolidated Statements of Comprehensive Income	3
				Consolidated Statements of Changes in Shareholders' Equity	4
				Consolidated Statements of Cash Flows	5
				Note 1 - Summary of Significant Accounting Policies	6
				Note 2 - Cash and Cash Equivalents	8
				Note 3 - Trading Account Assets	9
				Note 4 - Investment Securities Available for Sale	10
				Note 5 - Loans	13
				Note 6 - Other Loans Held for Sale	23
				Note 7 - Premises and Equipment, net	23
				Note 8 - Servicing Rights	24
				Note 9 - Foreclosed Real Estate and Repossessed Personal Property	24
				Note 10 - Bank-Owned Life Insurance	25
				Note 11 - Deposits	25
				Note 12 - Borrowings	26
				Note 13 - Shareholders' Equity	26
				Note 14 - Income Taxes	27
				Note 15 - Benefit Plans	28
				Note 16 - Equity-Based Compensation	29
				Note 17 - Average Share Information	31
				Note 18 - Commitments, Guarantees and Other Contingencies	31
				Note 19 - Derivative Financial Instruments and Hedging Activities	32
				Note 20 - Disclosures Regarding Fair Value	33
				Note 21 - Regulatory Capital Requirements	34
				Note 22 - Subsequent Event	36
	Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations		37
				Forward-Looking Statements	37
				Criticial Accounting Policies and Estimates	38
				Selected Financial Data	39
				Executive Summary	40
				Financial Condition	42
				Derivative Activities	54
				Liquidity	54
				Quarterly Earnings Review	56
				Recently Issued / Adopted Authoritative Pronouncements	63
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk		64
	Item 4.		Controls and Procedures		64
				Evaluation of Disclosure Controls and Procedures	64
				Changes in Internal Control over Financial Reporting	64
PART II		Other Information			65
	Item 1.		Legal Proceedings		65
	Item 1A.		Risk Factors		65
	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		65
	Item 3.		Defaults Upon Senior Securities		65
	Item 4.		Mine Safety Disclosures		65
	Item 5.		Other Information		65
	Item 6.		Exhibits		65
SIGNATURES					66
EXHIBIT INDEX					67

i 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands, except per share data)

(unaudited)

	March 31,			December 31,
	2015			2014
Assets
Cash and cash equivalents
Cash and due from banks	$	57,488		$	36,887
Total cash and cash equivalents		57,488			36,887
Federal Home Loan Bank stock, at cost		3,132			2,556
Trading account assets, at fair value		10,114			5,513
Investment securities available for sale, at fair value		211,968			211,511
Mortgage loans held for sale		3,600			1,125
Loans, gross		832,029			805,059
Less: allowance for loan losses		(12,914	)		(12,920	)
Loans, net		819,115			792,139
Premises and equipment, net		21,858			22,006
Accrued interest receivable		3,481			3,387
Foreclosed real estate		5,756			5,949
Deferred tax asset, net		15,127			17,053
Bank-owned life insurance		12,000			11,923
Other assets		9,583			8,762
Total assets	$	1,173,222		$	1,118,811
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing	$	208,338		$	196,219
Interest-bearing		758,652			732,101
Total deposits		966,990			928,320
Retail repurchase agreements		13,149			15,921
Federal Home Loan Bank advances		50,000			35,000
Other liabilities		7,055			6,526
Total liabilities		1,037,194			985,767
Shareholders' equity
Preferred stock - par value $0.01 per share; authorized 2,500,000 shares; none issued and outstanding		-			-
Common stock - par value $0.01 per share; authorized 75,000,000 shares; 12,814,574 and 12,810,388 issued and outstanding at March 31, 2015 and December 31, 2014, respectively		128			128
Capital surplus		145,575			145,384
Accumulated deficit		(858	)		(2,565	)
Accumulated other comprehensive loss, net of tax		(8,817	)		(9,903	)
Total shareholders' equity		136,028			133,044
Total liabilities and shareholders' equity	$	1,173,222		$	1,118,811

See Notes to Consolidated Financial Statements

1

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income 

(dollars in thousands, except per share data)

(unaudited)

	For the three months ended March 31,
	2015			2014
Interest income
Interest earned on cash and cash equivalents	$	13		$	14
Dividends received on Federal Home Loan Bank stock		12			14
Interest earned on trading account assets		78			46
Interest earned on investment securities available for sale		936			1,004
Interest and fees earned on loans		8,947			8,998
Total interest income		9,986			10,076
Interest expense
Interest expense on deposits		104			127
Interest expense on Federal Home Loan Bank advances		30			16
Total interest expense		134			143
Net interest income		9,852			9,933
Provision for loan losses		400			-
Net interest income after provision for loan losses		9,452			9,933
Noninterest income
Service charges on deposit accounts, net		1,580			1,562
Fees for trust, investment management and brokerage services		186			146
Mortgage-banking		633			461
Debit card and automatic teller machine income, net		581			586
Investment securities gains, net		29			85
Trading account income, net		105			171
Other		427			355
Total noninterest income		3,541			3,366
Noninterest expense
Salaries and other personnel		4,746			4,790
Occupancy		1,059			1,097
Furniture and equipment		956			1,045
Professional services		588			813
Federal Deposit Insurance Corporation deposit insurance assessment		176			356
Marketing		244			255
Foreclosed real estate writedowns and expenses		(79	)		313
Loan workout		39			131
Other		1,065			1,289
Total noninterest expense		8,794			10,089
Income before provision for income taxes		4,199			3,210
Provision for income taxes		1,467			1,182
Net income	$	2,732		$	2,028
Common and per common share data
Net income - basic	$	0.21		$	0.16
Net income - diluted		0.21			0.16
Cash dividends declared		0.08			-
Book value		10.62			9.92
Weighted average basic common shares		12,715,972			12,675,257
Weighted average diluted common shares		12,851,076			12,707,444

See Notes to Consolidated Financial Statements

2

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Comprehensive Income

(in thousands) (unaudited)

	For the three months ended March 31,
	2015		2014
Net income	$	2,732	$	2,028
Other comprehensive income, pretax Investment securities available for sale
Increase in net unrealized gains		1,723		1,293
Plus: reclassification adjustment of net gains included in net income		29		85
Increase in net unrealized gains on investment securities available for sale		1,752		1,378
Other comprehensive income, pretax		1,752		1,378
Provision for income taxes related to items of other comprehensive income		666		523
Other comprehensive income, net of tax		1,086		855
Comprehensive income	$	3,818	$	2,883

See Notes to Consolidated Financial Statements

3

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders' Equity

(dollars in thousands) (unaudited)

										Accumulated
	Shares of									other
	common		Common		Capital		Accumulated			comprehensive
	stock		stock		surplus		deficit			loss, net			Total
Balance, December 31, 2013		12,784,605	$	127	$	144,624	$	(10,641	)	$	(10,293	)	$	123,817
Net income								2,028						2,028
Other comprehensive income, net of tax											855			855
Compensation expense related to stock options and restricted stock granted under equity award plans						252								252
Common stock issued related to restricted stock granted under equity award plans		7,904												-
Balance, March 31, 2014		12,792,509	$	127	$	144,876	$	(8,613	)	$	(9,438	)	$	126,952
Balance, December 31, 2014		12,810,388	$	128	$	145,384	$	(2,565	)	$	(9,903	)	$	133,044
Net income								2,732						2,732
Other comprehensive income, net of tax											1,086			1,086
Compensation expense related to stock options and restricted stock granted under equity award plans						191								191
Common stock issued related to restricted stock granted under equity award plans		4,186												-
Cash dividends declared and paid on common stock								(1,025	)					(1,025	)
Balance, March 31, 2015		12,814,574	$	128	$	145,575	$	(858	)	$	(8,817	)	$	136,028

See Notes to Consolidated Financial Statements

4

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)

	For the three months ended March 31,
	2015			2014
Operating Activities
Net income	$	2,732		$	2,028
Adjustments to reconcile net income to net cash provided by (used for) operating activities
Investment securities gains, net		(29	)		(85	)
Amortization of unearned discounts / premiums on investment securities available for sale, net		842			845
Trading account income, net		(105	)		(171	)
Reduction in (purchases of) trading account assets, net		(4,496	)		42
Gain on sales of mortgage loans held for sale, net		(357	)		(363	)
Originations of mortgage loans held for sale		(15,972	)		(12,547	)
Proceeds from sales of mortgage loans held for sale		13,854			12,158
Gain on sales of Small Business Administration loans		(123	)		(70	)
Proceeds from sales of Small Business Administration loans		1,731			1,236
Provision for loan losses		400			-
Depreciation		588			593
Writedowns and losses (gains) on sales of foreclosed real estate, net		(141	)		203
Increase in cash surrender value of bank-owned life insurance		(77	)		(74	)
Compensation expense on equity-based awards		191			252
Net periodic pension expense		163			206
Contribution to defined benefit pension plan		(400	)		-
Provision for unfunded commitments		(253	)		(17	)
Decrease in interest receivable and other assets, net		345			646
Increase in interest payable and other liabilities, net		1,019			1,037
Net cash provided by (used for) operating activities		(88	)		5,919
Investing Activities
Purchases of Federal Home Loan Bank stock		(1,533	)		(225	)
Proceeds from redemption of Federal Home Loan Bank stock		957			1,294
Proceeds from sales of investment securities available for sale		786			14,956
Proceeds from maturities and repayments of investment securities available for sale		4,346			6,273
Purchases of investment securities available for sale		(4,650	)		(15,000	)
Purchase of mortgage loans held for investment		(12,326	)		-
Decrease (increase) in gross loans, net		(18,548	)		9,772
Purchases of premises and equipment, net		(440	)		(206	)
Proceeds from sales of foreclosed real estate		2,224			264
Investment in SBIC limited partnership		-			(100	)
Net cash provided by (used for) investing activities		(29,184	)		17,028
Financing Activities
Increase in transaction, money market and savings deposits, net		46,237			30,044
Decrease in time deposits, net		(7,567	)		(9,371	)
Decrease in retail repurchase agreements, net		(2,772	)		(856	)
Proceeds from Federal Home Loan Bank advances		35,300			20,000
Repayment of Federal Home Loan Bank advances		(20,300	)		(35,000	)
Dividends paid on common stock		(1,025	)		-
Net cash provided by financing activities		49,873			4,817
Net change in cash and due from banks		20,601			27,764
Cash and due from banks, beginning of period		36,887			38,178
Cash and due from banks, end of period	$	57,488		$	65,942
Supplemental cash flow disclosures
Cash paid during the period for:
Interest expense	$	143		$	153
Income taxes		174			970
Significant noncash activities
Change in net unrealized gains and losses on investment securities available for sale, net of tax		1,086			855
Loans transferred from gross loans to other loans held for sale		1,608			1,166
Loans transferred from gross loans to foreclosed real estate, at fair value		1,890			455

See Notes to Consolidated Financial Statements

5

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements

1.     Summary of Significant Accounting Policies

Nature of Operations

Palmetto Bancshares, Inc. (the “Company’) is a South Carolina bank holding company organized in 1982 and headquartered in Greenville, South Carolina. The Company serves as the bank holding company for The Palmetto Bank (the “Bank”), which began operations in 1906. The Bank, also headquartered in Greenville, South Carolina, is the third largest banking institution headquartered in South Carolina. The Bank serves the Upstate of South Carolina through 25 branch locations in nine counties along the economically attractive I-85 corridor, as well as 24/7/365 service through online and mobile banking and automatic teller machines. Through its Retail, Commercial and Wealth Management lines of business, the Bank specializes in providing financial solutions to consumers and small to mid-size businesses with deposit and cash management products, loans (including consumer, mortgage, credit card, automobile, Small Business Administration (“SBA”), commercial and corporate), lines of credit, trust, brokerage, private banking, financial planning and insurance.

Principles of Consolidation / Basis of Presentation

The accompanying Consolidated Financial Statements include the accounts of the Company, the Bank and subsidiaries of the Bank (collectively referred to herein as the “Company,” “we,” “us” or “our”). In management’s opinion, all significant intercompany accounts and transactions have been eliminated in consolidation, and all adjustments necessary for a fair presentation of the financial condition and results of operations for the periods presented have been included. Any such adjustments are of a normal and recurring nature. Assets held by the Company in a fiduciary or agency capacity for clients are not included in the Company’s Consolidated Financial Statements because those items do not represent assets of the Company. The accounting and financial reporting policies of the Company conform, in all material respects, to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the financial services industry.

The Consolidated Financial Statements at and for the three months ended March 31, 2015 and 2014 contained in this Quarterly Report on Form 10-Q have not been audited by our independent registered public accounting firm. The unaudited Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (the “SEC”). Accordingly, the Consolidated Financial Statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited Consolidated Financial Statements and notes thereto for the year ended December 31, 2014 included in our Annual Report on Form 10-K filed with the SEC on March 4, 2015 (the “2014 Annual Report on Form 10-K”).

Business Segments

Operating segments are components of an enterprise about which separate financial information is available and evaluated regularly by the Company’s chief operating decision makers in deciding how to allocate resources and assess performance. Public enterprises are required to report a measure of segment profit or loss, certain specific revenue and expense items for each segment, segment assets and information about the way that the operating segments were determined, among other items.

The Company considers business segments by analyzing distinguishable components that are engaged in providing individual products, services or groups of related products or services and that are subject to risks and returns that are different from those of other business segments. When determining whether products and services are related, the Company considers the nature of the products or services, the nature of the production processes, the type or class of client for which the products or services are designed and the methods used to distribute the products or provide the services.

For the past several years, we have been realigning our organizational structure and more specifically delineating our businesses for improved accountability and go-to-market strategies. However, financial information for these businesses has been separated to a limited extent, and, therefore, we do not have disaggregated financial information that meets the criteria to be considered reportable segments. Accordingly, at March 31, 2015, the Company had one reportable business segment, which was banking.

6

Use of Estimates

In preparing the Consolidated Financial Statements, the Company’s management makes estimates and assumptions that impact the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates and for the periods indicated in the Consolidated Financial Statements. Actual results could differ from these estimates and assumptions. Therefore, the results of operations for the three months ended March 31, 2015 are not necessarily indicative of the results of operations that may be expected in future periods.

Recently Adopted Authoritative Pronouncements

In January 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards

Update (“ASU”) 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Topic 310): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure (“ASU 2014-04”) to clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. An entity can elect to adopt the amendments in ASU 2014-04 using either a modified retrospective transition method or a prospective transition method. The Company adopted the provisions of ASU 2014-04 effective January 1, 2015. The adoption of ASU 2014-04 did not have a material impact on the Company’s financial position, results of operations or cash flows.

In August 2014, the FASB issued ASU 2014-14, Receivables – Troubled Debt Restructurings by Creditors (Topic 310): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (“ASU 2014-14”). The amendments in ASU 2014-14 require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met:

1. The loan has a government guarantee that is not separable from the loan before foreclosure.

2. At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim.

3. At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.

Upon foreclosure, the separate other receivable is to be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company adopted the provisions of ASU 2014-14 effective January 1, 2015. The adoption of ASU 2014-14 did not have a material impact on the Company’s financial position, results of operations or cash flows.

Recently Issued Authoritative Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606): Revenue from Contracts with Customers (“ASU 2014-09”). The scope of the guidance applies to revenue arising from contracts with customers, except for the following: lease contracts, insurance contracts, contractual rights and obligations within the scope of other guidance and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration that the entity receives or expects to receive. ASU 2014-09 is not expected to impact the timing or approach to revenue recognition for financial institutions. The likely impact for financial institutions will relate only to disclosures. Initially, the amendments were effective for public entities for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. However, in April 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year making the amendments effective for public entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Companies have the option to apply ASU 2014-09 as of the original effective date. The Company does not expect the adoption of ASU 2014-09 to have a material impact on its financial position, results of operations or cash flows.

7

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern (Topic 205): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). The amendments in ASU 2014-15 are intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. In connection with preparing financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the organization’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments are effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early application is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its financial position, results of operations or cash flows.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 amends the consolidation requirements and significantly changes the consolidation analysis required under GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 for public business entities with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. The Company does not expect the adoption of ASU 2015-02 to have a material impact on its financial position, results of operations or cash flows.

In April 2015, the FASB issued ASU 2015-04, Compensation (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets (“ASU 2015-04”). ASU 2015-04 provides a practical expedient for the measurement date of defined benefit plan assets and obligations. The practical expedient allows employers with fiscal year-end dates that do not fall on a calendar month-end (e.g., companies with a 52/53-week fiscal year) to measure pension and post-retirement benefit plan assets and obligations as of the calendar month-end date closest to the fiscal year-end. The FASB also provided a similar practical expedient for interim remeasurements for significant events. For public business entities, the standard is effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2015-04 to have a material impact on its financial position, results of operations or cash flows.

Other accounting standards that have been recently issued by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

2.     Cash and Cash Equivalents

Required Reserve Balances

The Federal Reserve Act requires each depository institution to maintain cash reserves against certain liabilities. The Bank reports these liabilities to the Board of Governors of the Federal Reserve System (the “Federal Reserve”) on a weekly basis and maintains reserves on these liabilities with a 30-day lag. As of March 31, 2015, after taking into consideration the Bank’s levels of vault cash, reserves of $1.1 million were maintained with the Federal Reserve.

Concentrations and Restrictions

From time to time, the Company may sell federal funds to, or place deposits with, other financial institutions. Federal funds and any deposits in excess of Federal Deposit Insurance Corporation (“FDIC”) insurance limits are essentially uncollateralized overnight loans. The Company regularly evaluates the risk associated with the potential counterparties to these transactions to ensure that it would not be exposed to any significant risks with regard to cash and cash equivalent balances if it were to sell federal funds or place deposits in amounts in excess of FDIC insurance limits. At March 31, 2015 and December 31, 2014 and 2013, the Company did not have any material deposits in excess of FDIC insurance limits with other financial institutions.

8

No cash and cash equivalents was pledged as collateral relative to public funds and other agreements at March 31, 2015. At December 31, 2014, $250 thousand cash and cash equivalents was pledged as collateral relative to public funds and other agreements.

3.     Trading Account Assets

The following table summarizes the components of trading account assets at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Municipal bonds	$	8,020	$	4,116
Insured bank deposits		2,094		1,397
Total trading account assets	$	10,114	$	5,513

The following table summarizes net realized gains and the unrealized gains (losses) due to change in fair value relative to trading account assets included in the Consolidated Statements of Income for the periods indicated (in thousands).

	For the three months ended March 31,
	2015		2014
Realized gains, net	$	47	$	178
Unrealized gains (losses), net due to the change in fair value relative to assets held at end of period		58		(7	)
Total trading account income, net	$	105	$	171

The Company may withdraw from the trading account the assets related to its initial $5.0 million investment made in 2013, subject to 30-days’ written notice. In January 2015, the Company invested an additional $4.5 million in the trading account, which is restricted from withdrawal until January 2016.

Ratings

The following tables summarize Moody’s and Standard and Poor’s ratings of municipal bond trading account assets, based on fair value, at March 31, 2015.

	Moody's Ratings
Aaa		11	%
Aa1 - Aa3		52
A1 - A3		20
Not rated		17
Total		100	%

	Standard and Poor's Ratings
AAA		12	%
AA+ - AA-		61
A+ - A-		14
Not rated		13
Total		100	%

All municipal bond trading account assets were rated by either Moody’s or Standard and Poor’s at March 31, 2015.

9

4.     Investment Securities Available for Sale

The following tables summarize the amortized cost, gross unrealized gains and losses included in accumulated other comprehensive loss and fair value of investment securities available for sale at the dates indicated (in thousands).

	March 31, 2015
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
U.S. agency	$	3,167	$	68	$	-		$	3,235
State and municipal		7,802		94		(26	)		7,870
Collateralized mortgage obligations (federal agencies)		88,901		497		(711	)		88,687
Other mortgage-backed (federal agencies)		78,626		702		(360	)		78,968
SBA loan-backed (federal agency)		33,041		232		(65	)		33,208
Total investment securities available for sale	$	211,537	$	1,593	$	(1,162	)	$	211,968

	December 31, 2014
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
U.S. agency	$	3,930	$	35	$	-		$	3,965
State and municipal		6,665		84		(17	)		6,732
Collateralized mortgage obligations (federal agencies)		89,311		13		(1,550	)		87,774
Other mortgage-backed (federal agencies)		78,532		411		(440	)		78,503
SBA loan-backed (federal agency)		34,394		210		(67	)		34,537
Total investment securities available for sale	$	212,832	$	753	$	(2,074	)	$	211,511

The following tables summarize securities in each category of investment securities available for sale that were in an unrealized loss position at the dates indicated (dollars in thousands).

	March 31, 2015
	Less than 12 months						12 months or longer						Total
	#		Fair value		Gross unrealized losses		#		Fair value		Gross unrealized losses		#		Fair value		Gross unrealized losses
State and municipal		4	$	2,789	$	26		-	$	-	$	-		4	$	2,789	$	26
Collateralized mortgage obligations (federal agencies)		5		5,001		52		7		34,788		659		12		39,789		711
Other mortgage-backed (federal agencies)		6		10,981		105		12		19,490		255		18		30,471		360
SBA loan-backed (federal agency)		3		5,835		12		5		10,364		53		8		16,199		65
Total		18	$	24,606	$	195		24	$	64,642	$	967		42	$	89,248	$	1,162

10

	December 31, 2014
	Less than 12 months						12 months or longer						Total
	#		Fair value		Gross unrealized losses		#		Fair value		Gross unrealized losses		#		Fair value		Gross unrealized losses
State and municipal		3	$	1,641	$	7		1	$	1,062	$	10		4	$	2,703	$	17
Collateralized mortgage obligations (federal agencies)		11		32,532		192		10		52,924		1,358		21		85,456		1,550
Other mortgage-backed (federal agencies)		10		14,889		119		10		18,979		321		20		33,868		440
SBA loan-backed (federal agency)		3		3,122		10		6		14,850		57		9		17,972		67
Total		27	$	52,184	$	328		27	$	87,815	$	1,746		54	$	139,999	$	2,074

Other-Than-Temporary Impairment

Based on the Company’s other-than-temporary impairment analysis at March 31, 2015, the Company concluded that gross unrealized losses detailed in the preceding table were due to changes in market interest rates and were not other-than-temporarily impaired as of that date.

Ratings

Except for state and municipal securities, all of the Company’s available for sale securities are backed by United States (“U.S.”) agencies and are rated Aaa and AA+ by Moody’s and Standard and Poor’s rating services, respectively. The following table summarizes ratings of the Company’s state and municipal investment securities available for sale, based on fair value, at March 31, 2015.

	Moody's Ratings
Aaa		6	%
Aa1 - Aa3		48
A1		3
Not rated		43
Total		100	%

	Standard and Poor's Ratings
AAA		14	%
AA+ - AA-		48
A+		2
Not rated		36
Total		100	%

All state and municipal securities were rated by either Moody’s or Standard and Poor’s at March 31, 2015.

11

Maturities

The following table summarizes the amortized cost and fair value of investment securities available for sale at March 31, 2015 by contractual maturity and estimated principal repayment distribution (in thousands). U.S. agency and state and municipal securities are organized based on contractual maturity. Principal amounts on collateralized mortgage obligations, other mortgage-backed securities and SBA loan-backed securities are not due at a single maturity date and are subject to early repayment based on prepayment activity of underlying loans. Therefore, collateralized mortgage obligations, other mortgage-backed securities and SBA loan-backed securities are organized based on estimated cash flows using current prepayment assumptions.

	Amortized cost		Fair value
Due in one year or less	$	-	$	-
Due after one year through five years		2,015		2,039
Due after five years through ten years		1,152		1,196
Due after ten years		-		-
U.S. agency		3,167		3,235
Due in one year or less		1,548		1,552
Due after one year through five years		2,039		2,112
Due after five years through ten years		4,215		4,206
Due after ten years		-		-
State and municipal		7,802		7,870
Due in one year or less		300		300
Due after one year through five years		14,408		14,307
Due after five years through ten years		74,193		74,080
Due after ten years		-		-
Collateralized mortgage obligations (federal agencies)		88,901		88,687
Due in one year or less		-		-
Due after one year through five years		39,524		39,934
Due after five years through ten years		19,866		19,829
Due after ten years		19,236		19,205
Other mortgage-backed (federal agencies)		78,626		78,968
Due in one year or less		-		-
Due after one year through five years		17,774		17,817
Due after five years through ten years		7,552		7,543
Due after ten years		7,715		7,848
SBA loan-backed (federal agency)		33,041		33,208
Due in one year or less		1,848		1,852
Due after one year through five years		75,760		76,209
Due after five years through ten years		106,978		106,854
Due after ten years		26,951		27,053
Total investment securities available for sale	$	211,537	$	211,968

Pledged

Investment securities were pledged as collateral for the following purposes at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Municipal and other secured deposits	$	85,252	$	84,255
Retail repurchase agreements		25,701		36,629
Federal Reserve line of credit		1,339		1,352
Correspondent bank lines of credit		11,059		10,959
Total investment securities available for sale pledged	$	123,351	$	133,195

Realized Gains and Losses

The following table summarizes the gross realized gains and losses from sales of investment securities available for sale for the periods indicated (in thousands).

	For the three months ended March 31,
	2015		2014
Realized gains	$	29	$	125
Realized losses		-		(40	)
Total investment securities gains, net	$	29	$	85

12

5.     Loans

In the tables below, loan classes are based on FDIC classification codes, and portfolio segments are an aggregation of those classes based on the methodology used to develop and document the allowance for loan losses. FDIC classification codes are based on the underlying loan collateral.

Composition

The following table summarizes gross loans, categorized by portfolio segment, at the dates indicated (dollars in thousands).

	March 31, 2015					December 31, 2014
	Total		% of total			Total		% of total
Commercial real estate	$	430,098		51.7	%	$	430,025		53.4	%
Single-family residential		217,174		26.1			204,439		25.4
Commercial and industrial		96,237		11.6			80,927		10.0
Consumer		75,921		9.1			76,984		9.6
Other		12,599		1.5			12,684		1.6
Loans, gross	$	832,029		100.0	%	$	805,059		100.0	%

Net unearned income and deferred fees totaled $591 thousand and $596 thousand at March 31, 2015 and December 31, 2014, respectively. Unamortized purchase premiums totaled $1.5 million and $1.3 million at March 31, 2015 and December 31, 2014, respectively, and are included in the applicable portfolio segment in the table above.

Residential mortgage loans serviced for the benefit of others totaled $373.5 million and $375.1 million at March 31, 2015 and December 31, 2014, respectively, and are excluded from the Consolidated Balance Sheets since they are not owned by the Company.

Pledged

The Bank, as a member of the FHLB of Atlanta, must pledge collateral to borrow from the FHLB and cover the various Federal Reserve services that are available for use by the Bank. Acceptable collateral includes, among other types of collateral, a variety of loans including residential, multifamily, home equity lines and second mortgages as well as qualifying commercial loans. At March 31, 2015 and December 31, 2014, $164.0 million and $170.6 million of gross loans, respectively, were pledged to collateralize FHLB advances of which $75.7 million and $79.1 million, respectively, were available as lendable collateral.

At March 31, 2015 and December 31, 2014, loans totaling $40.4 million and $38.2 million, respectively, were pledged as collateral to cover the various Federal Reserve services that are available for use by the Bank of which $29.5 million and $27.8 million, respectively, were available as lendable collateral.

Concentrations

The following table summarizes loans secured by commercial real estate, categorized by class, at March 31, 2015 (dollars in thousands).

	Total commercial real estate loans		% of gross loans			% of Bank's total regulatory capital
Secured by commercial real estate
Construction, land development and other land loans	$	48,002		5.8	%		32.9	%
Multifamily residential		8,868		1.1			6.1
Nonfarm nonresidential		373,228		44.8			256.0
Total loans secured by commercial real estate	$	430,098		51.7	%		295.0	%

13

The following table further categorizes loans secured by commercial real estate at March 31, 2015 (dollars in thousands).

	Total commercial real estate loans		% of gross loans			% of Bank's total regulatory capital
Development commercial real estate loans Secured by:
Land - unimproved (commercial or residential)	$	14,849		1.8	%		10.2	%
Land development - commercial		11,999		1.4			8.2
Land development - residential		5,764		0.7			4.0
Commercial construction:
Retail		2,551		0.3			1.7
Miscellaneous commercial		32		-			-
Total development commercial real estate loans		35,195		4.2			24.1
Existing and other commercial real estate loans Secured by:
Hotel / motel		39,909		4.8			27.4
Retail		36,824		4.4			25.2
Office		27,201		3.3			18.7
Multifamily		8,868		1.1			6.1
Industrial and warehouse		5,802		0.7			4.0
Healthcare		12,992		1.6			8.9
Miscellaneous commercial		100,151		12.0			68.7
Residential construction - speculative		347		-			0.2
Total existing and other commercial real estate loans		232,094		27.9			159.2
Commercial real estate owner-occupied and residential loans Secured by:
Commercial - owner-occupied		150,349		18.1			103.1
Commercial construction - owner-occupied		6,026		0.7			4.2
Residential construction - contract		6,434		0.8			4.4
Total commercial real estate owner-occupied and residential loans		162,809		19.6			111.7
Total loans secured by commercial real estate	$	430,098		51.7	%		295.0	%

14

Asset Quality

The following table summarizes various internal credit-quality indicators of gross loans, by class, at March 31, 2015 (in thousands).

	Construction, land development and other land loans		Multifamily residential		Nonfarm nonresidential		Total commercial real estate
Grade 1	$	-	$	-	$	-	$	-
Grade 2		-		-		-		-
Grade 3		979		138		75,334		76,451
Grade 4		23,052		1,164		186,913		211,129
Grade W		9,835		7,563		61,814		79,212
Grade 5		130		-		17,175		17,305
Grade 6		1,603		-		30,780		32,383
Grade 7		-		-		1,030		1,030
Not risk rated*		12,403		3		182		12,588
Total	$	48,002	$	8,868	$	373,228	$	430,098

      *Consumer real estate loans, included within construction, land development and other land loans, are not risk rated

         in accordance with the Company's policy.

	Commercial and industrial
Grade 1	$	393
Grade 2		1,685
Grade 3		13,268
Grade 4		69,543
Grade W		3,838
Grade 5		4,789
Grade 6		2,245
Grade 7		389
Not risk rated		87
Total	$	96,237

	Single-family residential revolving, open-end loans		Single-family residential closed-end, first lien		Single-family residential closed-end, junior lien		Total single-family residential loans
Accrual	$	82,404	$	129,455	$	2,745	$	214,604
Nonaccrual		702		1,821		47		2,570
Total	$	83,106	$	131,276	$	2,792	$	217,174

	Indirect automobile		All other consumer		Total consumer
Accrual	$	65,542	$	10,243	$	75,785
Nonaccrual		113		23		136
Total	$	65,655	$	10,266	$	75,921

	Other
Accrual	$	12,599
Nonaccrual		-
Total	$	12,599

15

The following table summarizes various internal credit-quality indicators of gross loans, by class, at December 31, 2014 (in thousands).

	Construction, land development and other land loans		Multifamily residential		Nonfarm nonresidential		Total commercial real estate
Grade 1	$	-	$	-	$	-	$	-
Grade 2		-		-		-		-
Grade 3		3,337		144		74,966		78,447
Grade 4		17,826		1,191		183,829		202,846
Grade W		9,595		7,690		62,429		79,714
Grade 5		138		-		25,502		25,640
Grade 6		1,724		-		25,131		26,855
Grade 7		-		-		1,051		1,051
Not risk rated*		15,443		-		29		15,472
Total	$	48,063	$	9,025	$	372,937	$	430,025

      *Consumer real estate loans, included within construction, land development and other land loans, are not risk rated

         in accordance with the Company's policy.

	Commercial and industrial
Grade 1	$	753
Grade 2		1,534
Grade 3		12,864
Grade 4		53,171
Grade W		3,953
Grade 5		5,786
Grade 6		2,476
Grade 7		339
Not risk rated		51
Total	$	80,927

	Single-family residential revolving, open-end loans		Single-family residential closed-end, first lien		Single-family residential closed-end, junior lien		Total single-family residential loans
Accrual	$	79,667	$	119,079	$	2,710	$	201,456
Nonaccrual		977		1,928		78		2,983
Total	$	80,644	$	121,007	$	2,788	$	204,439

	Indirect automobile		All other consumer		Total consumer
Accrual	$	66,161	$	10,673	$	76,834
Nonaccrual		116		34		150
Total	$	66,277	$	10,707	$	76,984

	Other
Accrual	$	12,684
Nonaccrual		-
Total	$	12,684

16

The following table summarizes delinquencies, by class, at March 31, 2015 (in thousands).

	30-89 days past due and still accruing interest		Greater than 90 days past due and still accruing interest		Greater than 90 days past due and not accruing interest (nonaccrual)		Total past due		Current		Loans, gross
Construction, land development and other land loans	$	-	$	-	$	345	$	345	$	47,657	$	48,002
Multifamily residential		-		-		-		-		8,868		8,868
Nonfarm nonresidential		1,064		-		6,842		7,906		365,322		373,228
Total commercial real estate		1,064		-		7,187		8,251		421,847		430,098
Single-family real estate, revolving, open-end loans		229		-		702		931		82,175		83,106
Single-family real estate, closed-end, first lien		754		233		1,821		2,808		128,468		131,276
Single-family real estate, closed-end, junior lien		100		-		47		147		2,645		2,792
Total single-family residential		1,083		233		2,570		3,886		213,288		217,174
Commercial and industrial		339		-		469		808		95,429		96,237
Indirect automobile		272		-		113		385		65,270		65,655
All other consumer		29		-		23		52		10,214		10,266
Total consumer		301		-		136		437		75,484		75,921
Farmland		-		-		-		-		5,897		5,897
Obligations of states and political subdivisions of the U.S.		-		-		-		-		396		396
Other		-		-		-		-		6,306		6,306
Total other		-		-		-		-		12,599		12,599
Loans, gross	$	2,787	$	233	$	10,362	$	13,382	$	818,647	$	832,029

Additional interest income of $80 thousand would have been reported during the three months ended March 31, 2015 had loans classified as nonaccrual during the period performed in accordance with their current contractual terms. This interest income was not recorded in the Company’s Consolidated Statements of Income.

17

The following table summarizes delinquencies, by class, at December 31, 2014 (in thousands).

	30-89 days past due and still accruing interest		Greater than 90 days past due and still accruing interest		Greater than 90 days past due and not accruing interest (nonaccrual)		Total past due		Current		Loans, gross
Construction, land development and other land loans	$	112	$	-	$	441	$	553	$	47,510	$	48,063
Multifamily residential		-		-		-		-		9,025		9,025
Nonfarm nonresidential		2,102		-		8,174		10,276		362,661		372,937
Total commercial real estate		2,214		-		8,615		10,829		419,196		430,025
Single-family real estate, revolving, open-end loans		151		-		977		1,128		79,516		80,644
Single-family real estate, closed-end, first lien		827		238		1,928		2,993		118,014		121,007
Single-family real estate, closed-end, junior lien		16		-		78		94		2,694		2,788
Total single-family residential		994		238		2,983		4,215		200,224		204,439
Commercial and industrial		361		-		715		1,076		79,851		80,927
Indirect automobile		283		-		116		399		65,878		66,277
All other consumer		33		-		34		67		10,640		10,707
Total consumer		316		-		150		466		76,518		76,984
Farmland		-		-		-		-		6,032		6,032
Obligations of states and political subdivisions of the U.S.		-		-		-		-		416		416
Other		-		-		-		-		6,236		6,236
Total other		-		-		-		-		12,684		12,684
Loans, gross	$	3,885	$	238	$	12,463	$	16,586	$	788,473	$	805,059

Troubled Debt Restructurings. The following table summarizes the carrying balance of troubled debt restructurings at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Accrual	$	14,255	$	15,585
Nonaccrual		4,987		4,286
Total troubled debt restructurings	$	19,242	$	19,871

The following table summarizes troubled debt restructurings removed from this classification during the periods indicated (dollars in thousands). Loans classified as troubled debt restructurings may be removed from this status for disclosure purposes after a specified period of time if the restructured agreement specifies an interest rate equal to or greater than the rate that the lender was willing to accept at the time of the restructuring for a new loan with comparable risk, and the loan is performing in accordance with the terms specified by the restructured agreement.

	For the three months ended March 31,
	2015		2014
Carrying balance	$	-	$	956
Count		-		3

The following table summarizes, by class, loans that were modified resulting in troubled debt restructurings during the periods indicated (dollars in thousands).

	For the three months ended March 31,
	2015						2014
	Number of loans		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment		Number of loans		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Single-family real estate		1	$	52	$	52		-		-		-
Loans, gross		1	$	52	$	52		-	$	-	$	-

18

The following table summarizes, by type of concession, loans that were modified resulting in troubled debt restructurings during the periods indicated (dollars in thousands).

	For the three months ended March 31,
	2015						2014
	Number of loans		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment		Number of loans		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Term concession		1	$	52	$	52		-		-		-
Loans, gross		1	$	52	$	52		-	$	-	$	-

The following table summarizes, by class, loans that were modified resulting in troubled debt restructurings within the previous 12-month period for which there was a payment default during the periods indicated (dollars in thousands).

	For the three months ended March 31,
	2015				2014
	Number of loans		Recorded investment		Number of loans		Recorded investment
Nonfarm nonresidential		-	$	-		2	$	2,597
Total commercial real estate		-		-		2		2,597
Loans, gross		-	$	-		2	$	2,597

Impaired Loans. The following tables summarize the composition of impaired loans at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Accrual troubled debt restructured loans	$	14,255	$	15,585
Nonaccrual troubled debt restructured loans		4,987		4,286
Accrual other loans		7,794		7,955
Nonaccrual other loans		1,679		3,736
Total impaired loans	$	28,715	$	31,562

19

The following table summarizes the composition of and information relative to impaired loans, by class, at March 31, 2015 (in thousands).

	Loans, gross
	Recorded investment		Unpaid principal balance		Related allowance
With no related allowance recorded:
Construction, land development and other land loans	$	185	$	185
Multifamily residential		-		-
Nonfarm nonresidential		18,077		19,044
Total commercial real estate		18,262		19,229
Single-family real estate, revolving, open-end loans		-		-
Single-family real estate, closed-end, first lien		564		668
Single-family real estate, closed-end, junior lien		23		23
Total single-family residential		587		691
Commercial and industrial		426		1,776
Consumer		-		-
Total impaired loans with no related allowance recorded	$	19,275	$	21,696
With an allowance recorded:
Construction, land development and other land loans	$	101	$	101	$	-
Multifamily residential		-		-		-
Nonfarm nonresidential		8,358		9,812		1,254
Total commercial real estate		8,459		9,913		1,254
Single-family real estate, revolving, open-end loans		-		-		-
Single-family real estate, closed-end, first lien		256		256		28
Single-family real estate, closed-end, junior lien		104		104		40
Total single-family residential		360		360		68
Commercial and industrial		607		607		116
Consumer		14		14		2
Total impaired loans with an allowance recorded	$	9,440	$	10,894	$	1,440
Total:
Construction, land development and other land loans	$	286	$	286	$	-
Multifamily residential		-		-		-
Nonfarm nonresidential		26,435		28,856		1,254
Total commercial real estate		26,721		29,142		1,254
Single-family real estate, revolving, open-end loans		-		-		-
Single-family real estate, closed-end, first lien		820		924		28
Single-family real estate, closed-end, junior lien		127		127		40
Total single-family residential		947		1,051		68
Commercial and industrial		1,033		2,383		116
Consumer		14		14		2
Total impaired loans	$	28,715	$	32,590	$	1,440

Interest income recognized on impaired loans during the three months ended March 31, 2015 was $256 thousand. The average balance of total impaired loans was $30.1 million for the same period.

20

The following table summarizes the composition of and information relative to impaired loans, by class, at December 31, 2014 (in thousands).

	Loans, gross
	Recorded investment		Unpaid principal balance		Related allowance
With no related allowance recorded:
Construction, land development and other land loans	$	283	$	805
Multifamily residential		-		-
Nonfarm nonresidential		18,534		23,055
Total commercial real estate		18,817		23,860
Single-family real estate, revolving, open-end loans		333		333
Single-family real estate, closed-end, first lien		645		750
Single-family real estate, closed-end, junior lien		24		24
Total single-family residential		1,002		1,107
Commercial and industrial		607		2,208
Consumer		-		-
Total impaired loans with no related allowance recorded	$	20,426	$	27,175
With an allowance recorded:
Construction, land development and other land loans	$	6	$	6	$	-
Multifamily residential		-		-		-
Nonfarm nonresidential		10,186		12,021		1,555
Total commercial real estate		10,192		12,027		1,555
Single-family real estate, revolving, open-end loans		-		-		-
Single-family real estate, closed-end, first lien		208		208		24
Single-family real estate, closed-end, junior lien		106		106		41
Total single-family residential		314		314		65
Commercial and industrial		616		616		115
Consumer		14		14		2
Total impaired loans with an allowance recorded	$	11,136	$	12,971	$	1,737
Total:
Construction, land development and other land loans	$	289	$	811	$	-
Multifamily residential		-		-		-
Nonfarm nonresidential		28,720		35,076		1,555
Total commercial real estate		29,009		35,887		1,555
Single-family real estate, revolving, open-end loans		333		333		-
Single-family real estate, closed-end, first lien		853		958		24
Single-family real estate, closed-end, junior lien		130		130		41
Total single-family residential		1,316		1,421		65
Commercial and industrial		1,223		2,824		115
Consumer		14		14		2
Total impaired loans	$	31,562	$	40,146	$	1,737

21

 Allowance for Loan Losses

The following tables summarize the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at the dates and for the periods indicated (in thousands).

	For the three months ended March 31, 2015
	Commercial			Single-family			Commercial and
	real estate			residential			industrial			Consumer			Other			Total
Allowance for loan losses, beginning of period	$	7,373		$	2,856		$	1,047		$	1,338		$	306			12,920
Provision for loan losses		62			174			131			12			21			400
Loan charge-offs		398			25			73			45			164			705
Loan recoveries		(52	)		(18	)		(135	)		(17	)		(77	)		(299	)
Net loans charged-off (recovered)		346			7			(62	)		28			87			406
Allowance for loan losses, end of period	$	7,089		$	3,023		$	1,240		$	1,322		$	240		$	12,914

	March 31, 2015
	Commercial		Single-family		Commercial and
	real estate		residential		industrial		Consumer		Other		Total
Individually evaluated for impairment	$	1,254	$	68	$	116	$	2	$	-	$	1,440
Collectively evaluated for impairment		5,835		2,955		1,124		1,320		240		11,474
Allowance for loan losses, end of period	$	7,089	$	3,023	$	1,240	$	1,322	$	240	$	12,914
Individually evaluated for impairment	$	26,721	$	947	$	1,033	$	14	$	-	$	28,715
Collectively evaluated for impairment		403,377		216,227		95,204		75,907		12,599		803,314
Loans, gross	$	430,098	$	217,174	$	96,237	$	75,921	$	12,599	$	832,029

22

	For the three months ended March 31, 2014
	Commercial			Single-family			Commercial and
	real estate			residential			industrial			Consumer			Other			Total
Allowance for loan losses, beginning of period	$	10,565		$	3,124		$	1,682		$	1,118		$	(4	)		16,485
Provision for loan losses		48			(37	)		(171	)		35			125			-
Loan charge-offs		161			104			-			56			155			476
Loan recoveries		(5	)		(91	)		(12	)		(31	)		(95	)		(234	)
Net loans charged-off (recovered)		156			13			(12	)		25			60			242
Allowance for loan losses, end of period	$	10,457		$	3,074		$	1,523		$	1,128		$	61		$	16,243

	March 31, 2014
	Commercial		Single-family		Commercial and
	real estate		residential		industrial		Consumer		Other		Total
Individually evaluated for impairment	$	1,838	$	151	$	478	$	3	$	-	$	2,470
Collectively evaluated for impairment		8,619		2,923		1,045		1,125		61		13,773
Allowance for loan losses, end of period	$	10,457	$	3,074	$	1,523	$	1,128	$	61	$	16,243
Individually evaluated for impairment	$	39,211	$	1,772	$	2,376	$	23	$	-	$	43,382
Collectively evaluated for impairment		405,942		174,682		70,101		51,296		10,475		712,496
Loans, gross	$	445,153	$	176,454	$	72,477	$	51,319	$	10,475	$	755,878

6.     Other Loans Held for Sale

The following table summarizes the changes in net other loans held for sale at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015			2014
Other loans held for sale, beginning of period	$	-		$	-
SBA loans transferred to other loans held for sale		1,608			1,166
Proceeds from sales of SBA loans		(1,731	)		(1,236	)
Gain on sale of SBA loans		123			70
SBA loan activity, net		-			-
Other loans held for sale, end of period	$	-		$	-

7.     Premises and Equipment, net

The following table summarizes premises and equipment balances, net at the dates indicated (in thousands).

	March 31,			December 31,
	2015			2014
Land	$	5,521		$	5,521
Buildings		19,559			19,539
Furniture and equipment		13,808			13,395
Software		5,563			5,556
Leasehold improvements		3,782			3,782
Capital lease asset		557			557
Bank automobiles		94			94
Premises and equipment, gross	$	48,884		$	48,444
Accumulated depreciation		(27,026	)		(26,438	)
Premises and equipment, net	$	21,858		$	22,006

At March 31, 2015, the Bank provided banking products and services through 25 branches of which five were leased and 20 were owned.

Depreciation expense for the three months ended March 31, 2015 and 2014 was $588 thousand and $593 thousand, respectively.

23

8.     Servicing Rights

Residential Mortgage-Servicing Rights

The following table summarizes the changes in residential mortgage-servicing rights at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015			2014
Mortgage-servicing rights portfolio, net of valuation allowance, beginning of period	$	2,248		$	2,431
Capitalized mortgage-servicing rights		126			115
Mortgage-servicing rights portfolio amortization and impairment		(140	)		(140	)
Mortgage-servicing rights portfolio, net of valuation allowance, end of period	$	2,234		$	2,406

The estimated fair value of residential mortgage-servicing rights was $3.3 million and $3.4 million at March 31, 2015 and December 31, 2014, respectively.

There was no activity in the valuation allowance for impairment of the residential mortgage-servicing rights portfolio during the three months ended March 31, 2015 or 2014. The valuation allowance totaled $21 thousand and $31 thousand at March 31, 2015 and March 31, 2014, respectively.

SBA Servicing Rights

The following table summarizes the changes in SBA servicing rights at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015			2014
SBA servicing rights portfolio, net of valuation allowance, beginning of period	$	77		$	64
Capitalized SBA servicing rights		43			31
SBA servicing rights portfolio amortization and impairment		(2	)		(5	)
SBA servicing rights portfolio, net of valuation allowance, end of period	$	118		$	90

The estimated fair value of SBA servicing rights was $126 thousand and $84 thousand at March 31, 2015 and December 31, 2014, respectively.

The following table summarizes the activity in the valuation allowance for impairment of the SBA servicing rights portfolio at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015			2014
Valuation allowance, beginning of period	$	12		$	8
Additions charged (reductions credited) to operations, net		(1	)		3
Valuation allowance, end of period	$	11		$	11

9.     Foreclosed Real Estate and Repossessed Personal Property

Composition

The following table summarizes foreclosed real estate and repossessed personal property at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Foreclosed real estate	$	5,756	$	5,949
Repossessed personal property		21		35
Total foreclosed real estate and repossessed personal property	$	5,777	$	5,984

Included in foreclosed real estate at March 31, 2015 were 55 residential lots with an aggregate net book value of $4.4 million, in three separate communities related to one real estate development.

24

Foreclosed Real Estate Activity

The following table summarizes changes in foreclosed real estate at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015			2014
Foreclosed real estate, beginning of period	$	5,949		$	7,502
Plus: new foreclosed real estate		1,890			455
Less: proceeds from sale of foreclosed real estate		(2,224	)		(264	)
Plus: gain on sale of foreclosed real estate		268			43
Less: writedowns and losses charged to expense		(127	)		(246	)
Foreclosed real estate, end of period	$	5,756		$	7,490

10.     Bank-Owned Life Insurance

The Company owns two fully-funded general account life insurance policies on certain members of its leadership team. The Company paid all premiums on these policies and is the sole beneficiary. However, in order to encourage the covered employees (which we refer to herein as “teammates”) to consent to the coverage, the Bank provided a $50 thousand taxable death benefit payable to the named beneficiaries of the covered teammates in the event of the death of a covered teammate while employed by the Bank. Each policy was funded with a premium of $5.0 million paid to AA+ rated insurance companies. The policies are reflected in the Consolidated Balance Sheets at the cash surrender value of $10.4 million at both March 31, 2015 and December 31, 2014.

In addition, the Company has fully-funded life insurance policies on two former members of executive management who are retired from the Company. At both March 31, 2015 and December 31, 2014, the cash surrender value of these policies attributable to the Company totaled $1.6 million.

11.     Deposits

Composition

The following table summarizes the composition of deposits at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Transaction deposits	$	566,533	$	528,633
Money market deposits		141,289		138,449
Savings deposits		95,815		90,318
Time deposits $100,000 and greater		63,401		67,419
Time deposits less than $100,000		99,952		103,501
Total deposits	$	966,990	$	928,320

At March 31, 2015 and December 31, 2014, $429 thousand and $531 thousand, respectively, of overdrawn transaction deposit accounts were reclassified to loans.

At March 31, 2015 and December 31, 2014, $15.6 million and $17.6 million, respectively, of time deposits meet or exceed the FDIC insurance limit of $250,000.

Interest Expense on Deposit Accounts

The following table summarizes interest expense on deposits for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015		2014
Transaction deposits	$	11	$	10
Money market deposits		10		9
Savings deposits		3		3
Time deposits		80		105
Total interest expense on deposits	$	104	$	127

25

12.     Borrowings

Retail Repurchase Agreements

Retail repurchase agreements represent overnight secured borrowing arrangements between the Bank and certain clients. Retail repurchase agreements are not insured deposits and were secured by $25.7 million and $36.6 million of the Company’s investment securities available for sale at March 31, 2015 and December 31, 2014, respectively.

FHLB Advances

As disclosed in Note 4, Investment Securities Available for Sale, and Note 5, Loans, the Bank may pledge investment securities and loans to collateralize FHLB advances. Additionally, the Bank may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages as calculated by the FHLB. The FHLB allows the Bank to borrow up to 25% of total assets, subject to available collateral.

The following table summarizes the collateral utilization and availability of borrowings from the FHLB at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Available lendable loan collateral value pledged to serve against FHLB advances	$	75,714	$	79,139
FHLB advances outstanding		50,000		35,000
Excess lendable collateral value pledged to serve against FHLB advances	$	25,714	$	44,139

Outstanding FHLB advances at March 31, 2015 consisted of the following: 

	Advance #1			Advance #2
Balance outstanding	$	20,000		$	30,000
Maturity date	4/30/2015			7/27/2015
Interest rate		0.22	%		0.29	%

The FHLB advance that matured on April 30, 2015 was repaid from the Bank's available cash balances.

Federal Reserve Discount Window

At March 31, 2015 and December 31, 2014, $41.7 million and $39.5 million, respectively, of loans and investment securities were pledged as collateral to cover the various Federal Reserve services that are available for use by the Bank. Of these amounts, $30.9 million and $29.1 million were available as lendable collateral at March 31, 2015 and December 31, 2014, respectively. The Bank’s borrowings from the Federal Reserve Discount Window (the “Discount Window”) are at the primary credit rate. Primary credit is available through the Discount Window to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. The Bank’s maximum maturity for potential borrowings is overnight. The Bank has not drawn on this availability other than to periodically test its ability to access the line. The Federal Reserve has the discretion to deny approval of borrowing requests.

Other Borrowings

Other borrowings generally consist of outstanding borrowings on correspondent bank lines of credit.

The following table summarizes the Bank’s correspondent bank lines of credit at both March 31, 2015 and December 31, 2014 (dollars in thousands).

	Secured		Unsecured		Total
Amount available	$	15,000	$	65,000	$	80,000
Number of lines available		2		6		8

None of the lines of credit were utilized as of either date. These correspondent bank funding sources may be canceled at any time at the correspondent bank’s discretion. 

13.     Shareholders’ Equity

Common Shares

At March 31, 2015, the Company had 75,000,000 authorized shares of common stock of which 12,814,574 were issued and outstanding. As of April 24, 2015, the Company has reserved a total of 554,645 shares for future issuance under various equity incentive plans.

26

For disclosure regarding actual and potential share issuances under the Company’s equity award plans, see Note 16, Equity-Based Compensation.

Accumulated Other Comprehensive Loss

The following table summarizes the components of accumulated other comprehensive loss, net of tax at the dates indicated (in thousands).

	March 31,			December 31,
	2015			2014
Net unrealized gain (loss) on investment securities available for sale	$	267		$	(819	)
Net unrealized defined benefit pension plan actuarial loss		(9,084	)		(9,084	)
Total accumulated other comprehensive loss, net of tax	$	(8,817	)	$	(9,903	)

Authorized Preferred Shares

The Company has authorized for issuance 2,500,000 shares of preferred stock with such preferences, limitations and relative rights within legal limits of the class, or one or more series within the class, as are set by the Board of Directors. To date, the Company has not issued any preferred shares.

Cash Dividends

Dividends from the Bank are the Company’s primary source of funds for payment of dividends to its common shareholders. During the three months ended March 31, 2015, the Company declared and paid cash dividends on its common stock as follows:

Declaration date	Record date	Payment date	Cash dividend per common share
1/15/2015	2/2/2015	2/16/2015	$	0.08

Subsequently, the Company declared a cash dividend of $0.08 per common share on April 16, 2015 payable on May 18, 2015.

The dividends payable to common shareholders were funded by dividends paid to the Company by the Bank.

14.     Income Taxes

As of March 31, 2015, the Company had federal net operating loss carryforwards of $6.4 million, which, if not utilized to offset future taxable income, will expire in 2032. During the three months ended March 31, 2015, the Company utilized $3.0 million of federal net operating loss carryforwards to offset federal taxable income. This amount was comprised of $200 thousand of federal net operating loss carryforwards that would have expired in 2031 and $2.8 million that would have expired in 2032.

As of March 31, 2015, net deferred tax assets of $15.1 million were recorded in the Company’s Consolidated Balance Sheet, a portion of which includes the after-tax impact of net operating loss carryforwards. Based on available information as of this date, the Company determined that a valuation allowance against the deferred tax asset was not necessary.

In 2010, the Company consummated a private offering pursuant to which the Company issued 9,993,995 shares of its common stock at $10.40 per share (the “Private Placement”). The Private Placement was considered a change in control under the Internal Revenue Code and Regulations. Accordingly, the Company was required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized pre-acquisition built-in losses which are subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, net unrealized pre-acquisition built-in losses realized within five years of the change in control on October 7, 2010 are subject to potential limitation. Through that date, the Company will continue to analyze its ability to utilize such losses to offset anticipated future taxable income as pre-acquisition built-in losses are ultimately realized. As of March 31, 2015, the Company estimates that future utilization of built-in losses of $53 million generated prior to the Private Placement will be limited to $1.1 million per year. However, this estimate will not be conclusively confirmed until the five-year limitation period expires in October 2015. The Company’s deferred tax asset does not include any recognized built-in losses that exceed the amount expected to be utilized against future taxable income.

27

The Company is subject to U.S. federal and South Carolina state income tax, as well as income tax in several other U.S. states. Tax authorities in various jurisdictions may examine the Company. The Company is not currently undergoing a U.S. federal or state examination; however, tax years dating back to 2011 are generally considered subject to examination based on federal and state regulations.

15.     Benefit Plans

401(k) Plan

Teammates are given the opportunity to participate in The Palmetto Bank 401(k) Retirement Plan (the “401(k) Plan”) which is designed to supplement a teammate’s retirement income. Teammates are eligible to participate in the 401(k) Plan immediately when hired and participants are able to defer a portion of their compensation into the 401(k) Plan. Matching contributions, if any, are contributed to the 401(k) Plan prior to the end of each plan year.

Through June 30, 2014, teammate contributions were matched at a rate of $0.10 per dollar up to 6% of a teammate’s eligible compensation. Effective July 1, 2014, the match of teammate contributions was increased to a rate of $0.25 per dollar up to 6% of a teammate’s eligible compensation. The Company’s matching contributions totaled $32 thousand and $12 thousand for the three months ended March 31, 2015 and 2014, respectively.

Under the Internal Revenue Service (“IRS”) rules related to 401(k) plans, the IRS imposes certain annual limitations on the amount of allowable contributions to the 401(k) Plan by highly compensated participants (as determined annually by applying the required IRS tests). To the extent teammates receive refunds of prior deferrals as a result of the annual limitations, the Bank has in place a benefit equalization plan into which such teammates may contribute refunds received. The benefit equalization plan operates similar to the 401(k) Plan except that this plan is a nonqualified plan under the IRS rules, and the assets of the benefit equalization plan are subject to the general creditors of the Bank. At March 31, 2015 and December 31, 2014, assets in the benefit equalization plan were $41 thousand and $40 thousand, respectively, and are included in Other assets in the Consolidated Balance Sheet. An offsetting liability of $41 thousand and $40 thousand, respectively, is reflected in Other liabilities and represents the Bank’s obligation to benefit equalization plan participants.

Defined Benefit Pension Plan

Prior to 2008, the Company offered a noncontributory, defined benefit pension plan. Effective December 31, 2007, the Company ceased accruing pension benefits for participants in the Pension Plan. Although no previously accrued benefits were lost, teammates no longer accrue benefits for service subsequent to 2007.

The Company accounts for the Pension Plan using an actuarial model. This model allocates pension costs over the service period of teammates in the Pension Plan. The underlying principle is that teammates render services ratably over this period; therefore, the income statement impacts of pension benefits should follow a similar pattern.    

The Company’s net accrued pension liability is included in Other liabilities in the Consolidated Balance Sheets and totaled $2.8 million and $3.0 million at March 31, 2015 and December 31, 2014, respectively.

Cost of the Pension Plan. The following table summarizes the components of net periodic pension expense, which is included in Salaries and other personnel expense in the Consolidated Statements of Income, for the periods indicated (in thousands).

	For the three months ended March 31,
	2015			2014
Interest cost	$	205		$	268
Expected return on plan assets		(267	)		(317	)
Amortization of net actuarial loss		225			255
Net periodic pension expense	$	163		$	206

As a result of the decision to cease accruing benefits under the Pension Plan effective December 31, 2007, no costs relative to service have been necessary since that date as teammates no longer accrue benefits for services rendered.

28

Pension Plan Assets. The following table summarizes the fair value of Pension Plan assets by major category at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Cash and cash equivalents	$	1,246	$	902
Mutual funds		916		902
Corporate stocks		1,097		1,085
Exchange traded funds		14,597		14,351
Foreign equities		66		182
Other		1		7
Total Pension Plan assets	$	17,923	$	17,429

Fair Value Measurements. The following tables summarize Pension Plan assets measured at fair value at the dates indicated aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).

	March 31,		December 31,
	2015		2014
Level 1	$	2,344	$	1,994
Level 2		15,579		15,435
Level 3		-		-
Total Pension Plan assets	$	17,923	$	17,429

There were no changes in the Pension Plan’s Level 3 assets during the three months ended March 31, 2015.

Current and Future Expected Contributions. The Company contributed $400 thousand to the Pension Plan in February 2015, and expects to contribute an additional $1.2 million during 2015.

16.     Equity-Based Compensation

1997 Stock Compensation Plan

The following table summarizes stock option activity for the Company’s 1997 Stock Compensation Plan (the “1997 Plan”) at the dates and for the periods indicated.

	Stock options outstanding			Weighted-average exercise price
Outstanding, December 31, 2014		2,950		$	109.80
Expired		(250	)		106.40
Outstanding, March 31, 2015		2,700			110.12

The following table summarizes information regarding stock options under the 1997 Plan that were outstanding and exercisable at March 31, 2015.

Weighted-average exercise price	Number of stock options outstanding and exercisable		Weighted-average remaining contractual life (years)
$109.20		2,500		1.18
121.60		200		1.80
Total		2,700		1.22

At March 31, 2015 and December 31, 2014, the fair value of the Company’s common stock did not exceed the exercise price of any options outstanding and exercisable under the 1997 Plan and, therefore, the stock options had no intrinsic value.

29

2008 Restricted Stock Plan

The weighted-average grant date fair value per share of granted shares under the Company’s 2008 Restricted Stock Plan (“the 2008 Plan”) net of forfeitures was $27.63 at both March 31, 2015 and December 31, 2014. There were no grants or forfeitures of restricted stock under the 2008 Plan during the three months ended March 31, 2015. There were 114 shares available for issuance under the 2008 Plan at March 31, 2015.

Of the 62,386 net restricted stock awards granted under the 2008 Plan, the following table summarizes vesting status and activity at the dates and for the period indicated.

	Unvested		Vested		Total granted, net of forfeitures
Balance, December 31, 2014		6,064		56,322		62,386
Vested		-		-		-
Balance, March 31, 2015		6,064		56,322		62,386

The shares that remained unvested at March 31, 2015 are expected to vest through 2016.

2011 Stock Incentive Plan

The following table summarizes stock option and restricted stock information for the Company’s 2011 Stock Incentive Plan (the “2011 Plan”) at the dates and for the periods indicated.

	Total shares		Stock options outstanding		Weighted-average exercise price per share		Shares of restricted stock		Weighted-average grant date fair value per share
Balance, December 31, 2014		545,984		402,001	$	10.90		132,733	$	11.42
Granted		4,186		-		-		4,186		16.70
Granted, net of forfeitures, March 31, 2015		550,170						136,919	$	11.58
Outstanding, March 31, 2015				402,001	$	10.90
Total shares available for grant under the 2011 Plan		700,000
Remaining shares available for grant, March 31, 2015		149,830

During the three months ended March 31, 2015, 4,186 shares of restricted stock with a total grant date fair value of $70 thousand were granted to the non-management members of the Board of Directors as compensation for their annual Board retainers.

The following table summarizes the activity of restricted stock under the 2011 Plan at the dates and for the period indicated.

	Unvested			Vested		Total granted, net of forfeitures
Balance, December 31, 2014		92,834			39,899		132,733
Granted		-			4,186		4,186
Vested		(667	)		667		-
Balance, March 31, 2015		92,167			44,752		136,919

The weighted-average grant date fair value of restricted stock awards that vested during the three months ended March 31, 2015 was $12.96 per share. The value of shares vested during the three months ended March 31, 2015 based on vesting date fair value totaled $11 thousand.

30

The following table summarizes information regarding stock options under the 2011 Plan that were outstanding and exercisable at March 31, 2015.

		Options outstanding						Options exercisable
Weighted-average exercise price		Number of stock options		Weighted-average remaining contractual life (years)		Value of outstanding in-the-money stock options		Number of stock options		Weighted-average remaining contractual life (years)		Value of exercisable in-the-money stock options
$	10.40		312,501		6.13	$	2,687,509		104,167		6.13	$	895,836
	11.00		59,500		6.30		476,000		19,833		6.30		158,664
	12.96		4,000		8.89		24,160		1,333		8.89		8,051
	16.43		26,000		9.72		66,820		-		-		-
Total			402,001		6.42	$	3,254,489		125,333		6.19	$	1,061,551

Compensation Expense Relating to Equity-Based Compensation

The following table summarizes compensation expense for the 1997 Plan, 2008 Plan and the 2011 Plan charged against pretax income for the periods indicated (in thousands).

	For the three months ended March 31,
	2015		2014
Compensation expense
1997 Plan	$	-	$	-
2008 Plan		11		31
2011 Plan		180		221
Total equity-based compensation expense	$	191	$	252
Income tax benefit	$	70	$	93

At March 31, 2015, the total unrecognized pretax compensation expense related to unvested equity awards granted under the 2008 Plan and the 2011 Plan was $38 thousand and $798 thousand, respectively. This expense is expected to be recognized through 2016 under the 2008 Plan and 2019 under the 2011 Plan. 

17.     Average Share Information

The following table reconciles the denominators of the basic and diluted net income per common share computations for the periods indicated (dollars in thousands, except per share data).

	For the three months ended March 31,
	2015			2014
Basic net income per common share
Net income applicable to common shareholders	$	2,732		$	2,028
Undistributed earnings allocated to participating securities		(13	)		(18	)
Net income allocated to common shareholders	$	2,719		$	2,010
Weighted average basic common shares		12,715,972			12,675,257
Basic net income per common share	$	0.21		$	0.16
Diluted net income per common share
Net income applicable to common shareholders	$	2,732		$	2,028
Undistributed earnings allocated to participating securities		(13	)		(18	)
Net income allocated to common shareholders	$	2,719		$	2,010
Weighted average basic common shares		12,715,972			12,675,257
Dilutive potential common shares (1)		135,104			32,187
Weighted average diluted common shares		12,851,076			12,707,444
Diluted net income per common share	$	0.21		$	0.16

      (1) Includes dilutive impact of stock options, as applicable

18.     Commitments, Guarantees and Other Contingencies

Unused lending commitments to clients are not recorded in the Consolidated Balance Sheets until funds are advanced. For commercial clients, lending commitments generally take the form of unused revolving credit arrangements to finance clients’ working capital requirements as well as unused credit arrangements to fund commercial construction. For retail clients, lending commitments are generally unused lines of credit secured by residential property as well as unused credit arrangements to fund residential construction. The Company routinely extends lending commitments for both floating and fixed-rate loans.

31

The following table summarizes the contractual amounts of the Company’s unused lending commitments relating to extensions of credit with off-balance sheet risk at March 31, 2015 (in thousands).

Commitments to extend credit:
Revolving, open-end loans secured by single-family residential properties	$	70,643
Commercial real estate, construction and land development loans secured by real estate     Single-family residential construction loans		10,805
Commercial real estate, other construction loans, and land development loans		33,392
Commercial and industrial loans		42,377
Overdraft protection loans		31,337
Other		11,294
Total commitments to extend credit	$	199,848

Standby letters of credit are issued for clients in connection with contracts between clients and third parties. Letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The maximum potential amount of undiscounted future advances related to letters of credit was $3.5 million and $2.7 million at March 31, 2015 and December 31, 2014, respectively.

The reserve for estimated credit losses on unfunded lending commitments at March 31, 2015 and December 31, 2014 was $219 thousand and $472 thousand, respectively.

For disclosure regarding our derivative financial instruments and hedging activities, see Note 19, Derivative Financial Instruments and Hedging Activities.

Contractual Obligations

In March 2013, the Bank entered into a subscription agreement for a limited partnership investment in Plexus Fund III, L.P. (the “Fund”). The Bank’s commitment represents approximately 1.3% of the Fund’s total capital commitments. During 2013 and 2014, the Bank invested $350 thousand and $250 thousand, respectively, into the Fund in connection with its capital call obligation. There were no investments during the three months ended March 31, 2015. As of March 31, 2015, $1.4 million remains subject to additional capital calls by the Fund. Capital calls are at the discretion of the Fund and are expected to be fully invested by 2018.

19.     Derivative Financial Instruments and Hedging Activities

At March 31, 2015 and December 31, 2014, the Company’s only derivative instruments related to residential mortgage-banking activities.

At March 31, 2015, the notional amount of commitments to originate conforming mortgage loans held for sale totaled $7.6 million. These derivative loan commitments had positive fair values, included in Other assets in the Consolidated Balance Sheets, totaling $259 thousand. At December 31, 2014, the notional amount of commitments to originate conforming mortgage loans held for sale totaled $2.4 million. These derivative loan commitments had positive fair values, included in Other assets in the Consolidated Balance Sheets, totaling $85 thousand. The net change in derivative loan commitment fair values during the three months ended March 31, 2015 and 2014 resulted in income of $174 thousand and $1 thousand, respectively.

The notional amount of forward sales commitments totaled $8.1 million at March 31, 2015. These forward sales commitments had positive fair values, included in Other assets in the Consolidated Balance Sheets, totaling $1 thousand and negative fair values, included in Other liabilities in the Consolidated Balance Sheets, totaling $44 thousand. The notional amount of forward sales commitments totaled $2.3 million at December 31, 2014. These forward sales commitments had negative fair values, included in Other liabilities in the Consolidated Balance Sheets, totaling $18 thousand. The net change in forward sales commitment fair values during the three months ended March 31, 2015 and 2014 resulted in expense of $25 thousand and $19 thousand, respectively.

32

20.     Disclosures Regarding Fair Value

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables summarize assets and liabilities measured at fair value on a recurring basis at the dates indicated aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).

	March 31, 2015
	Level 1		Level 2		Level 3		Total
Assets
Trading account assets	$	2,094	$	8,020	$	-	$	10,114
Investment securities available for sale
U.S. agency		-		3,235		-		3,235
State and municipal		701		7,169		-		7,870
Collateralized mortgage obligations (federal agencies)		1,000		87,687		-		88,687
Other mortgage-backed (federal agencies)		2,144		76,824		-		78,968
SBA loan-backed (federal agency)		18,796		14,412		-		33,208
Derivative financial instruments		-		260		-		260
Total assets measured at fair value on a recurring basis	$	24,735	$	197,607	$	-	$	222,342
Liabilities
Derivative financial instruments	$	-	$	44	$	-	$	44

	December 31, 2014
	Level 1		Level 2		Level 3		Total
Assets
Trading account assets	$	1,397	$	4,116	$	-	$	5,513
Investment securities available for sale
U.S. agency		-		3,965		-		3,965
State and municipal		572		6,160		-		6,732
Collateralized mortgage obligations (federal agencies)		-		87,774		-		87,774
Other mortgage-backed (federal agencies)		-		78,503		-		78,503
SBA loan-backed (federal agency)		19,675		14,862		-		34,537
Derivative financial instruments		-		85		-		85
Total assets measured at fair value on a recurring basis	$	21,644	$	195,465	$	-	$	217,109
Liabilities
Derivative financial instruments	$	-	$	18	$	-	$	18

For disclosure regarding the fair value of Pension Plan assets, see Note 15, Benefit Plans.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

For financial assets measured at fair value on a nonrecurring basis in the Consolidated Balance Sheets, the following tables summarize the level of valuation assumptions used to determine fair value of the related individual assets at the dates indicated (in thousands). There were no liabilities measured at fair value on a nonrecurring basis at March 31, 2015 or December 31, 2014.

	March 31, 2015
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans held for sale	$	-	$	3,600	$	-	$	3,600
Impaired loans		-		5,334		-		5,334
Foreclosed real estate		398		420		3,872		4,690
Total assets measured at fair value on a nonrecurring basis	$	398	$	9,354	$	3,872	$	13,624

	December 31, 2014
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans held for sale	$	-	$	1,125	$	-	$	1,125
Impaired loans		-		5,709		-		5,709
Foreclosed real estate		82		-		4,717		4,799
Total assets measured at fair value on a nonrecurring basis	$	82	$	6,834	$	4,717	$	11,633

33

Level 3 Valuation Methodologies. The following table summarizes the significant unobservable inputs used in the fair value measurements for Level 3 assets measured at fair value on a nonrecurring basis at the dates indicated (in thousands).

March 31, 2015	Fair value		Valuation technique	Significant unobservable inputs
Assets
Foreclosed real estate	$	3,872	Appraisals of collateral value	Adjustments to appraisal for age of comparable sales

December 31, 2014	Fair value		Valuation technique	Significant unobservable inputs
Assets
Foreclosed real estate	$	4,717	Appraisals of collateral value	Adjustments to appraisal for age of comparable sales

Carrying Amounts and Estimated Fair Value of Financial Assets and Liabilities Not Measured at Fair Value

Certain of the Company’s assets and liabilities are financial instruments whose fair value equals or closely approximates carrying value. Such financial instruments are reported in the following Consolidated Balance Sheet captions: cash and cash equivalents, retail repurchase agreements, FHLB advances and other borrowings.

The following table summarizes the carrying amount and fair value of other financial instruments included in the Consolidated Balance Sheets at the dates indicated (in thousands) all of which are considered Level 3 fair value estimates. These fair value estimates are subject to fluctuation based on the amount and timing of expected cash flows as well as the choice of discount rate used in the present value calculation. The Company used management's best estimate of fair value. Thus, the fair values presented may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair values presented.

	Carrying amount		Fair value
March 31, 2015
Financial instruments - assets
Loans (1)	$	815,340	$	818,918
Financial instruments - liabilities
Deposits		966,990		923,502
December 31, 2014
Financial instruments - assets
Loans (1)	$	788,228	$	788,334
Financial instruments - liabilities
Deposits		928,320		885,100

(1) Includes gross loans less impaired loans for which fair value exceeds carrying value and allowance for loan losses relative to loans collectively evaluated for impairment

21.     Regulatory Capital Requirements

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.

34

The following table summarizes capital ratios and related information in accordance with Basel III as measured at March 31, 2015 and pre-existing rules at December 31, 2014. For disclosure regarding changes resulting from Basel III see Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Condition, Capital, Basel III. The Bank was classified in the well-capitalized category at both March 31, 2015 and December 31, 2014 under the regulatory capital rules in effect at each date. Since March 31, 2015, no conditions or events have occurred, of which the Company is aware, that have resulted in a material change in the Bank's regulatory risk category other than as reported in this Quarterly Report on Form 10-Q.

	March 31, 2015
	Ratio			Amount		"Adequately-capitalized" minimum			"Well-capitalized" minimum
Common equity Tier 1 capital
Company		14.37	%	$	134,204		4.5	%		6.5	%
Bank		14.36			134,045		4.5			6.5
Tier 1 risk-based capital
Company		14.37			134,204		6.0			8.0
Bank		14.36			134,045		6.0			8.0
Total risk-based capital
Company		15.63			145,972		8.0			10.0
Bank		15.62			145,810		8.0			10.0
Tier 1 leverage
Company		11.86			134,204		4.0			5.0
Bank		11.84			134,045		4.0			5.0
Risk-weighted assets
Company	n/a				933,659	n/a			n/a
Bank	n/a				933,594	n/a			n/a
Adjusted quarterly average total assets (1)
Company	n/a				1,131,677	n/a			n/a
Bank	n/a				1,131,723	n/a			n/a

	December 31, 2014
	Ratio			Amount		"Adequately-capitalized" minimum			"Well-capitalized" minimum
Common equity Tier 1 capital
Company	n/a			n/a		n/a			n/a
Bank	n/a			n/a		n/a			n/a
Tier 1 risk-based capital
Company		15.00	%	$	132,455		4.0	%		6.0	%
Bank		14.99			132,299		4.0			6.0
Total risk-based capital
Company		16.26			143,519		8.0			10.0
Bank		16.24			143,363		8.0			10.0
Tier 1 leverage
Company		12.15			132,455		4.0			5.0
Bank		12.13			132,299		4.0			5.0
Risk-weighted assets
Company	n/a				882,809	n/a			n/a
Bank	n/a				882,781	n/a			n/a
Adjusted quarterly average total assets (1)
Company	n/a				1,090,314	n/a			n/a
Bank	n/a				1,090,281	n/a			n/a

      (1)      Reflects adjusted average total assets for the three months ended March 31, 2015 and December 31, 2014.

35

22.     Subsequent Event

On April 22, 2015, the Company and United Community Banks, Inc., the holding company for United Community Bank (“United”), jointly announced the signing of a definitive agreement (“Agreement”) pursuant to which the Company will merge with and into United.The Bank will merge into and operate under the brand of United Community Bank. Under the terms of the Agreement, which has been unanimously approved by the Boards of Directors of both companies, the Company’s shareholders will have the right to receive $19.25 in cash or 0.97 shares of United common stock, or any combination thereof, for each share of the Company’s common stock. The cash and stock elections are subject to proration to ensure that 30% of the outstanding shares of the Company’s common stock will be exchanged for cash and 70% of the Company’s common stock will be exchanged for shares of United common stock in the merger. The merger is subject to regulatory approval, the approval of the Company’s shareholders, and other customary conditions and is expected to close in the fourth quarter of 2015.

36

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

The following discussion and analysis addresses important factors impacting the financial condition and results of operations of the Company for the periods indicated. This discussion should be read in conjunction with, and is intended to supplement, all of the other Items presented in this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and the notes thereto for the year ended December 31, 2014 included in our Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (the “SEC”) on March 4, 2015 (the “2014 Annual Report on Form 10-K”).

Palmetto Bancshares, Inc. is a South Carolina bank holding company organized in 1982 and headquartered in Greenville, South Carolina. The Company serves as the bank holding company for The Palmetto Bank, which began operations in 1906. Given our 108-year history, we have developed long-standing relationships with clients in the communities in which we operate and a recognizable name, which has resulted in a well-established deposit network and loyal client base.

Throughout this Quarterly Report on Form 10-Q, the “Company,” “we,” “us,” or “our” refers to Palmetto Bancshares, Inc. and the Bank, except where the context indicates otherwise.

Forward-Looking Statements

This report, including information included in or incorporated by reference into this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements as they will depend on factors about which we are unsure including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Factors that may cause our actual results to differ materially from those anticipated in our forward-looking statements include, but are not limited to:

● Credit losses as a result of declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior, loan concentrations or other factors,

● Changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market,

● Sales of problem assets at discounted prices to accelerate the resolution of problem assets,

● The rate of loan delinquencies and amounts of loan charge-offs and recoveries,

● Adverse changes in asset quality and resulting credit-related losses and expenses,

● Our allowance for loan losses and the amount of loan loss provisions required in future periods,

● The rate of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio,

● Changes in availability of wholesale funding sources including increases in collateral margin requirements or reductions in eligible collateral,

● Our reliance on available secondary funding sources to meet our liquidity needs, such as Federal Home Loan Bank (“FHLB”) advances, Federal Reserve System (“Federal Reserve”) Discount Window (“Discount Window”) borrowings, brokered deposits, sales of investment securities and loans and lines of credit from correspondent banks,

● Our expectations regarding our operating revenues, expenses, effective tax rates and other results of operations,

● Changes in the interest-rate environment which could reduce net interest margins or result in deposits being withdrawn from the Bank,

● Increased cybersecurity risk, including potential network breaches, business disruptions or financial losses,

● Fraud committed by third parties, including cybersecurity risks associated with transactions initiated through our electronic banking products and services, whether initiated by clients or the Bank,

● Risks associated with a failure in, or breach of, our operations, security systems or infrastructure, or those of our third-party vendors or business partners,

● Changes in political conditions and the legislative or regulatory environment including the impact of ongoing financial reform legislation on the banking and financial services industries,

37

● Potential limitations on our ability to utilize net operating loss and net realized built-in loss carryforwards for income tax purposes,

● Risks associated with income taxes including the potential for adverse adjustments and the inability to fully realize deferred tax benefits,

● Potential corporate transactions, including mergers and acquisitions and securities offerings, and the impact on the market value of our common stock and integration risk,

● Our ability to successfully consummate our previously announced merger with United Community Banks, Inc., including the ability to obtain required governmental approvals of the merger on the proposed terms and schedule or that the terms of the proposed merger may need to be unfavorably modified to satisfy such approvals or other closing conditions,

● The diversion of management time from core banking functions due to merger-related issues,

● Potential difficulty in maintaining relationships with clients, associates or business partners as a result of our previously announced merger with United Community Banks, Inc.,

● Our ability to maintain appropriate levels of capital including levels required under the capital rules under Basel III,

● Our ability to comply with regulatory rules and restrictions and potential regulatory actions if we fail to comply,

● Results of examinations by our regulatory authorities including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write down assets,

● General economic conditions, either nationally or regionally and especially in our primary markets, becoming less favorable than expected, resulting in, among other things, reduced loan production and, in turn, interest income and deterioration in credit quality,

● Our ability to attract and retain key personnel,

● Our ability to retain our existing clients including our deposit relationships,

● Our current and future products, services, applications and functionality and plans to promote them,

● Changes in accounting policies and practices,

● Our ability to maintain effective internal control over financial reporting,

● The impact on the market value of our common stock based on the volume of trading activity, our continued listing on a national stock exchange and inclusion in the Russell 2000 index,

● Loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions and/or

● Other risks and uncertainties detailed in this Quarterly Report on Form 10-Q and, from time to time, in our other filings with the SEC.

The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements except as required by federal securities laws.

You should carefully consider these factors and the risk factors outlined under Item 1A. Risk Factors in our 2014 Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

General

The Company’s accounting and financial reporting policies are in conformity, in all material respects, with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices within the financial services industry. The preparation of financial statements in conformity with such principles requires management to make complex judgments to estimate the values of assets and liabilities. We have procedures and processes in place to facilitate making these judgments.

We have identified and described the variables most important in the estimation processes that involve mathematical models to derive the estimates. In many cases, there are numerous alternative judgments that could be used in the process of determining the inputs to the models. Where alternatives exist, we have used the factors that we believe represent the most reasonable value in developing the inputs. Actual performance that differs from our estimates of the key variables could impact our results of operations. These fluctuations would not be indicative of deficiencies in our models or inputs.

Management, in conjunction with the Company’s independent registered public accounting firm, discusses the development and selection of the critical accounting policies and estimates with the Audit Committee of our Board of Directors on an annual basis. Of those significant accounting policies, we determined that accounting for our allowance for loan losses and the related reserve for unfunded commitments, servicing rights, foreclosed real estate, net deferred tax asset, defined benefit pension plan and fair value measurements are critical. The determination of the carrying amounts for all of these items involves considerable subjective judgment and estimation by management. For additional information regarding our critical accounting policies and estimates, refer to our 2014 Annual Report on Form 10-K.

38

Selected Financial Data

The following selected financial data should be read in conjunction with Item 1. Financial Statements and Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands, except per share data).

	At and for the three months ended
	March 31, 2015			December 31, 2014			September 30, 2014			June 30, 2014			March 31, 2014
STATEMENTS OF INCOME
Interest income	$	9,986		$	9,783		$	9,871		$	9,920		$	10,076
Interest expense		134			123			126			131			143
Net interest income		9,852			9,660			9,745			9,789			9,933
Provision for loan losses		400			(1,800	)		(500	)		-			-
Net interest income after provision for loan losses		9,452			11,460			10,245			9,789			9,933
Noninterest income		3,541			3,274			3,408			3,490			3,366
Noninterest expense		8,794			9,486			10,482			10,084			10,089
Net income before provision for income taxes		4,199			5,248			3,171			3,195			3,210
Provision for income taxes		1,467			1,930			1,189			1,168			1,182
Net income	$	2,732		$	3,318		$	1,982		$	2,027		$	2,028
COMMON AND PER SHARE DATA
Net income per common share:
Basic	$	0.21		$	0.26		$	0.15		$	0.16		$	0.16
Diluted		0.21			0.26			0.15			0.16			0.16
Cash dividends declared per common share		0.08			0.05			0.05			-			-
Book value per common share		10.62			10.39			10.27			10.18			9.92
Outstanding common shares		12,814,574			12,810,388			12,793,543			12,791,621			12,792,509
Weighted average basic common shares		12,715,972			12,710,934			12,710,091			12,690,287			12,675,257
Weighted average diluted common shares		12,851,076			12,814,738			12,771,634			12,744,931			12,707,444
Dividend payout ratio		37.5	%		19.2	%		32.3	%		n/a	%		n/a	%
PERIOD-END BALANCES
Total assets	$	1,173,222		$	1,118,811		$	1,097,175		$	1,091,665		$	1,099,407
Investment securities available for sale, at fair value		211,968			211,511			214,582			209,617			208,772
Total loans, including loans held for sale		835,629			806,184			777,215			757,923			758,352
Deposits and retail repurchase agreements		980,139			944,241			960,339			946,120			945,352
Federal Home Loan Bank advances		50,000			35,000			-			10,000			20,000
Shareholders' equity		136,028			133,044			131,335			130,254			126,952
AVERAGE BALANCES
Total assets	$	1,141,944		$	1,100,296		$	1,090,636		$	1,099,617		$	1,094,578
Interest-earning assets		1,075,115			1,035,282			1,024,657			1,031,877			1,023,513
Investment securities available for sale, at fair value		210,892			212,301			210,929			207,575			212,186
Total loans, including loans held for sale		814,489			772,621			753,711			755,199			764,526
Deposits and retail repurchase agreements		952,906			960,232			952,314			952,768			931,828
Federal Home Loan Bank advances		48,057			2,663			2,174			13,187			31,222
Other borrowings		-			6			-			6			54
Shareholders' equity		134,186			132,823			131,094			128,612			125,664
SELECT PERFORMANCE RATIOS
Return on average assets		0.97	%		1.20	%		0.72	%		0.74	%		0.75	%
Return on average shareholders' equity		8.26			9.91			6.00			6.32			6.54
Net interest margin		3.72			3.70			3.77			3.81			3.94
CAPITAL RATIOS
Average shareholders' equity as a percentage of average assets		11.75	%		12.07	%		12.02	%		11.70	%		11.48	%
Shareholders' equity as a percentage of assets		11.59			11.89			11.97			11.93			11.55
Common equity Tier 1 capital		14.37			-			-			-			-
Tier 1 risk-based capital		14.37			15.00			15.41			15.29			14.82
Total risk-based capital		15.63			16.26			16.67			16.54			16.08
Tier 1 leverage		11.86			12.15			12.01			11.69			11.37
ASSET QUALITY INFORMATION
Allowance for loan losses	$	12,914		$	12,920		$	15,366		$	15,596		$	16,243
Nonaccrual loans		10,362			12,463			14,611			15,269			14,035
Nonperforming assets		16,139			18,447			21,256			22,693			21,538
Loans 90 days past due and still accruing interest		233			238			243			731			-
Net loans charged-off (recovered)		406			646			(270	)		647			242
Allowance for loan losses as a percentage of gross loans		1.55	%		1.60	%		1.98	%		2.07	%		2.15	%
Nonaccrual loans and loans 90 days past due and still accruing interest as a percentage of gross loans		1.27			1.58			1.91			2.12			1.86
Nonperforming assets and loans 90 days past due and still accruing interest as a percentage of total assets		1.40			1.67			1.96			2.15			1.96
Net loans charged-off (recovered) as a percentage of average gross loans, annualized		0.20			0.33			(0.14	)		0.34			0.13
OTHER DATA
Number of full-service branches		25			25			25			25			25
Number of full-time equivalent teammates		290.3			285.8			289.0			298.8			305.0

39

Executive Summary

Company Overview

Our financial results were significantly impacted by the recession from December 2007 to June 2009 (commonly referred to as the “Great Recession”) and its aftermath. In 2009, the Board of Directors and Company leadership adopted and began executing a proactive and aggressive Strategic Project Plan to address the Company’s issues resulting from the Great Recession. The Strategic Project Plan and subsequent annual strategic plans included significant strategic changes to the Company’s operations. These strategic changes resulted in a reduction in problem assets, additional capital, a repositioned balance sheet, an improved and more efficient infrastructure and enhanced product and service offerings. In addition, we reconstituted our Senior Leadership Team, returned to annual profitability in 2013 and exited all formal regulatory directives in 2014.

Our net income for the three months ended March 31, 2015 was $2.7 million ($0.21 per diluted common share). Our financial results since 2013 have reflected a growth strategy that includes controlled and managed growth concentrating first on organic loan and deposit growth, supplemented by tactical investments in other earning assets pending sustained loan growth that may be funded short-term by wholesale borrowing. We believe our growth strategy will continue to generate more stable and predictable earnings on a going-forward basis.

Our performance going forward is subject to numerous risks and uncertainties, many of which are beyond our control, and we can provide no assurance regarding the sustainability of, or improvement in, future earnings. In addition, the pace of future problem asset resolution activities may vary and, as a result, the level of credit-related expenses may fluctuate from period to period.

First Quarter 2015 Highlights

Since 2013 we have been focused on our forward-looking Value Creation Strategy with particular focus on the Client and Teammate Experiences under the mantra of “every experience counts.” The Client Experience is focused on execution of a comprehensive and intentional approach to engendering a “positive personal experience” for all interactions with the Bank. The Teammate Experience is focused on a culture of high performance in which our team is inspired to do its best and win against the competition. Both involve innovative and creative thinking to meet evolving market and teammate expectations. Our ongoing strategic decisions and investments are determined in the context of executing on the Client and Teammate Experiences, both of which, along with achieving high performing financial results, are expected to increase the value of The Palmetto Bank franchise.

For the three months ended March 31, 2015, the Company reported net income of $2.7 million compared to $2.0 million for the three months ended March 31, 2014. The results of operations for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014 were primarily influenced by the following factors:

● Net interest income decreased $81 thousand, and net interest margin decreased 22 basis points to 3.72%. The decrease in net interest income was due to a reduction in interest income on loans resulting primarily from higher-yielding loans maturing and being replaced with new loan originations at lower rates in the current low interest rate environment and a decline in investment securities rates. Partially offsetting this decline was net growth in average loans, an increase in trading account assets and a reduction in time deposit balances and costs as a result of a strategic reduction in higher-priced certificates of deposit.

● Beginning in late 2014 and continuing into the first quarter 2015, we initiated an earning asset strategy to begin 2015 with a higher level of earning assets, both to replace unscheduled loan payoffs in the fourth quarter 2014 and to supplement temporarily our organic loan growth to start 2015. The strategy included retaining on our balance sheet residential mortgage and SBA loan production, and purchases of loan pools, loan participations and trading account assets. Earning asset purchases during the past three quarters totaled $57.9 million and consisted of a pool of residential mortgage loans for $14.0 million in the third quarter 2014, a pool of indirect auto loans for $22.1 million in the fourth quarter 2014, a commercial loan participation of $5.0 million in the fourth quarter 2014, a pool of residential mortgage loans for $12.3 million in the first quarter 2015, and an additional investment in our trading account of $4.5 million in the first quarter 2015. The purchased loans were subjected to our normal internal due diligence and underwriting guidelines prior to purchase. The earning asset purchases were primarily funded by FHLB advances on a short-term basis which we expect to replace with deposits in 2015. At this time, we do not anticipate any additional loan pool purchases.

40

● The provision for loan losses was $400 thousand compared to no provision in the first quarter 2014. The provision in the first quarter 2015 reflects a provision for growth in the loan portfolio, offset somewhat by our improved credit quality, an increasing proportion of commercial loans that have been more recently originated under our improved underwriting standards and generally improving economic conditions. Both quarters reflect continued improvement in the risk profile of the loan portfolio.

● Total credit-related expenses, defined as foreclosed real estate writedowns and expenses and loan workout expenses, declined $484 thousand from the first quarter 2014, reflecting continued improvement in credit quality.

● Mortgage-banking income increased $172 thousand from the three months ended March 31, 2014 to the three months ended March 31, 2015 due to an increase in mortgage loan sales and an increase in income from the market value adjustment for mortgage banking derivatives. The increase in mortgage loan sales reflects a higher level of overall mortgage loan production.

● Salaries and other personnel expense declined $44 thousand as a result of fewer average full-time equivalent teammates and contract personnel (primarily related to reduced branch hours to better match client usage patterns of our various delivery channels, refined branch roles resulting in reduced headcount and process improvement initiatives that allowed us to combine certain positions), lower medical insurance premiums and lower pension plan expense partially offset by increased incentive accruals and annual merit increases that went into effect in February 2015.

● Professional services expense decreased $225 thousand from the first quarter 2014 to the first quarter 2015 primarily as a result of a decline in expenses related to the revenue enhancement and process improvement projects during the first quarter 2014 that were not incurred during the first quarter 2015.

● Through organic loan originations and purchased loans, we experienced a 3.4% increase in gross loans that outpaced normal and unscheduled pay-offs. Excluding loan pool purchases, first quarter 2015 organic loan growth was 2.4%. The face amount of organic loan originations in first quarter 2015 were $84.0 million, compared to $54.5 million in first quarter 2014. As noted above, during 2014 we retained on our balance sheet a portion of residential mortgage and SBA production; in January 2015 we resumed selling our residential mortgage and SBA production.

● Core deposits (defined as total deposits excluding time deposits of $100 thousand and greater) grew by $42.7 million to $903.6 million (overall cost of deposits of 0.04%).

● Based on a competitive market analysis, we implemented selected fee increases effective July 1, 2014 and September 1, 2014 which resulted in increased revenues beginning in the third quarter 2014 that continued in the first quarter 2015.

● We completed a number of process improvements to reduce expenses with the reductions beginning primarily in the third quarter 2014 that continued into the first quarter 2015, including refinement of our staffing model in our Retail branches resulting in fewer full-time equivalent employees.

● We declared a dividend of $0.08 per common share in January 2015 which was paid in February 2015. We also declared a dividend of $0.08 per common share in April 2015 based on first quarter 2015 results which will be paid on May 18, 2015.

● We continued to implement technological enhancements to improve the Client Experience, risk management and operational efficiency. Examples in first quarter 2015 related to the Client Experience include mobile deposits as well as additional products including online consumer loan applications and an upgraded website.

● Our common stock continued to be included in the small-cap Russell 2000® Index, and our stock price appreciated 14% during the first quarter 2015.

41

Financial Condition 

The following discussion and analysis of our financial condition is provided on a consolidated basis with commentary on business specific implications where more granular information is available.

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(in thousands) (unaudited)

	March 31,			December 31,			Dollar			Percent
	2015			2014			variance			variance
Assets
Cash and cash equivalents
Cash and due from banks	$	57,488		$	36,887		$	20,601			55.8	%
Total cash and cash equivalents		57,488			36,887			20,601			55.8
Federal Home Loan Bank stock, at cost		3,132			2,556			576			22.5
Trading account assets, at fair value		10,114			5,513			4,601			83.5
Investment securities available for sale, at fair value		211,968			211,511			457			0.2
Mortgage loans held for sale		3,600			1,125			2,475			220.0
Loans, gross		832,029			805,059			26,970			3.4
Less: allowance for loan losses		(12,914	)		(12,920	)		6			-
Loans, net		819,115			792,139			26,976			3.4
Premises and equipment, net		21,858			22,006			(148	)		(0.7	)
Accrued interest receivable		3,481			3,387			94			2.8
Foreclosed real estate		5,756			5,949			(193	)		(3.2	)
Deferred tax asset, net		15,127			17,053			(1,926	)		(11.3	)
Bank-owned life insurance		12,000			11,923			77			0.6
Other assets		9,583			8,762			821			9.4
Total assets	$	1,173,222		$	1,118,811		$	54,411			4.9	%
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing	$	208,338		$	196,219		$	12,119			6.2	%
Interest-bearing		758,652			732,101			26,551			3.6
Total deposits		966,990			928,320			38,670			4.2
Retail repurchase agreements		13,149			15,921			(2,772	)		(17.4	)
Federal Home Loan Bank advances		50,000			35,000			15,000			42.9
Other liabilities		7,055			6,526			529			8.1
Total liabilities		1,037,194			985,767			51,427			5.2
Shareholders' equity
Preferred stock		-			-			-			-
Common stock		128			128			-			-
Capital surplus		145,576			145,384			192			0.1
Accumulated deficit		(859	)		(2,565	)		1,706			(66.5	)
Accumulated other comprehensive loss, net of tax		(8,817	)		(9,903	)		1,086			(11.0	)
Total shareholders' equity		136,028			133,044			2,984			2.2
Total liabilities and shareholders' equity	$	1,173,222		$	1,118,811		$	54,411			4.9	%

Cash and Cash Equivalents

Carrying excess cash has a negative impact on our interest income since we currently only earn 25 basis points on our deposits with the Federal Reserve. As a result, we have strategically managed our cash to avoid holding excess cash balances. From time-to-time we may allow cash balances to increase to fund projected loan growth or maturing FHLB advances. In such cases, to supplement our earnings on excess cash we may deposit a portion of our excess funds in money market accounts at third party institutions that are well-capitalized under the regulatory capital rules that earn a return in excess of that available at the Federal Reserve.

Concentrations and Restrictions. From time to time, we may sell federal funds to, or place deposits with, other financial institutions. Federal funds and any deposits in excess of FDIC insurance limits are essentially uncollateralized overnight loans. We regularly evaluate the risk associated with the potential counterparties to these transactions to ensure that we would not be exposed to any significant risks with regard to cash and cash equivalent balances if we were to sell federal funds or place deposits in amounts in excess of FDIC insurance limits. At March 31, 2015 we had deposits of $4.9 million and $5.1 million with two financial institutions which exceed FDIC insurance limits in both instances. At December 31, 2014, we did not have any material deposits in excess of FDIC insurance limits with other financial institutions.

42

FHLB Stock

As an FHLB member, we are required to purchase and maintain stock in the FHLB. At December 31, 2014, we owned FHLB stock with a carrying value of $2.6 million. During the first quarter 2015, we purchased $1.5 million in FHLB stock, and the FHLB redeemed $958 thousand of our FHLB stock at book value thereby decreasing our balance to $3.1 million at March 31, 2015. No ready market exists for this stock, and it has no quoted market value. Purchases and redemptions are normally transacted each quarter to adjust our investment to an amount based on FHLB requirements. Requests for redemptions are met at the discretion of the FHLB. We have experienced no interruption in such redemptions. Dividends are paid on this stock at the discretion of the FHLB. The average dividend yield for the three months ended March 31, 2015 and 2014 was 1.55% and 2.08%, respectively. There can be no guarantee of future dividends.

Trading Account Assets

As part of our strategy to diversify our revenues, effectively utilize our cash balances and increase our earning assets, we have invested a total of $9.5 million in an account managed by a third party to trade municipal securities. Under the account agreement, the third party has discretionary power to trade in the account subject to certain contractual restrictions. The investment strategy is to trade small and odd lot municipal securities which tend to trade at wider bid and offered spreads, allowing for higher trading profits than larger block sizes. By trading in small and odd lot municipal securities, the account takes advantage of trading opportunities by allocating funds across a wide variety of securities that are immediately available for resale to broker-dealers, financial planners and electronic trading companies. Cash in the account pending investment in municipal bonds is generally held in liquid, insured bank deposits. We may withdraw trading account assets related to our initial investment of $5 million from the account subject to 30-days’ written notice. As a component of our earning asset strategy, in order to begin 2015 with a higher level of earning assets we invested an additional $4.5 million in the trading account in January 2015. This additional investment is restricted from withdrawal until January 2016.

At March 31, 2015, the trading account included municipal securities of $8.0 million and insured bank deposits of $2.1 million. At December 31, 2014, the trading account included municipal securities of $4.1 million and insured bank deposits of $1.4 million.

All of the municipal securities included in trading account assets at March 31, 2015 were investment grade.

Investment Securities Available for Sale

Composition. The fair value of the investment securities available for sale portfolio represented 18.1% and 18.9% of total assets at March 31, 2015 and December 31, 2014, respectively.

The following table summarizes the amortized cost and fair value composition of our investment securities available for sale portfolio at the dates indicated (dollars in thousands).

	March 31, 2015							December 31, 2014
	Amortized		Fair		% of			Amortized		Fair		% of
	cost		value		total			cost		value		total
U.S. agency	$	3,167	$	3,235		1.5	%	$	3,930	$	3,965		1.9	%
State and municipal		7,802		7,870		3.7			6,665		6,732		3.2
Collateralized mortgage obligations (federal agencies)		88,901		88,687		41.8			89,311		87,774		41.5
Other mortgage-backed (federal agencies)		78,626		78,968		37.3			78,532		78,503		37.1
SBA loan-backed (federal agency)		33,041		33,208		15.7			34,394		34,537		16.3
Total investment securities available for sale	$	211,537	$	211,968		100.0	%	$	212,832	$	211,511		100.0	%

The net unrealized gain on investment securities available for sale at March 31, 2015 reflects fluctuations in interest rates since the dates the securities were purchased.

All of the investment securities available for sale at March 31, 2015 were investment grade.

We continue to evaluate the interest rate sensitivity of our investment securities portfolio in anticipation of rising interest rates. At March 31, 2015, the estimated decrease in fair value resulting from an instantaneous 100 basis point increase in interest rates was 3.11%.

43

Maturities. The following table summarizes the amortized cost and book yield of investment securities available for sale at March 31, 2015 by contractual maturity and estimated principal repayment distribution (dollars in thousands). U.S. agency and state and municipal securities are organized based on contractual maturity. Principal amounts on collateralized mortgage obligations, other mortgage-backed securities and SBA loan-backed securities are not due at a single maturity date and are subject to early repayment based on prepayment activity of underlying loans. Therefore, collateralized mortgage obligations, other mortgage-backed securities and SBA loan-backed securities are organized based on estimated cash flows using current prepayment assumptions.

	Amortized cost		Book yield
Due in one year or less	$	-		-	%
Due after one year through five years		2,015		1.6
Due after five years through ten years		1,152		2.5
Due after ten years		-		-
U.S. agency		3,167		1.9
Due in one year or less		1,548		3.8
Due after one year through five years		2,039		2.6
Due after five years through ten years		4,215		2.2
Due after ten years		-		-
State and municipal		7,802		2.6
Due in one year or less		300		2.0
Due after one year through five years		14,408		1.9
Due after five years through ten years		74,193		2.4
Due after ten years		-		-
Collateralized mortgage obligations (federal agencies)		88,901		2.3
Due in one year or less		-		-
Due after one year through five years		39,524		1.9
Due after five years through ten years		19,866		1.1
Due after ten years		19,236		1.4
Other mortgage-backed (federal agencies)		78,626		1.6
Due in one year or less		-		-
Due after one year through five years		17,774		1.3
Due after five years through ten years		7,552		1.7
Due after ten years		7,715		2.6
SBA loan-backed (federal agency)		33,041		1.7
Due in one year or less		1,848		3.5
Due after one year through five years		75,760		1.8
Due after five years through ten years		106,978		2.1
Due after ten years		26,951		1.7
Total investment securities available for sale	$	211,537		2.0	%

Concentrations. The following table summarizes issuer concentrations of collateralized mortgage obligations for which aggregate fair values exceed 10% of shareholders’ equity at March 31, 2015 (dollars in thousands).

	Aggregate		Aggregate		Fair value as a % of
Issuer	amortized cost		fair value		shareholders' equity
Federal Home Loan Mortgage Corporation	$	59,219	$	59,503		43.7	%
Government National Mortgage Association		22,684		22,221		16.3

The following table summarizes issuer concentrations of other mortgage-backed investment securities for which fair values exceed 10% of shareholders’ equity at March 31, 2015 (dollars in thousands).

	Aggregate		Aggregate		Fair value as a % of
Issuer	amortized cost		fair value		shareholders' equity
Government National Mortgage Association	$	64,758	$	65,152		47.9	%

Pledged. At March 31, 2015 and December 31, 2014, securities totaling $123.4 million and $133.2 million, respectively, were pledged to secure municipal and certain other deposits, retail repurchase agreements and Federal Reserve and certain correspondent bank lines of credit.

44

Lending Activities

Gross loans continue to be the largest component of our assets and primary generator of interest income. The following table summarizes activity within gross loans at the dates and for the periods indicated (in thousands).

	At and for the three months ended March 31,
	2015		2014
Gross loans, beginning of period	$	805,059	$	767,513
Additions:
Purchased mortgage loans		12,326		-
Loan originations, net of paydowns and other reductions		18,548		-
Total additions		30,874		-
Reductions:
Transfers to foreclosed real estate		1,890		455
Transfers to other loans held for sale		1,608		1,166
Net loans charged-off		406		242
Paydowns and other reductions net of loan originations		-		9,772
Total reductions		3,904		11,635
Gross loans, end of period	$	832,029	$	755,878

We are aggressively pursuing organic loan growth to generate a higher level of interest-earning assets. While improved over the past three quarters, current demand for new loans from credit-worthy borrowers is not consistent or sustained and, therefore, very competitive with reduced rates. We have experienced uneven but generally improved loan origination volumes since 2012 in certain products and markets. The face amount of total organic loan production, excluding loan purchases, was $84.0 million and $54.5 million for the three months ended March 31, 2015 and 2014, respectively.

To offset unscheduled commercial loan payoffs, supplement organic loan growth and begin 2015 with a higher level of earning assets, during the past three quarters we purchased $14.0 million of performing jumbo hybrid adjustable-rate residential mortgages, $22.1 million of performing indirect auto loans, a $5.0 commercial loan participation, $12.3 of performing jumbo hybrid adjustable-rate residential mortgages and retained residential mortgage and SBA loan production that we normally would have sold. In January 2015, we resumed selling our residential mortgage and SBA loan production in the secondary market.

The following table summarizes purchased loan balances included in gross loans at the dates indicated (in thousands).

	March 31, 2015		December 31, 2014		September 30, 2014
Gross loans, as reported	$	832,029	$	805,059	$	776,947
Purchased mortgage loans		24,394		13,866		13,974
Purchased commercial loan participation		4,937		5,000		-
Purchased indirect automobile loans		20,516		22,111		-
Total purchased loans		49,847		40,977		13,974
Gross loans, organic	$	782,182	$	764,082	$	762,973

We believe that our organic loan pipeline beginning the second quarter 2015 is strong. While we do not currently anticipate additional loan purchases, to the extent organic loan production slows or unscheduled payoffs exceed our organic loan growth, we may once again retain residential mortgage and SBA loan production and consider additional loan purchases in the future.

Other Loans Held for Sale. For disclosure regarding activity within other loans held for sale for the three months ended March 31, 2015 and 2014, see Item 1. Financial Statements, Note 6, Other Loans Held for Sale.

During the three months ended March 31, 2015 and 2014, we sold SBA loans for proceeds totaling $1.7 million and $1.2 million, respectively, and recognized gains of $123 thousand and $70 thousand, respectively.

Loan Composition. See Item 1. Financial Statements, Note 5, Loans, for a summary of gross loans categorized by portfolio segment as of March 31, 2015 and December 31, 2014. Mortgage loans serviced for the benefit of others totaled $373.5 million and $375.1 million at March 31, 2015 and December 31, 2014, respectively, and are not included in our Consolidated Balance Sheets since they are not owned by us.

Concentrations. At March 31, 2015, commercial real estate loans comprised 51.7% of gross loans and 295.0% of the Bank’s total regulatory capital and are primarily concentrated within nonfarm nonresidential commercial real estate.

Pledged. The Bank must pledge collateral to borrow from the FHLB and cover the various Federal Reserve services that are available for use by the Bank. For disclosure regarding pledged loan collateral, see Item 1. Financial Statements, Note 5, Loans.

45

Asset Quality. Our commercial real estate loan portfolio was negatively impacted by the Great Recession. The primary contributor to our deteriorated asset quality and net losses from 2009 to 2012 resulted from a pool of loans that exhibited a loss rate much higher than the remainder of the loan portfolio (the pool of loans was comprised of 57 individual loans that resulted in $97.5 million (51%) of the $191.9 million of net loan charge offs and writedowns on other loans held for sale and foreclosed real estate recorded from 2009 to 2013). This pool of loans was comprised primarily of loans that were originated in 2004 to 2008, and that were larger and more complex commercial real estate loans than historically originated, generally not originated and underwritten by our loan officers (i.e., brokered and participated loans), not to existing clients of the Bank and not in our operating markets. This pool of loans exhibited a loss rate much higher than the remainder of our loan portfolio. By the end of 2012, we had substantially resolved this pool of problem loans and, as a result, our credit losses since then have been much lower. While our credit quality metrics have improved significantly from their negative peak levels, we continue to work aggressively to resolve our remaining problem assets.

Nonperforming Assets. The following table summarizes nonperforming assets, by class, at the dates indicated (dollars in thousands).

	March 31,			December 31,
	2015			2014
Commercial real estate
Construction, land development and other land loans	$	345		$	441
Multifamily residential		-			-
Nonfarm nonresidential		6,842			8,174
Total commercial real estate		7,187			8,615
Single-family residential
Single-family real estate, revolving, open-end loans		702			977
Single-family real estate, closed-end, first lien		1,821			1,928
Single-family real estate, closed-end, junior lien		47			78
Total single-family residential		2,570			2,983
Commercial and industrial		469			715
Indirect automobile		113			116
All other consumer		23			34
Total consumer		136			150
Total nonaccrual loans		10,362			12,463
Foreclosed real estate		5,756			5,949
Repossessed personal property		21			35
Total foreclosed real estate and repossessed personal property		5,777			5,984
Total nonperforming assets	$	16,139		$	18,447
Over 90 days past due and still accruing interest	$	233		$	238
Troubled debt restructurings included in nonaccrual loans above		4,987			4,286
Loans		832,029			805,059
Total assets		1,173,222			1,118,811
Total nonaccrual loans as a percentage of:
loans*		1.25	%		1.55	%
total assets		0.88			1.11
Total nonperforming assets and loans over 90 days and still accruing interest as a percentage of:
loans* and foreclosed real estate and repossessed personal property		1.95	%		2.30	%
total assets		1.40			1.67

Total loans migrating into nonaccrual status were $1.5 million and $2.0 million for the three months ended March 31, 2015 and 2014, respectively. We believe the overall trend in reduced loans migrating into nonaccrual status is an indication of improving credit quality in our overall loan portfolio and a leading indicator of reduced credit losses going forward.

Nonaccrual loans with balances greater than $1 million totaled $3.3 million at March 31, 2015 and were comprised of two loans collateralized by residential lots in conjunction with golf course developments. None of these loans were out-of-market or purchased participation loans.

Additional interest income of $80 thousand would have been reported during the three months ended March 31, 2015 had loans classified as nonaccrual during the period performed in accordance with their current contractual terms. As a result, our earnings did not include this interest income.

46

The following table summarizes the foreclosed real estate portfolio, by class, at the date indicated (in thousands).

	March 31, 2015
Construction, land development and other land	$	4,905
Single-family residential		381
Nonfarm nonresidential		470
Total foreclosed real estate	$	5,756

Included in foreclosed real estate at March 31, 2015 were 55 residential lots with an aggregate net book value of $4.4 million in three separate communities related to one real estate development. We recorded writedowns on these properties during the three months ended March 31, 2015 and 2014 of $3 thousand and $131 thousand, respectively, to reflect declines in fair value. In 2013, ownership of the development was consolidated and its development and marketing plan was refined. We continue to work directly with the primary owner to market and sell our remaining lots. During the fourth quarter 2014 and first quarter 2015, seven lots with a carrying value of $1.1 million were sold at gains. While our recent sales were at prices above carrying values, the ongoing resolution may result in sales at losses or writedowns based on receipt of annual appraisals. Due to the number of lots owned, absent a bulk sales of the lots, the resolution of these remaining lots may occur over several years.

For disclosure regarding balances of and changes in foreclosed real estate at and for the three months ended March 31, 2015 and 2014, see Item 1. Financial Statements, Note 9, Foreclosed Real Estate and Repossessed Personal Property.

The following table summarizes the components of foreclosed real estate writedowns charged to expense for the periods indicated (in thousands).

	For the three months ended March 31,
	2015		2014
Writedowns related to the receipt of updated appraisals	$	3	$	123
Writedowns related to the execution of sales contracts		124		73
Total foreclosed real estate writedowns charged to expense	$	127	$	196

Troubled Debt Restructurings. Troubled debt restructurings are loans for which we made concessions to the borrowers when they were restructured from their original contractual terms due to financial difficulty of the borrower (for example, a reduction in the contractual interest rate below that at which the borrower could obtain new credit from another lender). As part of our proactive actions to resolve problem loans and the resulting individual loan workout plans, we may restructure loans to assist borrowers facing cash flow challenges to facilitate ultimate repayment of the loan and minimize our loss. Troubled debt restructurings totaled $19.2 million and $19.9 million at March 31, 2015 and December 31, 2014, respectively, of which $5.0 million (25.9%) and $4.3 million (21.6%) were in nonaccrual status.

Five individual loans greater than $1 million comprised $15.5 million (80.3%) of our troubled debt restructurings at March 31, 2015. One of these loans experienced a term concession, one experienced rate and term concessions, one experienced rate and term concessions as well as principal reduction, one experienced a reduction in principal and one experienced a rate concession. At March 31, 2015, one of the five troubled debt restructurings individually greater than $1 million was in nonaccrual status.

For additional disclosure regarding troubled debt restructurings and impaired loans, see Allowance for Loan Losses below and Item 1. Financial Statements, Note 5, Loans.

Potential Problem Loans (accruing loans risk rated 6 or 7 under our risk rating system and, therefore, classified as substandard and doubtful, respectively). We monitor these loans closely and review performance on a regular basis. As of March 31, 2015, total potential problem loans totaled $31.5 million, of which $5.8 million were troubled debt restructurings.

Allowance for Loan Losses. The allowance for loan losses totaled $12.9 million, or 1.55% of gross loans, at March 31, 2015, compared to $12.9 million, or 1.60% of gross loans, at December 31, 2014. The reduced coverage percentage at March 31, 2015 as compared to December 31, 2014 was the result of the continued overall improvement in credit quality and reduced risk profile of the loan portfolio as discussed above.

In general, since 2012 we have experienced improved trends in certain credit-quality metrics related to our loan portfolio, and, as a result, nonaccrual loans of $10.4 million at March 31, 2015 represented a 90.8% reduction from the peak at March 31, 2010 and a 16.9% reduction from December 31, 2014. In addition, the loss severity on individual problem loans has decreased as we obtain annual appraisals. Overall loan loss rates have declined in each of the last five years and were $406 thousand (0.20% of average gross loans) during the first quarter 2015 as compared to $242 thousand (0.13% of average gross loans) during the first quarter 2014.

47

We continue to pursue collection of charged-off loans, which may result in recoveries in future periods. Recoveries during the first quarter 2015 totaled $299 thousand. During 2014, recoveries totaled $1.8 million. Additional recoveries, some of which may be individually significant, may occur in the future. Recoveries and/or other reductions in the allowance for loan losses may also reduce the provision for loan losses recorded in future periods. Conversely, there can be no assurance that loan losses in future periods will not exceed the current allowance for loan losses or that future increases in the allowance for loan losses will not be required. Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses thus adversely impacting our business, financial condition, results of operations and cash flows.

We sold certain foreclosed real estate properties at gains in 2014 and during the first quarter 2015. While it appears that appraised values on commercial real estate have stabilized, some appraisals continue to indicate reduced values with a few now showing increased values. Given our relatively heavy concentration in commercial real estate loans, including individually large loans, we continue to maintain an allowance for loan losses at an elevated amount compared to historical levels.

The allowance for loan losses at March 31, 2015, and indirectly the provision for loan losses for the three months ended March 31, 2015, was determined based on the following specific factors, though this is not intended to be an all-inclusive list:

● The impact of the overall economic environment including inconsistent month to month economic indicators, business activity and loan production within our market,

● The cumulative impact (although generally improving) of the extended duration of the economic environment on our clients, in particular commercial real estate loans for which we have a concentration,

● The level of real estate development loans in which the majority of our losses have occurred although such loans have decreased 82.0% since June 30, 2009 (peak quarter-end real estate development loans),

● The asset-quality metrics of our loan portfolio including a higher than historical level of nonperforming assets at March 31, 2015 although, while still at an elevated level, nonperforming assets decreased 88.6% from the peak at March 31, 2010,

● Our criticized loans decreased 6.3% from December 31, 2014.

● The trend and elevated level of the historical loan loss rates (and recoveries) within our loan portfolio,

● The results of our internal and external loan reviews and

● Our individual impaired loan analysis which identified improving but some stress on certain borrowers based on liquidity and stabilizing but still generally lower appraised values and market assumptions used to value real estate dependent loans.

48

The following table summarizes allowance for loan losses activity, by portfolio segment, at the dates and for the periods indicated (dollars in thousands). Loans charged-off and recovered are charged or credited to the allowance for loan losses at the time realized.

	At and for the three months ended March 31,
	2015			2014
Allowance for loan losses, beginning of period	$	12,920		$	16,485
Provision for loan losses		400			-
Loans charged-off
Commercial real estate		398			161
Single-family residential		25			104
Commercial and industrial		73			-
Consumer		45			56
Other		164			155
Total loans charged-off		705			476
Recoveries
Commercial real estate		52			5
Single-family residential		18			91
Commercial and industrial		135			12
Consumer		17			31
Other		77			95
Total loans recovered		299			234
Net loans charged-off		406			242
Allowance for loan losses, end of period	$	12,914		$	16,243
Average gross loans	$	812,622		$	762,939
Loans, gross		832,029			755,878
Nonaccrual loans		10,362			14,035
Net loans charged-off as a percentage of average gross loans		0.20	%		0.13	%
Allowance for loan losses as a percentage of gross loans		1.55			2.15
Allowance for loan losses as a percentage of nonaccrual loans		124.63			115.73

Included within loans charged-off were charge-offs on loans individually evaluated for impairment for the three months ended March 31, 2015 and 2014 totaling $386 thousand and $10 thousand, respectively.

At March 31, 2015, we had seven loan relationships totaling $40.4 million with Bank-funded interest reserves totaling $1.7 million. None of these loans were considered impaired at December 31, 2014.

At March 31, 2015 and December 31, 2014, impaired loans totaled $28.7 million and $31.6 million, respectively, of which $19.2 million and $19.9 million, respectively, were classified as troubled debt restructurings. At March 31, 2015, 80.9% of our loans evaluated individually for impairment, net of related allowance for loan losses, were valued based on the estimated fair value of collateral and 19.1%, net of related valuation allowance, were valued based on the present value of estimated future cash flows.

For additional disclosure regarding changes in the allowance for loan losses and recorded investment in gross loans, see Item 1. Financial Statements, Note 5, Loans.

While we utilize the best judgment and information available to us, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond our control including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. Absent the impact of unexpected negative trends in credit quality, we expect our allowance for loan losses coverage ratio to be reduced further in 2015 which could possibly result in a negative provision for loan losses.

Premises and Equipment, net

Premises and equipment, net decreased $148 thousand (0.7%) during the first quarter 2015 due primarily to depreciation of $588 thousand, partially offset by investments in technology.

Net Deferred Tax Asset

As of March 31, 2015, net deferred tax assets of $15.1 million were recorded in our Consolidated Balance Sheet. A portion of the net deferred tax asset includes the after-tax impact of net operating losses and realized built-in loss carryforwards. Based on available information as of this date, we determined that a valuation allowance against the deferred tax asset was not necessary.

Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because the future occurrence of events and circumstances cannot be predicted with certainty. The net operating losses and realized built-in losses generated in 2010, 2011 and 2012 may be carried forward for income tax purposes up to 20 years. Thus, to the extent we generate sufficient taxable income in the future, we may be able to utilize the net operating losses and realized built-in losses for income tax purposes. The determination of how much of the net operating losses and realized built-in losses we expect to ultimately utilize, and the resulting recognition of these tax benefits in the Consolidated Balance Sheets, is based on sustained trends in our profitability and the projected utilization of deferred tax assets.

49

For disclosure regarding the impact of the Private Placement on our net deferred tax asset, see Item 1. Financial Statements, Note 14, Income Taxes.

Bank-Owned Life Insurance

As an alternative source of income and to fund overall teammate benefits costs, we own two BOLI policies on certain members of our leadership team for which all premiums were paid by us. Each policy was funded with a premium of $5.0 million paid to an AA+ rated insurance company, and we are the sole beneficiary of the policies. To encourage the covered teammates to consent to the coverage, the Bank provided a $50 thousand taxable death benefit payable to the named beneficiaries of the covered teammates in the event of the death of a covered teammate while employed by the Bank. The policies are reflected in the Consolidated Balance Sheets at the cash surrender value at March 31, 2015. Income from these policies and changes in the cash surrender value are recorded in other noninterest income. During the three months ended March 31, 2015 and 2014, earnings on these policies totaled $77 thousand and $74 thousand, respectively, none of which was due to the death benefit.

Deposit Activities

Deposits have historically been our primary source of funds and a competitive strength resulting in a cost of funds of 0.04% for the three months ended March 31, 2015, which reflects our strong core deposit franchise. Deposits also provide a client base for the sale of additional financial products and services and the recognition of fee income through service charges and other ancillary banking services. We set annual targets for deposit balances in an effort to increase the number of products per banking relationship and households we service as well as to manage the composition of our deposit funding. Deposits are attractive sources of funding because of their stability and generally low cost as compared with other funding sources. Over our 108-year history, we have developed long-standing relationships with clients in the communities in which we operate and achieved considerable name recognition, resulting in a well-established branch network and loyal deposit base. On account of these factors, we believe that we have developed a higher core deposit mix and a historically lower cost of deposits relative to our peers. This competitive advantage is not as pronounced in the current low interest-rate environment.

The following table summarizes our composition of deposits at the dates indicated (dollars in thousands).

	March 31, 2015					December 31, 2014
	Total		% of total			Total		% of total
Noninterest-bearing transaction deposits	$	208,338		21.6	%	$	196,219		21.2	%
Interest-bearing transaction deposits		358,195		37.0			332,414		35.8
Transaction deposits		566,533		58.6			528,633		57.0
Money market deposits		141,289		14.6			138,449		14.9
Savings deposits		95,815		9.9			90,318		9.7
Time deposits		163,353		16.9			170,920		18.4
Total deposits	$	966,990		100.0	%	$	928,320		100.0	%

The decline in time deposits has resulted in an improvement in our interest expense on deposits. Going forward, there is minimal opportunity for improvement in our cost of funds paid on deposits from maturing time deposits as time deposits that are scheduled to mature in 2015 are at a weighted-average rate of 0.12%. We may also pursue time deposits at higher interest rates to replace our FHLB advances outstanding at March 31, 2015.

Noninterest-bearing deposits increased $12.1 million during the first quarter 2015 while interest-bearing deposits increased $26.6 million during the same period primarily related to $10.5 million of trust account deposits placed with the Bank during the first quarter 2015 and the results of refined consumer and business strategies to increase balances in existing accounts, attract new accounts and grow the number of households served. These strategies include proactively focusing on client retention, attracting new clients including in markets with local bank disruption, hiring teammates with specialized deposit product knowledge, providing a rewards program to clients for referrals and use of debit cards and enhancing existing deposit products. The efforts were partially offset by a strategic reduction in time deposits to lower our overall cost of funds and focus our efforts on relationship banking to reduce the number of single-product households that only maintain time deposit accounts with the Bank. These increases were also impacted by current client trends to retain funds in deposit accounts rather than other investment options given the current interest rate environment.

50

Deposit accounts continue to be our primary source of funding. As part of our liquidity management, we proactively pursue core deposit retention initiatives with our deposit clients and strategies to increase our transaction deposit accounts in proportion to our total deposits. Such initiatives include a client rewards program to encourage clients to use their debit cards in order to increase the likelihood that these accounts become the clients’ primary checking account, which typically carries higher balances and has higher account retention. We also maintain a referral rewards program which rewards clients for referring new clients to the Bank. In 2014 we hired a business deposit specialist whose primary role is to grow operating accounts from businesses and to provide employer banking packages for the employees of our business clients. We also introduced enhancements to existing deposit products and implemented new deposit products in September 2014 and during the first quarter 2015.

From a liquidity standpoint given the expectation of rising interest rates in the future, we are monitoring on a monthly basis changes in the deposit balances of our top 100 depositors and evaluating their deposit behavior to understand the likelihood of retaining those deposits in the future.

Time Deposits $100 Thousand or Greater. Time deposits $100 thousand or greater totaled $63.4 million and $67.4 million at March 31, 2015 and December 31, 2014, respectively. We believe our balance sheet management efforts to attract and retain lower-priced transaction deposit accounts and reduce our higher-priced deposit base contributed to this decrease in jumbo time deposit accounts.

Borrowing Activities

Borrowings as a percentage of total liabilities increased from 5.2% at December 31, 2014 to 6.1% at March 31, 2015 resulting primarily from an increase in FHLB advances. For additional disclosure regarding our borrowings, see Item 1. Financial Statements, Note 12, Borrowings.

Retail Repurchase Agreements. We offer retail repurchase agreements as an alternative investment tool to conventional savings deposits. In connection with the agreements, the client buys an interest in a pool of U.S. government, U.S. agency or state and municipal investment securities. Funds are swept daily between the client and the Bank. Retail repurchase agreements are not insured deposits.

Wholesale Funding. Wholesale funding options for the Bank include lines of credit from correspondent banks, brokered time deposits, FHLB advances and the Federal Reserve Discount Window. Wholesale funding generally provides us with the ability to access the type of funding needed, at the time and amount needed, at market rates. This provides us with the flexibility to tailor borrowings to our specific needs. Interest rates on such borrowings vary in response to general economic conditions and, in the case of FHLB advances, may be at fixed or floating rates. Our earning asset purchases in 2014 and 2015 were primarily funded by FHLB advances of $50.0 million with a weighted-average rate of 0.26% at March 31, 2015. The FHLB advances outstanding at March 31, 2015 mature between April and July 2015. We expect to replace all or a portion of these advances through deposit growth in 2015. The FHLB advance that matured on April 30, 2015 was repaid from the Bank's available cash balances.

Correspondent Bank Lines of Credit. The following table summarizes the Bank’s correspondent bank lines of credit at both March 31, 2015 and December 31, 2014 (dollars in thousands).

	Secured		Unsecured		Total
Amount available	$	15,000	$	65,000	$	80,000
Number of lines available		2		6		8

None of the lines of credit were utilized as of either date. These correspondent bank funding sources may be canceled at any time at the correspondent bank’s discretion. 

Brokered Time Deposits. We have agreements in place that allow us to offer time deposit accounts on a national basis through brokers and on-line listing services. Brokered time deposits are a ready source of funds that are generally more expensive than time deposits obtained through our local markets. Brokered time deposits are generally only available to banks that are considered well-capitalized under the regulatory prompt corrective action regulations. Other than to periodically test access to such markets, we have not obtained brokered time deposits or time deposits from on-line listing services and had no such borrowings outstanding at March 31, 2015 or December 31, 2014.

51

FHLB Advances. We pledge investment securities and loans to collateralize FHLB advances. Additionally, the Bank may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages as calculated by the FHLB. The Bank’s borrowing capacity with the FHLB is 25% of the Bank’s total assets, subject to available collateral.

The following table summarizes the collateral utilization and availability of borrowings from the FHLB at the dates indicated (in thousands).

	March 31,		December 31,
	2015		2014
Available lendable loan collateral value pledged to serve against FHLB advances	$	75,714	$	79,139
FHLB advances outstanding		50,000		35,000
Excess lendable collateral value pledged to serve against FHLB advances	$	25,714	$	44,139

Federal Reserve Discount Window. We have established a borrowing relationship with the Federal Reserve through its Discount Window. Our borrowings from the Discount Window are at the primary credit rate. Primary credit is available through the Discount Window to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. The maximum maturity for potential borrowings is overnight. We have not drawn on this availability other than to periodically test our ability to access the line. The Federal Reserve has the discretion to deny approval of borrowing requests.

Capital

At March 31, 2015, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds.

The following table summarizes capital key performance indicators at the dates and for the periods indicated (dollars in thousands, except per share data).

	At and for the three months ended March 31,
	2015			2014
Total shareholders' equity	$	136,028		$	126,952
Average shareholders' equity		134,186			125,664
Shareholders' equity as a percentage of total assets		11.59	%		11.55	%
Average shareholders' equity as a percentage of average total assets		11.75			11.48
Book value per common share	$	10.62		$	9.92
Cash dividends declared per common share		0.08			-
Dividend payout ratio		37.5	%	n/a

Dividends. Dividends from the Bank are the Company’s primary source of funds for payment of dividends to its common shareholders. During the three months ended March 31, 2015, the Company declared dividends on its common stock as follows:

Declaration date	Record date	Payment date	Cash dividend per common share
1/15/2015	2/2/2015	2/16/2015	$	0.08

Subsequently, the Company declared a cash dividend of $0.08 per common share on April 16, 2015 payable on May 18, 2015.

The dividends paid to common shareholders were funded by dividends paid to the Company by the Bank. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be paid, and at what level, because the payment of dividends is dependent on our financial condition, results of operations and/or cash flows as well as capital and dividend regulations of the FDIC and our other regulatory authorities.

52

Private Placement. In October 2010, we consummated the Private Placement in which institutional investors purchased 9,993,995 shares of our common stock at $10.40 per share resulting in proceeds of $103.9 million. Under the terms of the Private Placement, we conducted a common stock follow-on offering following the closing of the Private Placement directed to our shareholders as of the close of business on October 6, 2010. With respect to the follow-on offering, in December 2010, we issued 194,031 shares of common stock resulting in proceeds of $2.0 million, and in January 2011, we issued an additional 767,508 shares of common stock resulting in proceeds of $8.0 million. Net proceeds from the offerings totaling $104 million were contributed to the Bank as an additional capital contribution.

Basel III. In July 2013, federal bank regulatory agencies issued a final rule that revises their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision (“Basel III”) and certain provisions of the Dodd-Frank Act.

The rule imposes higher risk-based capital and leverage requirements than those in place at the time the rule was issued. Specifically, the rule imposes the following minimum capital requirements:

● A new common equity Tier 1 risk-based capital ratio of 4.5%,

● A Tier 1 risk-based capital ratio of 6% (increased from the previous 4% requirement),

● A total risk-based capital ratio of 8% (unchanged from previous requirements),

● A leverage ratio of 4% and

● A new supplementary leverage ratio of 3% applicable to advanced approaches banking organizations resulting in a leverage ratio requirement of 7% for such institutions.

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.

The rule also includes changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital and increased risk-weights (from 0% to up to 600%) for equity exposures.

Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

The final rule became effective on January 1, 2015, and the requirements in the rule will be fully phased-in by January 1, 2019. While the ultimate impact of the fully phased-in capital standards on the Company and the Bank is currently being reviewed, we currently do not believe Basel III will have a material impact once fully implemented.

Regulatory Capital and Other Requirements. The Company and the Bank are required to meet regulatory capital requirements that include several measures of capital. As permitted by the regulatory capital regulations in effect as of March 31, 2015, the Bank made a one-time election to exclude all of the components of accumulated other comprehensive income (loss) from its regulatory capital calculation.

For regulatory capital purposes as of March 31, 2015, deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities) are excluded from regulatory capital, in addition to certain overall limits on net deferred tax assets as a percentage of common equity Tier 1 capital. At March 31, 2015, $4.7 million of our net deferred tax asset was included in common equity Tier 1, Tier 1 and total regulatory capital. We will continue to evaluate the realizability of our net deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. This evaluation may result in the inclusion of a deferred tax asset in regulatory capital in an amount that is different from the amount determined under GAAP.

53

Since March 31, 2015, we are not aware of the occurrence of any conditions or events that have resulted in a material change in the Bank's regulatory capital category other than as reported in this Quarterly Report on Form 10-Q.

For additional disclosure regarding the Company’s and the Bank’s actual and required regulatory capital requirements and ratios, see Item 1. Financial Statements, Note 21, Regulatory Capital Requirements.

Equity. At March 31, 2015, we had authorized common stock and preferred stock of 75,000,000 shares and 2,500,000 shares, respectively. Authorized but unissued shares of common stock totaled 62,185,426 at April 24, 2015. To date, we have not issued any shares of preferred stock.

The Company’s common stock is traded on the NASDAQ Capital Market and has been included in the Russell 2000(R) Index since June 2013.

Derivative Activities

For disclosure regarding our derivative financial instruments and hedging activities, see Item 1. Financial Statements, Note 19, Derivative Financial Instruments and Hedging Activities. We are currently evaluating the potential use of additional interest-rate derivatives for balance sheet management purposes and to accommodate client requests.

Liquidity 

General

Liquidity measures our ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to accommodate possible outflows from deposit accounts, meet loan requests and commitments, maintain reserve requirements, pay operating expenses, provide funds for dividends and debt service, manage operations on an ongoing basis, capitalize on new business opportunities and take advantage of interest-rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining a level of liquid funds through proactive balance sheet management. 

Asset liquidity is provided by maintaining assets that are readily convertible into cash, are pledgeable or that will mature in the near future. Our liquid assets may include cash, interest-bearing deposits in banks, investment securities available for sale, portions of our trading account asset and federal funds sold. Liability liquidity is provided by access to funding sources including deposits, borrowings and public capital markets. We may also issue equity securities on the NASDAQ. To date, no preferred stock has been issued, and there can be no guarantee that a market would exist for such common or preferred shares at terms acceptable to us. Each of our sources of liquidity is subject to various factors beyond our control such as willingness of counterparties to extend credit to the Company or the Bank and systematic disruptions.

Overall, we continuously focus on balance sheet management to manage our cash effectively and invest in earning assets. Based on loan origination activity, this includes purchasing loans, and investing in investment securities and trading account assets (as compared to maintaining cash on deposit at the Federal Reserve) as well as paying down higher-priced funding such as maturing time deposits. Future net loan growth is expected to be funded primarily from increases in deposits and paydowns and maturities of investment securities. Wholesale borrowings and sales of investment securities may also be used to supplement short-term funding needs.

Liquidity resources and balances at March 31, 2015, as disclosed herein, are an accurate depiction of our activity during the period and, except as noted, have not materially changed since that date.

54

Cash Flow Needs

In the normal course of business, we enter into various transactions some of which, in accordance with GAAP, are not recorded in our Consolidated Balance Sheets. These transactions may involve, to varying degrees, elements of credit risk and interest-rate risk in excess of the amounts recognized in the Consolidated Balance Sheets, if any.

Our nonmortgage lending commitments and letters of credit do not meet the criteria to be recorded on the Consolidated Balance Sheets at fair value since our commitment letters contain material adverse change clauses. Accordingly, we account for estimated probable losses on these instruments in a manner similar to our loans.

We use the same credit policies in making and monitoring commitments as used for loan underwriting. Therefore, in general, the methodology to determine the reserve for unfunded commitments is inherently similar to that used to determine the general reserve component of the allowance for loan losses. However, commitments have fixed expiration dates, and most of our commitments to extend credit have adverse change clauses that allow us to cancel the commitments based on various factors including deterioration in the creditworthiness of the borrower. Accordingly, many of our loan commitments are expected to expire without being drawn upon and, therefore, the total commitment amounts do not necessarily represent potential credit exposure. The reserve for unfunded commitments at March 31, 2015 and December 31, 2014 was $219 thousand and $472 thousand, respectively, and is recorded in Other liabilities in the Consolidated Balance Sheets.

For additional disclosure regarding our commitments, guarantees and other contingencies, see Item 1. Financial Statements, Note 18, Commitments, Guarantees and Other Contingencies.

Dividend Obligations. The holders of the Company’s common stock are entitled to receive dividends, when and if declared by the Company’s Board of Directors, out of funds legally available for such dividends. The Company is a legal entity separate and distinct from the Bank and depends on the payment of dividends from the Bank.

55

Quarterly Earnings Review

The following discussion and analysis of our results of operations is provided on a consolidated basis with commentary on business specific implications where more granular information is available.

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income

(dollars in thousands, except per share data) 

(unaudited)

	For the three months ended March 31,					Dollar			Percent
	2015			2014		variance			variance
Interest income
Interest earned on cash and cash equivalents	$	13		$	14	$	(1	)		(7.1	)%
Dividends received on Federal Home Loan Bank stock		12			14		(2	)		(14.3	)
Interest earned on trading account assets		78			46		32			69.6
Interest earned on investment securities available for sale		936			1,004		(68	)		(6.8	)
Interest and fees earned on loans		8,947			8,998		(51	)		(0.6	)
Total interest income		9,986			10,076		(90	)		(0.9	)
Interest expense
Interest expense on deposits		104			127		(23	)		(18.1	)
Interest expense on Federal Home Loan Bank advances		30			16		14			87.5
Total interest expense		134			143		(9	)		(6.3	)
Net interest income		9,852			9,933		(81	)		(0.8	)
Provision for loan losses		400			-		400		n/m
Net interest income after provision for loan losses		9,452			9,933		(481	)		(4.8	)
Noninterest income
Service charges on deposit accounts, net		1,580			1,562		18			1.2
Fees for trust, investment management and brokerage services		186			146		40			27.4
Mortgage-banking		633			461		172			37.3
Debit card and automatic teller machine income, net		581			586		(5	)		(0.9	)
Investment securities gains, net		29			85		(56	)		(65.9	)
Trading account income, net		105			171		(66	)		(38.6	)
Other		427			355		72			20.3
Total noninterest income		3,541			3,366		175			5.2
Noninterest expense
Salaries and other personnel		4,746			4,790		(44	)		(0.9	)
Occupancy		1,059			1,097		(38	)		(3.5	)
Furniture and equipment		956			1,045		(89	)		(8.5	)
Professional services		588			813		(225	)		(27.7	)
Federal Deposit Insurance Corporation deposit insurance assessment		176			356		(180	)		(50.6	)
Marketing		244			255		(11	)		(4.3	)
Foreclosed real estate writedowns and expenses		(79	)		313		(392	)		(125.2	)
Loan workout		39			131		(92	)		(70.2	)
Other		1,065			1,289		(224	)		(17.4	)
Total noninterest expense		8,794			10,089		(1,295	)		(12.8	)
Income before provision for income taxes		4,199			3,210		989			30.8
Provision for income taxes		1,467			1,182		285			24.1
Net income	$	2,732		$	2,028	$	704			34.7	%
Common and per common share data
Net income - basic	$	0.21		$	0.16	$	0.05			31.3	%
Net income - diluted		0.21			0.16		0.05			31.3
Cash dividends declared		0.08			-		0.08		n/m
Book value		10.62			9.92		0.70			7.1
Weighted average basic common shares		12,715,972			12,675,257
Weighted average diluted common shares		12,851,076			12,707,444

56

Net Interest Income

Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets, primarily loans and investment securities, and interest expense incurred on interest-bearing deposits and other interest-bearing liabilities. The net interest margin measures the difference between the interest income earned on interest-earning assets and the interest expense incurred to fund those assets. Changes in interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to interest-bearing liabilities and the management of interest-rate sensitivity factor into fluctuations in net interest income.

Net interest income totaled $9.9 million for both the three months ended March 31, 2015 and 2014. Overall, net interest income for the three months ended March 31, 2015 was primarily influenced by the following factors:

● A continuation of the low interest-rate environment that generally began with the Federal Reserve’s actions to reduce short-term interest rates and subsequent quantitative easing measures which reduced longer-term rates. In response, taking into consideration the interest income earned on interest-earning assets and interest expense incurred on interest-bearing deposits and other interest-bearing liabilities, we refined the type of loan and deposit products we pursue and are exercising discipline in our loan and deposit pricing. We also utilize interest-rate floors on loans although current competitive pressures make the ability to obtain such floors more difficult. At March 31, 2015, loans aggregating $199.8 million had interest-rate floors, of which $85.5million had floors greater than or equal to 4.50%.

● The mix of our loan portfolio between fixed and variable rate loans. Based on the shape of the yield curve over the past few years, variable rate loans have been originated at a lower current rate than fixed rate loans. At March 31, 2015, loans aggregating $329.7 million (40% of our gross loan portfolio) are variable rate loans which will reprice upwards when interest rates rise.

● Very competitive loan pricing for credit-worthy clients, which has resulted in lower interest rates on loan originations and a decline in the overall yield on our loan portfolio, although these rates are still in excess of those for alternative uses of funds such as investment securities of similar duration.

● Foregone interest on nonaccrual loans for the three months ended March 31, 2015 and 2014 totaling $80 thousand and $169 thousand, respectively.

● An increase of $49.7 million (6.5%) in average gross loans during the first quarter 2015 as compared to the first quarter 2014 as new loan originations and purchases outpaced loan repayments, sales, foreclosures and charge-offs. We are actively pursuing new loan originations and are focused on generating additional loan growth.

● To attempt to avoid a decline in interest income in 2015 as compared to 2014, in late 2014 we began the execution of an earning asset strategy to begin 2015 with a higher level of earning assets, both to replace loans resulting from unscheduled payoffs in the fourth quarter 2014 and to supplement temporarily our organic loan growth. The strategy included retaining on our balance sheet residential mortgage and SBA loan production (which we resumed selling in January 2015), and earning asset purchases. The earning asset purchases included a pool of residential mortgage loans for $14.0 million in the third quarter 2014, a pool of indirect auto loans for $22.1 million in the fourth quarter 2014, a commercial loan participation of $5.0 million in the fourth quarter 2014, a pool of residential mortgage loans for $12.3 million in the first quarter 2015 and an additional $4.5 million investment in our trading account in the first quarter 2015. The loans purchased were subjected to our normal internal due diligence and underwriting guidelines prior to purchase. The earning asset purchases were primarily funded by short-term FHLB advances that we expect to replace with deposits in 2015.

● Reduction in time deposits to maintain our overall low cost of funds and focus our efforts on relationship banking to reduce the number of single-product households that only maintain time deposit accounts with the Bank. Our opportunity to reduce time deposit costs is limited as the weighted-average rate of time deposits scheduled to mature during the remainder of 2015 is 0.12%. In addition, we may pursue issuing time deposits to replace our FHLB advances outstanding at March 31, 2015.

● A general flattening of the yield curve during 2014 as short-term rates increased to reflect heightened expectations that the Federal Reserve will begin to increase the federal funds rate in 2015 and lower long term rates reflecting continued global economic uncertainty. Based on the fixed versus variable composition of our loan portfolio, relatively short duration of our investment securities portfolio and expected lag in deposit re-pricing compared to loan re-pricing, over time an increase in interest rates to historical levels is expected to improve our net interest margin.

● Increasing earning assets, including alternative investments. For example, in addition to the loan purchases described above, from 2013 through the first quarter 2015 we invested a total of $600 thousand in a small business investment fund (with a maximum potential investment of $2.0 million), $10.0 million in a municipal bond trading account and $10.0 million in BOLI policies.

57

Average Balance Sheets and Net Interest Income / Margin Analysis. The following table summarizes our average balance sheets and changes in net interest income / margin for the periods indicated (dollars in thousands). Our yields earned on interest-earning assets and rates incurred on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively. The following table does not include a tax-equivalent adjustment to net interest income for interest-earning assets earning tax-exempt income to a comparable yield on a taxable basis.

	For the three months ended March 31,
	2015								2014
	Average			Income/		Yield/			Average			Income/		Yield/
	balance			expense		rate			balance			expense		rate
Assets
Interest-earning assets
Cash and cash equivalents	$	36,584		$	13		0.14	%	$	38,891		$	14		0.15	%
Federal Home Loan Bank stock		3,141			12		1.55			2,732			14		2.08
Trading account assets		10,009			78		3.16			5,178			46		3.60
Investment securities available for sale, taxable (1)		203,534			887		1.74			204,803			944		1.84
Investment securities available for sale, nontaxable (1)		7,358			49		2.66			7,383			60		3.25
Total investment securities available for sale		210,892			936		1.78			212,186			1,004		1.89
Loans (2)		814,489			8,947		4.45			764,526			8,998		4.77
Total interest-earning assets		1,075,115			9,986		3.77			1,023,513			10,076		3.99
Noninterest-earning assets
Cash and cash equivalents		11,017								10,696
Allowance for loan losses		(12,966	)							(16,488	)
Premises and equipment, net		21,977								23,273
Accrued interest receivable		3,227								3,410
Foreclosed real estate		5,931								7,745
Deferred tax asset, net		16,343								21,489
Other assets		21,300								20,940
Total noninterest-earning assets		66,829								71,065
Total assets	$	1,141,944							$	1,094,578
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Transaction deposits	$	339,758		$	11		0.01	%	$	319,760		$	10		0.01	%
Money market deposits		140,351			10		0.03			133,367			9		0.03
Savings deposits		92,399			3		0.01			82,577			3		0.01
Time deposits		166,846			80		0.19			191,003			105		0.22
Total interest-bearing deposits		739,354			104		0.06			726,707			127		0.07
Retail repurchase agreements		14,938			-		-			18,269			-		-
Federal Home Loan Bank advances		48,057			30		0.25			31,222			16		0.21
Other borrowings		-			-		-			54			-		-
Total interest-bearing liabilities		802,349			134		0.07			776,252			143		0.07
Noninterest-bearing liabilities
Noninterest-bearing deposits		198,614								186,852
Other liabilities		6,795								5,810
Total noninterest-bearing liabilities		205,409								192,662
Total liabilities		1,007,758								968,914
Shareholders' equity		134,186								125,664
Total liabilities and shareholders' equity	$	1,141,944							$	1,094,578
NET INTEREST INCOME / NET INTEREST MARGIN				$	9,852		3.72	%				$	9,933		3.94	%

(1)	The average balances for investment securities include the applicable net unrealized gain or loss recorded for available for sale securities.
(2)	Calculated including mortgage and other loans held for sale excluding the allowance for loan losses. Nonaccrual loans are included in average balances for yield computations. The impact of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis. All loans and deposits are domestic.

58

Rate / Volume Analysis. The following rate / volume analyses summarize the dollar amount of changes in interest income and interest expense attributable to changes in volume and the amount attributable to changes in rate when comparing the periods indicated (in thousands). The impact of the combination of rate and volume change has been allocated between the rate change and volume change.

	For the three months ended March 31, 2015 compared with the three months ended March 31, 2014
	Change in			Change in			Total
	volume			rate			change
Assets
Interest-earning assets
Cash and cash equivalents	$	(1	)	$	-		$	(1	)
Federal Home Loan Bank stock		2			(4	)		(2	)
Trading account assets		37			(5	)		32
Investment securities available for sale		(6	)		(62	)		(68	)
Loans (1)		2,499			(2,550	)		(51	)
Total interest income		2,531			(2,621	)		(90	)
Liabilities and shareholders' equity
Interest-bearing liabilities
Transaction deposits		1			-			1
Money market deposits		-			1			1
Savings deposits		-			-			-
Time deposits		(12	)		(13	)		(25	)
Total interest-bearing deposits		(11	)		(12	)		(23	)
Retail repurchase agreements		-			-			-
Federal Home Loan Bank advances		11			3			14
Other borrowings		-			-			-
Total interest expense		-			(9	)		(9	)
Net interest income	$	2,531		$	(2,612	)	$	(81	)

      (1) Calculated including mortgage loans held for sale excluding the allowance for loan losses.

Provision for Loan Losses

A provision for loan losses of $400 thousand was recorded during the first quarter 2015 compared to no provision for loan losses during the first quarter 2014. This increase reflects primarily loan growth in the first quarter 2015, offset somewhat by our improved credit quality, an increasing proportion of commercial loans that have been more recently originated under our improved underwriting standards and generally improving economic conditions. The following table summarizes credit quality key performance indicators impacting the level of the provision for loan losses recorded for the periods indicated (in thousands).

	At and for the three months ended March 31,				Dollar			Percent
	2015		2014		variance			variance
Net loans charged-off	$	406	$	242	$	164			67.8	%
Nonaccrual loans		10,362		14,035		(3,673	)		(26.2	)
Loans past due greater than 90 days and still accruing		233		-		233		n/m
Loans past due 30-89 days and still accruing		2,787		6,115		(3,328	)		(54.4	)
Classified loans		41,410		44,781		(3,371	)		(7.5	)
Troubled debt restructurings		19,242		27,604		(8,362	)		(30.3	)

The lower level of problem assets, coupled with anticipated loan growth, is expected to result in a more stable provision for loan losses going forward. In addition, we continue to pursue the recovery of previously charged-off balances, the receipt of which may impact the level of future provisions for loan losses. Absent unexpected negative trends in credit quality, we expect our annual net charge-offs in 2015 to normalize at 25 to 35 basis points of average loans outstanding.

Noninterest Income

Service Charges on Deposit Accounts, Net. Service charges on deposit accounts, net comprise a significant component of noninterest income and totaled 1.2% and 1.3% of average transaction deposit balances for the three months ended March 31, 2015 and 2014, respectively. The $18 thousand increase in service charges from the first quarter 2014 to the first quarter 2015 reflects higher overdraft income and service charges on deposit accounts resulting from account growth and revenue enhancement initiatives discussed below. The increases were partially offset by lower nonsufficient funds (“NSF”) income which, we believe is a result of lower instances of NSF transactions due to industry and regulatory efforts to better inform consumers regarding NSF programs as well as our increase in the courtesy overdraft amount from $1 to $5 as discussed below.

59

During the first half of 2014, we performed an analysis of service charges on deposit accounts including comparison of our pricing to our local market competitors. As a result, we implemented selected fee changes with most of the changes effective July 1, 2014 and September 1, 2014. Among the changes were changes related to the NSF tiered pricing structure, overdraft fees, including a decrease in the time period before a daily overdraft fee is assessed from eight business days to five business days, an increase in the overdraft protection transfer fee from $5 to $10 per transfer and an increase in the courtesy overdraft amount from $1 to $5 that will not result in an item return / item paid fee on accounts overdrawn at the end of the business day by $5 or less. Effective April 25, 2015, we reduced the courtesy overdraft amount from $5 to $1 for business accounts.

We also refined the features of selected deposit products and introduced new products in the third quarter 2014, including a new basic business checking account and the re-introduction of student checking. These changes, along with other selected loan related and other fee increases, are projected to increase noninterest income by approximately $750 thousand in 2015 as compared to 2014.

Fees for Trust, Investment Management and Brokerage Services. Fees for trust and investment management services are earned through an arrangement with Thomasville National Bank (“TNB”) under which we provide office space and other support services in our existing facilities to the TNB employees who provide the trust and investment management services. TNB has ownership and responsibility for the accounts, trust employees and all operational and fiduciary responsibility for administering the accounts under the underlying client account agreements. We earn a percentage of the ongoing revenues generated from the assets under management in the transferred accounts owned by TNB and any new accounts subsequently referred to TNB.

Fees for brokerage and investment management services are earned through an agreement with Investment Professionals, Inc. (“IPI”) which permits IPI to provide brokerage services to our clients including acting as clearing agent, executing purchases and sales of securities products on behalf of and for the account of clients and maintaining securities in client accounts as agent. We provide office space and other support services in our existing facilities to the IPI employees who provide the brokerage and investment management services. We earn a percentage of the ongoing revenues generated from the brokerage assets managed by IPI.

The increase of $40 thousand in trust, investment management and brokerage services revenue during the first quarter 2015 as compared to the first quarter 2014 was the result of increased brokerage income. The increase in brokerage income reflects growth in the number of accounts and a higher level of account activity.

The trust, investment management and brokerage relationships are part of our integrated Wealth Management strategy to provide our clients seamless access to the comprehensive suite of products and services they need to achieve their financial goals. For trust and brokerage services, TNB and IPI, respectively, have invested and continue to invest in additional resources with relevant expertise and a focus on business development to obtain new clients and grow assets under management. In addition, we offer private banking services through a Private Banker who serves in a key relationship management role in our Wealth Management business.

Mortgage-Banking. We normally sell the residential mortgage loans we originate and retain the obligation to service these loans in order to maintain the client relationships. The following table summarizes the components of mortgage-banking income for the periods indicated (dollars in thousands).

	For the three months ended March 31,
	2015			2014
Mortgage-servicing fees	$	247		$	247
Gain on sale of mortgage loans held for sale		357			363
Mortgage-servicing rights portfolio amortization and impairment		(140	)		(140	)
Derivative loan commitment income		174			1
Forward sales commitment expense		(25	)		(19	)
Other		20			9
Total mortgage-banking income	$	633		$	461
Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others		0.27	%		0.26	%

60

Mortgage banking income increased from the first quarter 2014 to the first quarter 2015 primarily as a result of fair market value adjustments on mortgage loan origination and sales commitments considered derivative financial instruments. The value of mortgage loan origination and sales commitments fluctuates based on the change in interest rates between the time we enter into the commitment to originate / sell the loans and the balance sheet date. Since we have historically sold the mortgage loans we originate each quarter, the notional amount of our commitments to originate mortgage loans held for sale have been accounted for as derivative financial instruments and reflected at fair market value in the Consolidated Balance Sheets.

Mortgage loans originated during the first quarter 2015 increased to $16.0 million compared to $12.5 million during the first quarter 2014.

Debit Card and Automated Teller Machine Income, Net. Debit card and automated teller machine income, net decreased $5 thousand (0.9%) from the first quarter 2014 to the first quarter 2015 primarily as a result of an increase in debit card transaction processing expenses resulting from a new pass-through fee from MasterCard related to foreign card usage.

Investment Securities Gains, Net. During the three months ended March 31, 2015, we realized net gains on the sale of investment securities of $29 thousand as a result of balance sheet management efforts designed to reduce the investment securities portfolio’s exposure to rising interest rates and to manage liquidity.

During the first quarter 2014, we realized a net gain on the sale of investment securities of $85 thousand as a result of sales of certain mortgage-backed pass-through and collateralized mortgage obligations. Proceeds were reinvested into investment securities with a more favorable total return profile in a rising rate environment.

Trading Account Income, Net. As part of our strategy to diversify our revenues, increase earning assets and effectively utilize our cash balances, we have invested a total of $9.5 million in an account managed by a third party to trade municipal securities, of which $4.5 million was invested during the first quarter 2015. The following table summarizes trading account related income and expense included in earnings for the periods indicated (in thousands), which in the aggregate resulted in a net return of 4.14% and 10.22% in the three months ended March 31, 2015 and 2014, respectively. Interest earned on trading assets is included in Interest income and investment management expenses are included in Professional services noninterest expense in the Consolidated Statements of Income.

	For the three months ended March 31,
	2015		2014
Interest earned on trading account assets	$	78	$	46
Trading account income, net		105		171
Investment management expenses		81		88

Other. Other noninterest income increased $69 thousand (24.6%) from the three months ended March 31, 2014 to the three months ended March 31, 2015. This increase was driven by an increase in gains on sales of SBA loans of $53 thousand.

Noninterest Expense

As a component of our Strategic Plan to align our infrastructure and expense base with our current balance sheet size and the underlying revenue generating capacity of the franchise, we have been focused on implementing specific noninterest expense reductions and promoting a culture of strategic efficiency. Our expense management initiatives include aligning our teammate rewards with the financial results of the Company. Examples of actions for the periods included in this Quarterly Report on Form 10-Q include:

● A reduction in problem assets resulting in reduced writedowns and related carrying costs such as legal expenses, property taxes, property insurance and other costs incurred to resolve the problem assets and protect the collateral value,

● Eliminating the annual officer cash incentive plan awards under the corporate officer incentive plan beginning in 2009. In July 2014, we reinstated this plan with any potential payments under the plan tied directly to pre-established Company financial results related to pre-tax income, loan and deposit balances, and asset quality, as well as individual performance.

61

● Refining the Company’s ongoing regular match under the 401(k) Plan with the Company providing a match of $0.10 per dollar of participant contributions up to 6% of a teammate’s eligible compensation through June 30, 2014, which increased to $0.25 per dollar of participant contributions effective July 1, 2014,

● Refining our medical benefits plan, including the implementation of a wellness program, with higher premiums for certain unhealthy behaviors,

● Reducing the business hours of our branches,

● Implementing refined staffing models for our branches resulting in reduced teammate headcount,

● Reducing courier runs from our branches,

● Outsourcing and co-sourcing of certain operational functions,

● Renegotiating business partner contracts for price reductions and consolidating business partners for volume pricing,

● Process improvements for efficiency, and

● More fully leveraging existing technology, implementing more advanced technology, and automating manual processes.

These expense reduction initiatives contributed to the reduction in total noninterest expense of $1.3 million from the first quarter 2014 to the first quarter 2015. Our expense reduction initiatives are expected to result in an additional annual reduction in noninterest expense in 2015 as compared to 2014.

Salaries and Other Personnel. Salaries and other personnel expense declined $44 thousand as a result of fewer average full-time equivalent teammates and contract personnel (primarily related to reduced branch hours to better match client usage patterns of our various delivery channels, refined branch roles resulting in reduced headcount and process improvement initiatives that allowed us to combine certain positions), lower medical insurance premiums and lower pension plan expense partially offset by increased incentive accruals and annual merit increases that went into effect in February 2015. At March 31, 2015, full-time equivalent teammates (including contract personnel) were 290 compared to 305 at March 31, 2014.

Occupancy and Furniture and Equipment. Occupancy and furniture and equipment expenses decreased $127 thousand (5.9%) from the first quarter 2014 to the first quarter 2015 due to lower utility and general upkeep facility expenses as well as a reduction in equipment leases and contract expenses.

Professional Services. Professional services expense decreased $225 thousand (27.7%) from the first quarter 2014 to the first quarter 2015 primarily as a result of a decline in expenses related to the revenue enhancement and process improvement projects during the first quarter 2014 that were not incurred during the first quarter 2015.

Federal Deposit Insurance Corporation Deposit Insurance Assessment. FDIC deposit insurance premiums decreased $180 thousand (50.6%) from the first quarter 2014 to the first quarter 2015 due to improvement in the Bank’s risk tier for assessment purposes partially offset by an increase in our assessment base.

Marketing. Marketing expenses decreased $11 thousand (4.3%) from the first quarter 2014 to the first quarter 2015 and are a function of the type, timing and duration of marketing campaigns and initiatives.

Foreclosed Real Estate Writedowns and Expenses. Foreclosed real estate writedowns and expenses totaled a net gain of $79 thousand for the three months ended March 31, 2015 compared to a net expense of $313 thousand for the three months ended March 31, 2014.

The amount of foreclosed real estate writedowns and expenses is a function of the level of foreclosed real estate, the number of properties for which appraisals are received during the period and foreclosed real estate sales activity.

We own 55 residential lots with an aggregate net book value of $4.4 million in three separate communities related to one real estate development. We are working directly with the primary owner of the real estate development to market and sell our remaining lots. We recorded writedowns on these properties during the three months ended March 31, 2015 and 2014 of $3 thousand and $131 thousand, respectively, to reflect declines in fair value. However, during 2014 we sold all of our lots in one particular development, and sold five other individual lots all of which were sold at prices above carrying value. At December 31, 2014, two lots with a carrying value of $405 thousand were under contract for sale and closed during January 2015 at prices above carrying value. While our recent sales were at prices above carrying values, the ongoing resolution may result in sales at losses or writedowns based on receipt of annual appraisals. Due to the number of lots owned, absent a bulk sales of the lots, the resolution of these remaining lots may occur over several years.

62

Loan Workout. Loan workout expenses include costs to resolve problem loans such as legal fees, property taxes and operating expenses associated with collateral securing these loans. Changes in loan workout expenses are generally driven by the level of problem assets and pace of problem asset resolution.

Other. Other noninterest expense decreased $224 thousand (17.4%) from the first quarter 2014 to the first quarter 2015 primarily as a result of a decrease in the provision for unfunded commitments due to an increase in unfunded loan commitments.

Provision for Income Taxes

The provision for income taxes for the three months ended March 31, 2015 of $1.5 million included deferred federal income tax expense of $1.3 million, provision for state income tax of $131 thousand and federal alternative minimum tax of $75 thousand. South Carolina banking taxation law does not allow the use of net operating loss carryforwards as an offset to current period taxable income.

The provision for income taxes for the three months ended March 31, 2014 of $1.2 million included deferred federal income tax expense of $1.0 million, provision for state income tax of $92 thousand and federal alternative minimum tax of $72 thousand.

For additional disclosure regarding the net deferred tax asset and the provision for income taxes, see Financial Condition, Net Deferred Tax Asset and Item 1. Financial Statements, Note 14, Income Taxes.

Recently Issued / Adopted Authoritative Pronouncements 

For disclosure regarding recently issued and recently adopted authoritative pronouncements and the expected impact on our business, financial condition, results of operations and cash flows, see Item 1. Financial Statements, Note 1, Summary of Significant Accounting Policies.

63

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The following table summarizes as of March 31, 2015 the forecasted impact on net interest income over a 12-month horizon using a base case scenario given upward movements in interest rates of 100, 200, 300 and 400 basis points and downward movements in interest rates of 100, 200 and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Given the current low interest-rate environment, we have not prepared a parallel interest-rate scenario for downward movements in interest rates of 400 basis points. Estimates are based on current economic conditions, historical interest-rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to us at the time of the issuance of the Consolidated Financial Statements. Therefore, our assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual results to differ from underlying assumptions.

Interest rate scenario (1)	Percentage change in net interest income from base
Up 400 basis points		5.31	%
Up 300 basis points		3.81
Up 200 basis points		2.18
Up 100 basis points		1.61
Down 100 basis points		(4.78	)
Down 200 basis points		(7.25	)
Down 300 basis points		(10.50	)
Down 400 basis points	n/a

(1) The rising 100, 200, 300 and 400 basis point and falling 100, 200 and 300 basis point interest-rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve.

There are material limitations with the model presented above, which include, but are not limited to:

● It presents the balance sheet in a static position. When assets and liabilities mature or reprice, they do not necessarily keep the same characteristics,

● The computation of prospective impacts of hypothetical interest-rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results, and

● The computations do not contemplate any additional actions we could undertake in response to changes in interest rates.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the three months ended March 31, 2015 that has materially impacted, or is reasonably likely to materially impact, the Company’s internal control over financial reporting.

64

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

We are a party to claims and lawsuits arising in the course of normal business activities. Management is not aware of any material pending legal proceedings against the Company which, if resolved adversely, would have a material adverse impact on the Company’s financial position, results of operations or cash flows.

Item 1A. Risk Factors

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014 which could materially impact our business, financial condition, results of operations or cash flows. The risks described in the Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known or currently deemed to be immaterial also may materially and adversely affect our business, financial condition, results of operations or cash flows.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated herein by reference.

65

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/ Samuel L. Erwin

Samuel L. Erwin

Chief Executive Officer

Palmetto Bancshares, Inc.

(Principal Executive Officer)

/s/ Roy D. Jones

Roy D. Jones

Chief Financial Officer and Treasurer

Palmetto Bancshares, Inc.

(Principal Financial Officer and Principal Accounting Officer)

Date: May 1, 2015

66

EXHIBIT INDEX

Exhibit No.	Description
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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

101 The following materials from Palmetto Bancshares, Inc.’s Quarterly Report on Form 10-Q for the three months ended March 31, 2015, formatted in XBRL; (i) Consolidated Balance Sheets at March 31, 2015 and December 31, 2014, (ii) Consolidated Statements of Income for the three months ended March 31, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2015 and 2014, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2015 and 2014, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014 and (vii) Notes to Consolidated Financial Statements

Copies of exhibits are available upon written request to Corporate Secretary, Palmetto Bancshares, Inc., 306 East North Street, Greenville, South Carolina 29601.

67