Synergy
the interaction of elements that when combined produce a total effect that is
greater than the sum of the individual elements, contributions, etc.
[Picture of people in an office gathered around a desk appears here]
The whole is greater than the sum of its parts.
[PALMETTO BANCSHARES, INC. LOGO APPEARS HERE]
Palmetto Bancshares, Inc. 1997 Supplemental Annual Report
[THIS PAGE IS BLANK]
2
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1997, 1996 and 1995
(Dollars in Thousands, except per share data)
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto. The consolidated financial
statements of Palmetto Bancshares, Inc. and subsidiaries (the "Company"),
represent account balances for Palmetto Bancshares, Inc., (the "Parent
Company"), and its wholly-owned subsidiary, The Palmetto Bank, (the "Bank"), and
the Bank's wholly-owned subsidiary, Palmetto Capital, Inc.
General
The Company has undertaken a study to determine the remedial action necessary to
deal with the year 2000 issue with respect to its computer and business systems.
While most view the project as a data processing or computer concern, every
department and function of the Company is affected and must be included in the
Company's analysis and compliance process. The significance of the risks for
noncompliance are great and include business, legal and personal risks to the
Company. The process of assessing the problem has been completed. The testing
phase will begin during second quarter 1998 and continue until all systems are
tested by the Company in the Company's environment. All testing is scheduled to
be completed by December 31, 1998. The Company will not rely on assurances from
vendors. Implementation of renovated systems will begin when testing has been
completed on each system. All systems and functions will be implemented and
compliant by December 31, 1999. Year 2000 project progress will be reported to
the Board of Directors at least quarterly until complete. The cost to resolve
this problem is not expected to be material.
On July 22, 1997, the Bank announced that Richard R. (Randy) Hilton had been
named Senior Vice President and Chief Credit Officer.
In response to the Bank's commitment to quality customer service, the Medical
Savings Account (MSA) was introduced in early September for the Bank's small
business customers. The MSA is a product which provides a tax-sheltered savings
account for medical expenses for customers who have high deductible health
insurance and are either self-employed or are employed by a small business. Also
in September, the Bank enhanced the capabilities of its 24-Hour Account
Information Line through a new voice response system. This system offers many
new features including more detailed account information and statement retrieval
via fax, as well as an increased number of phone lines due to customer demand.
In October, the Bank introduced its Super Money Market Account. This new money
market account offers an annual percentage yield higher than the Bank's Premium
Money Market Account when a customer maintains a $25 thousand minimum balance.
In September, the board of directors for Palmetto Bancshares, Inc., approved
three new additions to the board. Ann B. Smith, Director of Annual Giving for
Clemson University, Edward K. (Keith)
3
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
Snead, President of Snead Builders Supply in Greenwood, and William S. (Bill)
Moore, currently an investor and former President of Reeves Brothers, Inc., in
Spartanburg, began their terms. Each of these directors has served in an
advisory capacity on local boards for the Bank in their respective communities
for several years. They will serve as directors until the next annual meeting of
shareholders, when they will be submitted as nominees for full terms as
directors.
On November 20, the Bank announced it was assuming the deposits of Greenwood
Bank & Trust's Ninety-Six office. This assumption of about $4.5 million
increases the Bank's presence in this market. Also, in December, the Bank
announced it will be opening two new branches in Greenville County in the spring
of 1998. These branches are located in Mauldin and on Woodruff Road in
Greenville. These openings bring the Bank's total number of branches to 26.
The Company's assets grew $44,830, or 10%, total loans grew $34,977, or 11%, and
deposits grew $37,004, or 9% in 1997 as a result of growth in all geographic
markets. In 1996, total assets grew $92,100, or 24%, total loans grew $77,800,
or 30%, and deposits grew $82,700, or 25%.
Results of Operations
Three Years Ended December 31, 1997, 1996 and 1995
Net income for 1997 was $5,925, an increase of 25% from the $4,753 reported in
1996. Net income in 1996 increased 32% from the $3,602 reported in 1995. Net
income per common share-basic, not subject to put/call was $1.97 in 1997,
compared with $1.54 in 1996, and $1.20 in 1995. Return on average assets before
effect of the ESOP adjustment (discussed on pages 11-12) was 1.20% in 1997
compared with 1.10% in 1996 and 1.05% in 1995.
Net Interest Income
The largest component of the Company's net income is the Bank's net interest
income, defined as the difference between gross interest and fees on earning
assets (primarily loans and investment securities), and interest paid on
deposits and borrowed funds. Net interest income is affected by the interest
rate earned or paid and by volume changes in loans, securities, deposits and
borrowed funds.
In 1997, net interest income was $21,236, which represented a 16% increase over
the $18,381 earned in 1996. This increase is due to increases in the volume of
earning assets offset by a decline in the net interest margin. In 1996, net
interest income increased $2,955 or 19%, over the $15,400 earned in 1995.
During 1997, the average tax equivalent yield on all interest-earning assets was
8.32%, down from 8.42% and 8.75% in 1996 and 1995, respectively. The prime
interest rate remained constant at 8.5% for most of 1997, compared to an average
prime rate of 8.25% and 8.83% for 1996 and 1995, respectively. The Bank's
average effective rate paid on all interest-bearing liabilities increased in
4
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
1997 to 4.06%, from 4.05 and 4.01% in 1996 and 1995, respectively. The Bank's
net tax equivalent yield on interest-earning assets (net interest margin) was
4.83%, 4.88% and 5.23% in 1997, 1996 and 1995, respectively. The consistency of
the net interest margin can be attributed to the Company's competitive market.
The Company expects the competitive deposit rate environment to continue.
Interest and fees on loans increased $4,016 from 1996 to 1997, and increased
$5,400 from 1995 to 1996 due to loan growth of 11% and 30% in 1997 and 1996,
respectively. Interest on investment securities increased $616 or 12% from 1996
to 1997 due to an 19% growth in securities. Interest on investment securities
increased $781, or 17%, from 1995 to 1996 due primarily to increased average
balances. Interest income on federal funds sold increased $198 or 213% due to
higher average balances. This compares to a decrease of $287, or 75%, from 1995
to 1996 due to lower average balances invested.
Total interest expense increased 15% or $2,031 from 1996 to 1997 and 27% or
$2,968 from 1995 to 1996. The largest component of total interest expense is
interest expense on deposits, which increased $2,092 or 16% from 1996 to 1997
due to a 9% growth in deposits. Interest expense on deposits increased $2,737 or
27% from 1995 to 1996 due to a 25% growth in deposits. This growth in deposits
is largely attributable to the acquisition of the First Union branches in the
second quarter of 1996. The average rate paid on deposits was 3.43%, 3.41% and
3.39% in 1997, 1996 and 1995, respectively.
Interest on securities sold under agreements to repurchase increased $99, or 22%
from 1996 to 1997 due to an increase in the average rate paid from 3.84% to
4.01%. This compares to an decrease of $42, or 8% from 1995 to 1996 due to a
decrease in the average rate paid from 4.31% to 3.84%. Interest on commercial
paper increased $68, or 22%, from 1996 to 1997 due to a increase in the average
rate paid from 3.88% to 4.06%. This compares to an decrease of $28, or 8%, from
1995 to 1996 due to a decrease in the average rate paid from 4.28% to 3.88%.
Asset and Liability Management
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its inherent rate risk exposure. Although the Company manages other
risks, as in credit quality and liquidity risk, in the normal course of
business, management considers interest rate risk to be its most significant
market risk and could potentially have the largest material effect on the
Company's financial condition and results of operations. Other types of market
risks, such as foreign currency exchange rate risk and commodity price risk, do
not arise in the normal course of the Company's business activities.
The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings. A sudden and substantial increase in
interest rates may adversely impact the Company's earnings to
5
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
the extent that the interest rates on interest-earning assets and
interest-bearing liabilities do not change at the same speed, to the same extent
or on the same basis. The Company monitors the impact of changes in interest
rates on its net interest income using several tools.
The Bank's goal is to minimize interest rate risk between interest bearing
assets and liabilities at various maturities through its Asset-Liability
Management (ALM). ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic
outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be controlled
by management. Understanding the current position and implications of past
decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.
Interest sensitivity management is part of the asset-liability management
process. Interest sensitivity gap (GAP) is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period. The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year. Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction accounts, time
deposits and borrowings. The profitability of the Company is influenced
significantly by management's ability to manage the relationship between rate
sensitive assets and liabilities. At December 31, 1997, approximately 26% of the
Company's earning assets could be repriced within one year compared to
approximately 95% of its interest-bearing liabilities. This compares to 28% and
93%, respectively, in 1996 and 27% and 95%, respectively, in 1995.
The Company's current GAP analysis reflects that in periods of increasing
interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities. The Company's GAP analysis also shows that at the interest
repricing of one year, the Company's net interest margin would be adversely
impacted. This analysis, however, does not take into account the dynamics of the
marketplace. GAP is a static measurement that assumes if the prime rate
increases by 100 basis points, all assets and liabilities that are due to
reprice will increase by 100 basis points at the next opportunity. However, the
Company is actually able to experience a benefit from rising rates in the short
term because deposit rates do not follow the national money market. They are
controlled by the local market. Loans do follow the money market; so when rates
increase they reprice immediately, but the Company is able to manage the deposit
side. The Company generally does not raise deposit rates as fast or as much. The
Company also has the ability to manage its funding costs by choosing alternative
sources of funds.
The Company's current GAP position would also be interpreted to mean that in
periods of declining interest rates, the Company's net interest margin would
benefit. However, competitive pressures in the local market may not allow the
Company to lower rates on deposits, but force the Company to lower rates on
loans. Furthermore, the Company can only lower rates on deposits to the extent
that the floors will allow.
6
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset/liability
strategies which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point shock over twelve months. At
December 31, 1997, this model shows that if interest rates rose by 300 basis
points over the next twelve months, net interest margin would be adversely
affected by approximately 11%. The asset/liability committee meets weekly to
address interest pricing issues, and this model is reviewed monthly. Management
will continue to monitor its liability sensitive position in times of higher
interest rates which might adversely affect its net interest margin.
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results. Further, the computations do not contemplate
any actions the Company could undertake in response to changes in interest
rates.
The following table shows the Company's financial instruments that are sensitive
to changes in interest rates, categorized by expected maturity, and the
instruments' fair values at December 31, 1997. Market risk sensitive instruments
are generally defined as on- and off-balance sheet derivatives and other
financial instruments.
Expected Maturity/Principal Repayments at December 31,
Average There- Fair
Rate 1998 1999 2000 2001 2002 after Balance Value
- -------------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands)
Interest-sensitive assets:
Federal funds sold 5.32% 388 -- -- -- -- -- 388 388
Loans receivable 8.5 115,669 50,292 39,420 61,938 48,308 52,336 367,963 365,858
Mortgage-backed
securities 6.39 3,743 6,361 5,153 4,997 5,317 590 26,161 26,114
Other investment
securities 7.41 2,477 4,768 8,202 10,736 9,839 35,233 71,255 73,189
FHLB stock 7.32 -- -- -- -- -- 1,452 1,452 1,452
Interest-sensitive liabilities:
Interest-bearing
checking 2.13 139,774 -- -- -- -- -- 139,774 139,774
Savings deposits 2.45 26,639 -- -- -- -- -- 26,639 26,639
Time deposits 5.43 193,819 11,275 4,748 2,373 155 12 212,382 212,933
Borrowings 4.16 25,013 -- -- -- -- -- 25,013 25,013
Off-balance sheet items:
Commitments to
extend credit * -- -- -- -- -- 68,632 68,632 68,632
Unused lines of
credit 9.27 -- -- -- -- -- 12,005 12,005 12,005
* There is no way to determine the rates on the commitments because they have
not been set yet. The rates vary according to prime.
7
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
Expected maturities are contractual maturities adjusted for prepayments of
principal when possible. The Company uses certain assumptions to estimate fair
values and expected maturities. For loans, the Company has used contractual
maturities due to the fact that the Company has no historical information on
prepayment speeds. Since most of these loans are consumer and commercial loans,
and since the Company's customer base is community-based, the Company feels its
prepayment rates are insignificant. For mortgage-backed securities, expected
maturities are based upon contractual maturity, projected repayments and
prepayment of principal. The prepayment experience herein is based on industry
averages as provided by the Company's investment trustee. Interest-bearing
liabilities are included in the period in which the balances are expected to be
withdrawn as a result of contractual maturities. For accounts with no stated
maturities, the balances are included in the one year category.
Provision For Loan Losses
The allowance for possible loan losses is established through charges to expense
in the form of a provision for loan losses. Additions to the allowance for loan
losses are based on management's evaluation of the loan portfolio under current
economic conditions, past loan loss experience, and such other factors which, in
management's judgment, deserve recognition in estimating loan losses. Loans are
charged off when, in the opinion of management, they are deemed to be
uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance. While management uses the best
information available to make evaluations, future adjustments to the allowance
may be necessary if economic conditions differ substantially from the
assumptions used in making the evaluation. The allowance for loan losses is
subject to periodic evaluation by various regulatory authorities and may be
subject to adjustment, based upon information that is available to them at the
time of their examination.
The provision for loan losses was $1,331, $1,450 and $1,140, respectively, for
the years ended December 31, 1997, 1996, and 1995. The provision in 1997
reflects replenishing the allowance for loan losses to cover net charge-offs of
$908, plus providing for the 11% increase in total loans outstanding. The
allowance for loan losses totaled $5,152, $4,729 and $3,700 at December 31,
1997, 1996 and 1995, respectively. The level of the allowance for loan losses to
total loans outstanding is 1.40% at December 31, 1997. This compares to 1.42%
and 1.45% as of December 31, 1996 and 1995, respectively. Net charge-offs to
average loans are 0.26% for 1997 as compared to 0.14% for 1996 and 0.20% for
1995. Non-performing loans for 1997, 1996 and 1995 were approximately $1,240 or
0.34% (of total loans), $1,113 or 0.33% and $799 or 0.31%, respectively. The
majority of these non-performing loans are smaller-balance homogeneous consumer
loans.
Non-Interest Income
Non-interest income for 1997 increased by $502 or 10% over 1996, as compared to
an increase in 1996 of $826 or 20% over 1995. These increases generally resulted
from increased service charges on deposit accounts as a result of increases in
the volume of deposit relationships. Management
8
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
views deposit fee income as a critical influence on profitability. Periodic
monitoring of competitive fee schedules and examination of alternative
opportunities insure that the Company realizes the maximum contribution to
profits from this area.
A significant contributor to non-interest income is fees for trust services,
which continued to increase in 1997 to $986 from $861 in 1996 and $773 in 1995.
Fees for trust services increased as a result of the generation of new trust
business and additional assets under management. The trust department had assets
under management of $152,968, $122,667 and $107,000 at December 31, 1997, 1996
and 1995, respectively.
There were $40 and $21 of gains from sales of investment securities during 1997
and 1996, respectively. These gains were in response to the market rebound in
the current year. There were $93 of losses from sales of investment securities
realized during 1995. These securities were sold in response to rising interest
rates and declining market value.
Non-Interest Expenses
Non-interest expenses totaled $17,085 in 1997 as compared to $15,544 in 1996 and
$13,630 in 1995. This represented a 10% increase from 1996 to 1997, and a 14%
increase from 1995 to 1996. The overall increases during the year were due to
growth in all geographic markets, which is evidenced by the growth in deposits
of 9% from 1996 to 1997 and 25% from 1995 to 1996. Salaries and other personnel
expense, which comprised 50% of total non-interest expenses for 1997, were up
$932 or 12% over 1996. During 1996 and 1995, salaries and other personnel
expenses accounted for 48% and 54%, of total other operating expenses,
respectively.
Combined net occupancy and furniture and equipment expenses increased $179, or
6% from 1996 to 1997, as compared to an increase of $690, or 30%, in 1996. The
increase in 1997 is due to normal growth and activity. The increase in 1996 was
due primarily to the increased depreciation and rental expense associated with
the addition of new branches and the renovation of the Corporate Center to
include the corporate offices and the Telephone Banking Center.
Income Taxes
Income tax expense totaled $2,415 in 1997 as compared to $1,652 in 1996 and
$1,246 in 1995. The changes in income tax expense for all three years were due
to changes in taxable income for each respective year.
9
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
Liquidity
The liquidity ratio is an indication of a company's ability to meet its
short-term funding obligations. The Company's policy is to maintain a liquidity
ratio between 15% - 25%. At December 31, 1997, the Company's liquidity ratio was
approximately 19%.
The Company's liquidity position is dependent upon its debt servicing needs and
dividends declared. The Company had no outstanding debt at December 31, 1997 and
1996, respectively.
During 1991 the Company began selling commercial paper as a alternative
investment tool for its commercial customers (Master note program). The
commercial paper is issued only in conjunction with the automated sweep account
customer agreement on deposits at the Bank level. At December 31, 1997, the
Company had $11,289 in commercial paper with a weighted average rate of 3.69%,
as compared to $7,435 in 1996 with a weighted average of 4.69% and $6,187 in
1995 with a weighted average rate of 3.30%.
The Parent Company has approximately $8 million in commercial paper backup lines
of credit from correspondent banks to use as additional sources of short-term
liquidity. The interest rates on these lines fluctuate with the prime rate and
are payable on demand. At December 31, 1997, there were no balances drawn on
these lines of credit.
The Parent Company's liquidity needs are met through the payment of dividends
from the Bank. At December 31, 1997 the Bank had available retained earnings of
$4,576 for payment of dividends.
The Bank's liquidity is affected by its ability to attract deposits, the
maturity of its loan portfolio, the flexibility of its investment securities,
lines of credit from correspondent banks, and current earnings. Sufficient
liquidity must be available to meet continuing loan demand and deposit
withdrawal requirements. Competition for deposits is intense in the markets
served by the Bank. However, the Bank has been able to attract deposits as
needed through pricing adjustments and expansion of its geographic market area.
The deposit base is comprised of diversified customer deposits with no one
deposit or type of customer accounting for a significant portion. Therefore,
withdrawals are not expected to fluctuate from historical levels. The loan
portfolio of the Bank is a source of liquidity through maturities and repayments
by existing borrowers. The investment securities portfolio is a source of
liquidity through scheduled maturities and sales of securities, and prepayment
of principal on mortgage-backed securities. Approximately 63% of the securities
portfolio was pledged to secure liabilities as of December 31, 1997, as compared
to 66% at December 31, 1996. Management believes that its sources of liquidity
are adequate to meet operational needs. Additional sources of short-term
liquidity are existing lines of credit from correspondent banks totaling $80
million, all of which are available. Loan demand has been constant and loan
originations can be controlled through pricing decisions.
In November 1995, the FASB issued a guide to implementation of SFAS No. 115 on
accounting for certain investments in debt and equity securities which allowed
for the one time transfer of
10
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
certain investments classified as held for investment to available for sale. The
Company transferred investment securities with an amortized cost of $29,107 and
a related unrealized gain of $69 in the fourth quarter of 1995. This transfer
enabled the Company to better position its balance sheet for asset/liability
management.
Capital Resources
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a material
effect on the financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of the
Company's and the Bank's assets, liabilities and certain off-balance sheet items
as calculated under regulatory accounting practices. The Company's and the
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier 1 capital to risk-weighted assets and to total assets. Management
believes, as of December 31, 1997, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
At December 31, 1997 and 1996 the Company and the Bank were each categorized as
"adequately capitalized," under the regulatory framework for prompt corrective
action. To be categorized as "adequately capitalized," the Company and the Bank
must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage
ratios of 8%, 4% and 4%, respectively. There are no current conditions or events
that management believes would change the Company's or the Bank's category. The
Company is categorized as "adequately capitalized" due to the infusion of
approximately $54,000 in deposits related to the acquisition of the three
branches in 1996. As a result of this change in capital adequacy, the Bank
incurred higher FDIC insurance premiums in 1997 compared to 1996. The Company's
strategic plan for controlled growth and profit improvement anticipates
sufficient internally generated capital to return the risk-weighted ratios to
the "well-capitalized" guidelines during the coming year.
Please see "Notes to Consolidated Financial Statements" footnote 17 for the
Company's and the Bank's various capital ratios at December 31, 1997.
Pursuant to the Internal Revenue Code of 1986, as amended, and the regulations
thereunder, the stock in the Employee Stock Option Plan (the "ESOP") has a put
and a call feature if the stock is not "readily tradable on an established
market." This term was clarified in 1995 as a result of a private letter ruling,
to mean publicly listed on a national securities exchange. Since the
11
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
Company's stock is not listed on a national securities exchange, the shares in
the ESOP Plan are subject to the put/call feature. Accordingly, 275,180 shares
of common stock are now recorded outside shareholders' equity at their fair
value, which is determined by an independent valuation. The Company's Board of
Directors voted to terminate the ESOP effective February 28, 1997. The shares to
be distributed in 1998 due to the termination of the ESOP will be subject to the
put/call until June 29, 1999.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in relative
purchasing power over time due to inflation. Virtually all of the assets and
liabilities of the Bank are monetary in nature and, as a result, its operations
can be significantly affected by interest rate fluctuations as discussed above.
Therefore, inflation will affect the Bank only to the extent that interest rates
change and according to the Bank's sensitivity to such changes. The Company
attempts to manage the effects of inflation through its asset/liability
management as described above in "Asset and Liability Management."
Accounting and Reporting Changes
In December 1996, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 127, Deferral of the
Effective Date of Certain Provisions of SFAS No. 125, an amendment of SFAS No.
125, which is effective December 31, 1996. This statement delays the effective
date of certain provisions of SFAS No. 125 until after December 31, 1997. The
amended provisions include those related to the transfers of financial assets
and secured borrowings. The provisions in SFAS No. 125 related to servicing
assets and liabilities are not delayed by this amendment. The Company does not
anticipate that adoption of this standard will have a material effect on the
Company's financial statements.
In February 1997, the FASB issued SFAS No. 128, Earnings per Share, which is
effective for both interim and annual periods ending after December 15, 1997.
This statement supersedes Accounting Principles Board Opinion No. 15, Earnings
per Share. The purpose of this statement is to simplify current reporting and
make U.S. reporting comparable to international standards. The statement
requires dual presentation of basic and diluted EPS by entities with complex
capital structures (as defined by the statement). Although the adoption of this
standard changed the appearance of the Company's income statement, there is not
a material difference between basic and diluted earnings per share for the
Company.
In June 1997, the FASB issued SFAS Nos. 130, Reporting Comprehensive Income. The
statement is effective for annual and quarterly financial statements for fiscal
years beginning after December 15, 1997, with earlier application permitted. For
the Company, the statement becomes effective in
12
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Management's Discussion and Analysis (Continued)
the first quarter of 1998 and requires reclassification of earlier financial
statements for comparative purposes. SFAS No. 130 requires that changes in the
amounts of comprehensive income items be shown in a primary financial statement.
Comprehensive income is defined by the statement as "the change in equity (net
assets) of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. It includes all changes in
equity during a period except those resulting from investments by owners and
distributions to owners." While this statement will change the look of the
Company's financial statements, the adoption of this standard is not expected to
have a material effect on the Company.
Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. The statement is effective for financial
statements for fiscal years beginning after December 15, 1997, with earlier
application permitted. SFAS No. 131 changes the way public companies report
information about segments of their business in their annual financial
statements and requires them to report selected segment information in their
quarterly reports issued to shareholders. A company is required to report on
operating segments based on the management approach. An operating segment is
defined as any component of an enterprise that engages in business activities
from which it may earn revenues and incur expenses. The management approach is
based on the way that management organizes the segments within the enterprise
for making operating decisions and assessing performance. Although this
statement may require the Company to disclose more detail information in its
financial statements, this SFAS will not have a material effect on the numbers
in those financial statements.
Industry Developments
Certain recently-enacted and proposed legislation could have an effect on both
the costs of doing business and the competitive factors facing the financial
institution's industry. Because of the uncertainty of the final terms and
likelihood of passage of the proposed legislation, the Company is unable to
assess the impact of any proposed legislation on its financial condition or
operations at this time.
13
Independent Auditors' Report
The Board of Directors
Palmetto Bancshares, Inc. and subsidiary:
We have audited the accompanying consolidated balance sheets of Palmetto
Bancshares, Inc. and subsidiary (the "Company") as of December 31, 1997 and
1996, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Palmetto Bancshares,
Inc. and subsidiary as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Greenville, South Carolina
February 20, 1998
14
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1997 and 1996
(Dollars in Thousands, except per share data)
Assets 1997 1996
---- ----
Cash and due from banks $ 25,539 28,373
Federal funds sold 388 1,951
Federal Home Loan Bank stock, at cost 1,452 -
Investment securities held to maturity (market values of $81,578
and $66,770 in 1997 and 1996, respectively) 80,006 66,207
Investment securities available for sale (amortized cost of $17,410
and $15,969 in 1997 and 1996, respectively) 17,725 16,240
Loans held for sale - 4,075
Loans 367,963 332,986
Less allowance for loan losses (5,152) (4,729)
---------------- ----------------
Loans, net 362,811 328,257
---------------- ----------------
Premises and equipment, net 13,386 12,323
Accrued interest 3,990 3,437
Other assets 7,910 7,514
---------------- ----------------
Total assets $ 513,207 468,377
================ ================
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Non-interest-bearing $ 70,595 71,349
Interest-bearing 378,795 341,037
---------------- -----------------
Total deposits 449,390 412,386
Securities sold under agreements to repurchase 12,224 11,636
Commercial paper (Master note) 11,289 7,435
Federal funds purchased 1,500 3,000
Other liabilities 2,188 2,482
---------------- -----------------
Total liabilities 476,591 436,939
Common stock subject to put/call option 3,784 3,314
Shareholders' equity:
Common stock - $5.00 par value. Authorized
10,000,000 shares; issued and outstanding 3,089,552 in 1997;
issued 3,032,952 and outstanding 3,023,841 in 1996; 15,448 15,165
Additional paid-in capital 317 334
Retained earnings 20,658 15,894
Treasury stock (9,111 shares in 1996) - (121)
Unrealized gain on investment securities available for sale, net 193 166
Common stock subject to put/call option, 275,180 shares at $13.75
per share in 1997 and 284,007 shares at $11.67 per share in 1996 (3,784) (3,314)
---------------- -----------------
Total shareholders' equity 32,832 28,124
---------------- -----------------
Total liabilities and shareholders' equity $ 513,207 468,377
=============== =================
See accompanying notes to consolidated financial statements.
15
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years ended December 31, 1997, 1996 and 1995
(Dollars in Thousands, except per share data)
1997 1996 1995
---- ---- ----
Interest income:
Interest and fees on loans $ 30,868 26,852 21,423
Interest and dividends on investment securities
available for sale:
U.S. Treasury 909 1,310 1,092
State and municipal 373 598 68
Interest and dividends on investment securities held to maturity:
U.S. Treasury and U.S. Government agencies 1,282 1,029 1,881
State and municipal 1,595 1,330 1,274
Mortgage-backed securities 1,703 979 150
Interest on federal funds sold 291 93 380
Dividends on FHLB stock 56 - -
------------ ------------ -----------
Total interest income 37,077 32,191 26,268
Interest expense:
Interest on deposits 14,816 12,724 9,987
Interest on securities sold under agreements to repurchase 558 459 501
Interest on federal funds purchased 86 314 -
Interest on commercial paper (Master note) 381 313 341
Interest on note payable to a bank - - 13
------------ ------------ ------------
Total interest expense 15,841 13,810 10,842
------------ ------------ ------------
Net interest income 21,236 18,381 15,426
Provision for loan losses 1,331 1,450 1,140
------------ ------------ ------------
Net interest income after provision for loan losses 19,905 16,931 14,286
------------ ------------ ------------
Non-interest income:
Service charges on deposit accounts 3,215 2,863 2,494
Fees for trust services 986 861 773
Gains on sales of loans 14 148 -
Investment securities gains (losses) 40 21 (93)
Other income 1,265 1,125 1,018
------------ ------------ ------------
Total non-interest income 5,520 5,018 4,192
------------ ------------ ------------
Non-interest expense:
Salaries and other personnel 8,468 7,536 7,399
Net occupancy 1,501 1,452 1,219
Furniture and equipment 1,679 1,549 1,093
FDIC assessment 177 2 320
Postage and supplies 885 873 702
Advertising 629 737 570
Telephone 518 474 407
Other expense 3,228 2,921 1,920
------------ ------------ ------------
Total non-interest expense 17,085 15,544 13,630
------------ ------------ ------------
Income before income taxes 8,340 6,405 4,848
Income tax provision 2,415 1,652 1,246
------------ ------------ ------------
NET INCOME $ 5,925 4,753 3,602
============ ============ ============
(Continued)
16
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations (continued)
Years ended December 31, 1997, 1996 and 1995
(Dollars in Thousands, except per share data)
1997 1996 1995
---- ---- ----
Increase in fair value of ESOP stock (470) (543) -
------------- ------------- -----------
Net income on common shares not subject
to put/call $ 5,455 4,210 3,602
============ ============ ============
Per share data:
Net income per common share-basic, not subject to put/call $ 1.97 1.54 1.20
============ ============ ============
Net income per common share-dilutive, not subject to put/call $ 1.93 1.51 1.18
============ ============ ============
Cash dividends declared $ 0.38 0.28 0.22
============ ============ ============
Weighted average shares outstanding 3,054,877 3,007,661 3,010,320
============ ============ ============
Weighted average shares outstanding not subject to put/call 2,772,298 2,732,305 3,010,320
============ ============ ============
See accompanying notes to consolidated financial statements.
17
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income $ 5,925 4,753 3,602
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,221 1,829 1,071
Loss (gain) on sale of investment securities (40) (21) 93
Gain on sale of loans (14) (147) -
Provision for loan losses 1,331 1,450 1,140
Origination/acquisition of loans held for sale (25,077) (58,239) -
Sale of loans held for sale 29,166 54,311 -
Provision (credit) for deferred taxes 259 309 (332)
Change in accrued interest receivable (553) (889) (105)
Change in other assets (1,319) (2,350) (600)
Change in other liabilities, net (311) 735 783
--------------- -------------- --------------
Net cash provided by operating activities 11,588 1,741 5,652
-------------- -------------- --------------
Cash flows from investing activities:
Purchase of investment securities held to maturity (29,594) (23,357) (30,407)
Purchase of investment securities available for sale (10,956) (9,991) (21,605)
Proceeds from maturities of investment securities
held to maturity 12,170 5,153 11,929
Proceeds from maturities of investment securities available
for sale 6,000 2,102 -
Proceeds from sale of investment securities available for sale 3,614 30,501 21,716
Principal paydowns on mortgage-backed securities 3,537 2,014 -
Purchase of Federal Home Loan Bank stock (1,452) - -
Net increase in loans outstanding (35,885) (84,554) (40,235)
Increase in premises and equipment (2,310) (2,746) (1,997)
--------------- -------------- --------------
Net cash used in investing activities (54,876) (80,878) (60,599)
--------------- --------------- ---------------
Cash flows from financing activities:
Net increase in deposits 36,723 29,246 55,086
Acquisition of deposits, net - 50,512 -
Net increase in securities sold under agreements to repurchase 588 4,090 2,294
Net increase (decrease) in commercial paper 3,854 1,248 (727)
Increase (decrease) in federal funds purchased (1,500) 100 2,900
Repayments on note payable to a bank - - (479)
Proceeds from issuance of common stock 266 2 12
Purchase of treasury stock - (121) (230)
Proceeds from sale of treasury stock 125 207 166
Dividends paid (1,165) (842) (652)
--------------- -------------- --------------
Net cash provided by financing activities 38,891 84,442 58,370
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents (4,397) 5,305 3,423
Cash and cash equivalents at beginning of year 30,324 25,019 21,596
-------------- -------------- --------------
Cash and cash equivalents at end of year $ 25,927 30,324 25,019
============== ============== ==============
(Continued)
18
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows (Continued)
Years ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
1997 1996 1995
---- ---- ----
Supplemental information:
Cash paid during the year for:
Interest $ 15,697 13,653 10,490
============== ============== ==============
Income taxes $ 2,385 1,641 1,280
============== ============== ==============
Supplemental schedule of non-cash investing
and financing transactions:
Unrealized gain on investment securities
available for sale, net $ 27 (470) 798
============== =============== ==============
Securitization of mortgage loans $ - 6,334 -
============== ============== =============
Transfer of investment securities held to maturity to
available for sale $ - - 29,107
============== ============== ==============
See accompanying notes to consolidated financial statements.
19
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
Unrealized
Gain (Loss) Common
on Investment Stock
Additional Securities Subject to
Common Paid-in Retained Treasury Available Put/call
Stock Capital Earnings Stock For Sale, Net Option Total
----- ------- -------- ----- ------------- ------ -----
Balance at December 31, 1994 $15,160 325 9,067 (177) (162) -- 24,213
Net income -- -- 3,602 -- -- -- 3,602
Cash dividend declared -- -- (652) -- -- -- (652)
Issuance of 2,100 shares in connection
with stock option 3 9 -- -- -- -- 12
Purchase of 17,712 shares treasury stock -- -- -- (230) -- -- (230)
Sale of 17,100 shares treasury stock -- -- (11) 177 -- -- 166
Change in unrealized loss on investment
securities available for sale, net -- -- -- -- 798 -- 798
Common stock subject to put/call option -- -- -- -- -- (2,771) (2,771)
------- ------- ------- ------- ------- ------- -------
Balance at December 31, 1995 15,163 334 12,006 (230) 636 (2,771) 25,138
Net income -- -- 4,753 -- -- -- 4,753
Cash dividend declared -- -- (842) -- -- -- (842)
Issuance of 300 shares in connection with
stock options 2 -- -- -- -- -- 2
Purchase of 9,111 shares treasury stock -- -- -- (121) -- -- (121)
Sale of 17,712 shares treasury stock -- -- (23) 230 -- -- 207
Change in unrealized gain on investment
securities available for sale, net -- -- -- -- (470) -- (470)
Common stock subject to put/call option -- -- -- -- -- (543) (543)
------- ------- ------- ------- ------- ------- -------
Balance at December 31, 1996 15,165 334 15,894 (121) 166 (3,314) 28,124
Net income -- -- 5,925 -- -- -- 5,925
Cash dividend declared -- -- (1,165) -- -- -- (1,165)
Issuance of 56,600 shares in connection with
stock options 283 (17) -- -- -- -- 266
Sale of 9,111 shares treasury stock -- -- 4 121 -- -- 125
Change in unrealized gain on investment
securities available for sale, net -- -- -- -- 27 -- 27
Common stock subject to put/call option -- -- -- -- -- (470) (470)
------- ------- ------- ------- ------- ------- -------
Balance at December 31, 1997 $15,448 317 20,658 -- 193 (3,784) 32,832
======= ======= ======= ======= ======= ======= =======
See accompanying notes to consolidated financial statements.
20
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(Dollars in thousands, except per share data)
(1) Summary of Significant Accounting Policies
The following is a description of the more significant accounting
policies used in preparing the consolidated financial statements. The
accounting and reporting policies of Palmetto Bancshares, Inc. (the
"Company") conform to generally accepted accounting principles ("GAAP")
and to general practices within the banking industry. The preparation of
the financial statements in conformity with GAAP requires management to
make estimates and assumptions. These estimates and assumptions affect
the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial
statements. In addition, they affect the reported amounts of income and
expense during the reporting period. Actual results could differ from
these estimates and assumptions.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, Palmetto Bank (the "Bank"). The Bank
provides a full range of banking services, including the taking of
deposits and the making of loans. Palmetto Capital, Inc. ("Capital"), a
wholly owned subsidiary of Palmetto Bank, was incorporated February 26,
1992. Capital offers the brokerage of stocks, bonds, mutual funds and
unit investment trusts. Capital also offers advisory services and
variable rate annuities. The Company's primary market area is the upstate
of South Carolina. All significant intercompany accounts and transactions
have been eliminated in consolidation.
Assets held by the Company or its subsidiary in a fiduciary or agency
capacity for customers are not included in the consolidated financial
statements as such items are not assets of the Company or its subsidiary.
On April 15, 1996, the Bank acquired three existing branches of First
Union National Bank of South Carolina. The Bank assumed deposits of
approximately $54 million, but assumed no loans.
Cash and Cash Equivalents
tlparCash and cash equivalents include cash, due from banks and federal
funds sold. Generally, both cash and cash equivalents are considered to
have maturities of three months or less, and accordingly, the carrying
amount of such instruments is deemed to be a reasonable estimate of fair
value. To comply with Federal Reserve regulations, the Bank is required
to maintain certain average cash reserve balances on-hand as vault cash
and/or at the Federal Reserve as compensating balances. These
compensating balances are $0 and $3,849 at December 31, 1997 and 1996,
respectively.
21
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, Continued
Federal Home Loan Bank Stock
ctlparDuring 1997, the Bank joined the Federal Home Loan Bank ("FHLB") of
Atlanta to increase the Bank's available liquidity. As a FHLB member, the
Bank is required to acquire and retain shares of capital stock in the
FHLB of Atlanta in an amount equal to the greater of (1) 1.0% of the
aggregate outstanding principal amount of the residential mortgage loans,
home purchase contracts and similar obligations, or (2) 0.3% of total
assets at the beginning of each year. The Bank is in compliance with this
requirement with an investment in FHLB stock of $1,452 at December 31,
1997. No ready market exists for this stock and it has no quoted market
value. However, redemption of this stock has historically been at par
value. The Bank has available $48,000 in lines of credit from the FHLB.
There were no advances on these lines at December 31, 1997.
Investment Securities
The Bank accounts for its investment securities in accordance with SFAS
No. 115, Accounting for Certain Investments in Debt and Equity
Securities. SFAS No. 115 addresses the accounting and reporting for
investments in equity securities that have readily determinable fair
values - other than those accounted for under the equity method or as
investments in consolidated subsidiaries - and all investments in debt
securities. Under SFAS No. 115, investments are classified into three
categories as follows: (1) Held to Maturity - debt securities that the
Company has the positive intent and ability to hold to maturity, which
are reported at amortized cost; (2) Trading - debt and equity securities
that are bought and held principally for the purpose of selling them in
the near term, which are reported at fair value, with unrealized gains
and losses included in earnings; and (3) Available for Sale - debt and
equity securities that may be sold under certain conditions, which are
reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity,
net of income taxes. The Company does not have any trading securities.
SFAS No. 115 allows for the sale of held to maturity securities if the
sale occurs within 90 days of the securities' maturity. The Bank sold
several held to maturity securities during 1995 that met this criteria,
and they are included with other maturities of held for maturity
investment securities in the accompanying consolidated statements of cash
flows.
In November 1995, the FASB issued a guide to implementation of SFAS No.
115 on accounting for certain investments in debt and equity securities
which allowed for the one time transfer of certain investments classified
as held to maturity to available for sale. The Company transferred
investment securities with an amortized cost of $29,107 and a related
unrealized gain of $69 in the fourth quarter of 1995.
22
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, Continued
Loans Held for Sale
At December 31, 1997, the Company has no loans held for sale due to a
reorganization in the Bankte s mortgage servicing department. The Bank is
currently not actively purchasing and originating mortgage loans to be
sold. The Bank plans to re-engage in these activities in the future, but
not to the same extent or volume as before. The Bank continues to service
its portfolio of loans sold. Loans serviced for the benefit of others
amounted to approximately $148 million at December 31, 1997, of which
approximately $85 million resulted from an acquisition of servicing in
1996. Most of these loans are serviced for Federal Home Loan Mortgage
Corporation (FHLMC).
The Bank recognizes mortgage servicing rights (MSR's) in accordance with
SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities, an Amendment of SFAS No. 122, which
became effective for transactions occurring after December 31, 1996. The
adoption of this standard did not have a material impact on the Company.
The statement requires the recognition of a separate asset for the right
to service mortgage loans for others, regardless of how those rights were
acquired. Further, it requires assessment of impairment based on fair
value. The Company evaluates these rights quarterly for possible
impairment. At December 31, 1997, the Company recognized $62 of
impairment. There was no impairment at December 31, 1996.
At December 31, 1997, the Company had net MSR's of approximately $1.6
million related to these loans included in other assets on the
consolidated balance sheet. The fair value of the mortgage servicing
rights are determined considering market prices for similar MSR's and on
the discounted anticipated future net cash flows considering market
consensus loan prepayment predictions, historical prepayment rates,
interest rates, and other economic factors. For purposes of measuring the
impairment, the Company stratifies the MSR's based on the predominant
risk characteristics of the underlying loans, including interest rate,
loan type, and amortization type (fixed rate or adjustable rate). To the
extent that the carrying value of MSR's exceeds this fair value by
individual stratum, a valuation allowance is established. The allowance
may be adjusted in the future as the values of the MSR's increase or
decrease. The cost of MSR's is amortized over the estimated period of net
servicing revenues.
Loans and Interest Income
Loans are carried at principal amounts outstanding reduced by unearned
discounts. Interest income on all loans is recorded on an accrual basis.
The accrual of interest is generally discontinued on loans which become
90 days past due as to principal or interest. The accrual of interest on
some loans, however, may continue even though they are 90 days past due
if the loans are well secured, in the process of collection, and
management deems it appropriate. If non-accrual loans decrease their past
due status to 60 days or less, they are reviewed individually by
management to determine if they should be returned to accrual status.
23
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, Continued
Impaired Loans
The FASB has issued SFAS No. 114, Accounting by Creditors for Impairment
of a Loan, which requires that all creditors value all specifically
reviewed nonhomogenous loans for which it is probable that the creditor
will be unable to collect all amounts due according to the terms of the
loan agreement at the loan's fair value. Fair value may be determined
based upon the present value of expected cash flows, market price of the
loan, if available, or value of the underlying collateral. Expected cash
flows are required to be discounted at the loan's effective interest
rate. SFAS No. 114 was amended by SFAS No. 118 to allow a creditor to use
existing methods for recognizing interest income on impaired loans and by
requiring additional disclosures about how a creditor recognizes interest
income related to impaired loans. On January 1, 1995, the provisions of
SFAS Nos. 114 and 118 were adopted. The adoption of the Standards
required no increase to the allowance for loan losses and had no impact
on net income upon adoption.
The Bank determines which loans are impaired through a loan review
process. When the ultimate collectibility of an impaired loan's principal
is in doubt, wholly or partially, all cash receipts are applied to
principal. When this doubt no longer exists, cash receipts are applied
under the contractual terms of the loan agreement first to principal and
then to interest income. Once the recorded principal balance has been
reduced to zero, future cash receipts are applied to interest income, to
the extent that any interest has been foregone. Further cash receipts are
recorded as recoveries of any amounts previously charged off.
SFAS No. 114 specifically states that it need not be applied to "large
groups of smaller-balance homogeneous loans that are collectively
evaluated for impairment." Thus, the Company determined that the
statement does not apply to its consumer loan, credit card or residential
mortgage loan portfolios, except that it may choose to apply it to
certain specific larger loans determined by management. In effect, these
portfolios are covered adequately in the Company's normal formula for
determining loan loss reserves.
Loan Fees and Costs
Non-refundable fees and certain direct costs associated with originating
or acquiring loans are recognized as a yield adjustment over the
contractual life of the related loans, or if the related loan is held for
resale, until the loan is sold. Commitment fees associated with lending
are deferred and if the commitment is exercised, the fee is recognized
over the life of the related loan as a yield adjustment. If the
commitment expires unexercised the amount is recognized upon expiration
of the commitment.
24
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, Continued
Allowance for Loan Losses
Additions to the allowance for loan losses are based on management's
evaluation of the loan portfolio under current economic conditions, past
loan loss experience, and such other factors which, in management's
judgment, deserve recognition in estimating loan losses. Loans are
charged-off when, in the opinion of management, they are deemed to be
uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance. While management uses
the best information available to make evaluations, future adjustments to
the allowance may be necessary if economic conditions differ
substantially from the assumptions used in making the evaluation. The
allowance for loan losses is subject to periodic evaluation by various
regulatory authorities and may be subject to adjustment, based upon
information that is available to them at the time of their examination.
Premises and Equipment
Premises and equipment are reported at cost less accumulated depreciation
and amortization. Depreciation is recorded using the straight-line method
over the estimated useful life of the related asset as follows:
buildings, 12 to 39 years; and furniture and equipment, 5 to 12 years.
Amortization of leasehold improvements is recorded using the
straight-line method over the lesser of the estimated useful life of the
asset or the term of the lease. Maintenance and repairs are charged to
operating expense as incurred.
Foreclosed Properties
Property acquired through foreclosure is included in other assets and
amounted to $30 and $82, at December 31, 1997 and 1996, respectively.
Such property is recorded at the lower of cost or fair value minus
estimated selling costs. Gains and losses on the sale of foreclosed
properties and write-downs resulting from periodic reevaluation are
charged to other operating expenses.
Income Taxes
Under the asset and liability method of SFAS No. 109, deferred tax assets
and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using the enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Under SFAS
No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the
enactment date.
25
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, Continued
Intangibles
At December 31, 1997, deposits are shown net of premium on deposits
acquired of approximately $963, net of amortization, which is being
amortized principally over 10 years using the double-declining balance
method. At December 31, 1997, goodwill of approximately $949, net of
amortization, related to a 1988 acquisition, is being amortized on a
straight-line basis over a 25 year period. At December 31, 1997, goodwill
of approximately $2,419, net of amortization, related to the acquisition
of three branches in 1996, is being amortized on a straight-line basis
over 15 years. The Company periodically assesses the recoverability of
these intangibles by evaluating whether the amortization of the remaining
balance can be recovered through projected undiscounted future cash flows
which are based on historical trends.
Net Income Per Share
Net income per share-basic, not subject to put/call is based on the
weighted average number of shares outstanding not subject to put/call.
See note 11 for further explanation on this put/call feature. Net income
per common share-dilutive, not subject to put/call is calculated based on
SFAS No. 128, as discussed in note 12. All share and per share amounts
have been retroactively restated for the three-for-one stock split in
1996 as discussed in note 9.
Stock Options
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-based
Compensation. This statement is effective for financial statements issued
for fiscal years beginning after December 15, 1995. SFAS No. 123
introduces a preferable fair-value based method of accounting for
stock-based compensation. It encourages, but does not require companies
to recognize compensation expense for grants of stock, stock options, and
other equity instruments to employees based on fair value. Companies that
choose not to adopt the fair value method will continue to apply the
existing accounting rules contained in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
chosen the latter option. SFAS No. 123 requires companies that choose not
to adopt the fair value method of accounting to disclose pro forma net
income and earnings per share under the fair value method. In addition,
all companies with stock-based plans are required to make detailed
disclosures about plan terms, exercise prices, and assumptions used in
measuring the fair value of stock-based grants (see note 11).
26
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(2) Federal Funds Sold
At December 31, 1997 and 1996, the Bank had $388 and $1,951,
respectively, outstanding in federal funds sold. The daily averages of
these outstanding agreements during 1997 and 1996 were $5,465 and $1,758,
respectively. The maximum amount of these outstanding agreements at any
month-end during 1997 and 1996 were $12,497 and $1,951, respectively. The
securities underlying these agreements were maintained in safekeeping by
an authorized broker.
(3) Investment Securities Held to Maturity
The amortized cost and fair values of investment securities held to
maturity as of December 31 are summarized as follows:
1997
--------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U.S. Treasury and U.S.
Government agencies $ 16,984 65 (13) 17,036
State and municipal 36,861 1,572 (5) 38,428
Mortgage-backed securities 26,161 101 (148) 26,114
--------------- -------------- ---------- --------------
$ 80,006 1,738 (166) 81,578
=============== ============== ========== ==============
1996
--------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----- ----- ------ -----
U.S. Treasury and U.S.
Government agencies $ 16,006 7 (122) 15,891
State and municipal 25,450 1,072 (30) 26,492
Mortgage-backed securities 24,751 12 (376) 24,387
------------ ------ ----- ------
$ 66,207 1,091 (528) 66,770
============ ====== ===== ======
27
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(3) Investment Securities Held to Maturity, Continued
The following is a maturity distribution of investment securities held to
maturity as of December 31:
1997
---------------------------
Amortized Fair
Cost Value
---------- --------
Due in one year or less $ 1,405 1,407
Due after one year
through five years 26,985 27,233
Due after five years
through ten years 30,810 31,581
Due after ten years 20,806 21,357
--------------- -------------
$ 80,006 81,578
=============== =============
(4) Investment Securities Available for Sale
The amortized cost and fair values of investment securities available for
sale as of December 31 are summarized as follows:
1997
--------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U.S. Treasury $ 12,492 201 (12) 12,681
State and Municipal 4,918 126 - 5,044
-------------- ---------- ----------- --------------
$ 17,410 327 (12) 17,725
============== ========== ============ ==============
1996
----------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------ ------- ------- -----
U.S. Treasury $ 8,993 93 (51) 9,035
State and Municipal 6,976 229 - 7,205
-------- -------------- ----------- -----------
$ 15,969 322 (51) 16,240
======== ============== =========== ===========
28
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(4) Investment Securities Available for Sale, Continued
During the year ended December 31, 1997 the Company had realized gains of
$49 and realized losses of $9; compared to realized gains of $121 and
realized losses of $100 in 1996. During 1995, the realized gains amounted
to $306, and the realized losses were $399. Specific identification is
the basis on which cost was determined in computing realized gains and
losses.
The following is a maturity distribution of investment securities
available for sale at December 31:
1997
-----------------------
Amortized Fair
Cost Value
---- ------
Due in one year or less $ 1,477 1,497
Due after one year through
five years 15,933 16,228
-------- -------
$ 17,410 17,725
========= =========
Investment securities held to maturity and available for sale with an
aggregate carrying value of approximately $61,734 and $54,497 at December
31, 1997 and 1996, respectively, are pledged to secure public deposits,
securities sold under agreements to repurchase, and for other purposes as
required or permitted by law.
(5) Loans
A summary of loans, by classification, as of December 31 follows:
1997 1996
---- ----
Commercial, financial and agricultural $ 81,678 68,616
Real estate - construction 8,799 9,598
Real estate - mortgage 195,462 181,775
Installment loans to individuals 82,024 72,997
----------------- ---------------
$ 367,963 332,986
================== ================
Non-accrual loans included above $ 1,096 1,113
================= ===============
29
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(5) Loans, Continued
The foregone interest income related to loans on non-accrual amounted to
$66, $52 and $66 for the years ended December 31, 1997, 1996 and 1995,
respectively.
In September 1996, the Company securitized approximately $6,300 of real
estate mortgage loans. These mortgage-backed securities are included in
the Company's held to maturity investment portfolio.
The following is a summary of activity affecting the allowance for loan
losses for the years ended December 31:
1997 1996 1995
---- ---- ----
Balance at beginning of year $ 4,729 3,700 3,016
Provision for loan losses 1,331 1,450 1,140
Loan recoveries 141 289 157
Loans charged-off (1,049) (710) (613)
-------------- ---------- ---------
Balance at end of year $ 5,152 4,729 3,700
============= ========== =========
At December 31, 1997, impaired loans amounted to approximately $70.
During 1997, the average recorded investment in impaired loans was
approximately $44, and there is $70 included in the allowance for loan
losses related to impaired loans at December 31, 1997.
During 1996, the Company charged-off some of the loans previously
considered impaired and was able to reclassify others due to improved
credit conditions; so that at December 31, 1996 there were no impaired
loans. During 1996, the average recorded investment in impaired loans was
approximately $76, and there is no allowance for loan losses related to
impaired loans at December 31, 1996.
At December 31, 1995, impaired loans amounted to approximately $193.
During 1995, the average recorded investment in impaired loans was
approximately $211. Included in the allowance for loan losses at December
31, 1995 is approximately $97 related to these impaired loans.
The Bank makes contractual commitments to extend credit, which are
legally binding agreements to lend money to customers at predetermined
interest rates for a specific period of time. The Bank also provides
standby letters of credit which are issued on behalf of customers in
connection with contracts between the customers and third parties. Under
a standby letter of credit the Bank assures that the third party will not
suffer a loss if the customer fails to meet the contractual obligation.
The Bank applies the same credit standards used in the lending process
when extending these commitments, and periodically reassesses the
customers' creditworthiness through ongoing credit reviews.
30
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(5) Loans, Continued
At December 31, 1997, except for the fact that the majority of the loan
portfolio is located in the Bank's immediate market area, there were no
concentrations of loans in any type of industry, type of property, or to
one borrower.
The Bank had outstanding, unused loan commitments as of December 31, 1997
as follows:
Home equity loans $ 8,148
Credit cards 21,496
Commercial real estate development 11,420
Other unused lines of credit 27,568
---------------
$ 68,632
Standby letters of credit $ 3,081
===============
All unused loan commitments are at adjustable rates that fluctuate with
prime rate, or are at fixed rates which approximate market rates. Current
amounts listed are therefore determined to be their market value.
(6) Premises and Equipment, Net
A summary of premises and equipment, net, as of December 31 follows:
1997 1996
---- ----
Land $ 1,925 1,888
Buildings and leasehold improvements 10,802 10,010
Furniture and equipment 10,151 8,713
-------------- --------------
22,878 20,611
Less accumulated depreciation and amortization (9,492) (8,288)
-------------- --------------
Premises and equipment, net $ 13,386 12,323
============== ==============
31
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(7) Deposits
A summary of deposits, by type, as of December 31 follows:
1997 1996
---- ----
Transaction accounts $ 156,299 150,985
Savings deposits 26,639 26,357
Insured money market accounts 55,033 42,609
Time deposits over $100 49,952 42,100
Other time deposits 162,430 151,579
Premium on deposits acquired (963) (1,244)
------------------ ------------
Total deposits $ 449,390 412,386
================ =============
Interest paid on time deposits of $100 or more amounted to $2,784,
$1,970, and $1,683 for the years ended December 31, 1997, 1996 and 1995,
respectively.
The following table displays the aggregate amounts of time deposits with
maturities for the years following December 31, 1997:
Maturing within one year $ 193,819
Maturing after one year through two years 11,275
Maturing after two years through three years 4,748
Maturing after three years through five years 2,528
Maturing after five years 12
---------------
Total $ 212,382
===============
(8) Short-Term Borrowings
1997 1996 1995
---- ---- ----
SECURITIES SOLD UNDER AGREEMENTS
TO REPURCHASE
Amount outstanding at year-end $ 12,224 11,636 7,546
Average amount outstanding during year 13,926 11,601 10,228
Maximum amount outstanding
at any month-end 15,112 12,694 11,680
Weighted average rate paid at year-end 3.44% 4.44% 3.05%
Weighted average rate paid during the year 4.01% 3.84% 4.31%
The securities underlying these agreements are held in the Bank's name in
safekeeping by NationsBank for the benefit of the Bank's customers.
32
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(8) Short-Term Borrowings, Continued
1997 1996 1995
---- ---- ----
FEDERAL FUNDS PURCHASED
Amount outstanding at year-end $1,500 3,000 2,900
Average amount outstanding during year 1,353 5,746 2,380
Maximum amount outstanding
at any month-end 8,125 17,500 3,000
Weighted average rate paid at year-end 6.13% 7.75% 5.50%
Weighted average rate paid during the year 6.36% 5.45% 5.68%
COMMERCIAL PAPER (MASTER NOTE)
Amount outstanding at year-end $11,289 7,435 6,187
Average amount outstanding during year 9,382 8,075 8,017
Maximum amount outstanding
at any month-end 12,292 9,168 9,370
Weighted average rate paid at year-end 3.69% 4.69% 3.30%
Weighted average rate paid during the year 4.06% 3.88% 4.28%
During 1991 the Company began selling commercial paper as an alternative
investment tool for its commercial customers. Through a master note
arrangement between the Company and the Bank, Palmetto Master Notes are
issued as an alternative investment for commercial sweep accounts. These
master notes are unsecured but are backed by the full faith and credit of
the Company. The commercial paper of the Company is issued only in
conjunction with the automated sweep account customer agreement on
deposits at the Bank level.
(9) Stock Split
On October 15, 1996, the shareholders approved that the common stock
authorized be increased from 2,000,000 to 10,000,000 shares at $5 par
value per share. Previously, on August 13, 1996, the Board of Directors
had approved a three-for-one stock split effected in the form of a 200%
dividend for shareholders of record on September 12, 1996, contingent on
this shareholder approval. All number of common shares outstanding and
per share amounts contained in this report have been retroactively
adjusted to give effect to the stock split.
33
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(10) Income Taxes
Components of income tax provision for the years ended December 31 are as
follows:
1997 1996 1995
---- ---- ----
Current:
Federal $ 1,888 1,155 1,422
State 268 188 156
-------- -------------- ------------
2,156 1,343 1,578
-------- -------------- ------------
Deferred:
Federal 259 309 (332)
State - - -
------- ------------- -------------
259 309 (332)
------- ------------- -------------
Total $ 2,415 1,652 1,246
============== ============== ============
The effective tax rates for the years ended December 31 vary from the
Federal statutory rates as follows:
1997 1996 1995
---- ---- ----
U.S. Federal income tax rates 34.0% 34.0% 34.0%
Changes from statutory rates
resulting from:
Tax-exempt interest income (7.5) (9.1) (10.7)
Expenses not deductible for
tax purposes .7 .8 1.0
State taxes, net of Federal
income tax benefit 2.1 2.3 2.1
Other (.3) (2.2) (.7)
-------- ----- ----
Effective tax rates 29.0% 25.8% 25.7%
====== ===== =====
Different accounting methods have been used for reporting income for
income tax and for financial reporting purposes. The tax provisions shown
in the financial statements relate to items of income or expense in those
statements and as a result may not be the amount paid for the period.
Deferred income taxes have been provided on such differences.
34
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(10) Income Taxes, Continued
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, are presented below.
1997 1996
---- ----
Deferred tax assets:
Loan loss reserves $1,330 1,147
Basis of intangible assets for tax purposes
in excess of basis for financial reporting 167 54
Other 41 --
------- -------
Total gross deferred tax assets 1,538 1,201
Less valuation allowance -- --
Net deferred tax assets 1,538 1,201
------- -------
Deferred tax liabilities:
Fixed assets, due to depreciation differences (571) (441)
Deferred loan costs deducted for tax purposes
as incurred (393) (260)
Deferred loan fees recognized under the principal
reduction method for tax purposes (304) (259)
Unrealized gain on securities available for sale (121) (104)
Prepaid pension expense (274) --
Other (34) (20)
Total gross deferred tax liabilities (1,697) (1,084)
------- -------
Net deferred tax asset (liability) $(159) 117
======= =======
A portion of the change in the net deferred tax asset relates to the
unrealized gains and losses on securities available for sale. A current
period deferred tax expense related to the change in unrealized gain on
securities available for sale of $17 has been recorded directly to
shareholders equity. The rest of the change in the deferred tax asset
results from the current period deferred tax expense of $259.
No valuation allowance for deferred tax assets has been established at
either December 31, 1997 or 1996. Because of taxes paid in carry back
periods, as well as estimates of future taxable income, it is
management's belief that realization of the net deferred tax asset is
more likely than not.
Tax returns for 1994 and subsequent years are subject to examination by
the taxing authorities.
35
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(11) Employee Benefit Plans
(a) The Bank has a noncontributory defined benefit pension plan which
covers all full-time employees who have at least twelve months
continuous service and have attained age 21. The plan is designed to
produce a designated retirement benefit, and benefits are fully
vested at five years or more of service. No vesting occurs with less
than five years of service. The plan is administered by the Bank's
Trust Department.
Contributions to the plan are made as required by the Employee
Retirement Income Security Act of 1974.
The following table details the funded status of the plan, the
amounts recognized in the Company's consolidated financial
statements, the components of pension expense, and the major
assumptions used in determining these amounts for the years ended
December 31:
1997 1996 1995
---- ---- ----
Actuarial present value of
benefit obligations:
Vested benefits $ 2,572 2,228 1,890
Non-vested benefits 84 73 55
------------- ------------ ------------
Accumulated benefit obligations $ 2,656 2,301 1,945
============= ============ ============
Projected benefit obligations for services
rendered to date 3,590 3,166 2,774
Plan assets at fair value, primarily listed
stocks and U.S. government securities 4,846 3,903 3,413
------------- ------------ ------------
Excess of assets over projected
benefit obligations $ 1,256 737 639
Unrecognized prior service cost 77 86 95
Unrecognized net loss (gain) from past
experience different from that assumed (266) 24 (66)
Unrecognized net asset being amortized
over the average remaining service
period of covered employees (129) (155) (181)
------------- ------------ ------------
Prepaid pension cost
included in other assets $ 938 692 487
================ ============ ===========
36
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(11) Employee Benefit Plans, Continued
1997 1996 1995
---- ---- ----
Components of pension expense:
Service cost $ 237 205 186
Interest cost 249 221 193
Return on plan assets (328) (286) (229)
Net amortization and deferral (17) (17) (17)
------------ ------------ ------------
Pension expense $ 141 123 133
============= ============ ============
Major assumptions at year end:
Discount rate 8% 8% 8%
Rate of increase in compensation levels 5% 5% 5%
Expected long-term rate of return on
plan assets 8% 8% 8%
(b) The Company has an Employee Stock Ownership Plan (ESOP) established
by its Board of Directors. The ESOP covers the same employees and
has the same vesting schedule as the pension plan. Based on
profits, the Company contributes annually to a trust created to
acquire shares of the Company's common stock for the exclusive
benefit of the participants. During 1997, 1996 and 1995, the
Company contributed to the ESOP common stock, which had been
previously repurchased as treasury stock, and accounted for these
transactions in accordance with Statement of Position 93-6. The
Company recorded compensation expense equal to the fair value of
the shares contributed. The charges to income for contributions to
the ESOP for the years ended December 31, are as follows:
1997 1996 1995
---- ---- ----
Repurchase of treasury stock
for ESOP $ 125 207 166
Investment income received by ESOP - (20) (30)
---------- -------- ----------
Contributions to ESOP $ 125 187 136
======== ======== ==========
At December 31, 1997, there were 275,180 allocated shares in the
plan. The fair value of unearned (non-vested) ESOP shares at
December 31, 1997 amounted to $0. Due to the termination of the ESOP
as of February 28, 1997, all shares are fully vested.
Pursuant to the Internal Revenue Code of 1986, as amended, and the
regulations thereunder, the stock in the ESOP Plan has a put and a
call feature if the stock is not "readily tradable on an established
market." This term was clarified in 1995 as a result of a private
letter ruling, to mean publicly listed on a national securities
exchange. Since the Company's stock is not listed on a national
securities exchange, the shares in the
(Continued)
37
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(11) Employee Benefit Plans, Continued
ESOP Plan are subject to the put/call feature. Accordingly, 275,180
shares of common stock are now recorded outside shareholders'
equity at their fair value, which is determined by an independent
valuation. The Company's Board of Directors has voted to terminate
the ESOP effective February 28, 1997. The shares to be distributed
in 1998 due to the termination of the ESOP will be subject to the
put/call until June 29, 1999.
(c) In 1987, the Company adopted a plan (Stock Option Plan) pursuant to
which the Company's Board of Directors may grant incentive stock
options and nonqualified stock options to officers and key
employees of the Company. The Stock Option Plan authorizes grants
of options to purchase up to 144,000 shares of authorized but
unissued common stock. The Stock Option Plan expired on December
31, 1997.
Stock options are granted at 100% of the fair value at the date of
grant. Because the Company's stock is not traded on an established
market, the fair value is determined by an annual independent
actuarial valuation. All stock options have ten year terms and vest
in increments over five years from the date of grant.
At December 31, 1997, there were no shares available for grant
under the Stock Option Plan because the plan has expired. At
December 31, 1996, there were 17,400 remaining shares available for
grant under the Stock Option Plan. Stock option activity is
summarized below:
Weighted-Average
Stock Options Exercise Price
----------------------------------------------------------------------------------------
Outstanding at December 31, 1994 98,400 $5.90
Granted 9,000 9.69
Exercised (2,100) 5.93
--------------------------------------------------------------------------------------
Outstanding at December 31, 1995 105,300 6.22
--------------------------------------------------------------------------------------
Granted 3,000 11.67
Exercised (300) 7.84
-------------------------------------------------------------------------------------
Outstanding at December 31, 1996 108,000 6.37
-------------------------------------------------------------------------------------
Granted 9,000 13.75
Forfeited (2,400) 11.67
Exercised (56,600) 4.69
-----------------------------------------------------------------------------------
Outstanding at December 31, 1997 58,000 $8.93
====================================================================================
38
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(11) Employee Benefit Plans, Continued
The following table summarizes information about stock options
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------------------------------------------
Weighted-
Average Weighted Weighted-
Number Remaining Average Number Average
Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Prices at 12/31/97 Life Price at 12/31/97 Price
- ------------------------------------------------------------------------------------------------------
$5.50 9,000 1.00 years $5.50 9,000 $5.50
$7.84 - 8.25 22,000 4.41 years 8.01 22,000 8.01
$9.05 - 9.69 18,000 6.50 years 9.37 12,600 9.32
$13.75 9,000 10.00 years 13.75 1,800 13.75
- -------------------------------------------------------------------------------------------------------
Total 58,000 5.40 years $8.93 45,400 $8.10
========================================================================================================
The Company follows the provisions of Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations, which requires compensation expense for
options to be recognized only if the market price of the underlying
stock exceeds the exercise price on the date of grant. Accordingly,
the Company has not recognized compensation expense for its options
granted in 1997, 1996 and 1995.
In 1996, the Company adopted SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123 permits companies to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. In management's opinion,
the existing stock option valuation models do not necessarily
provide a reliable single measure of stock option fair value.
Therefore, as permitted, the Company will continue to apply the
existing accounting rules under APB No. 25 and provide pro forma
net income and pro forma earnings per share disclosures for
employee stock option grants made in 1995 and subsequent years as
if the fair-value-based method defined in SFAS No. 123 had been
applied.
The per-share weighted average fair values of stock options granted
in 1997, 1996 and 1995 were $5.48, $4.12 and $3.95, respectively.
The fair values were estimated as of the respective grant dates
using the Black-Scholes option pricing model. Input variables used
in the model included weighted-average risk free interest rates of
6.03%, 6.16% and 7.74%, respectively; expected dividend yields of
1.30%, 1.48% and 1.50%, respectively; and expected volatility
factors of 22.30%, 15.60% and 13.42%, respectively; and estimated
option lives of 10 years. The pro forma impact on income assumes no
options will be forfeited. Had compensation expense for the
Company's Stock Option Plan been determined based on the fair value
grant date for awards granted
39
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(11) Employee Benefit Plans, Continued
in 1997, 1996 and 1995 consistent with the provisions of SFAS No.
123, the Company's net income and earnings per share would have
been effected as shown in the following table:
1997 1996 1995
---- ---- ----
Net earnings - as reported $5,925 4,753 3,602
Net earnings - pro forma 5,893 4,745 3,579
Earnings per share - as reported 1.97 1.54 1.20
Earnings per share - pro forma 1.96 1.54 1.19
The pro forma effects may not be representative of the effects on
reported net income for future years as most of the Company's
employee stock option grants vest in cumulative increments over a
period of five years.
(d) On December 9, 1997, the Company's Board of Directors adopted the
1997 Stock Compensation Plan (the "1997 Plan") subject to approval
by the appropriate shareholder vote at the next ensuing annual
meeting of shareholders of the Company. The 1997 Plan allows the
Board to grant incentive and non-incentive stock options to certain
key employees and directors of the Company and its subsidiaries.
The 1997 Plan authorizes grants of options to purchase up to
175,000 shares of authorized but unissued common stock. The option
price and term of the options shall be determined by the Board on
grant date, but shall not be less than 100% of fair market value as
of grant date and shall not be greater than 10 years, respectively.
The 1997 Plan expires on December 8, 2007. As of December 31, 1997,
no options had been granted under this plan; so 175,000 shares were
available for grant under the 1997 Plan, subject to shareholder
approval. On January 20, 1998, the Company's Board of Directors
granted 76,000 stock options under the 1997 Plan; leaving 99,000
stock options available for grant under the 1997 Plan, subject to
shareholder approval.
(12) Earnings per Share
The table below illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net
income for the years ended December 31, 1997, 1996 and 1995:
Income Shares Per-Share
1997 (Numerator) (Denominator) Amount
---- ---------------------------------------------
Basic EPS:
----------
Income available to common stockholders $5,455 2,772,298 $1.97
-----------------------------------------
Effect of Dilutive Securities:
Stock Options -- 52,371 --
Diluted EPS:
------------
Income available to common stockholders
plus assumed conversions $5,455 2,824,669 $1.93
=========================================
(Continued)
40
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(12) Earnings per Share, Continued
Income Shares Per-Share
1996 (Numerator) (Denominator) Amount
---- ---------------------------------------------
Basic EPS:
----------
Income available to common stockholders $4,210 2,732,305 $1.54
-----------------------------------------
Effect of Dilutive Securities:
Stock Options -- 64,733 --
Diluted EPS:
------------
Income available to common stockholders
plus assumed conversions $4,210 2,797,038 $1.51
=========================================
Income Shares Per-Share
1995 (Numerator) (Denominator) Amount
---- ---------------------------------------------
Basic EPS:
----------
Income available to common stockholders $3,602 3,010,320 $1.20
-----------------------------------------
Effect of Dilutive Securities:
Stock Options -- 52,759 --
Diluted EPS:
------------
Income available to common stockholders
plus assumed conversions $3,602 3,063,079 $1.18
=========================================
(13) Related Party Transactions
Certain of the Company's directors and executive officers are also
customers of the Bank who, including their related interests, were
indebted to the Bank in the approximate amounts of $4,327 and $2,858 at
December 31, 1997 and 1996, respectively. From January 1 through December
31, 1997, these directors and executive officers and their related
interests borrowed $2,614 and repaid $1,145. In the opinion of
management, these loans do not involve more than the normal risk of
collectibility and do not present other unfavorable features.
(Continued)
41
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(14) Commitments and Contingencies
On December 31, 1997, the Bank was obligated under a number of
noncancelable operating leases on certain property and equipment that
have initial terms of more than one year. The minimum scheduled payments
under these leases are as follows:
1998 $ 318
1999 227
2000 142
2001 118
2002 120
Subsequent years 1,085
---------------
$ 2,010
==============
Rental expense was $392, $398 and $336 for the years ended December 31,
1997, 1996 and 1995, respectively.
In the normal course of business, the Company and subsidiary are
periodically involved in legal proceedings. In the opinion of the
Company's management, none of these proceedings is likely to have a
materially adverse effect on the accompanying consolidated financial
statements.
(15) Disclosures Regarding Fair Value of Financial Instruments
SFAS No. 107, Disclosure About Fair Value of Financial Instruments
(Statement 107), requires disclosure of fair value information about
financial instruments whether or not recognized in the balance sheet, for
which it is practicable to estimate fair value. Fair value estimates are
made as of a specific point in time based on the characteristics of the
financial instruments and the relevant market information. Where
available, quoted market prices are used. In other cases, fair values are
based on estimates using present value or other valuation techniques.
These techniques involve uncertainties and are significantly affected by
the assumptions used and the judgments made regarding risk
characteristics of various financial instruments, discount rates,
prepayments, estimates of future cash flows, future expected loss
experience and other factors. Changes in assumptions could significantly
affect these estimates. Derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases,
may or may not be realized in an immediate sale of the instrument.
Under Statement 107, fair value estimates are based on existing financial
instruments without attempting to estimate the value of anticipated
future business and the value of the assets and liabilities that are not
financial instruments. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
42
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(15) Disclosures Regarding Fair Value of Financial Instruments, Continued
The following describes the methods and assumptions used by the Company
in estimating the fair values of financial instruments:
(a) Cash and Due From Banks
The carrying value approximates fair value.
(b) Investment Securities Held to Maturity and Available For Sale
The fair value of investment securities are derived from quoted
market prices.
(c) Federal Home Loan Bank Stock
No ready market exists for this stock and it has no quoted market
value. However, redemption of this stock has historically been at
par value.
(d) Loans Held for Sale
The fair value of loans held for sale is based on prices in
outstanding commitments to sell these loans.
(e) Loans
The current value of variable-rate consumer and commercial loans or
consumer and commercial loans with remaining maturities of three
months or less approximates fair value. The fair value of fixed-rate
consumer and commercial loans with maturities greater than three
months are valued using a discounted cash flow analysis and assumes
the rate being offered on these types of loans by the Company at
December 31, 1997, approximates market.
For credit cards and lines of credit the carrying value approximates
fair value. No value has been placed on the underlying credit card
relationship rights.
Unused loan commitments are at adjustable rates which fluctuate with
the prime rate or are funded within ninety days. Current amounts are
considered to be their fair value.
(f) Deposits
Under Statement 107, the estimated fair value of deposits with no
stated maturity is equal to the carrying amount. The fair value of
time deposits is estimated by discounting contractual cash flows, by
applying interest rates currently being offered on the deposit
products. Under Statement 107, the fair value estimates for deposits
do not include the benefit that results from the low-cost funding
provided by the deposits liabilities as compared to the cost of
alternative forms of funding.
43
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(15) Disclosures Regarding Fair Value of Financial Instruments, Continued
(g) Securities Sold Under Agreements to Repurchase, Commercial Paper,
Federal Funds Sold and Federal Funds Purchased The carrying amount
approximates fair value due to the short-term nature of these
instruments.
(h) Other Assets, Other Liabilities, and Accrued Interest Income
The carrying amount approximates fair value because of the
short-term nature of these instruments.
The estimated fair values of the Company's financial instruments at
December 31 are as follows:
1997 1996
-------------------------------- --------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Cash and due from banks $ 25,539 25,539 28,373 28,373
============== ============= ============= =============
Federal funds sold $ 388 388 1,951 1,951
============== ============= ============= =============
Federal Home Loan Bank stock $ 1,452 1,452 -- --
============== --------------- ============= =============
Investment securities held to maturity $ 80,006 81,578 66,207 66,770
============== ============= ============= =============
Investment securities available for sale $ 17,725 17,725 16,240 16,240
============== ============= ============= =============
Loans held for sale $ -- -- 4,075 4,080
============== ============= ============= =============
Loans:
Commercial mortgage $ 112,518 112,441 103,908 103,765
Commercial other 86,568 86,337 75,271 75,039
Real estate - mortgage 15,066 15,065 14,902 14,901
Installment mortgage 81,167 81,063 73,928 73,720
Installment other 72,644 70,952 64,977 64,625
-------------- ------------- ------------- -------------
$ 367,963 365,858 332,986 332,050
============== ============= ============= =============
Deposits $ 449,390 449,941 412,386 412,595
============== ============= ============= =============
Borrowings:
Securities sold under agreements
to repurchase $ 12,224 12,224 11,636 11,636
Commercial paper 11,289 11,289 7,435 7,435
Federal funds purchased 1,500 1,500 3,000 3,000
-------------- ------------- ------------- -------------
$ 25,013 25,013 22,071 22,071
============== ============= ============= =============
44
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(16) Palmetto Bancshares, Inc. (Parent Company)
The Parent Company's principal source of income is dividends from the
Bank. Certain regulatory requirements restrict the amount of dividends
which the Bank can pay to the Parent Company. At December 31, 1997, the
Bank had available retained earnings of approximately $4,576 for payment
of dividends.
The Parent Company's principal asset is its investment in its bank
subsidiary. The Parent Company's condensed statements of financial
condition data as of December 31, 1997 and 1996, and the related
condensed statements of operations data and cash flow data for the
three-year period ended December 31, 1997 are as follows:
Financial Condition Data
Assets 1997 1996
------ ---- ----
Cash $23 239
Due from subsidiary 11,289 7,668
Investment in wholly-owned bank subsidiary 35,644 29,955
Goodwill 949 1,010
------- -------
Total assets $47,905 38,872
======= =======
Liabilities and Shareholders' Equity
Commercial paper $11,289 7,435
------- -------
Total liabilities 11,289 7,435
------- -------
Common stock subject to put/call 3,784 3,313
Shareholders' equity 32,832 28,124
------- -------
Total liabilities and shareholders' equity $47,905 38,872
======= =======
Operations Data
1997 1996 1995
---- ---- ----
Interest income from commercial
paper $381 313 341
Other interest income 5 -- --
Dividends received from Bank 1,165 842 1,260
Equity in undistributed earnings
of subsidiary 4,840 3,991 2,435
Net operating expenses (466) (393) (434)
------- ------- -------
Net income $5,925 4,753 3,602
======= ======= =======
(Continued)
45
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(16) Palmetto Bancshares, Inc. (Parent Company), Continued
Cash Flow Data
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income $5,925 4,753 3,602
Decrease (increase) in due from
subsidiary (3,557) (1,248) 727
Earnings retained by
wholly-owned subsidiary (4,840) (3,991) (2,435)
Amortization of goodwill 61 61 61
------- ------- -------
Net cash (used) provided by
operating activities (2,411) (425) 1,955
------- ------- -------
Cash flows from financing activities:
Net change in commercial paper 3,854 1,248 (727)
Proceeds from issuance of
common stock 266 2 12
Purchase of treasury stock -- (121) (230)
Sale of treasury stock 125 207 166
Payments on note payable to a bank -- -- (479)
Cash transfer to Bank capital (885) -- --
Dividends paid (1,165) (842) (652)
Net cash (used) provided by
financing activities 2,195 494 (1,910)
------- ------- -------
Net increase (decrease) in cash (216) 69 45
Cash at beginning of year 239 170 125
------- ------- -------
Cash at end of year $23 239 170
======= ======= =======
46
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(17) Regulatory Capital Requirements
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory - and
possibly additional discretionary - actions by regulators that, if
undertaken, could have a material effect on the financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of the Company's and the
Bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's and the
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier 1 capital (as
defined in the regulation) to risk-weighted assets (as defined) and to
total assets. Management believes, as of December 31, 1997, that the
Company and the Bank meet all capital adequacy requirements to which they
are subject.
At December 31, 1997 and 1996 the Company and the Bank were each
categorized as "adequately capitalized," under the regulatory framework
for prompt corrective action. To be categorized as "adequately
capitalized," the Company and the Bank must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in
the table below. There are no current conditions or events that
management believes would change the Company's or the Bank's category.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------
As of December 31, 1997:
TOTAL CAPITAL TO RISK-WEIGHTED ASSETS:
Company $36,831 9.72% $30,305 8.00% $37,881 10.00%
Bank $36,808 9.72% $30,305 8.00% $37,881 10.00%
TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS:
Company $32,091 8.47% $15,152 4.00% $22,728 6.00%
Bank $32,068 8.47% $15,152 4.00% $22,728 6.00%
TIER 1 CAPITAL TO TOTAL ASSETS:
Company $32,091 6.20% $20,710 4.00% $25,888 5.00%
Bank $32,068 6.19% $20,710 4.00% $25,888 5.00%
47
(Continued)
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(17) Regulatory Capital Requirements, Continued
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
----------------------------------------------------------------------------
As of December 31, 1996:
TOTAL CAPITAL TO RISK-WEIGHTED ASSETS:
Company $30,618 9.11% $26,895 8.00% $ 33,619 10.00%
Bank $30,145 8.97% $26,895 8.00% $ 33,619 10.00%
TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS:
Company $26,415 7.86% $ 13,448 4.00% $ 20,172 6.00%
Bank $25,943 7.72% $ 13,448 4.00% $ 20,172 6.00%
TIER 1 CAPITAL TO TOTAL ASSETS:
Company $26,415 5.60% $ 18,865 4.00% $ 23,581 5.00%
Bank $25,943 5.50% $ 18,865 4.00% $ 23,581 5.00%
48
PALMETTO BANCSHARES, INC. AND SUBSIDIARY
QUARTERLY COMMON STOCK DATA
Set forth below is information concerning high and low sales prices by
quarter for each of the last two fiscal years and dividend information
for the last two fiscal years. The Company's common stock is not traded
on any established public trading market. The Company acts as its own
transfer agent, and the information concerning sales prices set forth
below is derived from the Company's stock transfer records. The
information below has been retroactively restated for the three-for-one
stock split in 1996. As of February 20, 1998, the Company had 572
shareholders with 3,089,852 shares outstanding.
SALES PRICES BY QUARTER
Fiscal Year 1997 HIGH LOW
---------------- ----------------------
First Quarter $22.50 $20.00
Second Quarter $26.50 $20.00
Third Quarter $26.00 $26.00
Fourth Quarter $28.00 $26.00
Fiscal Year 1996
----------------
First Quarter $15.00 $13.33
Second Quarter $13.33 $13.33
Third Quarter $14.33 $13.33
Fourth Quarter $20.00 $16.00
DIVIDENDS PAID PER SHARE
Fiscal Year 1997 Fiscal Year 1996
---------------- ----------------
March 28 $.08 March 28 $.067
June 30 $.09 June 28 $.067
September 30 $.10 September 27 $.067
December 26 $.11 December 27 $.08
49