Bank Of Granite 10-Q 2010 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period endedSeptember 30, 2010

OR

o Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from _______________ to _______________

Commission file number 0-15956

Bank of Granite Corporation

(Exact name of registrant as specified in its charter)

Delaware	56-1550545
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
Post Office Box 128, Granite Falls, N.C.	28630
(Address of principal executive offices)	(Zip Code)

(828) 496-2000

(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yesþ Noo

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filero	Accelerated filero	Non-accelerated filero	Smaller Reporting Companyþ
		(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesoNoþ

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

Common stock, $1.00 par value
15,454,641 shares outstanding as of October 31, 2010

Index

	Begins
	on Page
Part I — Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets September 30, 2010 and December 31, 2009		3
Condensed Consolidated Statements of Income (Loss) Three Months Ended September 30, 2010 and 2009 And Nine Months Ended September 30, 2010 and 2009		4
Condensed Consolidated Statements of Comprehensive Loss Three Months Ended September 30, 2010 and 2009 And Nine Months Ended September 30, 2010 and 2009		5
Condensed Consolidated Statements of Changes in Stockholders’ Equity Nine Months Ended September 30, 2010 and 2009		6
Condensed Consolidated Statements of Cash Flows Nine Months Ended September 30, 2010 and 2009		7
Notes to Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		27
Item 4. Controls and Procedures		27
Part II — Other Information
Item 1A. Risk Factors		27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		27
Item 6. Exhibits		28
Signatures		29
Exhibit Index		30
EX-31.1
EX-31.2
EX-32.1
EX-32.2

2

Item 1. Financial Statements

Bank of Granite Corporation
Condensed Consolidated Balance Sheets
(In thousands except per share data)

	September 30,			December 31,
	2010			2009
	(Unaudited)			(Note 1)
Assets:
Cash and cash equivalents:
Cash and due from banks	$	46,574		$	71,611
Interest-bearing deposits		2,938			1,763
Total cash and cash equivalents		49,512			73,374
Investment securities:
Available for sale, at fair value		277,570			190,921
Loans		606,359			775,019
Allowance for loan losses		(29,952	)		(27,837	)
Net loans		576,407			747,182
Premises and equipment, net		14,466			15,556
Accrued interest receivable		3,553			3,917
Investment in bank owned life insurance		4,261			4,106
Other assets		21,321			25,028
Total assets	$	947,090		$	1,060,084
Liabilities and Stockholders’ Equity:
Deposits:
Interest-bearing	$	791,016		$	856,932
Noninterest-bearing		98,152			109,673
Total deposits		889,168			966,605
Overnight and short-term borrowings		21,000			20,000
Long-term borrowings		3,000			20,000
Accrued interest payable		1,316			1,701
Other liabilities		4,398			4,692
Total liabilities		918,882			1,012,998
Stockholders’ equity:
Common stock, $1.00 par value per share Authorized - 25,000 shares Issued - 18,981 shares in 2010 and 2009 Outstanding - 15,454 shares in 2010 and 2009		18,981			18,981
Capital surplus		30,195			30,195
Retained earnings		31,137			52,308
Accumulated other comprehensive loss, net of deferred income taxes		(253	)		(2,546	)
Less: Cost of common stock in treasury; 3,527 shares in 2010 and 2009		(51,852	)		(51,852	)
Total stockholders’ equity		28,208			47,086
Total liabilities and stockholders’ equity	$	947,090		$	1,060,084

See notes to condensed consolidated financial statements.

3

Bank of Granite Corporation
Condensed Consolidated Statements of Income (Loss)
(Unaudited — in thousands except per share data)

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2010			2009			2010			2009
Interest income:
Interest and fees from loans	$	8,566		$	11,811		$	28,054		$	37,098
Federal funds sold		—			—			—			8
Interest-bearing deposits		39			18			101			41
Investments:
U.S. Treasury		—			1			—			18
U.S. Government agencies		2,172			1,247			6,303			2,378
States and political subdivisions		—			—			—			364
Other		9			59			54			309
Total interest income		10,786			13,136			34,512			40,216
Interest expense:
Time deposits of $100 or more		1,266			1,555			3,984			5,207
Other time and savings deposits		1,875			3,077			6,063			10,619
Overnight and short-term borrowings		171			129			446			580
Long-term borrowings		41			180			242			588
Total interest expense		3,353			4,941			10,735			16,994
Net interest income		7,433			8,195			23,777			23,222
Provision for loan losses		7,321			4,760			27,924			12,863
Net interest income (loss) after provision for loan losses		112			3,435			(4,147	)		10,359
Other income:
Service charges on deposit accounts		1,162			1,439			3,707			4,031
Other service fees and commissions		60			119			232			351
Securities gains (losses)		1,747			(34	)		1,982			985
Other-than-temporary impairment losses		—			—			—			(996	)
Other		355			635			982			2,575
Total other income		3,324			2,159			6,903			6,946
Other expenses:
Salaries and wages		2,078			3,065			6,478			11,286
Employee benefits		421			798			1,219			2,665
Equipment and occupancy expense, net		855			1,055			2,705			3,322
FDIC assessments		1,156			500			3,518			2,879
Other real estate owned		1,377			1,770			5,048			3,095
Other		1,859			2,136			5,749			6,534
Total other expenses		7,746			9,324			24,717			29,781
Loss before income tax benefit		(4,310	)		(3,730	)		(21,961	)		(12,476	)
Income tax benefit		—			—			(790	)		—
Net loss	$	(4,310	)	$	(3,730	)	$	(21,171	)	$	(12,476	)
Per share amounts:
Net loss — basic and diluted	$	(0.28	)	$	(0.24	)	$	(1.37	)	$	(0.81	)

See notes to condensed consolidated financial statements.

4

Bank of Granite Corporation
Condensed Consolidated Statements of Comprehensive Loss
(Unaudited — in thousands)

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2010			2009			2010			2009
Net loss	$	(4,310	)	$	(3,730	)	$	(21,171	)	$	(12,476	)
Items of other comprehensive loss:
Items of other comprehensive income (loss), before tax:
Change in unrealized gains (losses) on securities available for sale		(5,032	)		1,469			1,980			(185	)
Reclassification adjustment for available for sale securities gains included in net income		1,747			34			1,982			493
Prior service cost and net actuarial loss — SERP		—			41			—			124
Other comprehensive income (loss), before tax		(3,285	)		1,544			3,962			432
Change in deferred income taxes related to change in unrealized gains or losses on securities available for sale		1,313			(593	)		(1,669	)		(119	)
Change in deferred income taxes related to prior service cost and net actuarial loss — SERP		—			(16	)		—			(58	)
Items of other comprehensive income (loss), net of tax		(1,972	)		935			2,293			255
Comprehensive loss	$	(6,282	)	$	(2,795	)	$	(18,878	)	$	(12,221	)

See notes to condensed consolidated financial statements.

5

Bank of Granite Corporation
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited — in thousands except per share data)

	Nine Months
	Ended September 30,
	2010			2009
Common stock, $1.00 par value per share
At beginning of period	$	18,981		$	18,981
At end of period		18,981			18,981
Capital surplus
At beginning of period		30,195			30,190
Stock-based compensation expense		—			5
At end of period		30,195			30,195
Retained earnings
At beginning of period		52,308			77,928
Net loss		(21,171	)		(12,476	)
At end of period		31,137			65,452
Accumulated other comprehensive loss, net of deferred income taxes
At beginning of period		(2,546	)		(1,077	)
Net change in unrealized gains or losses on securities available for sale, net of deferred income taxes		2,293			189
Net change in prior service cost and net actuarial loss — SERP, net of deferred income taxes		—			66
At end of period		(253	)		(822	)
Cost of common stock in treasury
At beginning of period		(51,852	)		(51,852	)
At end of period		(51,852	)		(51,852	)
Total stockholders’ equity	$	28,208		$	61,954

See notes to condensed consolidated financial statements.

6

Bank of Granite Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited — in thousands)

	Nine Months
	Ended September 30,
	2010			2009
Increase (decrease) in cash & cash equivalents:
Cash flows from operating activities:
Net loss	$	(21,171	)	$	(12,476	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		1,080			1,357
Provision for loan losses		27,924			12,863
Investment security premium amortization, net		944			788
Acquisition premium amortization, net		—			19
Deferred income taxes		(89	)		(78	)
Gains on sales or calls of securities available for sale		(1,982	)		(503	)
Gains on sales or calls of securities held to maturity		—			(482	)
Impairment losses on securities		—			996
Originations of loans held for sale		—			(82,177	)
Proceeds from loans held for sale		—			99,924
Gains on loans held for sale		—			(977	)
Losses on writedowns or sale of other real estate		4,217			2,547
Losses on disposal of miscellaneous assets		10			7
Increase in cash surrender value of bank owned life insurance		(155	)		(874	)
Decrease in other assets		4,099			2,428
Decrease in accrued interest receivable		364			285
Decrease in accrued interest payable		(385	)		(856	)
Decrease in other liabilities		(294	)		(5,646	)
Net cash provided by operating activities		14,562			17,145
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of securities available for sale		62,220			46,774
Proceeds from sales, maturities, calls and paydowns of securities held to maturity		—			24,103
Proceeds from sales of securities available for sale		169,950			128,527
Purchase of securities available for sale		(313,820	)		(217,905	)
Net decrease in loans		130,689			87,092
Capital expenditures, net of proceeds from sale of miscellaneous assets		—			15,443
Proceeds from sale of other real estate		5,974			6,252
Net cash provided by investing activities		55,013			90,286
Cash flows from financing activities:
Net decrease in demand, NOW, money market and savings deposits		(46,836	)		(60,949	)
Net decrease in time deposits		(30,601	)		(38,514	)
Net increase (decrease) in overnight and short-term borrowings		1,000			(24,956	)
Net increase (decrease) in long-term borrowings		(17,000	)		5,999
Net cash used in financing activities		(93,437	)		(118,420	)
Net decrease in cash equivalents		(23,862	)		(10,989	)
Cash and cash equivalents at beginning of period		73,374			48,983
Cash and cash equivalents at end of period	$	49,512		$	37,994

See notes to condensed consolidated financial statements.

7

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements
September 30, 2010
(Unaudited)

1. UNAUDITED FINANCIAL STATEMENTS

Bank of Granite Corporation’s (the “Company’s” or the “Holding Company’s”) condensed consolidated balance sheet as of September 30, 2010, and the condensed consolidated statements of income (loss) and comprehensive income (loss) for the three and nine-month periods ended September 30, 2010 and 2009, and the condensed consolidated statements of changes in stockholders’ equity and cash flows for the nine-month periods ended September 30, 2010 and 2009 are unaudited and reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the interim period financial statements. Amounts as of December 31, 2009 included in the condensed consolidated financial statements and related notes were derived from the audited consolidated financial statements.

Certain amounts for the periods ended September 30, 2009 have been reclassified to conform to the presentation for the periods ended September 30, 2010.

The unaudited interim condensed consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2009 audited consolidated financial statements and notes thereto included in the Company’s 2009 Annual Report on Form 10-K.

The consolidated financial statements include the Company’s two wholly owned subsidiaries, Bank of Granite (the “Bank”), a full service commercial bank, and Granite Mortgage, Inc. (“Granite Mortgage”), a mortgage banking company which discontinued its origination activities during 2009. Because we now operate, manage, and, likewise, direct our corporate governance activities as a single reporting banking segment, we no longer have any reportable segments.

The accounting policies followed are set forth in Note 1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 on file with the Securities and Exchange Commission. There were no changes in significant accounting policies during the nine months ended September 30, 2010 except as described in Note 5 below.

2. REGULATORY MATTERS AND GOING CONCERN CONSIDERATIONS

Regulatory Actions

In 2009, the Bank entered into a Stipulation and Consent (“Consent”) to the issuance of an Order to Cease and Desist (“Order”) by the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Commissioner of Banks (“The Commissioner”). Based on the Company’s Consent, the FDIC and the Commissioner jointly issued the Order on August 27, 2009.

On November 11, 2009, the Company entered into a Memorandum of Understanding (“FRB Memorandum”) with the Federal Reserve Bank of Richmond (“FRB”).

The Order is a formal corrective action pursuant to which the Bank has agreed to address specific issues set forth below, through the adoption and implementation of procedures, plans and policies designed to enhance the safety and soundness of the Bank.

8

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

Among other things, the Order requires the Bank to:

• Present a written capital plan to the FDIC and the Commissioner by which the Bank would achieve a Tier 1 Leverage Capital Ratio of not less than 8 percent and Total Risk-Based Capital Ratio of not less than 12 percent during the life of the Order;

• Formulate a plan to improve the Bank’s earnings and evaluate the plan quarterly;

• Formulate and implement a plan to reduce the Bank’s risk exposure in assets classified “Substandard or Doubtful”;

• Reduce the real estate credit concentrations in the Bank’s loan portfolio;

• Develop a plan to improve the Bank’s liquidity; monitor contingent funding needs and improve asset liability management, and review and revise the plan on a quarterly basis;

• Not pay cash dividends without the prior written consent of the FDIC and the Commissioner;

• Neither renew, roll-over nor increase the amount of brokered deposits above the amount outstanding at the date of the Order.

The FRB Memorandum requires the Company to obtain FRB approval before paying dividends, taking dividends from its Bank, incurring debt or purchasing/redeeming Company stock. The FRB Memorandum requires the submission of a capital plan to maintain adequate capital on a consolidated basis and at the Bank. The Company must furnish periodic progress reports to the FRB regarding its compliance with the FRB Memorandum. The FRB Memorandum will remain in effect until modified or terminated by the FRB.

The Bank reports regularly to its regulators on matters of compliance with the Order, and the progress made to comply with the Order. The Company believes it is in substantial compliance with all matters except the earnings and capital requirements, and continued issues with asset quality.

Going Concern Considerations

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described herein create a substantial doubt about the Company’s ability to continue as a going concern.

The Bank has not achieved the required capital levels mandated by the Order. To date the Bank’s capital preservation activities have included balance sheet restructuring that has included curtailed lending activity; surrendering bank owned life insurance policies; reorganizing the securities portfolio to minimize the risk and related capital requirements; reducing salaries and certain other noninterest expenses; and curtailing the SERP pension obligation to reduce future expenses. The Company has engaged external advisors and has pursued various capital enhancing transactions and strategies throughout 2009 and to date in 2010. The operating loss in the nine months and quarter ended September 30, 2010 and the continuing level of problem loans have further eroded capital levels from December 31, 2009. There can be no assurance that any capital raising activities or other measures will allow the Bank to meet the capital levels required in the Order. Non-compliance with the capital requirements of the Order and the continued erosion of capital in the nine months ended September 30, 2010 may cause the Bank to be subject to further enforcement actions by the FDIC or the Commissioner.

9

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

Capital Matters

The Order, as set forth above, requires the Bank to achieve and maintain Tier 1 Leverage Capital Ratio of not less than 8 percent and a Total Risk-Based Capital of not less than 12 percent for the life of the Order.

The minimum capital requirements to be characterized as “well capitalized” and “adequately capitalized”, as defined by regulatory guidelines, and the Company’s actual capital ratios on a consolidated and Bank-only basis were as follows as of September 30, 2010:

							Minimum Regulatory
							Requirement
	Actual						Adequately			Well			Pursuant to
	Consolidated			Bank			Capitalized			Capitalized			Order
Leverage capital ratios		2.94	%		2.80	%		4.00	%		5.00	%		8.00	%
Risk-based capital ratios:
Tier 1 capital		4.53	%		4.34	%		4.00	%		6.00	%		8.00	%
Total capital		5.82	%		5.63	%		8.00	%		10.00	%		12.00	%

3. EARNINGS PER SHARE

Earnings per share have been computed using 15,454,000 shares of common stock outstanding as there have been no changes during the periods reported. The levels of outstanding stock options are insignificant and are not included for any period because their inclusion would be anti-dilutive.

4. COMMITMENTS AND CONTINGENCIES

In the normal course of business there are various commitments and contingent liabilities such as commitments to extend credit, which are not reflected on the financial statements. The unfunded portion of loan commitments and standby letters of credit as of September 30, 2010 and December 31, 2009 were as follows:

	September 30,		December 31,
(In thousands)	2010		2009
Financial instruments whose contract amounts represent credit risk
Unfunded commitments to extend credit		$80,102	$	106,122
Standby letters of credit		1,759		2,967

Commitments to extend credit are legally binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts outstanding do not necessarily represent future cash requirements. Standby letters of credit represent conditional commitments issued by the Bank to assure the performance of a customer to a third party.

10

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

The Bank’s exposure to credit loss for commitments to extend credit and standby letters of credit is the contractual amount of those financial instruments. The Bank uses the same credit policies for making commitments and issuing standby letters of credit as it does for on-balance sheet financial instruments. Each customer’s creditworthiness is evaluated on an individual case-by-case basis. The amount and type of collateral, if deemed necessary by management, is based upon this evaluation of creditworthiness. Collateral held varies, but may include marketable securities, deposits, property, plant and equipment, investment assets, inventories and accounts receivable. Management does not anticipate any significant losses as a result of these financial instruments.

Legal Proceedings

The nature of the businesses of the Company’s subsidiaries ordinarily results in a certain amount of litigation. The Company’s subsidiaries are involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that the liabilities, if any, arising from these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Company.

5. NEW ACCOUNTING STANDARDS

In January 2010, the Financial Accounting Standards Board (“FASB”) issued an update to the accounting standards for the presentation on fair value disclosures. The new guidance requires disclosures about inputs and valuation techniques for Level 2 and 3 fair value measurements, clarifies two existing disclosure requirements and requires two new disclosures as follows: (1) a “gross” presentation of activities (purchases, sales, and settlements) within the Level 3 rollforward reconciliation, which will replace the “net” presentation format; and (2) detailed disclosures about the transfers in and out of Level 1 and 2 measurements. This guidance is effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward information, which is required for annual reporting periods beginning after December 15, 2010, and for interim reporting periods within those years. The Company adopted the fair value disclosures guidance on January 1, 2010, except for the gross presentation of the Level 3 rollforward information which is not required to be adopted by the Company until January 1, 2011.

In July 2010, the FASB issued an update to the accounting standards governing the disclosures associated with credit quality and the allowance for loan losses. This new guidance requires additional disclosures related to the allowance for loan losses with the objective of providing financial statement users with greater transparency about an entity’s loan loss reserves and overall credit quality. Additional disclosures include showing on a disaggregated basis the aging of receivables, credit quality indicators, and troubled debt restructures with their effect on the allowance for loan losses. The provisions of this standard are effective for interim and annual reporting periods ending on or after December 15, 2010. The adoption of this standard will not have a material impact on the Company’s financial position and results of operations; however, it will increase the amount of disclosures in the notes to the consolidated financial statements.

11

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

In the third quarter of 2010, the SEC amended its rules and forms to reflect the provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that permanently exempts non-accelerated filers from the requirement of Section 404 (b) of the Sarbanes-Oxley Act to include in annual reports filed with the SEC the auditor’s attestation report on management’s assessment of internal control over financial reporting. This rule was effective September 21, 2010, and the Company’s 2010 annual reporting will be subject to the new ruling.

6. FAIR VALUE MEASUREMENTS AND DISCLOSURES

Investment Securities Available for Sale

A significant portion of the Company’s available for sale investment portfolio is government guaranteed, and the fair value measurements for the third quarter of 2010 were estimated using independent pricing sources that were determined to be Level 2 measurements, Significant Other Observable Inputs. Unrealized gains and losses on securities available for sale are reflected in accumulated other comprehensive income and recognized gains and losses are reported as securities gains and losses in noninterest income.

The following tables reflect investment securities available for sale measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009:

			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(In thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2010
U.S. Government agencies	$	55,652	$	—	$	55,652	$	—
Government agency and other mortgage-backed securities		218,428		—		218,428		—
Corporate bonds		3,490		—		3,490		—
Total investment securities available for sale	$	277,570	$	—	$	277,570	$	—
December 31, 2009
U.S. Government agencies	$	42,051	$	—	$	42,051	$	—
Government agency and other mortgage-backed securities		147,831		—		147,831		—
Equities		1,039		1,039		—		—
Total investment securities available for sale	$	190,921	$	1,039	$	189,882	$	—

12

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

The Company utilizes a third party pricing service to provide valuations on its securities portfolio. Despite most of these securities being U.S. Government agency debt obligations, corporate bonds, and agency mortgage-backed securities, third party valuations are determined based on the characteristics of a security (such as maturity, duration, rating, etc.) and in reference to similar or comparable securities. Due to the nature and methodology of these valuations, the Company considers these fair value measurements as Level 2. No securities were transferred between Level 1 and Level 2 during the first three quarters of 2010.

Impaired Loans

Loans considered impaired are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect write-downs that are based on the market price or current appraised value of the collateral, adjusted to reflect local market conditions or other economic factors. After evaluating the underlying collateral, the fair value of the impaired loans is recorded by allocating specific reserves from the allowance for loan losses to the loans.

Thus, the fair value reflects the loan balance less the specifically allocated reserve. Impaired loans for which no reserve has been specifically allocated are not included in the table below. At September 30, 2010, all impaired loan values were determined to be based on Level 3 measurements.

Other Real Estate Owned

Other real estate owned is initially accounted for at fair value, less estimated costs to dispose of the property. Any excess of the recorded investment over fair value, less costs to dispose, is charged to the allowance for loan losses at the time of transfer. Updated appraisals or evaluations are obtained at least annually for all other real estate owned properties. These appraisals are used to update fair value estimates. Writedowns are charged to earnings for subsequent losses on other real estate owned when these updates indicate such losses have occurred. The ability of the Company to recover the carrying value of other real estate owned is based upon future sales of the real estate. The ability to effect such sales is subject to market conditions and other factors beyond our control, and future declines in the value of the real estate could result in writedowns and charges to earnings. At September 30, 2010, the fair value measurements for other real estate were determined to be Level 3 measurements.

13

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

The following tables reflect certain loans and other real estate measured at fair value on a nonrecurring basis at September 30, 2010 and December 31, 2009:

			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(In thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2010
Impaired loans (1)	$	49,222	$	—	$	—	$	49,222
Other real estate owned		15,205		—		—		15,205
Total assets	$	64,427	$	—	$	—	$	64,427
December 31, 2009
Impaired loans (1)	$	26,788	$	—	$	—	$	26,788
Other real estate owned		13,235		—		—		13,235
Total assets	$	40,023	$	—	$	—	$	40,023

(1) Net of reserves and loans carried at cost.

7. INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses and fair values of investment securities at September 30, 2010 and December 31, 2009 were as follows:

(In thousands)	Amortized		Gross Unrealized				Fair
Type and Contractual Maturity	Cost		Gains		Losses		Value
AVAILABLE FOR SALE
At September 30, 2010:
U.S. Government agencies due:
Within 1 year	$	1,508	$	2	$	—	$	1,510
After 5 years but within 10 years		39,505		188		—		39,693
After 10 years		14,400		49		—		14,449
Total U.S. Government agencies		55,413		239		—		55,652
Government agency and other mortgage-backed securities due:
After 10 years		219,077		1,034		1,683		218,428
Corporate bonds due:
After 5 years but within 10 years		3,500		—		10		3,490
Total available for sale	$	277,990	$	1,273	$	1,693	$	277,570

14

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(unaudited)

Sales and calls of securities available for sale for the nine months ended September 30, 2010 resulted in proceeds of $210.1 million, $2.3 million in realized gains and $0.3 million in realized losses.

As of September 30, 2010, accumulated other comprehensive losses, net of deferred income taxes, included unrealized net losses of $420 thousand, net of deferred income tax benefit of $167 thousand, related to securities available for sale.

Sales and calls of securities available for sale for the nine months ended September 30, 2009 resulted in proceeds of $160.4 million, $839 thousand in realized gains and $336 in realized losses. The amortized cost of certain equity securities were written down by $582 thousand in the first nine months of 2009, and certain debt securities were written down $414 thousand in the first nine months of 2009, for credit related declines in value deemed to be other-than-temporary, resulting in a charge to earnings. Sales and calls of securities held to maturity resulted in proceeds of $24.1 million for the nine months ended September 30, 2009, $501 thousand in realized gains and $19 thousand in realized losses.

As of September 30, 2009, accumulated other comprehensive income, net of deferred income taxes, included unrealized net gains of $1.0 million, net of deferred income taxes of $0.4 million, related to securities available for sale.

(In thousands)	Amortized		Gross Unrealized				Fair
Type and Contractual Maturity	Cost		Gains		Losses		Value
AVAILABLE FOR SALE
At December 31, 2009:
U. S. Government agencies due:
Within 1 year	$	1,539	$	9	$	—	$	1,548
After 1 year but within 5 years		38,172		—		1,434		36,738
After 5 years but within 10 years		4,000		—		235		3,765
Total U.S. Government agencies		43,711		9		1,669		42,051
Government agency and other mortgage-backed securities due:
After 10 years		150,738		192		3,099		147,831
Others*:
Common stocks and mutual funds		853		186		—		1,039
Total available for sale	$	195,302	$	387	$	4,768	$	190,921

* Others include investments in common stocks, preferred stocks and mutual funds.

15

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

Securities with unrealized losses at September 30, 2010 and December 31, 2009 not recognized in income, all of which have been in a loss position less than 12 months were as follows:

	September 30, 2010				December 31, 2009
	Fair		Unrealized		Fair		Unrealized
(In thousands)	Value		Loss		Value		Loss
Less than 12 months:
U.S. Government agencies	$	—	$	—	$	40,503	$	1,669
Government agency and other mortgage-backed securities		131,970		1,683		124,311		3,099
Corporate bonds		3,490		10		—		—
Total temporarily impaired	$	135,460	$	1,693	$	164,814	$	4,768

Unrealized losses on securities have not been recognized in income because management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to decreases in market interest rates. The fair value is expected to recover as the securities approach their maturity date and/or market interest rates decline. Furthermore, it is not likely that the Company will have to sell any impaired securities before a recovery of the amortized cost.

8. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate the value, is based upon the characteristics of the instruments and relevant market information. Financial instruments include cash, evidence of ownership in an entity or contracts that convey or impose on an entity the contractual right or obligation to either receive or deliver cash for another financial instrument. These fair value estimates are based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price for which an asset could be sold or liability could be settled. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, it has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment, and are imprecise. Changes in assumptions could significantly affect the estimated values. The fair value estimates are determined in accordance with the accounting standards forFair Value Measurements and Disclosures.

16

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2010
(Unaudited)

	September 30, 2010					December 31, 2009
			Estimated					Estimated
	Carrying		Fair			Carrying		Fair
(In thousands)	Amount		Value			Amount		Value
Assets:
Cash and cash equivalents	$	49,512	$	49,512		$	73,374	$	73,374
Investment securities		277,570		277,570			190,921		190,921
Bank owned life insurance		4,261		4,261			4,106		4,106
Loans (1)		576,407		581,500			747,182		752,000
Market risk/liquidity adjustment		—		(30,000	)		—		(40,000	)
Net loans		576,407		551,500			747,182		712,000
Liabilities:
Demand deposits		383,209		383,209			430,045		430,045
Time deposits		505,959		506,800			536,560		539,000
Overnight and short-term borrowings		21,000		21,000			20,000		20,000
Long-term borrowings		3,000		3,300			20,000		21,000

(1) Loan fair values are based on a hypothetical exit price, which does not represent the estimated intrinsic value of the loan if held for investment. The assumptions used are expected to approximate those that a market participant purchasing the loans would use to value the loans, including a market risk premium and liquidity discount.

Estimating the fair value of the loan portfolio when loan sales and trading markets are illiquid, are for certain loan types, or are nonexistent, requires significant judgment. Therefore, the estimated fair value can vary significantly depending on a market participant’s ultimate considerations and assumptions. The final value yields a market participant’s expected return on investment that is indicative of the current distressed market conditions, but it does not take into consideration the Company’s estimated value from continuing to hold these loans or its lack of willingness to transact at these estimated values.

The Company estimated fair value based on estimated future cash flows discounted at current origination rates for loans with similar terms and credit quality. The estimated values in 2010 are a function of higher credit spreads, partially offset by lower risk-free interest rates. However, the values derived from origination rates at September 30, 2010 likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts ranging from 2% to 25%, depending on the nature of the loans, were subtracted to reflect the illiquid and distressed market conditions as of September 30, 2010. The discounted value is a function of a market participant’s required yield in the current environment and is not a reflection of the expected cumulative losses on the loans.

The book values of cash and due from banks, interest-bearing deposits, accrued interest receivable, accrued interest payable and other liabilities are considered to be equal to fair values as a result of the short-term nature of these items. The fair values of investment securities are based on quoted market prices, dealer quotes and prices obtained from independent pricing services. The fair value of time deposits, other borrowings, commitments and guarantees is estimated based on present values using applicable risk-adjusted spreads to the U.S. Treasury curve to approximate current entry-value interest rates applicable to each category of such financial instruments.

17

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

Disclosures About Forward Looking Statements

The discussions included in Part I of this document contain statements that may be deemed forward looking statements within the meaning of the Private Securities Litigation Act of 1995, including Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from these statements. For the purposes of these discussions, any statements that are not statements of historical fact may be deemed to be forward looking statements. Such statements are often characterized by the use of qualifying words such as “expects,” “anticipates,” “believes,” “estimates,” “plans,” “projects,” or other statements concerning opinions or judgments of our Company and our management about future events. The accuracy of such forward looking statements could be affected by certain factors, including but not limited to, the financial success or changing conditions or strategies of our customers or vendors, fluctuations in interest rates, actions of government regulators, the availability of capital and personnel, failure to comply with regulatory orders, and general economic conditions. For additional factors that could affect the matters discussed in forward looking statements, see the “Risk Factors” section in the Company’s most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Introduction

Management’s Discussion and Analysis is provided to assist in understanding and evaluating our results of operations and financial condition. The following discussion is intended to provide a general overview of our performance for the three and nine-month periods ended September 30, 2010. Readers seeking more in-depth information should read the more detailed discussions below as well as the condensed consolidated financial statements and related notes included under Item 1 of this quarterly report. The “Regulatory Matters and Going Concern Considerations” in Note 2 of the Notes to Condensed Consolidated Financial Statements addresses the significant risks and uncertainties for the Company.

All information presented is consolidated data unless otherwise specified. Uncertainty and future events could cause changes in accounting estimates that have material effects on the financial position and results of operations in future periods.

Executive Overview

The loss for the nine months ended September 30, 2010 of $21.2 million compared to $12.5 million for the same period of 2009 is primarily indicative of the depth of the economic depression which is affecting all businesses and the values of all classes of assets in the Bank’s markets. The $15.1 million increase in the loan loss provision compared to 2009 is the resultant impact.

While the 2010 third quarter loss of $4.3 million is less than the first two quarters of 2010, all three quarters exceed the comparative periods of 2009 by large margins. The third quarter loan loss provision was higher by $2.6 million as credit related issues in the loan portfolio accelerated.

Net interest income for the first nine months of 2010 is stable as compared to the same period for 2009. The third quarter results reflect erosion in the comparative net interest income amounts and the lower sequential net interest margin. The primary causes are the increasing nonaccrual component of the loan portfolio and the continuing decline in yields for investment securities. The non-interest expense, which includes losses on other real estate, fluctuates primarily because of periodic writedowns and losses on the sale of other real estate properties.

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The balance sheet management continues to provide very high levels of liquidity. While loans and to a lesser degree deposits are decreasing, this is consistent with the goal to provide a high level of liquidity in the operation and to the extent necessary, down size the balance sheet as part of capital management.

The following sections of this discussion provide more detail regarding current and prior year matters. Additionally, Note 2, “Regulatory Matters and Going Concern Consideration,” in the “Notes to Consolidated Financial Statements” discusses the regulatory and capital levels in significantly more detail.

Results of Operations

For the Three Months and Nine Months Ended September 30, 2010

Compared With the Same Periods in 2009

Financial Highlights for	Three Months
the Quarterly Periods	Ended September 30,
(In thousands except per share amounts)	2010			2009			% change
Earnings
Net interest income	$	7,433		$	8,195			-9.3	%
Provision for loan losses		7,321			4,760			53.8	%
Other income		3,324			2,159			54.0	%
Other expense		7,746			9,324			-16.9	%
Net loss		(4,310	)		(3,730	)		15.5	%

Financial Highlights for	Nine Months
the Year-to-Date Periods	Ended September 30,
(In thousands except per share amounts)	2010			2009			% change
Earnings
Net interest income	$	23,777		$	23,222			2.4	%
Provision for loan losses		27,924			12,863			117.1	%
Other income		6,903			6,946			-0.6	%
Other expense		24,717			29,781			-17.0	%
Net loss		(21,171	)		(12,476	)		69.7	%
Per share
Net loss
- Basic	$	(1.37	)	$	(0.81	)		69.1	%
- Diluted		(1.37	)		(0.81	)		69.1	%
Average for period
Assets	$	1,010,545		$	1,127,850			-10.4	%
Loans		688,728			894,524			-23.0	%
Deposits		926,251			979,893			-5.5	%
Stockholders’ equity		40,247			69,876			-42.4	%

Performance Summary

Net interest income

Net interest income of $7.4 million for the third quarter of 2010 was down 6.8% from the second quarter of 2010 and is reflective of the contracting loan portfolio (down $168.7 million or 21.8% since December 2009).

The third quarter 2010 net interest margin of 3.37% was slightly lower than the first two quarters of 2010.

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The net interest income for the first nine-month periods of $23.8 million for 2010 versus $23.2 million for 2009 reflects the net interest margin improvement of 3.43% for 2010 versus 2.98% for 2009 as the Bank focused on risk based loan pricing while cost of funds rates were declining because of the Federal Reserve reductions of interest rates in late 2008.

Provision for loan losses

The provision for loan losses of $7.3 million for the third quarter was down $1.2 million from the second quarter of 2010 as the continued resolution of problem assets reduced the size of the loan portfolio and required lower levels of provisions to maintain the allowance for losses at reasonable levels.

The provision for loan losses for the first nine-month period of 2010 of $27.9 million versus $12.9 million for the same period of 2009 is reflective of the escalating severity of the effect of the economic depression on asset values underlying the loan portfolio and increased nonperforming loans.

See additional discussion in the Executive Overview and Provisions for Loan Losses, Allowance for Loan Losses and Discussions of Asset Quality.

Other noninterest income

Noninterest income in the third quarter of 2010 was higher on a linked quarter basis and increased from $2.2 million in 2009 to $3.3 million in 2010. The significant change for the comparative three-month periods is the $1.7 million securities gains included in the 2010 quarter compared to a $34 thousand loss in 2009.

The deposit service charges were slightly lower for the comparative nine-month periods — $3.7 million for 2010 versus $4.0 million for 2009.

The total noninterest income for the nine-month periods remained consistent ($6.9 million for each period). Noninterest income reflects the inclusion of $0.9 million mortgage banking income in 2009, which was not included in 2010, and $874 thousand income on Bank owned life insurance in 2009, compared to $155 thousand in 2010. Securities gains increased $1.0 million from $985 thousand for the nine months ended September 30, 2009 to $2.0 million for the nine months ended September 30, 2010.

Noninterest expense

Noninterest expense was down in the third quarter of 2010 by $1.6 million compared to 2009, primarily because of the $1.4 million decrease in salaries and benefits, which is consistent with the nine-month change discussed below. All other expense categories remained controlled and consistent in comparative periods. The nine-month comparison in which 2010 noninterest expense was less than 2009 reflects the significant decrease in salaries and benefits — $3.7 million for the Bank, or a 32.0% decrease related to continued staff reductions, and $2.6 million for the mortgage company in 2009. The mortgage company operations were essentially closed in the second half of 2009. These amounts were offset by the $2.0 million increase in other real estate writedowns reflected in the other expense category.

Income taxes

The income tax benefit of $0.8 million in the first nine months of 2010 was recorded after the 2009 income tax returns were filed and settled, when we determined the deferred tax valuation reserve exceeded the recorded deferred tax assets by $0.8 million.

20

Changes in Financial Condition

September 30, 2010 Compared With December 31, 2009

The following table reflects the changes in our assets and liabilities as of September 30, 2010 compared with December 31, 2009.

	September 30,		December 31,
(In thousands)	2010		2009		$ Change			% Change
Total assets	$	947,090	$	1,060,084	$	(112,994	)		-10.7	%
Earning assets		886,867		967,703		(80,836	)		-8.4	%
Cash and cash equivalents		49,512		73,374		(23,862	)		-32.5	%
Investment securities		277,570		190,921		86,649			45.4	%
Gross loans		606,359		775,019		(168,660	)		-21.8	%
Investment in bank owned life insurance		4,261		4,106		155			3.8	%
Other assets		21,321		25,028		(3,707	)		-14.8	%
Total liabilities	$	918,882	$	1,012,998	$	(94,116	)		-9.3	%
Deposits		889,168		966,605		(77,437	)		-8.0	%
Non-interest-bearing demand deposits		98,152		109,673		(11,521	)		-10.5	%
Interest-bearing demand deposits		264,449		301,578		(37,129	)		-12.3	%
NOW accounts		111,973		145,833		(33,860	)		-23.2	%
Money market accounts		152,476		155,745		(3,269	)		-2.1	%
Savings deposits		20,608		18,794		1,814			9.7	%
Time deposits		505,959		536,560		(30,601	)		-5.7	%
Overnight and short-term borrowings		21,000		20,000		1,000			5.0	%
Long-term borrowings		3,000		20,000		(17,000	)		-85.0	%
Other liabilities		4,398		4,692		(294	)		-6.3	%

The changes in the Company’s balance sheet for the nine months ended September 30, 2010 reflect the continued deleveraging of the Bank and changing the risk based asset mix.

The loan portfolio contracted $168.7 million during first the nine months of 2010 due to continued aggressive problem loan resolution; the pay off of large relationships whose borrower requirements exceeded the Bank’s current risk tolerance; and the significantly declining market of quality loan opportunities. The loan to deposit ratio at September 30, 2010 was 68.2% compared to 80.2% at December 31, 2009.

The proceeds from the loan portfolio reduction have primarily been deployed as investment security purchases ($87.0 million). As set forth in the financial statement footnotes, the securities portfolio is predominately government backed mortgage securities or government agency single maturity bonds.

The Bank’s deposits decreased $77.4 million during the first nine months of 2010. While the offered deposit rates are competitive in the market, the marketing and rate posture for the nine months has been neutral to the local market. The Bank has been notified that the state of North Carolina is a high cost deposit market, and that allows the Bank to price deposit products in relation to the local market offered rates as compared to more restrictive national market rate caps. The issue has no effect currently; however, it could allow the Bank more flexibility in pricing deposits in the future.

Liquidity and Asset/Liability Management

The Company’s historical liquidity management process included anticipating operating cash requirements, evaluating time deposit maturities, monitoring loan to deposit ratios, and correlating these activities to an overall periodic internal liquidity measure. In evaluating our asset mix, we have sought to maintain a securities portfolio sufficient to provide short-term liquidity in periods of unusual fluctuations.

21

As outside funding sources have been withdrawn or restricted to current levels of outstandings, our liquidity management has focused on insuring adequate internal funding by the Bank.

The Bank’s primary internal sources of liquidity are customer deposits, cash and balances due from other Banks, and unencumbered investment securities. These funds, together with loan repayments, are used to fund continuing operations. Additionally, retail and commercial deposit balances fluctuate significantly, and we target liquidity levels to meet those periodic declines. The Bank’s liquidity (cash + unencumbered securities / total deposits) was approximately $262.5 million, or 29.5% of total deposits at September 30, 2010 and has exceeded the 20% target throughout the third quarter.

As of September 30, 2010, our core deposits, defined as total deposits excluding time deposits of $100 thousand or more, totaled $648.5 million, or 72.9% of our total deposits, compared to $719.0 million, or 74.4%, of our total deposits as of December 31, 2009.

Certificates of deposit of $100 thousand or more represented 27.1% and 25.6%, respectively, of the Bank’s total deposits at September 30, 2010 and December 31, 2009. Management believes that a sizeable portion of the Bank’s time deposits are relationship-oriented. Brokered certificates of deposit totaled $4.7 million and $8.2 million at September 30, 2010 and December 31, 2009, respectively. While the Bank appreciates the need to pay competitive rates to retain these deposits, other subjective factors also influence deposit retention. Based upon prior experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity, if the Bank elects to competitively price these deposits.

The Company utilizes an independent asset/liability modeling tool as a primary interest rate management guide. The periodic analysis considers the current contractual agreements for deposits, borrowings, loans, investments and any commitments to enter these transactions. Additionally current and projected volumes, scheduled payments and maturities and likely management pricing strategies in various rate scenarios are considered. Although these methods are subject to the accuracy of the assumptions that underlie the process and do not take into account the pricing strategies that management would undertake in response to sudden interest rate changes, the Company believes that these methods provide a better indication of the sensitivity of earnings to changes in interest rates than other analyses.

The objective of the Bank’s asset/liability management process is focused on providing relative stability and reduction of volatility for the Bank’s net interest income through various scenarios of changes in interest rates. The process attempts to balance the need for stability and predictability of net interest income against competing needs such as balance sheet mix constraints, overall earnings targets and the risk/return relationships between liquidity, interest rate risk, market risk and capital adequacy. The Bank maintains an asset/liability management policy approved by the Bank’s Board of Directors. This policy and the analysis process undertaken by management and the Board’s Asset/Liability Management Committee (“ALCO”) provides guidelines to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a range around an “earnings neutral position”, which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

The management of interest rate risk and the overall asset/liability position is integrated with the liquidity management process. Currently less than 10% of the Bank’s loans are directly related to market interest rates. The remaining loans are fixed rate or relate to the Bank’s independent index, which relates more directly to the Bank’s operating footprint.

In the current environment, the Bank is generally investing available funds in securities, primarily securities issued by U.S. governmental agencies, to manage liquidity and to limit any credit risk and risk based asset allocation.

22

The gap analysis that we conducted for the current balance sheet indicates the Company is liability sensitive. However, the flexibility provided by the small percentage of loans tied to market rates versus the Bank’s index and the general flexibility in deposit pricing results in management’s most likely pricing action producing increased net interest income in moderately increasing or decreasing interest rate scenarios. (This is more indicative of an asset sensitive balance sheet.) Under a moderate rising rate environment the Company’s interest rate risk is moderate and net interest income would be expected to increase modestly.

Provisions for Loan Losses, Allowance for Loan Losses and Discussions of Asset Quality

The risks inherent in our loan portfolio, including the adequacy of the allowance or reserve for loan losses, are significant estimates that are based on assumptions by our management regarding, among other factors, general and local economic conditions, which are difficult to predict. In estimating these risks and the related loss reserve levels, we also consider the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.

We use several measures to assess and monitor the credit risks in our loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectibility becomes doubtful. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Furthermore, loans and commitments of $500 thousand or more made during the month, as well as commercial loans past due 30 days or more, are reviewed monthly by the Loan Committee of the Bank’s Board of Directors.

Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review for impairment. When individual loans are impaired, the impairment allowance is measured in accordance with the accounting standard entitledAccounting By Creditors for Impairment of a Loan. The predominant measurement method for the Bank is the evaluation of the fair value of the underlying collateral. Allowance levels are estimated for other commercial loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. The Bank aggregates non-graded retail type loans into pools of similar credits and reviews the historical loss experience associated with these pools as the criteria to allocate the allowance to each category.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. Generally, all loans with outstanding balances of $250 thousand or greater that have been identified as impaired are reviewed periodically in order to determine whether a specific allowance is required. When the value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects the best estimate of probable losses that exist within the portfolios of loans that have not been specifically identified. The general allowance for the commercial loan portfolio is established considering several factors including: current loan grades, historical loss rates, estimated future cash flows available to service the loan, and the results of individual loan reviews and analyses. The allowance for loan losses for consumer loans, mortgage loans, and leases is determined based on past due levels and historical projected loss rates relative to each portfolio.

The unallocated allowance is determined through our assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects our acknowledgement of the imprecision and subjectivity that underlie the assessment of credit risk.

23

The allowance for loan losses is created by direct charges to operations. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by us to be uncollectible. Recoveries during the period are credited to the allowance for loan losses.

Management is continuing to closely monitor the value of real estate serving as collateral for our loans, particularly lots and land under development, due to continued concern that the low level of real estate sales activity will continue to have a negative impact on the value of real estate collateral. In addition, depressed market conditions have adversely impacted, and may continue to adversely impact, the financial condition and liquidity position of certain of our borrowers. Also, the value of commercial real estate collateral may come under further pressure from weak economic conditions and prevailing unemployment levels.

We believe that our allowance is an adequate estimation of probable losses incurred in our loan portfolio at September 30, 2010. No assurance can be given, however, that adverse economic circumstances or other events, including additional and continued loan review, future regulatory examination findings or changes in borrowers’ financial conditions, will not result in increased losses in the loan portfolio or in the need for increases in the allowance for loan losses or further writedowns of other real estate owned.

The following table and subsequent discussion present an analysis of changes in the allowance for loan losses for the third quarters and year-to-date periods of 2010 and 2009, respectively.

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
(In thousands)	2010			2009			2010			2009
Allowance for loan losses, beginning of period	$	29,620		$	22,787		$	27,837		$	24,806
Net charge-offs:
Loans charged off:
Real estate, commercial, financial and agricultural		7,560			3,760			27,813			16,194
Consumer loans		38			82			151			227
Total charge-offs		7,598			3,842			27,964			16,421
Recoveries of loans previously charged off:
Real estate, commercial, financial and agricultural		594			233			2,090			2,616
Consumer loans		15			24			65			98
Total recoveries		609			257			2,155			2,714
Net charge-offs		6,989			3,585			25,809			13,707
Loss provisions charged to operations		7,321			4,760			27,924			12,863
Allowance for loan losses, end of period	$	29,952		$	23,962		$	29,952		$	23,962
Ratio of annualized net charge-offs during the period to average loans during the period		4.39	%		1.68	%		5.01	%		2.05	%
Allowance coverage of annualized net charge-offs		108.02	%		168.47	%		86.80	%		130.75	%
Allowance as a percentage of loans		4.94	%		2.89	%		4.94	%		2.89	%

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Nonperforming assets at September 30, 2010 and December 31, 2009 were as follows:

	September 30,			December 31,
(In thousands)	2010			2009
Nonperforming assets:
Nonaccrual loans	$	65,780		$	40,736
Restructured loans — nonaccrual		9,172			12,404
Total nonperforming loans		74,952			53,140
Other real estate owned		15,205			13,235
Total nonperforming assets	$	90,157		$	66,375
Restructured loans — accruing	$	4,551		$	13,284
Loans past due 90 days or more and still accruing interest		2,518			1,195
Nonperforming loans to total loans		12.36	%		6.86	%
Allowance coverage of nonperforming loans		39.96	%		52.38	%
Nonperforming assets to total assets		9.52	%		6.26	%

If interest from nonaccrual loans, including impaired loans, had been recognized in accordance with the original terms of the loans, the estimated gross interest income for the third quarters of 2010 and 2009 that would have been recorded was approximately $1.1 million and $582 thousand, respectively. For the comparable year-to-date periods, interest income of approximately $2.8 million in 2010 and $1.2 million in 2009 would have been recognized in accordance with the original terms of the nonaccrual loans.

We classify loans as nonaccrual when the loan is 90 days past due, or we believe the loan may be impaired, and the accrual of interest on such loans is discontinued. The recorded accrued interest receivable deemed uncollectible is reversed to the extent it was accrued in the current year or charged-off to the extent it was accrued in previous years. A loan classified as nonaccrual is returned to accrual status when the obligation has been brought current, it has been performed in accordance with its contractual terms for a sufficient period of time, and the ultimate collection of principal and interest is no longer considered doubtful. Of the Bank’s $75.0 million in nonperforming loans at September 30, 2010, approximately $30.0 million are for single family homes, unimproved land or residential lots in various stages of development. The remaining population consists of loans to a variety of small business operations that are in default.

All of our investment in impaired loans, $63.2 million at September 30, 2010 is included in nonaccruing loans in the table above, and the related loan loss allowance was $12.8 million. At December 31, 2009, our investment in impaired loans was $38.9 million, and the related loan loss allowance was $7.7 million. The average recorded balance of impaired loans was $50.5 million for the first nine months of 2010 and $38.0 million for the first nine months of 2009.

In addition to the nonaccrual loans, the Bank has potential problem loans of approximately $80.0 million at September 30, 2010. Potential problem loans are loans as to which management had serious doubts as to the ability of the borrowers to comply with present repayment terms. These loans do not meet the criteria for, and are therefore not included in, nonperforming assets. Management defines potential problem loans as those loans graded substandard in the Bank’s grading system. These loans were considered in determining the adequacy of the allowance for loan losses and are closely and regularly monitored to protect the Bank’s interests.

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Changes in other real estate owned for the nine months ended September 30, 2010 and 2009 were as follows:

	Nine Months
	Ended September 30,
(In thousands)	2010			2009
Balance at beginning of period	$	13,235		$	6,805
Additions		12,161			19,420
Proceeds from sale		(5,974	)		(6,252	)
Write-downs and net gain (loss) on sale		(4,217	)		(2,547	)
Balance at end of period	$	15,205		$	17,426

Off-Balance Sheet Arrangements

We have off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. Further discussions of off-balance sheet arrangements are included in Note 4 under “Notes to Condensed Consolidated Financial Statements.”

Contractual Obligations

As of September 30, 2010, there were no material changes to contractual obligations in the form of long-term borrowings and operating lease obligations as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009. See also Note 4 under “Notes to Condensed Consolidated Financial Statements” for changes in other commitments in the form of commitments to extend credit and standby letters of credit.

Recent Legislation Impacting the Financial Services Industry

On July 21 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things:

• Create a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;

• Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws;

• Establish strengthened capital standards for banks and bank holding companies, and disallow trust preferred securities from being included in a bank’s Tier 1 capital determination (subject to a grandfather provision for existing trust preferred securities);

• Contain a series of provisions covering mortgage loan original standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments;

• Require financial holding companies, such as our Company, to be well-capitalized and well-managed as of July 21, 2011. Bank holding companies and banks must also be both well-capitalized and well-managed in order to acquire banks located outside their home state;

• Grant the Federal Reserve the power to regulate debit card interchange fees;

• Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions;

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• Make permanent the $250 thousand limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100 thousand to $250 thousand and provide unlimited federal deposit insurance until January 1, 2013 for noninterest-bearing demand transaction accounts at all insured depository institutions;

• Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts; and

• Increase the authority of the Federal Reserve to examine our Company and our nonbank subsidiaries.

Many provisions of the Dodd-Frank Act are subject to further rulemaking over future years, and the effects of the Act on the banking industry are not fully known at this time.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

As of September 30, 2010, the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based upon, and as of the date of this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. During the period covered by this Quarterly Report, no change in our internal control over financial reporting has occurred that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II — Other Information

Item 1A — Risk Factors

For additional factors that could affect the matters discussed above, see the “Risk Factors” section of the Company’s most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission. The following is an addition to the Risk Factors included in our 2009 Annual Report on Form 10-K:

Continued decline in market value of Company stock could trigger delisting on the stock exchange.

The market value of the Company’s stock traded on the NASDAQ Global Select Market has declined below $1.00 per share since mid August 2010. The Company received notice in September 2010 that it has a 180 day grace period for the bid price to exceed $1.00 per share for 10 consecutive days. If the Company’s stock price does not meet this criteria, the stock could be delisted.

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

There were no unregistered sales of our securities or share repurchase transactions for the three months ended September 30, 2010.

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Item 6 — Exhibits

Exhibits incorporated by reference into this filing were filed with the Securities and Exchange Commission. We provide these documents through our Internet site at www.bankofgranite.com or by mail upon written request.

3.1	Bank of Granite Corporation’s Restated Certificate of Incorporation, filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q dated May 9, 2006, is incorporated herein by reference.
3.2	Bank of Granite Corporation’s Amended and Restated Bylaws, filed as Exhibit 3.1 to our Current Report on Form 8-K dated April 28, 2008, is incorporated herein by reference.
4.1	Form of stock certificate for Bank of Granite Corporation’s common stock, filed as Exhibit 4.1 to our Registration Statement on Form S-4 (Registration Statement No. 333-104233) dated April 1, 2003, is incorporated herein by reference.
4.2	Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite Corporation (included in Exhibit 3.1 hereto)
11.	Schedule of Computation of Net Income Per Share
	The information required by this item is set forth under Item 1 of Part I, Note 3.
31.1	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
32.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Signatures

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

	Bank of Granite Corporation (Registrant)
Date: November 15, 2010	By:	/s/ Jerry A. Felts
		Jerry A. Felts
		Chief Financial Officer and Principal Accounting Officer

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Exhibit Index

		Begins
		on Page
3.1	Certificate of Incorporation, as amended	*
3.2	Amended and Restated Bylaws of the Registrant	*
4.1	Form of stock certificate for Bank of Granite Corporation’s common stock	*
4.2	Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite Corporation	*
11.	Schedule of Computation of Net Income Per Share	**
31.1	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002	Filed herewith
31.2	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002	Filed herewith
32.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith
32.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith

*	Incorporated herein by reference.
**	The information required by this item is set forth under Item 1 of Part I, Note 3.

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