Bank Of Granite 10-K 2006 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For the fiscal year endedDecember 31, 2006

Commission file number0-15956

Bank of Granite Corporation

(Exact name of registrant as specified in its charter)

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

Registrant’s telephone number, including area code (828) 496-2000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $1.00 par value
(Title of Class)

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.
Yeso      Noþ

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yeso      Noþ

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

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

Large Accelerated filero      Accelerated filerþ      Non-accelerated filero

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

     As of February 28, 2007, 16,029,978 shares of common stock, $1.00 par value, were outstanding. As of June 30, 2006, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $258,049,420 based on the closing sales price as reported on The NASDAQ Global Select Market.^SM

Documents Incorporated by Reference

     PART III: Portions of the Definitive Proxy Statement dated March 15, 2007 as filed pursuant to Section 14 of the Securities Exchange Act of 1934 in connection with the 2007 Annual Meeting of Stockholders.

Exhibit Index begins on page 79

FORM 10-K CROSS-REFERENCE INDEX

			2007
	2006		Proxy
	Form 10-K		Statement
	Page		Page
PART I
Item 1 — Business		3		n/a
Item 1A — Risk Factors		8		n/a
Item 1B — Unresolved Staff Comments		10		n/a
Item 2 — Properties		10		n/a
Item 3 — Legal Proceedings		10		n/a
Item 4 — Submission of Matters to a Vote of Security Holders		10		n/a
PART II
Item 5 — Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		11		n/a
Item 6 — Selected Financial Data		12		n/a
Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		13		n/a
Item 7A — Quantitative and Qualitative Disclosures about Market Risk		35		n/a
Item 8 — Financial Statements and Supplementary Data		36		n/a
Item 9 — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		70		n/a
Item 9A — Controls and Procedures		71		n/a
Item 9B — Other Information		73		n/a
PART III
Item 10 — Directors, Executive Officers and Corporate Governance		74		*
Item 11 — Executive Compensation		74		*
Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		74		*
Item 13 — Certain Relationships and Related Transactions and Director Independence		74		*
Item 14 — Principal Accountant Fees and Services		74		*
PART IV
Item 15 — Exhibits and Financial Statement Schedules**		75		n/a
Signatures		78		n/a
Exhibit 10.16
Exhibit 10.17
Exhibit 21
Exhibit 23.1
Exhibit 23.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

*	Incorporated by reference in the Proxy Statement
**	Exhibits incorporated by reference into this filing were filed with the Securities and Exchange Commission. Bank of Granite Corporation provides these documents through its Internet site at www.bankofgranite.com or by mail upon request.

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PART I

ITEM 1 — BUSINESS

Bank of Granite Corporation (the “Company”) is a Delaware corporation that was organized June 1, 1987 as a bank holding company. The Company currently engages in no operations other than ownership and operation of Bank of Granite (the “Bank”), a state bank chartered under the laws of North Carolina on August 2, 1906 and Granite Mortgage, Inc. (“Granite Mortgage”), a mortgage bank chartered under the laws of North Carolina on June 24, 1985.

The Company conducts its business through three reportable business segments: Community Banking, Mortgage Banking and Other. The Community Banking segment offers a variety of loan and deposit products and other financial services. The Mortgage Banking segment originates, retains and sells mortgage loans. The Other segment includes activities at the holding company level such as corporate and stockholder relations and funding from the issuance of commercial paper and trust preferred securities. For financial information on the Company’s three business segments, see Note 21, “Operating Segments,” of the “Notes to Consolidated Financial Statements.” The Company conducts its community banking business operations from 22 full-service offices located in Burke, Caldwell, Catawba, Forsyth, Iredell, Mecklenburg, Watauga, and Wilkes counties in North Carolina. According to the Federal Deposit Insurance Corporation (the “FDIC”), as of September 30, 2006, the Bank ranked 12th in assets and 12th in deposits among North Carolina banking institutions. The Company conducts its mortgage banking business operations from 14 offices in Cumberland, Guilford and Rowan counties in North Carolina, in addition to the counties where the Bank has community banking offices.

GENERAL BUSINESS

The Bank is an independent community bank. The Bank’s principal community banking activities include the taking of demand and time deposits and the making of loans, secured and unsecured, to individuals, associations, partnerships and corporations. The majority of the Bank’s customers are individuals and small businesses. No material part of its business is dependent upon a single customer or a few customers whose loss would have a material adverse effect on the business of the Bank. No material portion of the business of the Bank is seasonal.

Granite Mortgage’s principal mortgage banking activities include the origination and underwriting of mortgage loans to individuals. Granite Mortgage also sells mortgage servicing rights and appraisal services. Granite Mortgage specializes in government guaranteed mortgage products. The majority of its customers are individuals. Granite Mortgage’s business is not dependent on a single customer or a few customers whose loss would have a material adverse effect on the business. The mortgage business is sensitive to changes in interest rates in the market. When rates decline, Granite Mortgage generally experiences an increase in its mortgage business. When rates rise, Granite Mortgage’s business generally declines. No material portion of the business of Granite Mortgage is seasonal.

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GENERAL DESCRIPTION OF ECONOMIC AREAS

Prior to 2003, the Company conducted its community banking operations primarily in Caldwell, Catawba and Burke counties of North Carolina. This area was historically known as a center for the manufacture of fiber optic and coaxial cable, furniture, and apparel. When the economy began to weaken in 2001, there were massive layoffs in these industries, and these counties were significantly impacted with a sudden and sustained rise in their unemployment rates. Since 2003, these counties have experienced gradual improvements in the high unemployment rates that occurred in 2001.

Since 2003, the Company has expanded its business by entering three new markets where the local economies are more diversified and growing. In 2003, the Bank opened new offices in Watauga County (Boone), Wilkes County (Wilkesboro), and Mecklenburg County (Matthews), and acquired First Commerce Bank and its three banking offices in Mecklenburg County (Charlotte and Cornelius). In 2004, the Bank opened a banking office in Forsyth County (Winston-Salem). The Bank opened a new loan production office in Iredell County (Statesville) in August 2006 and converted it to a full-service banking office in October 2006. The relative unemployment rates and the population growth in Mecklenburg, Forsyth and Iredell Counties, each as shown in the tables below, formed the primary basis for the Company’s decision to expand into those new markets.

Month of December	2006			2005			2004			2003			2002
Unemployment Rates*
Caldwell County		8.4	%		7.5	%		7.2	%		7.5	%		7.6	%
Catawba County		5.4	%		5.3	%		6.1	%		7.0	%		8.2	%
Burke County		5.8	%		5.8	%		6.0	%		6.9	%		7.7	%
Watauga County		3.1	%		3.2	%		3.4	%		3.5	%		4.2	%
Wilkes County		5.7	%		4.9	%		6.0	%		6.4	%		7.5	%
Mecklenburg County		4.3	%		4.2	%		4.8	%		5.0	%		5.6	%
Forsyth County		4.2	%		4.2	%		4.5	%		5.0	%		5.4	%
Iredell County		4.4	%		4.4	%		5.1	%		5.7	%		6.3	%
North Carolina		4.9	%		5.1	%		5.3	%		6.1	%		6.5	%
United States		4.5	%		4.9	%		5.4	%		5.7	%		6.0	%

* Source: Employment Security Commission of North Carolina

The population projections and estimates for the counties in the Company’s primary market areas are as follows:

	July 2009		July 2005		April 2000
	Projections		Estimates		Census
Population Projections and Estimates*
Caldwell County		79,820		78,492		77,386
Catawba County		156,587		149,032		141,686
Burke County		90,169		88,293		89,145
Watauga County		43,794		42,934		42,693
Wilkes County		68,288		66,897		65,632
Mecklenburg County		884,211		796,232		695,370
Forsyth County		344,139		326,340		306,067
Iredell County		153,092		139,727		122,660
North Carolina		9,243,581		8,682,066		8,046,485

* Source of projection, estimate and census data: North Carolina Office of State Budget and Management

4

TERRITORY SERVED AND COMPETITION

The Bank operates 22 full-service community banking offices in the North Carolina cities and communities of Granite Falls, Lenoir, Hudson, Newton, Morganton, Hickory, Boone, Wilkesboro, Charlotte, Cornelius, Conover, Matthews, Winston-Salem, and Statesville.

The Federal Deposit Insurance Corporation (the “FDIC”) collects deposit data from insured depository institutions as of June 30 of each year as presented below (deposit dollars in millions).

	June 30, 2006									June 30, 2005
	Bank of Granite					Market				Bank of Granite					Market
County	Deposits		Market Share			Deposits		No. of Banks		Deposits		Market Share			Deposits		No. of Banks
Caldwell	$	320.4		39.2	%	$	817.1		9	$	303.6		39.6	%	$	767.5		9
Catawba		386.0		15.7	%		2,457.9		13		331.2		14.4	%		2,293.7		13
Burke		51.7		7.3	%		706.1		9		47.5		7.1	%		670.5		9
Watauga		22.6		2.8	%		805.8		12		15.3		2.2	%		683.2		12
Wilkes		14.3		1.9	%		749.7		11		8.1		1.2	%		690.8		11
Mecklenburg		170.9		0.2	%		86,748.9		22		148.7		0.2	%		83,121.7		21
Forsyth		15.9		0.1	%		13,168.2		16		8.7		0.1	%		12,953.4		16
Iredell*	none			0.0	%		1,916.7		17	none			0.0	%		1,744.1		16

* Deposit data for Bank of Granite in Iredell County will not be available until June 30, 2007.

The Bank’s community banking markets are highly competitive. The table above reflects the continuing competition in the Bank’s markets. In addition to competing with other large and small banks, which tend to be numerous, especially in the higher growth markets, the Bank also competes for both loan and deposit business with thrifts or savings institutions, credit unions, brokerage and insurance firms, and other nonbank businesses, such as manufacturers and retailers.

The mortgage banking business is also highly competitive, with both bank and nonbank mortgage originators competing in the market. Granite Mortgage conducts its mortgage banking business from 14 offices in the North Carolina cities and communities of Winston-Salem, Hickory, High Point, Lenoir, Morganton, Newton, Salisbury, Boone, Charlotte, Conover, Fayetteville, Wilkesboro, and Matthews.

The Company’s community banking and mortgage banking operations are both required to compete based on price in order to conduct business in each of the Company’s markets, as demonstrated in the Bank’s recent increases in interest rates on deposit accounts. However, the Company believes that its focus on and commitment to providing superior customer service is what distinguishes it from its competitors.

EMPLOYEES

As of December 31, 2006, the Bank had 278 and Granite Mortgage had 59 full-time equivalent employees. Each of the Bank and Granite Mortgage considers its relationship with its employees to be excellent.

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SUPERVISION AND REGULATION

The following summaries of statutes and regulations affecting bank holding companies, banks and mortgage banks do not purport to be complete. Such summaries are qualified in their entirety by reference to such statutes and regulations.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is required to register as such with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”). Because of its number of stockholders, the Company is also regulated by the Securities and Exchange Commission (the “SEC”).

A bank holding company is required to file with the FRB annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to acquiring, directly or indirectly, more than 5% of the voting stock of a bank, unless it already owns a majority of the voting stock of the bank. Furthermore, with limited exceptions, a bank holding company must engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares of a company the activities of which the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

The FRB has cease-and-desist powers over bank holding companies and nonbank subsidiaries where their action would constitute a serious threat to the safety, soundness or stability of a subsidiary bank.

Although the Company is not presently subject to any regulatory restrictions on dividends, the Company’s ability to pay dividends depends to a large extent on the amount of dividends paid by the Bank and Granite Mortgage. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to Section 53-87 of the North Carolina General Statutes. As of December 31, 2006, the Bank had undivided profits of approximately $101.6 million. Additionally, current federal regulations require that the Bank maintain a ratio of total capital to assets, as defined by regulatory authorities, in excess of 6%. As of December 31, 2006, this ratio was 11.77% for the Bank, leaving approximately $68.5 million of the Bank’s undivided profits available for the payment of dividends.

In an effort to achieve a measurement of capital adequacy that is more sensitive to the individual risk profiles of financial institutions, the various financial institution regulators mandate minimum capital regulations and guidelines that categorize various components of capital and types of assets and measure capital adequacy in relation to a particular institution’s relative levels of those capital components and the level of risk associated with various types of assets of that financial institution. The FDIC and the FRB statements of policy on “risk-based capital” require the Company to maintain a level of capital commensurate with the risk profile assigned to its assets in accordance with the policy statements. The capital standards require minimum ratios of 4% for tier 1 capital, 8% for total risk-adjusted capital and 4% for leverage. At December 31, 2006, the Company’s tier 1 ratio, total capital ratio to risk-adjusted assets, and leverage ratio were 13.8%, 11.6% and 15.0%, respectively. The Company is in compliance with all regulatory capital requirements.

The Bank is subject to supervision and regulation, of which regular bank examinations are a part, by the FDIC and the North Carolina State Banking Commission (the “Banking Commission”). The Bank is a member of the FDIC, which currently insures the deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a semi-annual statutory assessment and is subject to the rules and regulations of the FDIC.

6

Federal banking laws applicable to all depository financial institutions, among other things, (i) afford federal bank regulatory agencies with powers to prevent unsafe and unsound banking practices; (ii) restrict preferential loans by banks to “insiders” of banks; (iii) require banks to keep information on loans to major stockholders and executive officers, and (iv) bar certain director and officer interlocks between financial institutions. The prohibitions against certain director and officer interlocks may inhibit the ability of the Bank and the Company to obtain experienced and capable officers and directors, to replace current officers and directors, or to add to their number.

The Company is an “affiliate” of the Bank within the meaning of the Federal Reserve Act, which imposes restrictions on loans by the Bank to the Company and on investments by the Bank in the stock or securities of the Company, which serve as security for loans by the Bank to any borrower. The Company is also subject to certain restrictions with respect to engaging in the business of issuing, underwriting and distributing securities.

Stockholders of banks (including bank holding companies that own stock in banks) may be compelled by bank regulatory authorities to invest additional capital in the event their banks experience either significant loan losses or rapid growth of loans or deposits. In addition, the Company may also be required to provide additional capital to any banks that it acquires as a condition to obtaining the approvals and consents of regulatory authorities in connection with such acquisitions.

Granite Mortgage, as a mortgage bank, is regulated by the Banking Commission. Because Granite Mortgage is a nonbank subsidiary of a bank holding company, it is also regulated by the FRB. In addition, because Granite Mortgage underwrites mortgages guaranteed by the government, it is subject to other audits and examinations as required by the government agencies or the investors who purchase the mortgages.

The Company cannot predict what other legislation might be enacted or what other regulation might be adopted or, if enacted or adopted, the effect thereof.

EFFECTS OF GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONTROLS

The Company is directly affected by governmental monetary policy and by regulatory measures affecting the banking industry in general. Of primary importance is the FRB, whose actions directly affect the money supply and, in general, affect banks’ lending abilities by increasing or decreasing the cost and availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in the United States government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against bank deposits.

Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks have eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates have increased banks’ costs of funds and made them more sensitive to fluctuations in money market rates.

In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, predictions as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Company are difficult and have very limited reliability.

INVESTMENT POLICIES

For a discussion of the Company’s investment policies, see “Investment Securities” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report.

7

LOAN PORTFOLIO

For a discussion of the Company’s loan portfolio, see “Loans” and “Provisions and Allowances for Loan Losses” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report.

AVAILABLE INFORMATION

Additional information about the Company and its business is available at the Company’s website, at www.bankofgranite.com. The Company’s filings with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934, are available, free of charge, on the Company’s website at www.bankofgranite.com under the heading “Investor Relations — SEC Filings.” These reports are available as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. In addition, copies of these filings are available at the Securities and Exchange Commission’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission’s website, www.sec.gov, is another source of this information. Information included on the Company’s website is not incorporated by reference into this annual report.

ITEM 1A — RISK FACTORS

Decreases in interest rates could cause our earnings to decline.

Our balance sheet remains asset sensitive because of its significant level of variable rate loans. Asset sensitive means that when market interest rates change, interest rates on our variable rate assets, primarily loans, change more rapidly than the interest rates on our deposits. Therefore, when interest rates fall, our interest income on variable rate loans declines at a faster pace than the interest we pay on time deposits and other fixed rate funding.

Strong competition within our market areas may limit our growth and profitability. Larger banks and numerous other financial institutions with greater resources may be able to compete more effectively than smaller community banks and mortgage banks.

We face numerous competitors in both our community banking and mortgage banking operations in all of our market areas. In addition to competing with larger and smaller banks, which tend to be numerous, especially in the higher growth markets, we also compete for both loan and deposit business with thrifts or savings institutions, credit unions, brokerage and insurance firms and other nonbank businesses, such as manufacturers and retailers that engage in consumer financing activities. Price competition for loans and deposits might result in earning less on our loans and paying more on our deposits, which would reduce our net interest income. Competition also makes it more challenging to grow loans and deposits and to hire and retain experienced employees. Some of the institutions with which we compete have substantially greater resources and lending limits than we do and may offer services that we do not provide. We expect competition to continue to increase in the future as a result of legislative, regulatory, and technological changes and the continuing trend of consolidation in the financial services industry.

The mortgage banking business is also highly competitive, with both large and small bank and nonbank mortgage originators competing in our mortgage banking markets.

8

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.

We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in increases to our allowance. Material additions to our allowance would materially decrease our net income.

In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs required by regulatory authorities could have a material adverse effect on our financial condition and results of operations.

We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.

Our holding company, community banking, and mortgage banking businesses are highly regulated. Our holding company is regulated by the Federal Reserve Board, the Banking Commission, and the Securities and Exchange Commission. Our community banking subsidiary is regulated by the Federal Deposit Insurance Corporation and the Banking Commission. Our mortgage banking subsidiary is regulated by the Federal Reserve Board and the Banking Commission. Such regulation and supervision govern the activities in which we may engage and are intended primarily for the protection of the deposit insurance fund and depositors. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations or legislation, may have a material impact on our operations. In addition to the risks of noncompliance, we are required to dedicate considerable time and monetary resources in our efforts to comply with the numerous laws and regulations that govern the ways in which we conduct our community banking and mortgage banking activities.

Economic declines in our markets could impair the ability of our customers, both individuals and businesses, to repay their loans.

We have significantly expanded our lending during the past five years as we have entered new markets in the high country of the Blue Ridge Mountains and the Winston-Salem and Charlotte metro areas of North Carolina. Our loan portfolios may not be as seasoned as the loan portfolios of our competitors in some of these new markets. Should local real estate markets or economies weaken, we may begin to experience higher default rates. Increased levels of non-performing loans would likely result in higher loan losses and lower profits.

We may have additional tax liabilities.

Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be different from our historical income tax provisions and accruals. Based on the results of an audit or litigation, a material effect on our income tax provision, net income or cash flows in the period or periods for which that determination is made could result.

9

If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings.

Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicated the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could have a negative impact on our results of operations.

Changes in accounting may affect our reported earnings and operating income.

Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations for many aspects of our business, such as accounting for investments, and treatment of goodwill or amortizable intangible assets, are highly complex and involve subjective judgments. Changes in these rules or their interpretation could significantly change our reported earnings. See Note 1, “Summary of Significant Accounting Policies,” of the “Notes to Consolidated Financial Statements.”

ITEM 1B — UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2 — PROPERTIES

The Company indirectly owns and operates real estate through its ownership of the Bank and Granite Mortgage. The Bank owns its headquarters, operations and information technology center offices located in Granite Falls, North Carolina. The Bank also owns banking offices in the North Carolina cities and communities of Conover, Granite Falls, Hickory, Hudson, Lenoir, Morganton, Newton, and Wilkesboro. The Bank leases banking offices in the North Carolina cities and communities of Boone, Charlotte, Cornelius, Granite Falls, Matthews, Statesville, and Winston-Salem. Granite Mortgage leases its headquarters offices, which are located in Winston-Salem, North Carolina. Granite Mortgage also leases mortgage origination offices located in the North Carolina cities and communities of Boone, Charlotte, Conover, Fayetteville, Hickory, High Point, Lenoir, Matthews, Morganton, Newton, Salisbury, Wilkesboro, and Winston-Salem. Management believes that the premises occupied by the Bank and Granite Mortgage are well located and suitably equipped to serve and support the Company’s community banking and mortgage banking businesses. Management does not currently anticipate any problems with the renewal of its leases. See also Note 5, “Premises and Equipment,” of the “Notes to Consolidated Financial Statements.”

ITEM 3 — LEGAL PROCEEDINGS

There were no material legal proceedings pending as of December 31, 2006. During the year ended December 31, 2006, we were not required to pay any penalties for failure to disclose certain “reportable transactions” under Section 6707A of the Internal Revenue Code.

ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of stockholders in the fourth quarter of 2006.

10

PART II

ITEM 5 — MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock, $1.00 par value, trades on The NASDAQ Global Select Market^SM of The NASDAQ Stock Market^® under the symbol GRAN. Price and volume information is contained inThe Wall Street Journal^® and many other major daily newspapers in the NASDAQ section under the National Market System listings.

During 2006, the market participants making a market in the Company’s common stock with the highest volumes of Company shares traded were UBS Securities, LLC, Knight Equity Markets, LP, Goldman, Sachs & Company, and Wachovia Capital Markets. There were no issuances of unregistered securities by the Company during the year ended December 31, 2006.

As of December 31, 2006, there were 16,022,230 shares of the Company’s common stock outstanding, owned by approximately 2,500 stockholders of record and an estimated 4,400 holders of shares registered in street name or as beneficial owners. The following table presents the quarterly market sales prices and dividend information for the two years in the period ended December 31, 2006.

Quarterly Common Stock Market Price Ranges and Dividends

2006	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Price Range
High	$	16.60	$	16.66	$	18.10	$	19.69
Low		14.62		15.09		15.21		16.99
Close		16.22		16.66		17.53		18.97
Dividends		0.11		0.11		0.13		0.13

2005	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Price Range
High	$	16.82	$	15.70	$	17.45	$	16.82
Low		14.16		13.28		14.42		14.01
Close		14.79		15.31		15.23		14.82
Dividends		0.10		0.10		0.10		0.11

* Amounts for periods prior to September 25, 2006 have been adjusted to reflect the 5-for-4 stock split distributed September 25, 2006.

Although future cash dividends cannot be guaranteed, the Company currently expects to pay comparable cash dividends in the future.

The following table sets forth information as of December 31, 2006 regarding shares of the Company’s common stock that may be issued upon exercise of options previously granted and currently outstanding under the Company’s stock option plans, as well as the number of shares available for the grant of options that had not been granted as of that date.

	(a) Number of		(b) Weighted-		(c) Number of Securities
	Securities To Be		Average Exercise		Remaining Available for
	Issued Upon Exercise		Price Of		Future Issuance Under
	Of Outstanding		Outstanding		Equity Compensation Plans
	Options, Warrants and		Options, Warrants		(excluding securities
	Rights		and Rights		reflected in column (a))
Equity compensation plans —
Approved by security holders		207,210	$	12.86		309,774
Not approved by security holders		-0-		n/a		n/a
Total		207,210	$	12.86		309,774

The Company purchases shares of its common stock in open-market and occasional privately negotiated transactions pursuant to publicly announced share repurchase programs. The Company did not purchase any of its common shares during the quarter ended December 31, 2006. The maximum approximate dollar value of shares that may be purchased under the Company’s share repurchase programs was $2,298,917 as of December 31, 2006.

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ITEM 6 — SELECTED FINANCIAL DATA

The following table presents selected consolidated historical financial data of the Company for the periods indicated. This financial data should be read in conjunction with the Company’s consolidated financial statements and notes thereto.

	For the Years Ended December 31,
	2006			2005			2004			2003			2002
Interest income	$	86,541,783		$	68,159,074		$	55,265,889		$	50,696,176		$	45,710,526
Interest expense		31,778,230			20,173,144			13,107,985			11,389,491			10,802,422
Net interest income		54,763,553			47,985,930			42,157,904			39,306,685			34,908,104
Provision for loan losses		6,413,509			5,193,902			5,439,160			4,764,010			3,492,382
Net interest income after provision for loan losses		48,350,044			42,792,028			36,718,744			34,542,675			31,415,722
Other income		12,507,115			11,911,287			11,256,723			14,437,740			11,397,705
Other expense		32,945,231			31,815,235			29,114,940			25,862,457			20,316,234
Income before income taxes		27,911,928			22,888,080			18,860,527			23,117,958			22,497,193
Income taxes		9,879,899			7,878,536			6,142,307			7,810,065			7,394,893
Net income	$	18,032,029		$	15,009,544		$	12,718,220		$	15,307,893		$	15,102,300
Per share Net income
Basic*	$	1.12		$	0.91		$	0.75		$	0.91		$	0.89
Diluted*		1.12			0.91			0.75			0.91			0.89
Dividends*		0.48			0.42			0.39			0.37			0.33
Book value*		9.27			8.66			8.47			8.34			7.65
Share price
High*		19.69			17.45			18.34			21.57			17.27
Low*		14.62			13.28			14.14			12.94			12.45
Close*		18.97			14.82			16.72			17.42			14.00
Average shares outstanding
Basic*		16,048,439			16,413,742			16,849,526			16,797,024			16,933,453
Diluted*		16,104,018			16,469,047			16,911,919			16,895,221			16,940,040
Performance ratios
Return on average assets		1.56	%		1.41	%		1.28	%		1.78	%		2.13	%
Return on average equity		12.57	%		10.70	%		9.02	%		11.40	%		11.98	%
Average equity to average assets		12.42	%		13.14	%		14.20	%		15.58	%		17.80	%
Dividend payout		41.45	%		46.50	%		52.06	%		40.56	%		37.05	%
Efficiency ratio		48.26	%		52.12	%		53.17	%		46.81	%		42.29	%
Balances at year-end
Assets	$	1,199,772,473		$	1,106,724,022		$	1,032,238,449		$	971,382,727		$	742,014,674
Investment securities		169,566,168			153,682,706			158,560,042			159,436,361			124,924,296
Loans (gross)		912,491,736			832,447,148			778,137,430			715,844,632			532,921,937
Allowance for loan losses		15,787,114			13,923,884			13,665,013			10,798,897			8,834,611
Mortgage loans held for sale		11,796,899			14,219,444			21,553,548			23,092,846			32,452,162
Liabilities		1,053,338,969			966,876,031			891,222,228			829,567,628			614,571,832
Deposits		963,836,692			879,111,425			749,861,552			735,099,355			547,249,315
Stockholders’ equity		146,433,504			139,847,991			141,016,221			141,815,099			127,442,842
Asset quality ratios
Net charge-offs to average loans		0.52	%		0.61	%		0.35	%		0.75	%		0.21	%
Nonperforming assets to total assets		1.29	%		1.04	%		1.18	%		1.35	%		0.76	%
Allowance coverage of nonperforming loans		109.91	%		130.96	%		125.82	%		95.29	%		199.98	%

* Amounts for periods prior to September 25, 2006 have been adjusted to reflect the 5-for-4 stock split distributed September 25, 2006.

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ITEMS 7 AND 7A — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

     CONDITION AND RESULTS OF OPERATIONS, INCLUDING

     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Management’s Discussion and Analysis is provided to assist in understanding and evaluating the Company’s results of operations and financial condition. The following discussion should be read in conjunction with the consolidated financial statements and related notes included herein. In 1987, the Company was formed under a plan whereby all previously issued shares of the Bank’s stock were exchanged for shares of the Company’s stock. The Bank then became a wholly owned subsidiary of the Company. In 1997, the Company acquired Granite Mortgage through a merger, which was accounted for as a pooling of interests. In July 2003, the Company acquired First Commerce Corporation and its subsidiary bank through a merger, which was accounted for as a purchase transaction. All information presented is consolidated unless otherwise specified. Amounts per share have been adjusted to reflect the 5-for-4 stock split distributed September 25, 2006.

This discussion is intended to provide a general overview of the Company’s performance in 2006 and outlook for 2007. Readers seeking a more in-depth discussion of 2006 are invited to read the more detailed discussions below as well as the consolidated financial statements and related notes included herein.

The Year 2006 in Review

Earnings increased in 2006 primarily as a result of higher income from interest and fees from loans, partially offset by higher interest expense on deposits. In addition to growth in loans and deposits, the Federal Reserve Board increased its overnight interest rate during the first two quarters of 2006 in its efforts to control inflation. The resulting increased net interest margin was partially offset by increases in other expenses.

Financial Highlights	2006			2005			% change
($ in thousands, except per share data)
Earnings
Net interest income	$	54,764		$	47,986			14.1	%
Provision for loan losses		6,414			5,194			23.5	%
Other income		12,507			11,911			5.0	%
Other expense		32,945			31,815			3.6	%
Net income		18,032			15,010			20.1	%
Per share
Net income
- Basic	$	1.12		$	0.91			23.1	%
- Diluted		1.12			0.91			23.1	%
At year-end
Assets	$	1,199,772		$	1,106,724			8.4	%
Loans		912,492			832,447			9.6	%
Deposits		963,837			879,111			9.6	%
Ratios
Return on average assets		1.56	%		1.41	%
Return on average equity		12.57	%		10.70	%
Average capital to average assets		12.42	%		13.14	%
Efficiency ratio		48.26	%		52.12	%

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Higher earnings from both community banking activities and mortgage origination activities resulted in increased earnings for the Company in 2006. Earnings increased 20.14% to $18,032,029 from the $15,009,544 earned in 2005. On a per share basis, earnings increased to $1.12 in 2006 compared to $0.91 in 2005. In 2006, the Company earned 1.56% on average assets and 12.57% on average equity. Its efficiency ratio was 48.26%. In 2005, the Company’s return on average assets, return on average equity and efficiency ratio were 1.41%, 10.70% and 52.12%, respectively. Earnings for 2005 included a one-time charge of $759,000 after tax, or $0.05 per share, for a retirement bonus and other benefits granted by the Board of Directors to the Company’s retiring chairman and former chief executive officer.

Factors that significantly affected 2006 earnings and financial position:

o Net interest income increased $6,777,623, or 14.1%, primarily resulting from increased interest income from higher rates on loans and, to a lesser extent, higher volumes of loans, which was partially offset by increased interest expense from higher rates on deposits and, to a lesser extent, higher volumes of deposits. As a result, the Company’s net interest margin increased 24 basis points to 5.18% in 2006 compared to 4.94% in 2005.

o Loans grew by $80,044,588 or 9.6%, and deposits grew by $84,725,267, or 9.6%.

o During 2006, loan loss provisions increased $1,219,607, or 23.5%, from the provisions in 2005, which were established to provide for possible charge-offs due to continued weak local economies in certain markets. Total nonperforming loans increased to $14,365,155 as of December 31, 2006 compared to $10,632,029 as of December 31, 2005.

o Other expenses, or operating overhead, increased $1,129,996, or 3.6%. The overhead costs of community banking operations increased $1,227,943, which was partially offset by a slight decrease in mortgage banking other expenses. The increase in overhead costs was driven primarily by higher employee benefit, occupancy, and equipment related costs, which increased $1,121,776. Personnel costs increased $163,990 in 2006. Excluding a one-time charge in 2005 of $1,265,000 before tax, personnel costs increased $1,428,990 in 2006 compared to 2005.

o Other income increased $595,828, or 5%, primarily due to increased cash surrender values of life insurance policies owned by the Bank and increased fees on deposits.

o Granite Mortgage posted 2006 net income of $400,671, an increase of 24.6% from the $321,463 earned in 2005, primarily due to a decrease in advertising and other overhead expenses. Mortgage volumes were $248,041,523 in 2006 compared to $265,696,694 in 2005, a decline of 6.6%.

o During 2006, the Company repurchased 168,410 shares of its common stock for $2,643,410 or an average cost of $15.70 per share.

OUTLOOK FOR 2007

The Federal Reserve’s Federal Open Market Committee (the “FOMC”) continued its removal of monetary policy accommodation by increasing its overnight rate on funds by 25 basis points at four of its meetings in the first six months of 2006, and the overnight rate remained the same for the second half of 2006. The FOMC stated in its December 12, 2006 release that “Some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth.”

The Company anticipates it will continue to adjust both the mix and pricing of its rate-sensitive assets and liabilities so as to improve, to the extent possible, its net interest margin and spreads. In addition, longer term interest rates are anticipated to remain low relative to historical levels for the periods preceding the most recent low interest rate cycle. Granite Mortgage has historically performed better during periods of lower interest rates due to the effect that low longer term rates tend to have on the housing market, which can serve to partially offset the effects that asset sensitivity may have on net interest income.

Efforts are underway to develop the Company’s retail and commercial banking services in its new Statesville market, as it also continues to grow loans and deposits in its other newer markets. The Company may consider opening additional loan production offices or full-service offices in some of its newer markets in an effort to meet the demand for its loan and deposit products and services in those markets.

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The Company will consider entering additional new markets and remains optimistic regarding its ability to enter and compete in new markets. Although entry into new markets, such as those added in recent years, may have a challenging effect on near-term earnings, the Company believes the long-term benefits outweigh any near-term challenges. Over the near term, the Company plans to continue its focus on improving the profitability of and strengthening its banking operations in its current markets. Over the longer term, the Company plans to continue to diversify and broaden its market and economic base, when determined prudent to do so, as it seeks sustainable earnings growth for its stockholders. The Company’s longer term strategy may take the form of opening new offices or acquiring other banking institutions or offices of other banking institutions as opportunities arise.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The more critical accounting and reporting policies include the Company’s accounting for securities, loans, the allowance for loan losses and income taxes. In particular, the Company’s accounting policies relating to the allowance for loan losses, investment securities and mortgage loans held for sale involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position or consolidated results of operations. Please see the discussions below under the captions “Loans,” “Provisions and Allowance for Loan Losses,” “Investment Securities,” “Mortgage Loans Held for Sale” and “Derivatives and Hedging Activities.” Also, please refer to Note 1, “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for additional information regarding all of the Company’s critical and significant accounting policies.

LOANS — Loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances adjusted for any deferred fees or costs. Substantially all loans earn interest on the level yield method based on the daily outstanding balance.

PROVISIONS AND ALLOWANCE FOR LOAN LOSSES — The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb probable losses in the portfolio. Management’s determination of the adequacy of the allowance is based on an evaluation of the portfolio, current economic conditions, periodic and systematic loan reviews, historical loan loss experience, value of the collateral and other risk factors.

Specific allowance is made and maintained to absorb losses for individually identified borrowers. These losses are assessed on an account-by-account basis based on management’s current evaluation of the Company’s loss exposure for each credit, given the payment status, financial condition of the borrower, and value of underlying collateral. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, “Accounting for Creditors for Impairment for a Loan.” Loans are deemed to be impaired when the Company determines that it is probable the Company will be unable to collect all amounts due according to the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical matter, at the loan’s observable market value or fair value of the collateral if the loan is collateral dependent. A reserve, recorded as a specific reserve in the allowance for loan losses, is established to record the difference between the stated loan amount and the present value or market value of the impaired loan. Impaired loans may be valued on a loan-by-loan basis (e.g., loans with risk characteristics unique to an individual borrower) or on an aggregate basis (e.g., loans with similar risk characteristics). The Company’s policy for recognition of interest income on impaired loans is the same as its interest income recognition policy for non-impaired loans. The Company discontinues the accrual of interest when the collectibility of such interest becomes doubtful. Recovery of the carrying value of loans is dependent to some extent on future economic, operating and other conditions that may be beyond the Company’s control. For the homogeneous pools of loans that have not been specifically identified, estimates of losses are largely based on charge-off trends, expected default rates, general economic conditions and overall portfolio quality. This evaluation is inherently subjective as it requires material estimates and unanticipated future adverse changes in such conditions could result in material adjustments to the allowance for loan losses that could adversely impact earnings in future periods. The Company’s nonperforming assets were $15,525,603 and $11,558,013 as of December 31, 2006 and 2005, respectively, and its gross charge-offs were $5,202,579 and $5,250,436 for 2006 and 2005, respectively.

15

INVESTMENT SECURITIES — Securities not classified as either held to maturity securities or trading securities, and equity securities not classified as trading securities, are classified as “available for sale securities” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated stockholders’ equity. The fair values of these securities are based on quoted market prices, dealer quotes and prices obtained from independent pricing services. Available for sale and held to maturity securities are reviewed quarterly for possible other-than-temporary impairment. The review is inherently subjective as it requires material estimates and judgments, including an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Company’s ability to hold the security to maturity. Declines in the fair value of the individual held to maturity and available for sale securities below their costs that are other-than-temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in consolidated earnings as realized losses.

MORTGAGE LOANS HELD FOR SALE — Through its mortgage subsidiary, the Company originates certain residential mortgage loans with the intent to sell. Mortgage loans held for sale are reported at the lower of cost or market value on an aggregate loan portfolio basis. Gains or losses realized on the sales of mortgage loans are recognized at the time of sale and are determined by the difference between the net sales proceeds and the carrying value of the loans sold, adjusted for any servicing asset or liability. Gains and losses on sales of mortgage loans are included in noninterest income.

DERIVATIVES AND HEDGING ACTIVITIES — The Company enters into derivative contracts to hedge certain assets, liabilities, and probable forecasted transactions. On the date the Company enters into a derivative contract, the derivative instrument is designated as: (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a “fair value” hedge); (2) a hedge of the variability in expected future cash flows associated with an existing recognized asset or liability or a forecasted transaction (a “cash flow” hedge); or (3) held for other risk management purposes (“risk management derivatives”).

The Company’s primary transactions involve cash flow hedges. In a cash flow hedge, the effective portion of the changes in the fair value of the hedging derivative is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings during the same period in which the hedged item affects earnings. The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

The Company formally documents the relationship between the hedging instruments and hedged items, as well as its risk management objective and strategy before undertaking the hedge. To qualify for hedge accounting, the derivatives and related hedged items must be designated as a hedge. Both at the inception of the hedge and on an ongoing basis, the Company assesses whether the hedging relationship is expected to be highly effective in offsetting changes in fair value or cash flows of hedged items. If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued.

16

RESULTS OF OPERATIONS

The following discussion relates to operations for the year ended December 31, 2006 compared to the year ended December 31, 2005 and the year ended December 31, 2005 compared to the year ended December 31, 2004.

2006 COMPARED TO 2005

In 2006, the Company earned $18,032,029, or $1.12 per share, compared to $15,009,544, or $0.91 per share, in 2005. The earnings provided returns on average assets of 1.56% in 2006 compared to 1.41% in 2005 and returns on average equity of 12.57% in 2006 compared to 10.70% in 2005. The earnings increase was primarily attributable to higher income from interest and fees from loans, partially offset by higher interest expense on deposits and increased other expenses.

The Company’s net interest income increased $6,777,623, or 14.12%, during 2006 compared to 2005. This increase resulted from higher rates on loans and, to a lesser extent, higher volumes of loans, which were partially offset by increased interest expense from higher rates on deposits and, to a lesser extent, higher volumes of deposits. The Company’s net interest margin averaged 5.18% for 2006, up from 4.94% for 2005. For a discussion of the Company’s asset sensitivity and the related effects on the Company’s net interest income and net interest margin, please see “Net Interest Income” and “Liquidity, Interest Rate Sensitivity and Market Risks” below.

Interest income for 2006 increased $18,382,709, or 26.97%, from 2005 primarily because of higher rates on both loans and investments in general, accompanied by a higher volume of commercial loans. Interest and fees on loans increased $16,598,469, or 29.08%, due to higher rates on loans and, to a lesser extent, higher average volumes during the year. Yields on loans averaged 8.81% for 2006, up from 7.41% for 2005. The prime rate averaged 7.96% during 2006 compared to 6.19% during 2005. Gross loans averaged $886,256,029 in 2006 compared to $827,002,929 in 2005, an increase of $59,253,100, or 7.16%. Average loans of the Bank were $860,221,000 compared to $797,273,290 in 2005, an increase of $62,947,710, or 7.90%, while average loans of Granite Mortgage were $26,035,029 compared to $29,729,639 in 2005, a decrease of $3,694,610, or 12.43%. The decline in Granite Mortgage’s average loans resulted from mortgage originations of $248,041,523 in 2006 compared to $265,696,694 in 2005. In general, the levels of mortgage origination and refinancing activities are very sensitive to changes in interest rates. Rising mortgage interest rates generally have the effect of reducing both mortgage originations and refinancings, falling mortgage interest rates generally have the effect of increasing mortgage originations and refinancings, and sustained low mortgage interest rates eventually have the effect of reducing refinancings as the demand for such refinancings becomes satisfied. Interest on securities and overnight investments increased $1,615,183 or 23.59%. The yield on investment securities and overnight investments increased to 4.96% in 2006 from 4.76% in 2005. Investment security yields increased 8 basis points to 4.94% from 4.86% when comparing 2006 and 2005, primarily due to the replacement of maturing investments with investments at higher interest rates. Average securities and overnight investments were $190,833,016 compared to $168,035,814 in 2005, an increase of $22,797,202, or 13.57%. The higher average levels of securities and overnight investments primarily resulted from a 12.23% growth rate in average deposits, which outpaced a 7.86% growth rate in average loans.

Interest expense increased $11,605,086, or 57.53%, primarily from higher rates on interest-bearing deposits and borrowings and, to a lesser extent, higher volumes of interest-bearing liabilities. Rates on interest-bearing deposits averaged 3.62% for 2006, up from 2.48% for 2005. Interest-bearing deposits averaged $778,372,330 in 2006 compared to $686,123,711 in 2005, an increase of $92,248,619, or 13.44%. NOW deposits averaged $125,594,314 compared to $123,953,354 in 2005, an increase of $1,640,960, or 1.32%. Money market deposits averaged $192,750,942 in 2006 compared to $168,826,355 last year, an increase of $23,924,587, or 14.17%. Time deposits averaged $436,522,539 compared to $367,668,263 for the same periods, an increase of $68,854,276, or 18.73%. The growth in average money market and time deposits resulted from the Bank’s competitive pricing strategies to to fund anticipated loan growth. Overnight and other borrowings averaged $77,973,368 compared to $96,071,846 in 2005, a decrease of $18,098,478, or 18.84%. Overnight borrowings averaged $29,805,688 compared to $39,006,234 in 2005, a decrease of $9,200,546, or 23.59%. Other borrowings averaged $48,167,680 compared to $57,065,612 in 2005, a decrease of $8,897,932, or 15.59%, due to reductions in other borrowings for both the Bank and Granite Mortgage.

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Provision for loan losses increased 23.48% to $6,413,509 in 2006 compared to $5,193,902 in 2005. Charge-offs, net of recoveries, in 2006 were $4,550,279, a decrease of $384,752 from net charge-offs of $4,935,031 in 2005. The continued effects of a prolonged recession in the Company’s Catawba Valley market area were evidenced by the significant increase in continued high levels of the Company’s allowance for loan losses in 2006, as well as nonperforming asset levels and loans with higher risk grades. Nonperforming loans totaled $14,363,155 at the end of 2006 compared with $10,632,029 at the end of 2005. The amount of loans with the three highest risk grades totaled $20,459,772 at December 31, 2006 as compared with $17,543,686 at December 31, 2005. The Bank’s new markets have helped diversify the Bank’s loan base; however, the Catawba Valley economy continues to impact the levels required for loan losses.

For 2006, total noninterest income was $12,507,115, up $595,828, or 5%, from $11,911,287 earned in 2005, primarily because of an increase in cash surrender values on policies owned by the Bank, up $293,594, or 51.60%, from 2005, and a $124,540 increase in fees on deposit accounts, up 2.21%. Mortgage origination fee income was $3,974,980 for 2006, down slightly from 2005. Mortgage loans originated during 2006 and 2005 were $248,041,523 and $265,696,694, respectively. Mortgage fees and origination volumes may not move together or even in the same direction because mortgage fees can vary as a function of origination volumes and/or as a function of differences in the demand for and the supply of mortgage loans in specific markets. Gains on sales of securities were $91,317 for 2006 compared to $68,326 in 2005.

Total noninterest expenses were $32,945,231 during 2006, up $1,129,996, or 3.55%, from $31,815,235 in 2005. The changes in the various overhead categories included costs associated with higher operating expenses of the Bank, slightly offset by lower costs of mortgage origination activities.

Total personnel costs, the largest of the overhead expenses, were $20,646,890 during 2006, up $163,990, or 0.8%, from $20,482,900 in 2005. Profit sharing contributions for 2006 were $1,630,908 for banking operations, compared to $1,471,613 for 2005, an increase of $159,295 or 10.82%. Excluding a one-time charge of $1,265,000 related to a one-time retirement bonus and other benefits granted to the Company’s retiring chairman in 2005, personnel costs would have increased $1,428,990 from 2005 to 2006.

Noninterest expenses other than for personnel increased 8.52% to $12,298,341 during 2006 from the $11,332,335 incurred in 2005. The Bank’s nonpersonnel costs increased $1,029,011, and Granite Mortgage’s nonpersonnel costs decreased $64,666. Occupancy expenses were $2,290,933 in 2006, up $270,637, or 13.40%, from $2,020,296 in 2005. Of the $270,637 increase, $226,161 were related to banking operations and $44,476 were associated with mortgage operations. Equipment costs rose to $2,488,181 during 2006, up $312,869, or 14.38%, from $2,175,312 in 2005, as the Bank continued to invest in technology. Other noninterest expenses were $7,519,227 in 2006, up $382,500, or 5.36%, from $7,136,727 in 2005. A $498,353 increase in costs for banking operations, primarily in marketing expenses, was partially offset by $117,514 in decreased costs for mortgage operations. Income tax expenses were $9,879,899 in 2006, up $2,001,363, or 25.40%, from $7,878,536 in 2005. The effective tax rates were 35.40% and 34.42% for 2006 and 2005, respectively, with the increase in 2006 being primarily attributable to lower relative levels of income from investments in tax-exempt bonds and loans.

2005 COMPARED TO 2004

In 2005, the Company earned $15,009,544, or $0.91 per share, compared to $12,718,220, or $0.76 per share, in 2004. The earnings provided returns on average assets of 1.41% in 2005 compared to 1.28% in 2004 and returns on average equity of 10.70% in 2005 compared to 9.02% in 2004. The earnings increase was primarily attributable to higher income from interest and fees from loans and other fee income, partially offset by higher interest expense on deposits and increased personnel expenses.

The Company’s net interest income increased $5,828,026, or 13.82%, during 2005 compared to 2004. This increase resulted from higher rates on loans and, to a lesser extent, higher volumes of loans, which was partially offset by increased interest expense from high rates on deposits and, to a lesser extent, higher volumes of deposits. The Company’s net interest margin averaged 4.94% for 2005, up from 4.70% for 2004. For a discussion of the Company’s asset-sensitivity and the related effects on the Company’s net interest income and net interest margin, please see “Net Interest Income” and “Liquidity, Interest Rate Sensitivity and Market Risks” below.

18

Interest income for 2005 increased $12,893,185, or 23.34%, from 2004 primarily because of growth in interest income from higher rates on both loans and investments in general, accompanied by an increase in interest income due to higher volumes of commercial loans. Interest and fees on loans increased $12,931,833, or 29.29%, due to higher rates on loans and higher average volumes during the year. Yields on loans averaged 7.41% for 2005, up from 6.36% for 2004. The prime rate averaged 6.19% during 2005 compared to 4.31% during 2004. Gross loans averaged $827,002,929 in 2005 compared to $762,994,754 in 2004, an increase of $64,008,175, or 8.39%. Average loans of the Bank were $797,273,290 compared to $731,856,005 in 2004, an increase of $65,417,285, or 8.94%, while average loans of Granite Mortgage were $29,729,639 compared to $31,138,749 in 2004, a decrease of $1,409,110, or 4.53%. The decline in Granite Mortgage’s average loans resulted from mortgage originations of approximately $265,697,000 in 2005 compared to approximately $280,898,000 in 2004. In general, the levels of mortgage origination and refinancing activities are very sensitive to changes in interest rates in that rising mortgage interest rates generally have the effect of reducing both mortgage originations and refinancings, falling mortgage interest rates generally have the effect of increasing mortgage originations and refinancings, and sustained low mortgage interest rates eventually have the effect of reducing refinancings as the demand for such refinancings becomes satisfied. Interest on securities and overnight investments increased $105,211, or 1.56%. The yield on investment securities and overnight investments declined to 4.76% in 2005 from 5.00% in 2004. Investment security yields declined 26 basis points when comparing 2005 and 2004, primarily due to the replacement of maturing investments with investments at lower interest rates. Average securities and overnight investments were $168,035,814 compared to $161,737,648 in 2004, an increase of $6,298,166, or 3.89%.

Interest expense increased $7,065,159, or 53.90%, primarily from higher rates on interest-bearing deposits and borrowings and higher volumes of interest-bearing liabilities. Rates on interest-bearing deposits averaged 2.48% for 2005, up from 1.73% for 2004. Interest-bearing deposits averaged $686,123,711 in 2005 compared to $617,538,254 in 2004, an increase of $68,585,457, or 11.11%. NOW deposits averaged $123,953,354 compared to $117,153,841 in 2004, an increase of $6,799,513, or 5.80%. Money market deposits averaged $168,826,355 in 2005 compared to $152,453,153 last year, an increase of $16,373,202, or 10.74%. Time deposits averaged $367,668,263 compared to $321,027,297 for the same periods, an increase of $46,640,966, or 14.53%. Overnight and other borrowings averaged $96,071,846 compared to $99,420,084 in 2004, a decrease of $3,348,238, or 3.37%. Overnight borrowings averaged $39,006,234 compared to $35,575,198 in 2004, an increase of $3,431,036, or 9.64%. Other borrowings averaged $57,065,612 compared to $63,844,886 in 2004, a decrease of $6,779,274, or 10.62%, primarily due to a reduction in other borrowings for Granite Mortgage.

Provision for loan losses decreased 4.51% to $5,193,902 in 2005 compared to $5,439,160 in 2004. Charge-offs, net of recoveries, in 2005 were $4,935,031, an increase of $2,361,987 from net charge-offs of $2,573,044 in 2004. The effects of a prolonged recession in the Company’s Catawba Valley market area were evidenced by the significant increase in charge-offs in 2005, as well as continued high levels of the Company’s allowance for loan losses, nonperforming asset levels and loans with higher risk grades. Nonperforming loans totaled $10,632,029 at the end of 2005 compared with $10,861,104 at the end of 2004. The amount of loans with the three highest risk grades totaled $17,543,686 at December 31, 2005 as compared with $14,245,082 at December 31, 2004. Some portions of the Bank’s local Catawba Valley economy, particularly in Catawba and Burke counties, are showing signs of growth, and the new markets should continue to help diversify the Bank’s loan base, but it is difficult to determine if or when the Catawba Valley economy will return to its former strength.

For 2005, total noninterest income was $11,911,287, up $654,564, or 5.81%, from $11,256,723 earned in 2004, primarily because of higher fees on deposit accounts. These fees were $5,630,576 during 2005, up $271,370, or 5.06%, from $5,359,206 in 2004. Mortgage origination fee income was $3,990,690 for 2005, up $146,393, or 3.81%, from $3,844,297 earned in 2004. Mortgage loans originated during 2005 and 2004 were approximately $265,697,000 and $280,898,000, respectively. Mortgage fees and origination volumes may not move together or even in the same direction because mortgage fees can vary as a function of origination volumes and/or as a function of differences in the demand for and the supply of mortgage loans in specific markets. Gains on sales of securities were $68,326 for 2005, an increase of $53,979 from 2004.

Total noninterest expenses were $31,815,235 during 2005, up $2,700,295, or 9.27%, from $29,114,940 in 2004. The changes in the various overhead categories included costs associated with higher operating expenses of the Bank, slightly offset by lower costs of mortgage origination activities.

19

Total personnel costs, the largest of the overhead expenses, were $20,482,900 during 2005, up $2,584,069, or 14.44%, from $17,898,831 in 2004. Of the $2,584,069 increase, $1,265,000 of increased personnel cost of banking operations is attributable to a one-time retirement bonus and other benefits granted by the Board of Directors in December to the Company’s retiring chairman, while nonrecurring personnel charges for 2004 were $490,272. Profit sharing contributions for 2005 were $1,471,613 for banking operations compared to $693,116 for 2004, an increase of $795,106 or 175%. Profit-sharing contributions increased primarily because performance-based payouts were 15% for 2005 compared to 8% for 2004.

Noninterest expenses other than for personnel increased 1.04% to $11,332,335 during 2005 from the $11,216,109 incurred in 2004. Of the $116,226 increase, the Bank’s nonpersonnel costs increased $104,575, while Granite Mortgage’s nonpersonnel costs increased $43,520. Occupancy expenses were $2,020,296 in 2005, up $290,310, or 16.78%, from $1,729,986 in 2004, primarily reflecting the additional costs associated with a full year of occupancy cost in the Bank’s new Winston-Salem market in 2005 compared to less than a full year of such costs in 2004 and higher occupancy cost associated with mortgage operations. Equipment costs rose to $2,175,312 during 2005, up $217,206, or 11.09%, from $1,958,106 in 2004, as both the Bank and Granite Mortgage invested in the technology needed to support expanded market operations. Other noninterest expenses were $7,136,727 in 2005, down $391,290, or 5.20%, from $7,528,017 in 2004. Of the $391,290 decrease in other noninterest expenses, $246,506 in decreased cost related to banking operations, primarily in marketing expenses, and $112,915 in decreased cost related to mortgage operations. Income tax expenses were $7,878,536 in 2005, up $1,736,229, or 28.27%, from $6,142,307 in 2004. The effective tax rates were 34.42% and 32.57% for 2005 and 2004, respectively, with the increase in 2005 being primarily attributable to higher relative levels of income taxable at the statutory tax rates.

NET INTEREST INCOME

Net interest income (the difference between interest earned on interest-earning assets, primarily loans in the Bank, and interest paid on interest-bearing liabilities, primarily deposits in the Bank) represents the most significant portion of the Company’s earnings. It is management’s ongoing policy to maximize net interest income. Net interest income totaled $54,763,553, $47,985,930, and $42,157,904 for 2006, 2005 and 2004 respectively, representing an increase of 14.12% for 2006 over 2005, and an increase of 13.82% for 2005 over 2004. Interest rate spreads have been at least 4.25% over the last three years, and the Company continues efforts to optimize these favorable spreads by managing both loan and deposit rates in order to support the overall earnings growth. The following table presents the daily average balances, interest income and expense and average rates earned and paid on interest-earning assets and interest-bearing liabilities of the Company for the last three years.

20

AVERAGE BALANCES AND INTEREST INCOME ANALYSIS

for the years ended December 31,

	2006							2005							2004
			Average			Interest				Average			Interest				Average			Interest
	Average		Yield/			Income/		Average		Yield/			Income/		Average		Yield/			Income/
dollars in thousands	Balance		Cost			Expense		Balance		Cost			Expense		Balance		Cost			Expense
Assets
Loans (1)	$	886,256		8.81	%	$	78,079	$	827,003		7.41	%	$	61,312	$	762,995		6.36	%	$	48,524
Taxable securities		134,759		4.41	%		5,942		114,306		3.97	%		4,533		104,334		4.06	%		4,232
Nontaxable securities (2)		42,789		6.65	%		2,847		49,060		6.70	%		3,287		56,849		6.77	%		3,851
Federal funds sold		13,285		5.04	%		670		4,671		3.81	%		178		555		1.26	%		7
Total interest-earning assets		1,077,089		8.13	%		87,538		995,040		6.97	%		69,310		924,733		6.12	%		56,614
Cash and due from banks		28,271							27,631							26,103
All other assets		50,114							44,536							42,185
Total assets	$	1,155,474						$	1,067,207						$	993,021
Liabilities and stockholders’ equity
NOW deposits	$	125,594		1.16	%		1,452	$	123,953		0.91	%		1,133	$	117,154		0.82	%		958
Money market deposits		192,751		4.02	%		7,744		168,826		2.54	%		4,289		152,453		1.70	%		2,587
Savings deposits		23,505		0.36	%		85		25,676		0.19	%		50		26,904		0.16	%		42
Time deposits of $100,000 or more		206,782		4.51	%		9,324		174,464		3.29	%		5,741		152,663		2.37	%		3,622
Other time deposits		229,740		4.16	%		9,559		193,204		3.02	%		5,833		168,364		2.08	%		3,503
Interest-bearing deposits		778,372		3.62	%		28,164		686,123		2.48	%		17,047		617,538		1.73	%		10,712
Overnight borrowings		29,806		3.21	%		956		39,006		1.85	%		721		35,575		1.39	%		493
Other borrowings		48,168		5.52	%		2,658		57,066		4.21	%		2,405		63,845		2.98	%		1,903
Total interest-bearing liabilities		856,346		3.71	%		31,778		782,195		2.58	%		20,173		716,958		1.83	%		13,108
Noninterest-bearing deposits		145,530							137,130							128,942
Other liabilities		10,103							7,662							6,098
Stockholders’ equity		143,495							140,220							141,023
Total liabilities and stockholders’ equity	$	1,155,474						$	1,067,207						$	993,021
Net yield on earning assets and net interest income (2)(3)				5.18	%	$	55,760				4.94	%	$	49,137				4.70	%	$	43,506
Interest rate spread (4)				4.42	%						4.39	%						4.29	%

(1)	Non-accrual loans have been included.
(2)	Yields and interest income on tax-exempt investments have been adjusted to tax equivalent basis using 35% for 2006, 2005 and 2004. The taxable equivalent adjustments were $996,291, $1,150,553 and $1,347,763 for 2006, 2005 and 2004, respectively.
(3)	Net yield on earning assets is computed by dividing net interest earned by average earning assets.
(4)	The interest rate spread is the interest earning assets rate less the interest earning liabilities rate.

Changes in interest income and interest expense can result from changes in both volume and rates. The following table sets forth the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest earning assets and interest bearing liabilities and from changes in yields and rates.

INTEREST RATE AND VOLUME VARIANCE ANALYSIS
for the years ended December 31,

	2006 compared to 2005									2005 compared to 2004
	Change									Change
	Attributable to									Attributable to
dollars in thousands	Volume(1)			Rate(1)			Total			Volume(1)			Rate(1)			Total
Loans	$	4,807		$	11,960		$	16,767		$	4,408		$	8,380		$	12,788
Taxable securities		856			553			1,409			400			(99	)		301
Nontaxable securities		(419	)		(21	)		(440	)		(525	)		(39	)		(564	)
Federal funds sold		381			111			492			104			67			171
Interest-earning assets	$	5,625		$	12,603		$	18,228		$	4,387		$	8,309		$	12,696
NOW deposits	$	17		$	302		$	319		$	59		$	116		$	175
Money market deposits		785			2,670			3,455			347			1,355			1,702
Savings deposits		(6	)		41			35			(2	)		10			8
Time deposits of $100,000 or more		1,260			2,323			3,583			617			1,502			2,119
Other time deposits		1,312			2,414			3,726			633			1,697			2,330
Interest-bearing deposits		3,368			7,750			11,118			1,654			4,680			6,334
Overnight borrowings		(233	)		468			235			55			173			228
Other borrowings		(433	)		686			253			(244	)		746			502
Interest-bearing liabilities	$	2,702		$	8,904		$	11,606		$	1,465		$	5,599		$	7,064

(1) The rate/volume variance for each category has been allocated equally on a consistent basis between rate and volume variances.

21

LIQUIDITY, INTEREST RATE SENSITIVITY AND MARKET RISKS

(INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS)

The objectives of the Company’s liquidity management policy include providing adequate funds to meet the cash needs of both depositors and borrowers, as well as providing funds to meet the basic needs for on-going operations of the Company and regulatory requirements. Depositor cash needs, particularly those of commercial depositors, can fluctuate significantly depending on both business and economic cycles, and both retail and commercial deposits can fluctuate significantly based on the yields and returns available from alternative investment opportunities. Borrower cash needs are also often dependent upon business and economic cycles. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. As of December 31, 2006 and 2005, such unfunded commitments to extend credit were $175,874,722 and $158,256,508, respectively, while commitments in the form of standby letters of credit totaled $5,911,050 and $3,273,905, respectively.

The Company has a common stock repurchase plan, which it uses (1) to reduce the number of shares outstanding when its share price in the market makes repurchases advantageous and (2) to manage capital levels. The Company repurchases its shares in the open market, subject to legal requirements and the repurchase rules of The NASDAQ Global Select Market^SM, the stock exchange on which the Company’s common stock is listed, and through unsolicited privately negotiated transactions. The Company’s share repurchases are funded through the payment of dividends to the Company by its subsidiaries, principally the Bank. Because such dividend payments have the effect of reducing the subsidiaries’ capital and liquidity positions, the subsidiaries consider both capital and liquidity levels needed to support current and future business activities when deciding the dividend amounts appropriate to fund share repurchases. The Company plans to continue to repurchase its shares, subject to regulatory requirements and market conditions, for the foreseeable future, while maintaining a well capitalized level. Although shares repurchased are available for reissuance, the Company has not historically reissued, nor does it currently anticipate reissuing, repurchased shares. During 2006, the Company repurchased 168,410 shares of its common stock at an average price of $15.70.

Granite Mortgage arranges for the sale of most of the mortgage loans it originates after the mortgage loan closes, rather than obtaining purchase commitments from mortgage investors at the time the mortgage commitment is made to the mortgage customer. This method allows Granite Mortgage to bundle mortgage loans and obtain better pricing compared with the sale of individual mortgage loans. However, this method also introduces interest rate risk to Granite Mortgage’s loans in process because rates may fluctuate subsequent to Granite Mortgage’s rate commitment to the mortgage customer.

In order to minimize the risk that interest rates may move against Granite Mortgage subsequent to the rate commitment, Granite Mortgage began entering into hedge contracts to “forward sell” mortgage-backed securities at the same time as the rate commitment. When the mortgage loan is ultimately sold, Granite Mortgage then buys the mortgage-backed security, thereby completing the hedge contract. Granite Mortgage classifies all of its hedge contracts in accordance with SFAS No. 133 as a hedge of an exposure to changes in cash flows from forecasted transactions, referred to as a “cash flow” hedge. As of December 31, 2006, Granite Mortgage held $9,030,913 in open mortgage-backed security commitments with an estimated market value of $12,311. For 2006, there were realized losses on hedged mortgage loan commitments of $896,658 and realized losses of $27,926 on commitments to sell mortgage-backed securities. In addition to the improved spreads resulting from more advantageous pricing from bundling mortgage loans for sale, Granite Mortgage also believes that this management method increases production efficiencies.

Through its 2003 acquisition of First Commerce, the Company acquired a statutory business trust, First Commerce Capital Trust I, created by First Commerce in 2001 to facilitate the issuance of a $5,000,000 trust preferred security through a pooled trust preferred securities offering. First Commerce issued this security to increase its regulatory capital. This security bearing a variable interest rate based on the sixty-day LIBOR plus 375 basis points, with maturity in 2031 was called on December 8, 2006 because the Company secured financing at a lower interest rate.

22

Except for the Granite Mortgage hedging strategy, neither the Company nor its subsidiaries have historically incurred off-balance sheet obligations through the use of or investment in off-balance sheet derivative financial instruments or structured finance or special purpose entities organized as corporations, partnerships or limited liability companies or trusts. The Bank and Granite Mortgage both had contractual off-balance sheet obligations in the form of noncancelable operating leases with unrelated vendors. As of December 31, 2006, payments due under such operating lease arrangements are $701,762 in 2007, $753,692 in the years 2008 through 2009, $608,843 in the years 2010 through 2011 and $0 in the years 2012 and thereafter. Further discussions are included under “Off-Balance Sheet Arrangements” below.

Liquidity requirements of the Bank are primarily met through two categories of funding. The first is core deposits, which includes demand deposits, savings accounts and certificates of deposit. The Bank considers these to be a stable portion of the Bank’s liability mix and the result of ongoing consumer and commercial banking relationships. As of December 31, 2006, the Bank’s core deposits, defined as total deposits excluding time deposits of $100,000 or more, totaled $789,431,575, or 79.1%, of the Bank’s total deposits.

The other principal methods of funding used by the Bank are through large denomination certificates of deposit, federal funds purchased, repurchase agreements and other short and intermediate term borrowings. The Bank’s policy is to emphasize core deposit growth rather than growth through purchased or brokered time deposits as the cost of purchased or brokered time deposits is greater. During periods of weak demand for its deposit products, the Bank maintains several credit facilities under which it may borrow on a short-term basis. As of December 31, 2006, the Bank had three unsecured lines of overnight borrowing capacity with its correspondent banks, which totaled $30,000,000. In addition, the Bank uses its capacity to pledge assets to serve as collateral to borrow on a secured basis. As of December 31, 2006, the Bank had investment securities pledged to secure overnight funding lines in the approximate amounts of $9,750,000 with the Federal Reserve Bank. As of December 31, 2006, the Bank had no securities pledged to the Federal Home Loan Bank. The Bank also has pledged its loans secured by first liens on residential and commercial real estate as collateral for additional borrowings from the Federal Home Loan Bank during periods when loan demand exceeds deposit growth or when the interest rates on such borrowings compare favorably to interest rates on deposit products. As of December 31, 2006, the Bank had the capacity to borrow approximately $117,773,000 from the Federal Home Loan Bank against its pledged residential and commercial real estate loans. Overnight borrowings were $31,152,468 as of December 31, 2006, an increase of $3,414,825 from the $27,737,643 in overnight borrowings at December 31, 2005, as the Bank temporarily funded its loan growth with overnight borrowings.

Granite Mortgage temporarily funds its mortgages, from the time of origination until the time of sale, through the use of a one-year warehouse line of credit from one of the Company’s correspondent financial institutions. For the years ended December 31, 2006 and 2005, this line of credit was $40,000,000, of which $18,487,421 and $17,335,942, respectively, were outstanding at year end. Granite Mortgage requests the line of credit based on its estimated funding needs for the year. The line is secured by the mortgage loans originated, and the Company serves as guarantor on this borrowing.

The Company has an unsecured line of credit from one of the Bank’s correspondent banks for general corporate purposes, which matures June 30, 2009. The line is in the amount of $10,000,000 and bears an interest rate of one-month LIBOR plus 120 basis points, with interest payable quarterly. The Company is required to meet certain financial covenants regarding its total stockholders’ equity, its ratio of loan loss reserves to total loans, and its regulatory capital ratios. As of December 31, 2006, the Company owed $5,000,000 under this line of credit and was in compliance with all financial covenants.

The majority of the Company’s deposits are rate-sensitive instruments with rates that tend to fluctuate with market rates. These deposits, coupled with the Company’s short-term certificates of deposit, have increased the opportunities for deposit repricing. The Company places great significance on monitoring and managing the Company’s asset/liability position. The Company’s policy of managing its interest margin (or net yield on interest-earning assets) is to optimize net interest income while maintaining a stable deposit base. Because the Company has historically relied on deposits from its local market areas as its primary source of funding, it has not historically sought out-of-market or brokered time deposits as a funding source, resulting in a deposit base that has not generally been subject to the volatility experienced in national financial markets in recent years. However, the Company realizes the importance of minimizing such funding volatility while at the same time maintaining and improving earnings. A common method used to manage interest rate sensitivity is to measure, over various time periods, the difference or gap between the volume of interest-earning assets and interest-bearing liabilities repricing over a specific time period. However, this method addresses only the magnitude of funding mismatches and does not address the magnitude or relative timing of rate changes. Therefore, management prepares earnings projections based on a range of interest rate scenarios, including rising, flat and declining rates, in order to more accurately measure interest rate risk.

23

Interest-bearing liabilities and the loan portfolio are generally repriced to current market rates. The Company’s balance sheet is asset-sensitive, meaning that in a given period there will be more assets than liabilities subject to immediate repricing as the market rates change. Because most of the Company’s loans are at variable rates, they reprice more rapidly than rate sensitive interest-bearing deposits. During periods of rising rates, this results in increased net interest income. The opposite occurs during periods of declining rates.

INTEREST RATE SENSITIVITY (GAP ANALYSIS)
As of December 31, 2006

													Non-sensitive
	Interest Sensitive Within									Total			or Sensitive
	1 to			91 to			181 to			Within			Beyond
dollars in thousands	90 Days			180 Days			365 Days			1 Year			1 Year		Total
Interest-earning Assets
Interest-bearing due from banks	$	4,715								$	4,715				$	4,715
Federal funds sold		15,700									15,700					15,700
Securities (at amortized cost) (1):
U.S. Treasury											—		$	5,121		5,121
U.S. Government agencies		899					$	7,063			7,962			105,623		113,585
States and political subdivisions		1,515		$	3,953			100			5,568			35,235		40,803
Other (including equity securities)		—			—			—			—			11,576		11,576
Loans (gross):
Real estate — Construction		145,022			249			460			145,731			15,340		161,071
Real estate — Mortgage		392,942			2,759			6,870			402,571			85,776		488,347
Commercial, financial and agricultural		223,544			1,681			2,127			227,352			21,339		248,691
Consumer		3,550			528			1,127			5,205			10,112		15,317
All other		—			—			135			135			607		742
Mortgages held for sale		11,797			—			—			11,797			—		11,797
Total interest-earning assets	$	799,684		$	9,170		$	17,882		$	826,736		$	290,729	$	1,117,465
Interest-bearing Liabilities
Interest-bearing deposits:
Savings and NOW accounts	$	152,889								$	152,889				$	152,889
Money market accounts		216,573									216,573					216,573
Time deposits of $100,000 or more		75,428		$	51,081		$	57,584			184,093		$	24,818		208,911
Other time deposits		79,053			55,882			74,167			209,102			31,726		240,828
Overnight borrowings		31,152									31,152					31,152
Other borrowings		28,546			3,000			2,000			33,546			10,141		43,687
Total interest-bearing liabilities	$	583,641		$	109,963		$	133,751		$	827,355		$	66,685	$	894,040
Interest sensitivity gap	$	216,043		$	(100,793	)	$	(115,869	)	$	(619	)
Cumulative interest sensitivity gap		216,043			115,250			(619	)		(619	)
Interest earning-assets as a percentage of interest-bearing liabilities		137	%		8	%		13	%		100	%

(1) Interest sensitivity periods for debt securities are based on contractual maturities.

24

The Company uses several modeling techniques to measure interest rate risk including the gap analysis previously discussed, the simulation of net interest income under gradual interest rate changes and the theoretical impact of immediate and sustained rate changes referred to as “rate shocks.”

The following table summarizes the estimated theoretical impact on the Company’s tax equivalent net interest income from a gradual interest rate increase and decrease of 3%, prorated over a twelve-month period, and from hypothetical immediate and sustained interest rate increases and decreases of 1%, 2%, 3% and 4%, as compared to the estimated theoretical impact of rates remaining unchanged. The theoretical effects of these hypothetical interest rate changes are based upon numerous assumptions including relative and estimated levels of key interest rates. Although such simulation modeling is useful in estimating interest rate risk inherent in the Company’s asset and liability positions, its use is limited because it does not take into account the asset and liability mix decisions and pricing strategies management would undertake in response to the depicted rate changes.

			Estimated Resulting Theoretical Tax Equivalent Net Interest Income
			For the Twelve-month Periods Following
			December 31, 2006					December 31, 2005
dollars in thousands			Amount		% Change			Amount		% Change
3% interest rate changes prorated over a twelve-month period
	+3	%	$	58,848		5.1	%	$	56,229		5.5	%
	0	%		55,982		0.0	%		53,295		0.0	%
	- 3	%		47,625		-14.9	%		45,337		-14.9	%
Hypothetical immediate and sustained rate changes of 1%, 2%, 3% and 4%
	+4	%	$	58,275		7.0	%	$	58,943		14.0	%
	+3	%		57,348		5.3	%		57,161		10.6	%
	+2	%		56,416		3.5	%		55,371		7.1	%
	+1	%		55,468		1.8	%		53,547		3.6	%
	0	%		54,486		0.0	%		51,703		0.0	%
	- 1	%		50,433		-7.4	%		46,480		-10.1	%
	- 2	%		45,620		-16.3	%		41,187		-20.3	%
	- 3	%		40,998		-24.8	%		36,000		-30.4	%
	- 4	%		36,524		-33.0	%		31,463		-39.1	%

The following table presents the maturity distribution of the Company’s loans by type, including fixed rate loans.

MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES

As of December 31, 2006

	Within		One to		Five
	One		Five		Years or
dollars in thousands	Year		Years		More		Total
Real estate — Construction	$	82,400	$	58,551	$	20,120	$	161,071
Real estate — Mortgage		111,835		236,020		140,492		488,347
Commercial, financial and agricultural		150,115		79,781		18,795		248,691
Consumer		3,998		10,991		328		15,317
All other		742						742
Total	$	349,090	$	385,343	$	179,735	$	914,168
Predetermined rate, maturity greater than one year			$	98,657	$	24,662	$	123,319
Variable rate or maturing within one year	$	349,090		286,686		155,073		790,849
Total	$	349,090	$	385,343	$	179,735	$	914,168

25

The Company’s rate paid on interest-bearing deposits rose to 3.62% in 2006 compared to 2.48% in 2005. The Company’s deposit growth was primarily reflected in transaction deposits, which increased $38,464,096, or 8.09%, from 2005 to 2006. Rate sensitive consumers chose to place funds in transaction deposit accounts because of increased liquidity and lower interest rate differentials to time deposits. Increased customer awareness of interest rates increases the importance of rate management by the Company. The Company’s management continuously monitors market pricing, competitor rates, and internal interest rate spreads in an effort to maintain the Company’s growth and profitability. Deposits continue to be the principal source of funds for continued growth, so the Company attempts to structure its rates so as to promote deposit and asset growth while increasing the overall profitability of the Company. The daily average amounts of deposits of the Bank are summarized below.

AVERAGE DEPOSITS
for the years ended December 31,

dollars in thousands	2006		2005		2004
Non-interest-bearing demand deposits	$	145,530	$	137,130	$	128,942
Interest-bearing demand deposits		318,345		292,779		269,607
Savings deposits		23,505		25,676		26,904
Time deposits		436,522		367,668		321,027
Total	$	923,902	$	823,253	$	746,480

The preceding table includes certificates of deposits $100,000 and over, which at December 31, 2006 totaled approximately $208,911,000. The following table presents the maturities of these time deposits of $100,000 or more.

MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE
As of December 31, 2006

	Within		Three to		Six to		Within		One to
	Three		Six		Twelve		One		Five
dollars in thousands	Months		Months		Months		Year		Years		Total
Time deposits of $100,000 or more	$	75,428	$	51,081	$	57,584	$	184,093	$	24,818	$	208,911

CAPITAL RESOURCES

Funding for the future growth and expansion of the Company is dependent upon earnings of the Company’s subsidiaries. As of December 31, 2006, the Company’s ratio of total capital to risk-adjusted assets was 15.05%. The Company fully expects to be able to meet future capital needs caused by growth and expansion as well as regulatory capital requirements. The Company is not aware of any current recommendation by regulatory authorities which if implemented would materially affect the Company’s liquidity, capital resources or operations. The Company currently plans no significant capital expenditures in 2007.

26

LOANS

Historically, the Company has made loans within its market areas. It makes consumer and commercial loans through the Bank and mortgage loans through Granite Mortgage. The Bank generally considers its primary markets to be Burke, Caldwell, Catawba, Forsyth, Iredell, Mecklenburg, Watauga, and Wilkes counties in North Carolina. Granite Mortgage considers its market area to be the central and southern Piedmont and Catawba Valley regions of North Carolina. Total loans at December 31, 2006 were $912,491,736, which compares with $832,447,148 at December 31, 2005 for an increase of $80,044,588 or 9.62%. The Company places emphasis on consumer based installment loans and commercial loans to small and medium sized businesses. The Company has a diversified loan portfolio with no concentrations to any one borrower. The amounts and types of loans outstanding for the past five years are shown on the following table.

LOANS
As of December 31,

	2006						2005						2004						2003						2002
				% of						% of						% of						% of						% of
				Total						Total						Total						Total						Total
dollars in thousands	Amount			Loans			Amount			Loans			Amount			Loans			Amount			Loans			Amount			Loans
Loans
Real estate -
Construction	$	161,071			17.6	%	$	125,555			15.1	%	$	105,111			13.5	%	$	90,176			12.6	%	$	75,383			14.1	%
Mortgage		488,347			53.4	%		455,322			54.6	%		420,860			54.0	%		377,956			52.7	%		245,496			46.0	%
Commercial, financial and agricultural		248,691			27.2	%		231,229			27.7	%		223,605			28.7	%		211,477			29.5	%		175,409			32.9	%
Consumer		15,317			1.7	%		20,911			2.5	%		29,015			3.7	%		35,981			5.0	%		37,046			6.9	%
All other		742			0.1	%		915			0.1	%		704			0.1	%		1,206			0.2	%		449			0.1	%
Total loans		914,168			100.0	%		833,932			100.0	%		779,295			100.0	%		716,796			100.0	%		533,783			100.0	%
Deferred origination fees, net		(1,677	)					(1,485	)					(1,158	)					(951	)					(860	)
Total loans, net of deferred fees	$	912,491					$	832,447					$	778,137					$	715,845					$	532,923

Real estate loans comprised 71.0% of the portfolio in 2006 compared to 69.7% in 2005. Commercial loans comprised 27.2% of the portfolio in 2006 compared to 27.7% in 2005, and consumer loans comprised 1.7% in 2006 compared to 2.5% in 2005. Real estate construction loans of $161,071,478 are loans for which the principal source of repayment comes from the sale of real estate or from obtaining permanent financing. Commercial loans of $248,690,527, consumer loans of $15,316,637 and real estate mortgage loans of $488,347,172 are loans for which the principal source of repayment is derived from the ongoing cash flow of the business or the borrower.

NONPERFORMING LOANS AND NONPERFORMING ASSETS
As of December 31,

dollars in thousands	2006			2005			2004			2003			2002
Nonperforming assets
Nonaccrual loans	$	9,289		$	6,424		$	6,634		$	8,115		$	3,265
Loans past due 90 days or more and still accruing interest		5,074			4,208			4,227			3,218			1,153
Foreclosed properties		1,162			926			1,280			1,775			1,203
Total	$	15,525		$	11,558		$	12,141		$	13,108		$	5,621
Nonperforming loans to total loans		1.57	%		1.28	%		1.40	%		1.58	%		0.83	%
Allowance for loan losses to nonperforming loans		109.91	%		130.96	%		125.82	%		95.29	%		199.98	%
Nonperforming loans to total assets		1.20	%		0.96	%		1.05	%		1.17	%		0.60	%
Nonperforming assets to total assets		1.29	%		1.04	%		1.18	%		1.35	%		0.76	%

27

Certain loans are classified as nonaccrual, meaning that interest is not being accrued on these instruments. Accrual of interest on loans is discontinued when management believes that such interest will not be collected in a reasonable period of time. The recorded accrued interest is also reversed or charged off. A loan classified as nonaccrual is returned to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The significant increase in nonperforming assets as of December 31, 2006 continues to reflect the weakened economy in the Company’s Catawba Valley markets.

The Company’s investment in impaired loans for the past five years ended December 31 was as follows:

IMPAIRED LOANS
As of December 31,

dollars in thousands	2006		2005		2004		2003		2002
Investment in impaired loans:
Impaired loans still accruing interest	$	5,747	$	4,297	$	5,237	$	3,114	$	1,890
Accrued interest on accruing impaired loans		423		129		116		90		56
Impaired loans not accruing interest		9,289		6,424		6,634		8,115		3,265
Accrued interest on nonaccruing impaired loans		57		197		151		215		127
Total investment in impaired loans	$	15,516	$	11,047	$	12,138	$	11,534	$	5,338
Loan loss allowance related to impaired loans	$	3,926	$	3,249	$	4,325	$	2,412	$	2,196

Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical matter, at the loan’s observable market value or fair value of the collateral if the loan is collateral dependent. Most of the loans measured by fair value of the underlying collateral are commercial loans, while others consist of small balance homogenous loans and are measured collectively. The Bank classifies a loan as impaired when, based on current information and events, management believes it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. At December 31, 2006 and 2005, the recorded investment in loans that were considered to be impaired, including accrued interest, was $15,515,924 ($9,345,888 of which was on a nonaccrual basis) and $11,046,163 ($6,620,701 of which was on a nonaccrual basis), respectively. The average recorded balance of impaired loans during 2006 and 2005 was not significantly different from the balance at December 31, 2006 and 2005. The related allowance for loan losses for these loans was $3,926,439 and $3,248,549 at December 31, 2006 and 2005, respectively. The allowance for impaired loans increased $677,890, or 20.86%, while the total balance of impaired loans increased $4,469,761, or 40.46%. Of the $4,469,761 increase in impaired loans, $3,285,497 relates to two loan customers. The loan loss allowance related to impaired loans was 25.31% as of December 31, 2006 compared to 29.41% as of December 31, 2005. For the years ended December 31, 2006, 2005 and 2004 , the Bank recognized interest income on those impaired loans of approximately $480,082, $325,266 and $266,829, respectively.

For the years ended December 31, 2006 and 2005, the estimated gross interest income that would have been recorded had the nonaccruing loans been current in accordance with their original terms was approximately $1,002,915 and $425,170, respectively, while the interest recognized on such loans was $219,570 and $12,484, respectively.

28

PROVISIONS AND ALLOWANCES FOR LOAN LOSSES

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

Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectibility becomes doubtful. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of seven risk grades, each grade indicating a different level of loss reserves. The loan officer monitors the loan’s performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third party risk assessment group (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan as well as the level of reserves deemed appropriate for the loan. Furthermore, loans and commitments of $500,000 or more made during the month, as well as commercial loans past due 30 days or more, are reviewed monthly by the Bank’s Board of Directors. The Bank’s Board of Directors also reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

As an additional measure, the Bank engages an independent third party risk assessment group to review the underwriting, documentation, risk grading analyses and the methodology of determining the adequacy of the allowance for losses. This independent third party determines its own selection criteria to select loan relationships for review and evaluation. The third party’s evaluation and report is shared with management, the Bank’s Audit Committee and ultimately, the Bank’s Board of Directors.

Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. In estimating reserve levels, the Bank also aggregates non-graded loans into pools of similar credits and reviews the historical loss experience associated with these pools as additional criteria to allocate the allowance to each category.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in determining the appropriate levels of the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. Generally, all loans with outstanding balances of $10,000 or greater that have been identified as impaired are reviewed on a monthly basis in order to determine whether a specific allowance is required. After a loan has been identified as impaired, management measures impairment in accordance with SFAS No. 114, “Accounting By Creditors for Impairment of a Loan.” When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Company’s loss exposure for each credit, given the payment status, financial condition of the borrower, and value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

29

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. Commercial loans are assigned a loan grade and the loss percentages assigned for each loan grade are determined based on periodic evaluation of actual loss experience over a period of time and management’s estimate of probable incurred losses as well as other factors that are known at the time when the appropriate level for the allowance for loan losses is assessed, including the average term of the portfolio. The allowance for loan losses for consumer loans, mortgage loans, and leases is determined based on past due levels and historical and projected loss rates relative to each portfolio.

The unallocated allowance is determined through management’s 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 management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Company’s loan portfolio as of the date of the financial statements. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States of America and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company. There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2006 as compared to the year ended December 31, 2005. Such revisions, estimates and assumptions are made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowances for loan losses. Such agencies may require adjustments to the allowances based on their judgments of information available to them at the time of their examinations.

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 management to be uncollectible. Recoveries during the period are credited to the allowance for loan losses.

General economic trends greatly affect loan losses, and no assurances can be made that further charges to the loan loss allowance will not be significant in relation to the amount provided during a particular period or that further evaluation of the loan portfolio based on conditions then prevailing may not require sizable additions to the allowance, thus necessitating similarly sizable charges to operations. Due to continued high levels of nonperforming loans resulting from the still recovering local economy in the Catawba Valley, management believed it prudent to charge operations in the amounts of $6,413,509 in 2006 compared to $5,193,902 in 2005 and $5,439,160 in 2004 to provide for future losses related to uncollectible loans. At December 31, 2006, the loan loss reserve was 1.76% of net loans outstanding compared to 1.70% as of December 31, 2005. Approximately $961,000 of the provision for loan losses was attributable to loan growth, while $5,453,000 was attributable to declining credit quality.

30

The following table presents an analysis of changes in the allowance for loan losses for years indicated.

CHANGES IN THE ALLOWANCE FOR LOAN LOSSES
for the years ended December 31,

dollars in thousands	2006			2005			2004			2003			2002
Balance at beginning of year	$	13,924		$	13,665		$	10,799		$	8,835		$	6,426
Loans charged off:
Real estate		1,708			919			930			1,616			329
Commercial, financial and agricultural		2,808			3,484			1,040			2,275			538
Credit cards and related plans		26			45			88			41			57
Installment loans to individuals		410			540			683			767			260
Demand deposit overdraft program		251			262			297			389			371
Total charge-offs		5,203			5,250			3,038			5,088			1,555
Recoveries of loans previously charged off:
Real estate		84			63			24			3			78
Commercial, financial and agricultural		282			29			70			176			168
Credit cards and related plans		10			3			4			5			2
Installment loans to individuals		138			42			220			71			59
Demand deposit overdraft program		138			178			147			170			165
Total recoveries		652			315			465			425			472
Net charge-offs		4,551			4,935			2,573			4,663			1,083
Provision for loan losses		6,414			5,194			5,439			4,764			3,492
Allowance of loans acquired in purchase transaction		—			—			—			1,863			—
Balance at end of year	$	15,787		$	13,924		$	13,665		$	10,799		$	8,835
Ratio of net charge-offs during the year to average loans outstanding during the year		0.52	%		0.61	%		0.35	%		0.75	%		0.21	%
Allowance coverage of net charge-offs		346.95	%		282.14	%		531.08	%		231.62	%		814.81	%
Allowance as a percentage of gross loans		1.73	%		1.67	%		1.76	%		1.51	%		1.66	%
Allowance as a percentage of net loans		1.76	%		1.70	%		1.79	%		1.53	%		1.69	%

The allowance for loan losses acquired in the purchase transaction represents general loan loss reserves. Any specific reserves were evaluated and recorded in the fair value adjustment for the applicable loan.

The following table presents the allocation of the allowance for loan losses by category.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
As of December 31,

	2006					2005					2004					2003					2002
			% of					% of					% of					% of					% of
			Total					Total					Total					Total					Total
dollars in thousands	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
Real estate	$	5,091		71.0	%	$	4,448		69.7	%	$	5,782		67.5	%	$	4,602		65.3	%	$	3,564		60.1	%
Commercial, financial, and agricultural		9,891		27.2	%		8,401		27.7	%		6,759		28.7	%		5,226		29.5	%		4,410		32.9	%
Consumer		443		1.7	%		577		2.5	%		617		3.7	%		684		5.0	%		649		6.9	%
All other loans		—		0.1	%		—		0.1	%		—		0.1	%		—		0.2	%		—		0.1	%
Unallocated		362		n/a			498		n/a			507		n/a			287		n/a			212		n/a
Total loans	$	15,787		100.0	%	$	13,924		100.0	%	$	13,665		100.0	%	$	10,799		100.0	%	$	8,835		100.0	%

The allowance for loan losses was 1.73%, 1.67% and 1.76% of loans outstanding at December 31, 2006, 2005 and 2004, respectively, which was consistent with management’s assessment of the credit quality of the loan portfolio. The ratios of net charge-offs during the year to average loans outstanding during the period were 0.52%, 0.61% and 0.35% at December 31, 2006, 2005 and 2004, respectively. Management believes these ratios reflect management’s conservative lending and effective efforts to recover credit losses.

Charge-offs totaled $5,202,579 in 2006, compared to $5,250,436 in 2005, a decrease of $47,857, or 0.91%. Charge-offs related to commercial loans were $2,807,522 in 2006, including $1,496,228 for three unrelated commercial loan customers, compared to charge-offs for commercial loans of $3,484,172 in 2005. The effects of a slow economic recovery in the Company’s Catawba Valley market area continued to be evidenced by increases in the Company’s charge-offs as presented above, and the increase in loans with higher risk grades. The amount of loans with the three highest risk grades totaled $20,459,772 at December 31, 2006 as compared with $17,543,686 at December 31, 2005 and $14,245,082 at December 31, 2004.

31

INVESTMENT SECURITIES

The Company invests in securities as permitted under bank regulations. These securities include all obligations of the U.S. Treasury, agencies of the U.S. government, including mortgage-backed securities and certain derivatives, bank eligible obligations of any state or political subdivision, bank eligible corporate obligations, including commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities.

The Company’s investment activities are governed internally by a written, board-approved policy. Investment policy is carried out by the Company’s Asset/Liability Committee (“ALCO”), which meets regularly to review the economic environment, assess current activities for appropriateness and establish investment strategies.

Investment strategies are established by the ALCO in consideration of the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of the Company. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits as prescribed by law and other borrowings; and (iii) to earn the maximum return on funds invested that is commensurate with meeting the requirements of (i) and (ii).

At December 31, 2006, the securities classified as available for sale, carried at market value, totaled $134,312,576, with an amortized cost of $135,831,343, compared to a December 31, 2005 total market value of $112,319,269 with an amortized cost of $114,054,772. Securities available for sale are securities that will be held for an indefinite period of time, including securities that management intends to use as a part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or the need to increase regulatory capital or other similar factors. Securities available for sale consist of securities of U.S. Treasury with an average life of 1.9 years, US Government agencies with an average life of 2.8 years, State and political subdivisions with an average life of 10.3 years and other bonds, notes and debentures with an average life of 21.6 years. There have been no transfers or sales of securities classified as held to maturity. Securities classified as held to maturity totaled $35,253,592, with a market value of $36,019,901 at December 31, 2006. Management determined that it has both the ability and intent to hold those securities classified as investment securities until maturity. Securities held to maturity consist of municipal bonds with an average life of 3.5 years. During 2006, $21,971,118 in securities matured and $759,413 in proceeds were collected from securities sold. The proceeds from maturities were reinvested along with funds in excess of loan demand.

CONTRACTUAL MATURITIES AND YIELDS OF DEBT SECURITIES

As of December 31, 2006

						After One Year but					After Five Years but
	Within One Year					Within Five Years					Within Ten Years					After Ten Years
dollars in thousands	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Available for sale: (1)
U.S. Treasury						$	5,121		3.33	%
U.S. government agency	$	7,962		3.28	%		103,624		4.39	%	$	1,999		5.13	%
State and political subdivisions (2)							718		4.91	%		2,014		5.34	%	$	2,817		5.93	%
Other																	3,546		7.43	%
Total	$	7,962		3.28	%	$	109,463		4.34	%	$	4,013		5.24	%	$	6,363		6.77	%
Held to maturity:
State and political subdivisions (2)	$	5,568		6.59	%	$	22,204		6.55	%	$	4,973		7.00	%	$	2,509		7.40	%
Total	$	5,568		6.59	%	$	22,204		6.55	%	$	4,973		7.00	%	$	2,509		7.40	%

(1)	Securities available for sale are stated at amortized cost.
(2)	Yields on tax-exempt investments have been adjusted to tax equivalent basis using 35% for 2006.

32

The following table provided information regarding the composition of the Company’s investment securities portfolio at the end of each of the past three years.

COMPOSITION OF INVESTMENT SECURITIES PORTFOLIO

As of December 31,

dollars in thousands	2006		2005		2004
Available for sale (at estimated fair value):
U.S. Treasury	$	4,994	$	5,048	$	5,238
U.S. government agency		111,740		89,815		77,410
State and political subdivisions		5,533		5,527		5,606
Other		12,046		11,928		19,104
Total	$	134,313	$	112,318	$	107,358
Held to maturity (at amortized cost):
U.S. government agency	$	—	$	—	$	2,700
State and political subdivisions		35,254		41,363		48,502
Total	$	35,254	$	41,363	$	51,202

CONTRACTUAL OBLIGATIONS

The Company’s contractual obligations and other commitments are summarized in the table below. Other commitments include commitments to extend credit. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below.

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
As of December 31, 2006

	Within		One to		Three to		Five
	One		Three		Five		Years or
dollars in thousands	Year		Years		Years		More		Total
Contractual Cash Obligations
Overnight borrowings	$	49,640	$	—	$	—	$	—	$	49,640
Short-term borrowings		8,000		—		—		—		8,000
Long-term borrowings		—		7,059		3,141		7,000		17,200
Capitalized lease obligations		55		—		—		1,199		1,254
Operating lease obligations		702		754		609		—		2,065
Purchase obligations		522		—		—		—		522
Total	$	58,919	$	7,813	$	3,750	$	8,199	$	78,681
Other Commitments
Commitments to extend credit	$	92,578	$	25,468	$	4,651	$	53,178	$	175,875
Standby letters of credit		5,559		341		—		—		5,900
Total	$	98,137	$	25,809	$	4,651	$	53,178	$	181,775

OFF-BALANCE SHEET ARRANGEMENTS

The Company enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December 31, 2006 do not represent the amounts that may ultimately be paid under these contracts. In addition, the Company has off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. As of December 31, 2006 and 2005, such unfunded commitments to extend credit were $175,874,722 and $158,256,508, respectively, while commitments in the form of standby letters of credit totaled $5,911,050 and $3,273,905, respectively. Further discussions of derivative instruments are included under “Liquidity, Interest Rate Sensitivity and Market Risks” above and under Note 1, “Summary of Significant Accounting Policies,” Note 18, “Commitments and Contingencies,” Note 19, “Fair Value of Financial Instruments” and Note 20, “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements.”

RELATED PARTY TRANSACTIONS

The Company has no material related party transactions. The Company may extend credit to certain directors and officers in the ordinary course of business. These extensions of credit are made under substantially the same terms as comparable third-party lending arrangements and are made in compliance with applicable banking regulations and federal securities laws.

33

SEGMENT RESULTS

The Company’s operations are divided into three reportable business segments: Community Banking, Mortgage Banking, and Other. These operating segments have been identified based primarily on the Company’s existing organizational structure. See Note 21, “Operating Segments”, in the “Notes to Consolidated Financial Statements” herein, for a full discussion of the segments, the internal accounting and reporting practices utilized by the Company to manage these segments and financial disclosures by segment as required by SFAS No. 131. Fluctuations in noninterest income and expense earned and incurred related to external customers are more fully discussed in the “Noninterest Income” and “Noninterest Expense” sections of this discussion and analysis.

Community Banking

The Community Banking segment was comprised of 22 banking offices at the end of 2006, up from 21 banking offices at December 31, 2005. Net interest income from Community Banking activities totaled $52,561,122 in 2006, an increase of $7,404,868, or 16.40%, compared to 2005. Net interest income in 2005 increased $6,401,511, or 16.52%, compared to 2004.

The 2006 provision for loan losses increased $1,207,607 or 23.41%, from 2005. The 2005 provision decreased $273,258, or 5.03%, from 2004. The 2006 increase reflected the increase in levels of loans during 2006 with the three highest risk grades.

Noninterest income produced from Community Banking customers increased $641,304, or 8.25% in 2006 from the noninterest income produced in 2005. Comparing 2005 to 2004, noninterest income increased $359,521, or 4.85%. Noninterest expenses related to Community Banking activities increased $1,227,943, or 4.95% in 2006, primarily in employee benefits costs. Comparing 2005 to 2004, noninterest expense increased $2,745,541, or 12.45%, due in part, to a $1,265,000 increase in personnel costs for a one-time retirement bonus and other benefits granted by the Board of Directors to the retiring chairman.

The provision for income taxes allocated to the Community Banking segment increased $1,948,478, or 25.42%, because of a 24.43% increase in pretax income and higher effective tax rates. Effective tax rates increased to 33.64% in 2006 from 33.37% in 2005. The 2005 provision for income taxes increased $1,878,597, or 32.47%, compared to 2004 because of an increase in pretax income and a higher effective tax rate.

The Community Banking segment’s net income totaled $18,966,205 for 2006, an increase of $3,662,144 , or 23.93%, compared to 2005.

Total identifiable assets for Community Banking increased $91,618,663, or 8.53%, to a total of $1,166,170,945, compared to 2005.

Mortgage Banking

The Mortgage Banking segment’s mortgage originations totaled $248,041,523 in 2006, down $17,655,171, or 6.64%, from originations of $265,696,694 in 2005, primarily due to higher mortgage interest rates.

Net interest income for the Mortgage Banking segment totaled $3,225,374 in 2006, up $39,179, or 1.23%, compared to 2005. The 2005 amount reflected a decrease of 13.27% when compared to net interest income in 2004.

The continued strong credit quality of the mortgage portfolio has resulted in the Mortgage Banking segment’s provision for loan losses being relatively stable during the years ended December 31, 2006, 2005, and 2004.

Noninterest income in 2006 decreased $15,710, or 0.39%, compared to 2005. Noninterest income in 2005 increased $146,393, or 3.81%, from 2004. Noninterest expenses incurred in 2006 within the Mortgage Banking segment decreased $120,624, or 1.83%, compared to 2005, as a result of lower costs associated with lower origination activity. Comparing 2005 and 2004, noninterest expenses decreased $13,377, or 0.20%.

The 2006 provision for income taxes allocated to the Mortgage Banking segment increased $52,885, or 24.69%, due to higher pretax income. For 2005, the provision for income taxes decreased $142,365, or 39.92%, compared to 2004.

The Mortgage Banking segment’s net income totaled $400,671 in 2006, an increase of $79,208, or 24.64%, compared to 2005.

34

Other

The Company’s Other segment represents primarily treasury and administration activities. Included in this segment are certain investments, commercial paper issued to the Bank’s commercial sweep account customers, debt, and stockholder communications, reporting, and record keeping.

NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements and is effective for annual periods ending after November 15, 2006. The Company adopted the provisions of SAB No. 108 effective December 31, 2006. The adoption of SAB No. 108 and the resulting impact on its consolidated financial statements is disclosed in Note 16.

FORWARD LOOKING STATEMENTS

The discussions presented in this annual report contain statements that could be deemed forward looking statements within the meaning of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, which statements are inherently subject to risks and uncertainties. Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as “expects,” “anticipates,” “believes,” “estimates,” “plans,” “projects,” or other statements concerning opinions or judgments of the Company and its management about future events. Factors that could influence the accuracy of such forward looking statements include, but are not limited to, the financial success or changing strategies of the Company’s customers or vendors, the Company’s level of success in integrating acquisitions, the Company’s success operating in new markets that it enters, actions of government regulators, the level of market interest rates, and general economic conditions.

ITEM 7A — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information responsive to this item is contained in Item 7 above under the caption “Liquidity, Interest Rate Sensitivity and Market Risks.”

35

ITEM 8 — FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements and Supplementary Financial Data

	Begins on
	Page
Report Of Independent Registered Public Accounting Firm		37 & 38
Financial Statements:
Consolidated Balance Sheets December 31, 2006 and 2005		39
Consolidated Statements Of Income Years Ended December 31, 2006, 2005 and 2004		40
Consolidated Statements Of Comprehensive Income Years Ended December 31, 2006, 2005 and 2004		41
Consolidated Statements Of Changes In Stockholders’ Equity Years Ended December 31, 2006, 2005 and 2004		42
Consolidated Statements Of Cash Flows Years Ended December 31, 2006, 2005 and 2004		43
Notes To Consolidated Financial Statements Years Ended December 31, 2006, 2005 and 2004		45
Supplementary Financial Data:
Selected Quarterly Financial Data (Unaudited) Years Ended December 31, 2006 and 2005		70

36

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Bank of Granite Corporation
Granite Falls, North Carolina

We have audited the accompanying consolidated balance sheet of Bank of Granite Corporation and subsidiaries (the “Company”) as of December 31, 2006 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year then ended. 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. The consolidated financial statements of Bank of Granite Corporation and subsidiaries as of December 31, 2005 and for the two years then ended, before the effects of the adjustments to retrospectively reflect the 2006 5-for-4 stock split effected in the form of a stock dividend as disclosed in Notes 1 and 8 to the consolidated financial statements, were audited by other auditors whose report dated March 2, 2006 expressed an unqualified opinion on those statements.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides 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 Bank of Granite Corporation and subsidiaries as of December 31, 2006, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

We also have audited the adjustments to the 2005 and 2004 consolidated financial statements to retrospectively reflect the 2006 5-for-4 stock split effected in the form of a stock dividend as disclosed in Notes 1 and 8 to the consolidated financial statements. In our opinion, such retrospective adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review or apply any procedures to the 2005 and 2004 consolidated financial statements of the Company other than with respect to the retrospective adjustments and, accordingly, we do not express any opinion or any other form of assurance on the 2005 and 2004 consolidated financial statements taken as a whole.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Bank of Granite Corporation’s internal control over financial reporting as of December 31, 2006, based on the criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 9, 2007 expressed unqualified opinions on both management’s assessment of the Company’s internal control over financial reporting and the effectiveness of the Company’s internal control over financial reporting.

/s/ Dixon Hughes PLLC
DIXON HUGHES PLLC
Charlotte, North Carolina
March 9, 2007

37

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Bank of Granite Corporation
Granite Falls, North Carolina

We have audited, before the effects of the adjustments to retrospectively reflect the 2006 5-for-4 stock split effected in the form of a stock dividend as discussed in Note 1 to the consolidated financial statements, the accompanying consolidated balance sheet of Bank of Granite Corporation and its subsidiaries (the “Company”) as of December 31, 2005, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years ended December 31, 2005 and 2004 (the 2005 and 2004 consolidated financial statements before the effects of the adjustments discussed in Note 1 to the consolidated financial statements are not presented herein). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, such consolidated financial statements, before the effects of the adjustments to retrospectively reflect the 2006 5-for-4 stock split effected in the form of a stock dividend as discussed in Note 1 to the consolidated financial statements, present fairly, in all material respects, the financial position of the Company as of December 31, 2005, and the results of its operations and its cash flows for the years ended December 31, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America.

We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively reflect the 2006 5-for-4 stock split effected in the form of a stock dividend as discussed in Note 1 to the consolidated financial statements and, accordingly, we do not express an opinion or any other form of assurance about whether such retrospective adjustments are appropriate and have been properly applied. Those retrospective adjustments were audited by other auditors.

/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Charlotte, North Carolina
March 2, 2006

38

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005

	2006			2005
ASSETS:
Cash and cash equivalents
Cash and due from banks	$	29,566,519		$	34,976,107
Interest-bearing deposits		4,714,736			3,905,812
Federal funds sold		15,700,000			18,600,000
Total cash and cash equivalents		49,981,255			57,481,919
Investment securities
Available for sale, at fair value (amortized cost of $135,831,343 and $114,054,772 at December 31, 2006 and 2005, respectively)		134,312,576			112,319,269
Held to maturity, at amortized cost (fair value of $36,019,901 and $42,513,168 at December 31, 2006 and 2005, respectively)		35,253,592			41,363,437
Loans		912,491,736			832,447,148
Allowance for loan losses		(15,787,114	)		(13,923,884	)
Net loans		896,704,622			818,523,264
Mortgage loans held for sale		11,796,899			14,219,444
Premises and equipment, net		13,426,075			14,805,876
Accrued interest receivable		8,620,893			7,387,075
Investment in bank owned life insurance		26,925,411			19,692,889
Intangible assets		11,044,083			11,129,997
Other assets		11,707,067			9,800,852
Total assets	$	1,199,772,473		$	1,106,724,022
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Deposits
Demand	$	144,635,530		$	147,576,746
NOW accounts		130,971,241			129,281,747
Money market accounts		216,573,314			174,866,304
Savings		21,917,407			23,908,599
Time deposits of $100,000 or more		208,911,053			192,568,963
Other time deposits		240,828,147			210,909,066
Total deposits		963,836,692			879,111,425
Overnight borrowings		31,152,468			27,737,643
Other borrowings		43,687,183			49,675,003
Accrued interest payable		3,326,943			2,500,743
Other liabilities		11,335,683			7,851,217
Total liabilities		1,053,338,969			966,876,031
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Common stock, $1.00 par value, authorized — 25,000,000 shares; issued — 18,921,611 shares in 2006 and 15,096,699 shares in 2005; outstanding — 16,022,230 shares in 2006 and 12,911,922 shares in 2005		18,921,611			15,096,699
Additional paid-in capital		29,524,350			32,678,939
Retained earnings		141,661,875			133,209,287
Accumulated other comprehensive loss, net of deferred income taxes of $645,633 and $715,866 at December 31, 2006 and 2005, respectively		(973,249	)		(1,079,261	)
Less: Cost of common stock in treasury; 2,899,381 shares in 2006 and 2,184,777 shares in 2005		(42,701,083	)		(40,057,673	)
Total stockholders’ equity		146,433,504			139,847,991
Total liabilities and stockholders’ equity	$	1,199,772,473		$	1,106,724,022

See notes to consolidated financial statements.

39

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

	2006		2005		2004
INTEREST INCOME:
Interest and fees from loans	$	73,682,108	$	57,083,639	$	44,151,806
Interest and fees from mortgage banking		4,397,380		4,228,323		4,372,182
Federal funds sold		669,618		177,568		6,747
Interest-bearing deposits		755,164		232,056		71,861
Investments:
U.S. Treasury		173,018		173,018		173,011
U.S. Government agencies		4,308,680		3,445,771		3,155,472
States and political subdivisions		1,850,254		2,136,742		2,502,988
Other		705,561		681,957		831,822
Total interest income		86,541,783		68,159,074		55,265,889
INTEREST EXPENSE:
Time deposits of $100,000 or more		9,324,454		5,740,572		3,622,035
Other time and savings deposits		18,839,489		11,306,523		7,090,697
Overnight borrowings		956,161		721,441		492,728
Other borrowed funds		2,658,126		2,404,608		1,902,525
Total interest expense		31,778,230		20,173,144		13,107,985
NET INTEREST INCOME		54,763,553		47,985,930		42,157,904
PROVISION FOR LOAN LOSSES		6,413,509		5,193,902		5,439,160
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		48,350,044		42,792,028		36,718,744
OTHER INCOME:
Service charges on deposit accounts		5,755,116		5,630,576		5,359,206
Other service charges, fees and commissions		862,704		775,284		797,961
Mortgage banking income		3,974,980		3,990,690		3,844,297
Securities gains		91,317		68,326		14,347
Other		1,822,998		1,446,411		1,240,912
Total other income		12,507,115		11,911,287		11,256,723
OTHER EXPENSES:
Salaries and wages		16,170,194		16,544,474		14,668,944
Employee benefits		4,476,696		3,938,426		3,229,887
Occupancy expense, net		2,290,933		2,020,296		1,729,986
Equipment rentals, depreciation and maintenance		2,488,181		2,175,312		1,958,106
Other		7,519,227		7,136,727		7,528,017
Total other expenses		32,945,231		31,815,235		29,114,940
INCOME BEFORE INCOME TAXES		27,911,928		22,888,080		18,860,527
INCOME TAXES		9,879,899		7,878,536		6,142,307
NET INCOME	$	18,032,029	$	15,009,544	$	12,718,220
PER SHARE AMOUNTS
Net income — Basic	$	1.12	$	0.91	$	0.75
— Diluted		1.12		0.91		0.75
Dividends		0.48		0.42		0.39
Book value		9.27		8.66		8.47

See notes to consolidated financial statements.

40

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

	2006			2005			2004
NET INCOME	$	18,032,029		$	15,009,544		$	12,718,220
ITEMS OF OTHER COMPREHENSIVE INCOME:
Items of other comprehensive income, before tax:
Unrealized gains (losses) on securities available for sale		125,419			(2,178,684	)		(878,316	)
Reclassification adjustment for gains included in net income		91,317			(60,489	)		—
Unrealized gains (losses) on mortgage derivative instruments		(40,492	)		36,587			7,529
Other comprehensive income (loss), before tax		176,244			(2,202,586	)		(870,787	)
Change in deferred income taxes related to change in unrealized gains or losses on securities available for sale		(86,429	)		892,884			350,230
Changes in deferred income taxes related to change in unrealized gains or losses on mortgage derivative instruments		16,197			(14,635	)		(3,012	)
Items of other comprehensive income (loss), net of tax		106,012			(1,324,337	)		(523,569	)
COMPREHENSIVE INCOME	$	18,138,041		$	13,685,207		$	12,194,651

See notes to consolidated financial statements.

41

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

	2006			2005			2004
COMMON STOCK, $1.00 par value
At beginning of year	$	15,096,699		$	15,079,133		$	14,993,493
Par value of shares issued under stock option plan		41,321			17,566			85,640
Transfer from surplus due to stock splits		3,783,591			—			—
At end of year		18,921,611			15,096,699			15,079,133
ADDITIONAL PAID-IN CAPITAL
At beginning of year		32,678,939			32,478,404			31,497,057
Surplus of shares issued under stock option plan		573,878			146,830			848,108
Tax benefit from nonqualifying dispositions of stock options		34,108			53,705			133,239
Stock-based compensation expense		21,016			—			—
Transfer to common stock due to stock splits		(3,783,591	)		—			—
At end of year		29,524,350			32,678,939			32,478,404
RETAINED EARNINGS
At beginning of year		133,209,287			125,178,824			119,081,744
Cumulative effect of adoption of SAB 108		(1,807,501	)		—			—
Net income		18,032,029			15,009,544			12,718,220
Dividends		(7,760,725	)		(6,979,081	)		(6,621,140	)
Cash paid for fractional shares		(11,215	)		—			—
At end of year		141,661,875			133,209,287			125,178,824
ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF DEFERRED INCOME TAXES
At beginning of year		(1,079,261	)		245,076			768,645
Net change in unrealized gains or losses on securities available for sale, net of deferred income taxes		130,307			(1,346,289	)		(528,086	)
Net change in unrealized gains or losses on mortgage derivative instruments, net of deferred income taxes		(24,295	)		21,952			4,517
At end of year		(973,249	)		(1,079,261	)		245,076
COST OF COMMON STOCK IN TREASURY
At beginning of year		(40,057,673	)		(31,965,216	)		(24,525,840	)
Cost of common stock repurchased		(2,643,410	)		(8,092,457	)		(7,439,376	)
At end of year		(42,701,083	)		(40,057,673	)		(31,965,216	)
Total stockholders’ equity	$	146,433,504		$	139,847,991		$	141,016,221
Shares issued
At beginning of year		15,096,699			15,079,133			14,993,493
Shares issued under incentive stock option plans		41,321			17,566			85,640
Shares issued due to stock splits		3,783,591			—			—
At end of year		18,921,611			15,096,699			15,079,133
Common shares in treasury
At beginning of year		(2,184,777	)		(1,763,031	)		(1,393,311	)
Common shares repurchased		(134,728	)		(421,746	)		(369,720	)
Shares issued due to stock splits		(579,876	)		—			—
At end of year		(2,899,381	)		(2,184,777	)		(1,763,031	)
Total shares outstanding		16,022,230			12,911,922			13,316,102

See notes to consolidated financial statements.

42

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

	2006			2005			2004
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:
Cash flows from operating activities:
Net income	$	18,032,029		$	15,009,544		$	12,718,220
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,795,232			1,563,257			1,344,432
Provision for loan loss		6,413,509			5,193,902			5,439,160
Stock-based compensation expense		21,016			—			—
Investment security premium amortization, net		239,181			423,259			489,703
Acquisition premium amortization (discount accretion),		212,424			245,842			(150,565	)
Deferred income taxes		(1,635,483	)		(482,929	)		(1,517,901	)
Gains on sales or calls of securities available for sale		(88,861	)		(60,489	)		—
Gains on calls of securities held to maturity		(2,456	)		(7,837	)		(14,347	)
Net decrease in mortgage loans held for sale		2,285,877			7,454,578			1,643,060
Loss on disposal or sale of premises		102,805			—			—
Losses (gains) on disposal or sale of equipment		(13,306	)		5,665			(1,500	)
Gain on sale of other real estate		(25,343	)		(169,271	)		(77,310	)
Increase (decrease) in taxes payable		(195,584	)		349,066			1,191,228
Increase in interest receivable		(1,233,818	)		(1,705,984	)		(60,257	)
Increase in interest payable		826,200			1,111,814			92,390
Increase in cash surrender value of bank owned life insurance		(862,522	)		(568,928	)		(598,683	)
Decrease (increase) in other assets		(1,029,166	)		(531,387	)		437,418
Increase in other liabilities		1,693,133			2,780,526			864,686
Net cash provided by operating activities		26,534,867			30,610,628			21,799,734
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities, calls and paydowns of securities available for sale		15,898,118			218,725			29,570,573
Proceeds from maturities, calls and paydowns of securities held to maturity		6,073,000			9,799,250			10,511,475
Proceeds from sales of securities available for sale		759,413			14,638,657			5,885,000
Purchases of securities available for sale		(38,545,120	)		(22,373,402	)		(46,444,401	)
Net increase in loans		(84,686,036	)		(59,435,864	)		(65,194,466	)
Increases in unrealized gains or losses on hedged mortgage loan commitments		—			—			(96,233	)
Investment in bank owned life insurance		(6,370,000	)		(1,420,000	)		(3,745,000	)
Capital expenditures		(2,464,520	)		(3,314,136	)		(2,277,650	)
Proceeds from sales of fixed assets		1,959,590			13,524			72,807
Proceeds from sales of other real estate		747,652			709,696			835,424
Net cash used by investing activities		(106,627,903	)		(61,163,550	)		(70,882,471	)

See notes to consolidated financial statements.

(continued on next page)

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BANK OF GRANITE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

(concluded from previous page)

	2006			2005			2004
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW and savings accounts	$	38,464,096		$	39,446,622		$	35,252,860
Net increase (decrease) in time deposits		46,261,718			89,843,926			(19,982,849	)
Net increase (decrease) in overnight borrowings		3,414,825			(44,010,789	)		46,543,261
Net decrease in other borrowings		(6,023,708	)		(13,908,608	)		(1,628,769	)
Net proceeds from issuance of common stock		615,199			164,396			933,748
Dividends paid		(7,485,133	)		(6,979,081	)		(6,621,140	)
Purchases of common stock for treasury		(2,643,410	)		(8,092,457	)		(7,439,376	)
Cash paid for fractional shares		(11,215	)		—			—
Net cash provided by financing activities		72,592,372			56,464,009			47,057,735
NET INCREASE (DECREASE) IN CASH EQUIVALENTS		(7,500,664	)		25,911,087			(2,025,002	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		57,481,919			31,570,832			33,595,834
CASH AND CASH EQUIVALENTS AT END OF YEAR	$	49,981,255		$	57,481,919		$	31,570,832
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest	$	30,952,030		$	19,061,330		$	13,015,595
Income taxes		10,075,483			7,529,470			5,014,227
Noncash investing and financing activities:
Transfer from surplus to common stock due to stock split		3,783,591			—			—
Transfer from loans to other real estate owned		1,281,191			944,513			905,609

See notes to consolidated financial statements.

44

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION — Bank of Granite Corporation is a bank holding company with two wholly owned subsidiaries, Bank of Granite (the “Bank”), a state chartered commercial bank incorporated in North Carolina on August 2, 1906 and Granite Mortgage, Inc., a mortgage banking company incorporated in North Carolina on June 24, 1985. Bank of Granite Corporation and its two subsidiaries, Bank of Granite and Granite Mortgage, Inc. are referred to herein collectively as the “Company.”

The Bank is headquartered in Granite Falls, North Carolina and provides consumer and commercial banking services in the Blue Ridge foothills through the southern Piedmont areas of North Carolina through twenty-two banking offices. Granite Mortgage is headquartered in Winston-Salem, North Carolina and provides mortgage origination services in the central and southern Piedmont areas of North Carolina through fourteen mortgage offices. Granite Mortgage was acquired by Bank of Granite Corporation on November 5, 1997.

BASIS OF PRESENTATION — The consolidated financial statements include the accounts of Bank of Granite Corporation and its wholly owned subsidiaries, Bank of Granite and Granite Mortgage, Inc. All significant intercompany accounts and transactions have been eliminated.

USE OF ESTIMATES — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS — Cash and cash equivalents include cash on hand, amounts due from banks, short-term interest bearing deposits, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

INVESTMENT SECURITIES — Debt securities that the Company has the positive intent and ability to hold to maturity are classified as “held to maturity securities” and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in consolidated earnings. Debt securities not classified as either held to maturity securities or trading securities, and equity securities not classified as trading securities, are classified as “available for sale securities” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated stockholders’ equity and as an item of other comprehensive income. Gains and losses on held for investment securities are recognized at the time of sale based upon the specific identification method. Declines in the fair value of individual held to maturity and available for sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in consolidated earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Transfers of securities between classifications are accounted for at fair value. No securities have been classified as trading securities.

LOANS — Loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances adjusted for any deferred fees or costs. Substantially all loans earn interest on the level yield method based on the daily outstanding balance.

45

Loans that are deemed to be impaired (i.e., probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement) are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical matter, at the loan’s observable market value or fair value of the collateral if the loan is collateral dependent. A valuation reserve is established to record the difference between the stated loan amount and the present value or market value of the impaired loan. Impaired loans may be valued on a loan-by-loan basis (e.g., loans with risk characteristics unique to an individual borrower) or on an aggregate basis (e.g., loans with similar risk characteristics). The Company’s policy for recognition of interest income on impaired loans is the same as its interest income recognition policy for non-impaired loans. The Company discontinues the accrual of interest when the collectibility of such interest becomes doubtful. The total of impaired loans, impaired loans on a nonaccrual basis, the related allowance for loan losses and interest income recognized on impaired loans is disclosed in Note 4.

ALLOWANCE FOR LOAN LOSSES — The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb probable losses in the portfolio. Management’s determination of the adequacy of the allowance is based on an evaluation of the portfolio, current economic conditions, historical loan loss experience and other risk factors. Recovery of the carrying value of loans is dependent to some extent on future economic, operating and other conditions that may be beyond the Company’s control. Unanticipated future adverse changes in such conditions could result in material adjustments to the allowance for loan losses.

MORTGAGE LOANS HELD FOR SALE — The Company originates certain residential mortgage loans with the intention of selling these loans. Between the time that the Company enters into an interest rate lock or a commitment to originate a residential mortgage loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments. The Company believes that it is prudent to limit the variability of expected proceeds from the future sales of these loans by entering into forward sales commitments of mortgage- backed securities. The commitments to originate residential mortgage loans and the forward sales commitments are freestanding derivative instruments. See Note 19 for additional information related to derivatives and financial instruments.

REAL ESTATE ACQUIRED BY FORECLOSURE — Real estate acquired by foreclosure is stated at the lower of cost or fair value. Any initial losses at the time of foreclosure are charged against the allowance for loan losses with any subsequent losses or write-downs included in the consolidated statements of income as a component of other expenses.

PREMISES AND EQUIPMENT AND OTHER LONG-LIVED ASSETS — Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization, computed by the straight-line method, are charged to operations over the properties’ estimated useful lives, which range from 25 to 50 years for buildings and 5 to 15 years for furniture and equipment or, in the case of leasehold improvements, the term of the lease if shorter. Maintenance and repairs are charged to operations in the year incurred. Gains and losses on dispositions are included in current operations.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. If the sum of the expected future cash flows is less than the stated amount of the asset, an impairment loss is recognized for the difference between the fair value of the asset and its carrying amount.

GOODWILL AND OTHER INTANGIBLES — The Company’s 2003 acquisition of First Commerce generated goodwill of $10,763,447 and core deposit intangible assets of $630,013. The Company uses a non-amortization approach to account for purchased goodwill and other intangible assets with indefinite useful lives. Intangible assets with finite useful lives are amortized over their useful lives. The carrying value of the core deposit intangible asset totaled $280,636, net of accumulated amortization of $349,377, as of December 31, 2006. This intangible asset was determined by management to meet the criteria for recognition apart from goodwill and to have a finite life of 10 years. Amortization expense associated with the core deposit intangible asset was $85,914, $97,368, and $108,819 for the years ended December 31, 2006, 2005 and 2004, respectively. Projected amortization expense for the years ending December 31, 2007, 2008, 2009, 2010, and 2011 is $74,000, $63,000, $52,000, $40,000, and $29,000, respectively.

Under generally accepted accounting principles, the Company reviews its amortizable intangible assets for impairment when events or changes in circumstances indicated the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. The Company tests goodwill for impairment annually as of May 31 and on an interim basis when events or circumstances change. Management completed the annual goodwill impairment tests as of May 31, 2006, which indicated that no impairment had occurred. Management does not believe that events and circumstances subsequent to that date indicated that goodwill has been impaired.

46

INCOME TAXES — Provisions for income taxes are based on amounts reported in the consolidated statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include changes in deferred income taxes. Deferred taxes are computed using the asset and liability approach. The tax effects of differences between the tax and financial accounting basis of assets and liabilities are reflected in the balance sheets at the tax rates expected to be in effect when the differences reverse.

INCOME AND EXPENSES — The Company uses the accrual method of accounting. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

PER SHARE AMOUNTS — Per share amounts have been computed using both the weighted average number of shares outstanding of common stock for the purposes of computing basic earnings per share and the weighted average number of shares outstanding of common stock plus dilutive common stock equivalents for the purpose of computing diluted earnings per share. See Note 14 for further information regarding the computation of earnings per share.

During 2006, the Company declared a 5-for-4 stock split effected in the form of a stock dividend payable September 25, 2006 to stockholders of record on September 11, 2006. Per share amounts, average shares, and option shares for periods ended prior to September 25, 2006 have been adjusted to reflect the split.

STOCK-BASED COMPENSATION — The Company adopted SFAS No. 123R, “Share-Based Payment”, using the modified prospective transition method effective the first quarter of 2006 for accounting for share-based compensation to employees, recognizing in the income statement the grant-date fair value of stock options and other equity-based compensation. The Company recognized $21,016 as pre-tax stock-based employee compensation expense for 2006. The impact of stock-based compensation on the statements of income, statements of cash flow, and earnings per share are immaterial to the overall financial statements. Had compensation cost for the Company’s employee stock option plan been determined using the fair value method, the pre-tax expense for 2005 and 2004 would have been $36,847 and $68,318, respectively, and would not have effected the reported earnings per share for 2005 or 2004.

The Company estimated aggregate option values of $4.66, $5.51 and $6.00 for 2006, 2005 and 2004, respectively, in order to compute its estimation of option compensation expense associated with the fair value method, using The Black Scholes Model. The following assumptions were used:

	2006			2005			2004
Risk-free rate		5.00	%		4.03	%		3.45	%
Average expected term (years)	5.6 years			5.6 years			5.6 years
Expected volatility		34.24	%		37.53	%		41.04	%
Expected dividend yield		2.85	%		2.96	%		2.61	%
Expected turnover		8.66	%		8.76	%		8.96	%

LOANS HELD FOR SALE AND DERIVATIVE FINANCIAL INSTRUMENTS — Loans held for sale primarily consist of one to four family residential loans originated for sale in the secondary market and are carried at the lower of cost or fair value determined on an aggregate basis, and are sold with servicing released. Gains and losses on sales of loans held for sale are included in mortgage banking income in the consolidated statement of income. Granite Mortgage uses two types of financial instruments to manage risk. These financial instruments, commonly referred to as derivatives, consists of contracts to forward sell mortgage-backed securities and options to forward sell securities. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument. Granite Mortgage uses derivatives primarily to hedge against changes in the market values of the mortgage loans it generates and sells.

Granite Mortgage classifies its derivative financial instruments as a hedge of an exposure to changes in cash flow from forecasted transactions (sales of loans to third parties) (“cash flow hedge”). For a qualifying cash flow hedge, changes in the value of the derivatives that have been highly effective as hedges are recognized in other comprehensive income. For cash flow hedges, net income may be affected to the extent that changes in the value of the derivative instruments do not perfectly offset changes in the cash flow of the hedged asset or liability. See Notes 18, 19 and 20 for further information regarding derivative financial instruments.

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NEW ACCOUNTING STANDARDS — In the first quarter of 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 156, “Accounting or Servicing of Financial Assets” (“SFAS No. 156”). SFAS No. 156 sets accounting requirements for separately recognizing a servicing asset or a servicing liability when a company undertakes an obligation to service a financial asset under a servicing contract in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS No. 156 also allows an entity to choose one of two methods when subsequently measuring its servicing assets and servicing liabilities: (1) the amortization method or (2) the fair value measurement method. The amortization method existed under Statement 140 and remains unchanged in (1) allowing entities to amortize their servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and (2) requiring the assessment of those servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date. The fair value measurement method allows entities to measure their servicing assets or servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period the change occurs. SFAS No. 156 permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights upon initial adoption, provided certain criteria are met. The Company adopted SFAS No. 156 in the first quarter of 2007 and does not expect the adoption of SFAS No. 156 to have a material impact on its financial position and results of operations, including the valuation methods and support for the assumptions that underlie the valuation.

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—and interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the Company’s 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company does not expect the adoption of FIN 48 to have a material impact on its financial statements.

In September 2006, the Financial Accounting Standards Board issued FASB Statement No. 157, “Fair Value Measurements” (“FASB No. 157”), which enhances existing guidance for measuring assets and liabilities using fair value and requires additional disclosure about the use of fair value for measurement. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company will be required to adopt SFAS No. 157 in the first quarter of 2008, and is currently evaluating the impact of the adoption of SFAS No. 157 on its financial position and results of operations, including the valuation methods and support for the assumptions that underlie the valuation.

In September 2006, the Financial Accounting Standards Board issued FASB Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“FASB No. 158”), which requires a calendar year-end company with publicly traded equity securities that sponsors a post- retirement benefit plan to fully recognize, as an asset or liability, the overfunded or underfunded status of its benefit plan(s) in its 2006 year-end balance sheet. Prospective application of FASB No. 158 is required for fiscal years ending after December 15, 2006, for entities with publicly traded equity securities. The adoption of FASB No. 158 did not have a material impact on its consolidated financial statements.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements and is effective for annual periods ending after November 15, 2006. The Company adopted the provisions of SAB No. 108 effective December 31, 2006. The adoption of SAB No. 108 and the resulting impact on its consolidated financial statements is disclosed in Note 16.

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In September 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (“EITF Issue 06-4”). EITF Issue 06-4 requires that for endorsement split-dollar insurance arrangements that provide a benefit to an employee that extends to postretirement periods, an employer should recognize a liability for future benefits in accordance with FASB Statement No. 106 or Accounting Principles Board (“APB”) Opinion No. 12 based on the substantive agreement of the employee. If the employee has effectively agreed to maintain a life insurance policy during postretirement periods, the costs of the life insurance policy during the postretirement periods should be accrued in accordance with either FASB Statement No. 106 or APB Opinion No. 12. If the employer has agreed to provide a death benefit, the employer should recognize a liability for the future death benefit in accordance with either FASB Statement No. 106 or APB Opinion No. 12. EITF Issue 06-4 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact of EITF Issue 06-4 on its financial statements.

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2. INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses and fair values of investment securities at December 31, 2006 and 2005 are as follows:

	Amortized		Gross Unrealized				Fair
Type and Contractual Maturity	Cost		Gains		Losses		Value
AVAILABLE FOR SALE
At December 31, 2006:
U. S. Treasury due:
After 1 year but within 5 years	$	5,120,838	$	—	$	127,088	$	4,993,750
Total U.S. Treasury		5,120,838		—		127,088		4,993,750
U. S. Government agencies due:
Within 1 year		7,961,624		—		127,194		7,834,430
After 1 year but within 5 years		103,623,668		22,998		1,701,502		101,945,164
After 5 years but within 10 years		1,999,339		—		38,880		1,960,459
Total U.S. Government agencies		113,584,631		22,998		1,867,576		111,740,053
State and local due:
After 1 year but within 5 years		718,083		—		9,970		708,113
After 5 years but within 10 years		2,014,392		4,922		4,618		2,014,696
After 10 years		2,817,468		9,452		16,627		2,810,293
Total state and local		5,549,943		14,374		31,215		5,533,102
Others due:
After 10 years		3,545,551		218,126		24,917		3,738,760
Equity securities		8,030,380		437,887		161,356		8,306,911
Total others		11,575,931		656,013		186,273		12,045,671
Total available for sale	$	135,831,343	$	693,385	$	2,212,152	$	134,312,576
HELD TO MATURITY
At December 31, 2006:
State and local due:
Within 1 year	$	5,567,780	$	12,419	$	225	$	5,579,974
After 1 year but within 5 years		22,203,573		376,441		—		22,580,014
After 5 years but within 10 years		4,973,161		207,551		—		5,180,712
After 10 years		2,509,078		170,123		—		2,679,201
Total state and local		35,253,592		766,534		225		36,019,901
Total held to maturity	$	35,253,592	$	766,534	$	225	$	36,019,901

Sales and calls of securities available for sale for the year ended December 31, 2006 resulted in $126,306 realized gains and $37,445 realized losses. Calls of securities held to maturity resulted in gross gains of $2,456 and no losses in 2006.

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	Amortized		Gross Unrealized				Fair
Type and Contractual Maturity	Cost		Gains		Losses		Value
AVAILABLE FOR SALE
At December 31, 2005:
U. S. Treasury due:
After 1 year but within 5 years	$	5,185,320	$	—	$	136,882	$	5,048,438
Total U.S. Treasury		5,185,320		—		136,882		5,048,438
U. S. Government agencies due:
Within 1 year		9,521,111		26,150		17,371		9,529,890
After 1 year but within 5 years		76,263,846		—		1,857,251		74,406,595
After 5 years but within 10 years		6,007,726		—		129,027		5,878,699
Total U.S. Government agencies		91,792,683		26,150		2,003,649		89,815,184
State and local due:
After 1 year but within 5 years		261,626		—		1,662		259,964
After 5 years but within 10 years		2,060,322		—		19,016		2,041,306
After 10 years		3,261,808		—		35,631		3,226,177
Total state and local		5,583,756		—		56,309		5,527,447
Others due:
Within 1 year		199,964		845		—		200,809
After 10 years		3,558,909		247,449		42,543		3,763,815
Equity securities		7,734,140		435,071		205,635		7,963,576
Total others		11,493,013		683,365		248,178		11,928,200
Total available for sale	$	114,054,772	$	709,515	$	2,445,018	$	112,319,269
HELD TO MATURITY
At December 31, 2005:
State and local due:
Within 1 year	$	5,871,982	$	22,033	$	—	$	5,894,015
After 1 year but within 5 years		24,757,828		574,613		—		25,332,441
After 5 years but within 10 years		8,029,428		364,879		—		8,394,307
After 10 years		2,704,199		188,206		—		2,892,405
Total state and local		41,363,437		1,149,731		—		42,513,168
Total held to maturity	$	41,363,437	$	1,149,731	$	—	$	42,513,168

Sales and calls of securities available for sale for the year ended December 31, 2005 resulted in $60,489 realized gains. Calls of securities held to maturity resulted in gross gains of $7,837 and no losses in 2005.

Sales and calls of securities available for sale for the year ended December 31, 2004 resulted in no realized gains or losses. Calls of securities held to maturity resulted in gross gains of $14,347, and no losses in 2004.

Securities with an amortized cost of $54,019,484 and $64,684,143 were pledged as collateral for public deposits and for other purposes as required by law at December 31, 2006 and 2005, respectively.

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Securities with unrealized losses at December 31, 2006 not recognized in income are as follows:

	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
2006
U.S. Treasury	$	—	$	—		$	4,993,750	$	( 127,088	)	$	4,993,750	$	( 127,088	)
U.S. Government agencies		25,371,398		( 89,916	)		77,373,818		(1,777,661	)		102,745,216		(1,867,577	)
State and local		559,887		(225	)		3,976,365		( 31,215	)		4,536,252		( 31,440	)
Others		—		—			4,680,266		( 186,272	)		4,680,266		( 186,272	)
Total temporarily impaired	$	25,931,285	$	( 90,141	)	$	91,024,199	$	(2,122,236	)	$	116,955,484	$	(2,212,377	)

Unrealized losses on securities have not been recognized into income because management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to increases in market interest rates. The fair value is expected to recover as the securities approach their maturity date and/or market interest rates decline.

U.S. Treasury/U.S. Government agency obligations — The unrealized losses on the Company’s investments in U.S. Treasury obligations and direct obligations of the U.S. government agencies were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the par value of the investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2006.

State and local government obligations — The unrealized losses on the company’s investments in State and local government obligations were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the par value of the investment. The issuers have the ability to increase tax revenues if necessary to fulfill their obligations. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2006.

Others

Marketable equity securities — The Company’s investments in marketable equity securities consist primarily of investments of mutual funds of U.S. government income trusts. The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold those investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2006.

Investments in equity securities carried at cost — The aggregate cost of the Company’s cost-method investments totaled $2,961,200 at December 31, 2006, which were investments in common stock of the Federal Home Loan Bank. Because of the redemption provisions of these entities, the Company estimates that the fair value equals the cost of investments on those investments, and the investments are not impaired.

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3. LOANS

Loans are made primarily to customers in the Company’s market area. Loans at December 31, 2006 and 2005, classified by type, are as follows:

	2006			2005
Real estate:
Construction	$	161,071,478		$	125,555,445
Mortgage		488,347,172			455,322,477
Commercial, financial and agricultural		248,690,527			231,228,504
Consumer		15,316,637			20,910,544
All other loans		742,430			915,154
		914,168,244			833,932,124
Deferred origination fees, net		(1,676,508	)		(1,484,976	)
Total	$	912,491,736		$	832,447,148

Nonperforming assets at December 31, 2006 and 2005 are as follows:

	2006		2005
Nonaccrual loans	$	9,288,977	$	6,423,997
Loans 90 days or more and still accruing interest		5,074,178		4,208,032
Foreclosed properties		1,162,448		925,984
Total	$	15,525,603	$	11,558,013

If interest from nonaccrual loans had been recognized in accordance with the original terms of the loans, interest income would have been higher by $1,002,915 in 2006, $425,170 in 2005 and $408,114 in 2004. Interest income recognized on nonaccrual loans for 2006, 2005 and 2004 was $219,570, $12,484, and $65,024, respectively.

Directors and officers of the Company and companies with which they are affiliated are customers of and borrowers from the Bank in the ordinary course of business. At December 31, 2006 and 2005, directors’ and principal officers’ direct and indirect indebtedness to the Bank was an aggregate amount of $3,071,126 and $3,164,510, respectively. During 2006, additions to such loans were $1,727,583 and repayments totaled $1,820,967. In the opinion of management, these loans do not involve more than normal risk of collectibility, nor do they present other unfavorable features.

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4. ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses for the years ended December 31, 2006, 2005 and 2004 are as follows:

	2006			2005			2004
Balance at beginning of year	$	13,923,884		$	13,665,013		$	10,798,897
Loans charged off:
Real estate		1,707,800			919,071			929,609
Commercial, financial and agricultural		2,807,522			3,484,172			1,040,391
Credit cards and related plans		25,559			45,150			87,711
Installment loans to individuals		410,378			540,254			683,282
Demand deposit overdraft program		251,320			261,789			297,456
Total charge-offs		5,202,579			5,250,436			3,038,449
Recoveries of loans previously charged off:
Real estate		83,508			62,957			23,675
Commercial, financial and agricultural		282,099			29,004			70,245
Credit cards and related plans		9,927			3,492			3,925
Installment loans to individuals		138,427			41,662			220,389
Demand deposit overdraft program		138,339			178,290			147,171
Total recoveries		652,300			315,405			465,405
Net charge-offs		4,550,279			4,935,031			2,573,044
Provision for loan losses		6,413,509			5,193,902			5,439,160
Balance at end of year	$	15,787,114		$	13,923,884		$	13,665,013
Ratio of net charge-offs during the year to average loans outstanding during the year		0.52	%		0.61	%		0.35	%

At December 31, 2006 and 2005, the recorded investment in loans that are considered to be impaired, including accrued interest, was $15,515,924 ($9,345,888 of which is on a nonaccrual basis) and $11,046,163 ($6,620,701 of which is on a nonaccrual basis), respectively. The average recorded balance of impaired loans during 2006 and 2005 is not significantly different from the balance at December 31, 2006 and 2005. The related allowance for loan losses for these loans was $3,926,439 and $3,248,549 at December 31, 2006 and 2005, respectively. The allowance for impaired loans increased $677,890, or 20.87%, while the total investment in impaired loans increased $4,469,761, or 40.46%. For the years ended December 31, 2006, 2005 and 2004, the Bank recognized interest income on those impaired loans of $480,082, $325,266 and $266,829, respectively.

54

5. PREMISES AND EQUIPMENT

Summaries of premises and equipment at December 31, 2006 and 2005 follow:

					Premisesand
			Accumulated		Equipment,
	Cost		Depreciation		Net
At December 31, 2006:
Land	$	2,813,762	$	—	$	2,813,762
Buildings		9,837,071		3,995,756		5,841,315
Leasehold improvements		567,986		213,745		354,241
Furniture, equipment and vehicles		13,839,207		10,695,519		3,143,688
Capitalized leases		1,212,743		50,100		1,162,643
Construction in progress		110,426		—		110,426
Total	$	28,381,195	$	14,955,120	$	13,426,075
At December 31, 2005:
Land	$	3,241,745	$	—	$	3,241,745
Buildings		11,405,532		3,825,997		7,579,535
Leasehold improvements		322,817		114,282		208,535
Furniture, equipment and vehicles		12,768,518		9,476,983		3,291,535
Construction in progress		484,526		—		484,526
Total	$	28,223,138	$	13,417,262	$	14,805,876

6. OTHER INCOME AND EXPENSES

For the years ended December 31, 2006, 2005 and 2004, items included in service charges on deposit accounts and other expenses that exceeded 1% of total revenues are set forth below.

	2006		2005		2004
Items included in service charges on deposit accounts
Fees from demand deposit overdrafts	$	4,085,249	$	3,973,899	$	3,740,312
Items included in other expenses
Telephone		780,690		690,486		768,781
Marketing		923,910		806,866		820,892

7. INCOME TAXES

The components of the income tax provision for the years ended December 31, 2006, 2005 and 2004 follow.

	2006			2005			2004
Income tax provision
Current	$	11,515,382		$	8,361,465		$	7,660,208
Deferred		(1,635,483	)		(482,929	)		(1,517,901	)
Total	$	9,879,899		$	7,878,536		$	6,142,307

55

Changes in deferred taxes of $86,429, $(892,884) and $(350,230) related to unrealized gains and losses on securities available for sale during 2006, 2005 and 2004, respectively, were allocated to other comprehensive income in the respective years. Changes in deferred taxes of $(16,197) and $14,635 related to unrealized gains and losses on mortgages held for sale were allocated to other comprehensive income during 2006 and 2005, respectively.

A reconciliation of reported income tax expense for the years ended December 31, 2006, 2005 and 2004 to the amount of tax expense computed by multiplying income before income taxes by the statutory federal income tax rate follows.

	2006			2005			2004
Statutory federal income tax rate	35%			35%			35%
Tax provision at statutory rate	$	9,769,175		$	8,010,828		$	6,601,184
Increase (decrease) in income taxes resulting from:
Tax-exempt interest income		(668,203	)		(765,073	)		(888,588	)
State income taxes net of federal tax benefit		1,011,745			790,801			606,663
Other		(232,818	)		(158,020	)		(176,952	)
Income tax provision	$	9,879,899		$	7,878,536		$	6,142,307

The tax effect of the cumulative temporary differences and carryforwards that gave rise to the deferred tax assets and liabilities at December 31, 2006 and 2005 are as follows:

	December 31, 2006
	Assets		Liabilities			Total
Excess book over tax bad debt expense	$	6,232,594	$	—		$	6,232,594
Excess tax over book depreciation		—		(362,137	)		(362,137	)
Unrealized losses on securities available for sale		605,587		—			605,587
Unrealized losses on mortgage derivative instruments		40,046		—			40,046
Other, net		2,302,881		(923,071	)		1,379,810
Total	$	9,181,108	$	(1,285,208	)	$	7,895,900

	December 31, 2005
	Assets		Liabilities			Total
Excess book over tax bad debt expense	$	5,506,001	$	—		$	5,506,001
Excess tax over book depreciation		—		(614,166	)		(614,166	)
Unrealized losses on securities available for sale		692,017		—			692,017
Unrealized losses on mortgage derivative instruments		23,849		—			23,849
Other, net		1,671,459		(948,510	)		722,949
Total	$	7,893,326	$	(1,562,676	)	$	6,330,650

The net deferred tax asset is included in “other assets” on the balance sheet.

Although realization of the deferred tax assets is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.

56

8. STOCK OPTIONS

At December 31, 2006, 2005 and 2004, 207,210, 271,890 and 297,298 shares of common stock, respectively, were reserved for stock options outstanding under the Company’s stock option plans. Shares available for grants under the Company’s stock option plans were 309,774 shares at December 31, 2006, 296,495 shares at December 31, 2005, and 293,041 shares at December 31, 2004. Option prices are established at market value on the dates granted by the Board of Directors. Option shares and option prices have been restated for the 5-for-4 stock split effected in the form of a stock dividend payable September 25, 2006 to stockholders of record on September 11, 2006.

A summary of the status of the Company’s incentive stock option plans at December 31, 2006, 2005 and 2004 and changes during the years then ended are presented below:

	2006				2005				2004
			Weighted				Weighted				Weighted
			Average				Average				Average
			Exercise				Exercise				Exercise
	Shares		Price		Shares		Price		Shares		Price
Outstanding at beginning of year		271,890	$	12.90		297,298	$	12.54		425,113	$	11.66
Granted		2,500		15.36		3,125		14.28		11,250		14.50
Exercised		51,401		11.97		21,954		7.49		107,033		8.72
Expired, forfeited or canceled		15,779		16.81		6,579		15.38		32,032		14.34
Outstanding at end of year		207,210	$	12.86		271,890	$	12.90		297,298	$	12.54
Options exercisable at end of year		194,210	$	12.74		253,515	$	12.78		264,464	$	12.33

For various price ranges, weighted average characteristics of outstanding stock options at December 31, 2006 follow.

	Outstanding Options						Exercisable Options
			Weighted
	Shares		Average		Weighted		Shares		Weighted
	Outstanding at		Remaining		Average		Exercisable at		Average
Range of	December 31,		Contractual		Exercise		December 31,		Exercise
Exercise Prices	2006		Life (years)		Price		2006		Price
$  0.00 —   8.25		37,980		2.9	$	6.44		37,980	$	6.44
8.26 — 10.25		41,127		3.1		8.92		41,127		8.92
10.26 — 14.25		33,738		0.9		13.91		29,238		13.87
14.26 — 15.25		42,051		2.6		14.56		37,301		14.56
15.26 — 18.25		6,718		2.9		15.71		2,968		15.87
18.26 — 20.25		44,815		1.4		18.97		44,815		18.97
20.26 — 26.50		781		1.4		20.96		781		20.96
7.18 — 26.20		207,210		2.2	$	12.86		194,210	$	12.74

Options granted become exercisable in accordance with the vesting schedule specified by the Board of Directors in the grant. Options granted prior to January 1, 1997 and after December 31, 1997 become exercisable over a five-year period at the rate of 20% per year beginning one-year from the date of grant. Options granted during 1997 became exercisable over a four-year period at the rate of 20% after six-months from the date of grant and 20% per year beginning one-year from the date of grant. The Company issued options to purchase shares of its common stock in exchange for the First Commerce stock options that were outstanding at the time the merger was completed. First Commerce’s stock option plans provided that all of the outstanding options were vested as of the acquisition date. There is no change in the aggregate intrinsic value of the options issued compared to the intrinsic value of the options held immediately before the exchange, nor does the ratio of the exercise price per option to the market value per share change. The option plans assumed in the acquisition of First Commerce are exercisable for ten-years after the date of grant and became fully vested as of the July 15, 2003 acquisition date. No other options may be exercisable more than five-years after the date of grant, unless the exercise date is extended by the Board of Directors. In 2002, the Board of Directors extended the exercise period to ten-years for options granted during 1997 and 1998 because the exercise prices of such grants exceeded the market price resulting in no value to the Company or the optionee. In 2004, the Board of Directors also extended the exercise period to ten-years for options granted during 1999, and in 2005 extended the period for options granted during 2000, respectively.

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9. EMPLOYEE BENEFIT PLANS

The Bank sponsors a tax-qualified profit-sharing retirement plan covering substantially all employees. Contributions to the plan are made at the discretion of the Board of Directors but may not exceed the maximum amount allowable for federal income tax purposes. The Company’s expense totaled $1,597,543, $1,434,210, and $676,507 for the years ended December 31, 2006, 2005 and 2004, respectively.

The Bank sponsors non-tax qualified profit-sharing supplemental executive retirement plans for certain executive officers, which allow the Bank to supplement the level of the executive officers’ retirement incomes over that which is obtainable through the tax-qualified profit sharing retirement plan sponsored by the Bank. The Company’s expense totaled $33,365, $37,403, and $16,609 for the years ended December 31, 2006, 2005 and 2004, respectively.

The Bank sponsors a non-tax qualified Supplemental Executive Retirement Plan for its officers (“Officers’ SERP”) to supplement the benefit each officer can receive under the Bank’s tax-qualified profit sharing retirement plan. Once the officer has completed 7 full years of service with the Bank, the Officers’ SERP is designed to provide a benefit to the officer at the normal retirement age of 65, or thereafter, or an early retirement age of 50. Benefits are payable for 10 years for certain officers or life for certain officers. Actual retirement benefits payable under the Officers’ SERP are dependent on an indexed retirement benefit formula, which accrues benefits equal to the excess of the aggregate annual after-tax income from associated life insurance contracts over the Bank’s opportunity costs related to the Officers’ SERP. Retirement benefits payable under the Officers’ SERP are dependent on the performance of insurance contracts, which is not guaranteed by the Bank. In the event of an officer’s termination of employment for any reason, other than for cause, the officer is 100% vested after 7 or more full years of service with the Bank after the officer has attained the age of 18. In the event of the officer’s termination of employment due to disability or change of control of the Company or the Bank, payments from the plan would begin at the officer’s normal or early retirement age and the officer would be 100% vested in the entire retirement benefit amount. The present value of the post retirement benefits for each participant are accounted for in a rational and systematic manner over the working life of each participant.

In connection with the Officers’ SERP, the Bank has also entered into Life Insurance Endorsement Method Split Dollar Agreements (the “Agreements”) with the participants covered under the Officers’ SERP. Under the Agreements, in the event of the officer’s death, the officer’s beneficiary will receive the lesser of 2 times the officer’s salary at the time of death or 100% of the net-at-risk life insurance of the policy, which is defined as the death benefit in excess of cash value, together with any remaining balance in the liability reserve account.

The Bank purchases bank-owned life insurance (“BOLI”), which may be used, at the Bank’s sole discretion, to fund the benefits payable under the Officers’ SERP. During 2006, an additional $6,370,000 was invested in BOLI for 14 participants added during the year. During 2005, the Bank made additional investments in BOLI of $1,420,000 for two participants added during the year. As of December 31, 2006, and 2005, cash values from the BOLI policies equaled $26,925,411 and $19,692,889, respectively. The accrued liability for the Officers’ SERP amounted to $2,633,975 and $2,119,682 at December 31, 2006, and 2005, respectively, and is included in other liabilities. Total expenses for 2006 and 2005, were $608,913 and $628,604, respectively, for retirement benefits and plan related costs. As of December 31, 2006, the Officers’ SERP had 58 participants.

Granite Mortgage sponsors a retirement plan for its employees under Section 401(k) of the Internal Revenue Code. The plan covers all employees over 21 years of age who have completed 1,000 hours of service. At its discretion, Granite Mortgage may make matching contributions to the plan. Total expenses were $99,564, $129,951 and $132,104 for the years ended December 31, 2006, 2005 and 2004, respectively.

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10. LEASES

LESSEE — CAPITALIZED — The Company’s subsidiaries lease certain premises under capitalized lease agreements. Leases that meet the criteria for capitalization are recorded as assets and the related obligations are included in other liabilities on the accompanying balance sheets. Amortization of property under capital lease is included in depreciation expense. Included in premises and equipment as of December 31, 2006 is $1,212,743 as the capitalized cost of these leases and accumulated amortization of $50,100.

As of December 31, 2006, future minimum lease payments under noncancelable capitalized leases are as follows:

Year	Payments
2007	$	300,221
2008		237,567
2009		237,567
2010		237,567
2011		237,567
2012 and thereafter		1,806,590
Total minimum lease payments		3,057,078
Less amount representing interest		(1,803,263	)
Present value of net minimum lease payments	$	1,253,815

LESSEE — OPERATING — The Company’s subsidiaries lease certain premises and equipment under operating lease agreements. As of December 31, 2006, future minimum lease payments under noncancelable operating leases are as follows:

Year	Payments
2007	$	701,762
2008		425,326
2009		328,366
2010		294,387
2011		314,456
Total	$	2,064,297

Rental expense charged to operations under all operating lease agreements was $970,947, $1,046,849 and $882,086 for the years ended December 31, 2006, 2005 and 2004, respectively.

In September 2003, the Company entered into commercial leases with Salem Investors, LLC, a company jointly owned by the chief executive officer and a senior vice president of Granite Mortgage, for the purpose of providing a community banking facility to the Bank and a mortgage banking facility to Granite Mortgage in Winston-Salem, North Carolina. Facility construction was completed in the third quarter of 2004. The leases commenced on September 1, 2004 and have an initial lease term of seven years. Based on a fairness opinion obtained from an independent third party expert, the Company has determined that the leases are on terms comparable to similar properties in the area and that the leases are in the best interests of the Company’s community banking and mortgage banking operations. Total lease payments were paid to the related party under this lease of $270,000 during each year of 2006 and 2005, and $51,715 during 2004.

59

11. OVERNIGHT AND SHORT-TERM BORROWED FUNDS

Federal funds purchased, securities sold under agreements to repurchase, and short-term borrowed funds are summarized as follows:

	December 31,
	2006		2005
Overnight borrowings
Bank of Granite Corporation:
Commercial deposits swept into commercial paper	$	29,662,145	$	26,790,353
Bank of Granite:
Securities sold under agreements to repurchase		1,490,323		947,290
Total overnight borrowings		31,152,468		27,737,643
Short-term borrowings
Bank of Granite:
Short-term borrowings from the Federal Home Loan Bank		8,000,000		12,000,000
Granite Mortgage:
Warehouse line of credit		18,487,421		17,335,942
Total short-term borrowings		26,487,421		29,335,942
Total overnight and short-term borrowings	$	57,639,889	$	57,073,585

A summary of selected data related to Federal funds purchased, securities sold under agreements to repurchase, and short-term borrowed funds follows:

Overnight borrowings

	December 31,
	2006			2005			2004
Balance outstanding at end of year	$	31,152,468		$	27,737,643		$	71,748,432
Maximum outstanding at any month-end during the year		35,785,626			67,618,194			72,391,061
Average daily balance outstanding during the year		29,805,688			39,006,233			35,575,198
Average interest rate during the year		3.20	%		1.85	%		1.38	%
Average interest rate at end of year		3.70	%		1.33	%		2.03	%
Other short-term borrowings*

	December 31,
	2006
Balance outstanding at end of year	$	26,487,421
Maximum outstanding at any month-end during the year		35,328,260
Average daily balance outstanding during the year		31,583,260
Average interest rate during the year		5.74	%
Average interest rate at end of year		6.16	%

* Included in other borrowings for prior years

Granite Mortgage temporarily funds its mortgages, from the time of origination until the time of sale, through the use of a one-year warehouse line of credit from one of the Company’s correspondent financial institutions. For the years ended December 31, 2006 and 2005, this line of credit was $40,000,000, of which $18,487,421 and $17,335,942, respectively, were outstanding at year end. Outstanding balances at year end for loan disbursement overdraft protection, which were funded by this line of credit, were $2,058,877 and $3,234,064, for 2006 and 2005, respectively. Granite Mortgage requests the line of credit based on its estimated funding needs for the year. Outstanding balances under this line of credit accrue interest at a rate of the 30-day LIBOR plus 115 basis points to fund mortgages originated and sold and construction loans. The line is secured by the mortgage loans originated and the Company serves as guarantor on Granite Mortgage’s borrowings under this arrangement. Under the terms of the loan agreement, the Company is required to meet certain financial covenants regarding its total stockholders’ equity, its ratio of non- performing assets to stockholders’ equity and loan loss reserves, and its regulatory capital ratios. As of December 31, 2006, the Company was in compliance with all financial covenants.

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12. LONG-TERM BORROWINGS

Long-term borrowings are summarized as follows:

	December 31, 2006
	2006		2005
Bank of Granite Corporation:
Unsecured line of credit at 30-day LIBOR plus 1.20% due June 30, 2009	$	5,000,000	$	—
Junior subordinated debt to unconsolidated trusts at 60-day LIBOR plus 3.75%, due December 8, 2031 callable on or after December 8, 2006 (1)		—		5,000,000
Bank of Granite:
Federal Home Loan Bank convertible advance at 4.78% due February 1, 2011 callable on or after February 1, 2006 (2)		—		2,000,000
Federal Home Loan Bank convertible advance at 5.22% due March 9, 2011 callable on March 9, 2006		3,140,885		3,000,000
Federal Home Loan Bank convertible advance at 3.24% due September 20, 2012 callable on September 20, 2007		7,000,000		7,000,000

(1)	The Company called this debt on December 8, 2006.
(2)	The Federal Home Loan Bank called this advance on February 1, 2006.

The Company has an unsecured line of credit from one of the Bank’s correspondent banks for general corporate purposes, which matures June 30, 2009. The line is in the amount of $10,000,000 and bears an interest rate of one-month LIBOR plus 120 basis points, with interest payable quarterly. The Company is required to meet certain financial covenants regarding its total stockholders’ equity, its ratio of loan loss reserves to total loans, and its regulatory capital ratios. As of December 31, 2006, the Company owed $5,000,000 under this line of credit and was in compliance with all financial covenants.

Through its acquisition of First Commerce, the Company acquired a statutory business trust, First Commerce Capital Trust I, created by First Commerce in 2001 to facilitate the issuance of a $5,000,000 trust preferred security through a pooled trust preferred securities offering. This security, bearing a variable interest rate based on the sixty-day LIBOR plus 375 basis points, with maturity in 2031, was called on December 8, 2006.

13. MATURITIES OF TIME DEPOSITS

Principal maturities of the Bank’s time deposits as of December 31, 2006 are as follows:

Year	Maturities
2007	$	392,951,781
2008		28,716,388
2009		14,439,277
2010		13,631,754
Total	$	449,739,200

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14. RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Basic EPS excludes the dilutive effect that could occur if any securities or other contracts to issue common stock were exercised or converted into or resulted in the issuance of common stock. Diluted EPS is computed by dividing net income by the sum of the weighted average number of common shares outstanding for the period plus the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. Options to purchase 46,064, 59,590 and 57,325 common shares were excluded from the computation of diluted net income per share for the years ended December 31, 2006, 2005 and 2004, respectively, because the options’ exercise prices were greater than the average market price of common shares. Following is the reconciliation of EPS for the years ended December 31, 2006, 2005 and 2004.

	2006		2005		2004
BASIC EARNINGS PER SHARE
Net income	$	18,032,029	$	15,009,544	$	12,718,220
Divide by: Weighted average shares outstanding		16,048,439		16,413,742		16,849,526
Basic earnings per share	$	1.12	$	0.91	$	0.75
DILUTED EARNINGS PER SHARE
Net income	$	18,032,029	$	15,009,544	$	12,718,220
Divide by: Weighted average shares outstanding		16,048,439		16,413,742		16,849,526
Potentially dilutive effect of stock options		55,579		55,305		62,393
Weighted average shares outstanding, including potentially dilutive effect of stock options		16,104,018		16,469,047		16,911,919
Diluted earnings per share	$	1.12	$	0.91	$	0.75

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15. REGULATION AND REGULATORY RESTRICTIONS

The Company is regulated by the Board of Governors of the Federal Reserve System (“FRB”) and is subject to securities registration and public reporting regulations of the Securities and Exchange Commission. The Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”), the North Carolina State Banking Commission and the FRB.

The primary source of funds for the payment of dividends by the Company is dividends received from its subsidiaries, the Bank and Granite Mortgage. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. As of December 31, 2006, the Bank had undivided profits, as defined, of $101,574,587.

The Bank is 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 direct material effect on the Bank’s assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. 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 I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Company and the Bank meet all capital adequacy requirements to which it is subject.

As of December 31, 2006, the most recent regulatory notifications categorized both the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. Management is not aware of conditions or events subsequent to such notifications that would cause a change in the Company’s or the Bank’s capital categories.

The Company’s actual capital amounts and ratios are also presented in the table:

											To Be Well
											Capitalized
											Under Prompt
						For Capital					Corrective
						Adequacy					Action
	Actual					Purposes					Provisions
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2006
Total capital to risk weighted assets	$	148,898		15.05	%	$	79,154		8.00	%	$	98,943		10.00	%
Tier I capital to risk weighted assets		136,363		13.78	%		39,577		4.00	%		59,366		6.00	%
Tier I capital to average assets		136,363		11.56	%		47,173		4.00	%		58,966		5.00	%
As of December 31, 2005
Total capital to risk weighted assets	$	146,290		16.10	%	$	72,694		8.00	%	$	90,868		10.00	%
Tier I capital to risk weighted assets		134,797		14.83	%		36,347		4.00	%		54,521		6.00	%
Tier I capital to average assets		134,797		12.37	%		43,597		4.00	%		54,496		5.00	%

The average reserve balance required to be maintained under the requirements of the Federal Reserve was approximately $6,280,000 for the year ended December 31, 2006. The Bank maintained average reserve balances in excess of the requirements.

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16. ADOPTION OF STAFF ACCOUNTING BULLETIN NUMBER 108

The Company adopted SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, during the year ended December 31, 2006. Traditionally, there have been two widely recognized methods for quantifying the effect of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year’s errors on the income statement. The Company has previously used the roll-over method for quantifying identified financial statement misstatements.

SAB 108 establishes an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods.

SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been used or (ii) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities with an offsetting adjustment recorded to the opening balance of retained earnings. Use of the “cumulative effect” transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment, and how and when it arose.

The Company historically recorded its cash dividends on a cash basis and should have recorded them on an accrual basis. The adjustment recorded as of January 1, 2006 was $1,807,501. The Company elected to use the cumulative effect transition method in connection with the preparation of its financial statements for the year ending December 31, 2006. The company evaluated this error under the roll-over method and concluded it was immaterial.

17. PARENT COMPANY CONDENSED FINANCIAL INFORMATION

Condensed financial data for Bank of Granite Corporation (parent company only) follows:

	December 31,
Condensed Balance Sheets	2006		2005
Assets:
Cash on deposit with bank subsidiary	$	34,436,675	$	31,622,272
Investment in subsidiary bank at equity		137,242,831		129,398,857
Investment in subsidiary mortgage bank at equity		6,394,216		6,014,733
Other investments		4,858,767		4,662,545
Other assets		254,987		246,935
Total	$	183,187,476	$	171,945,342
Liabilities and Stockholders’ Equity:
Other borrowings	$	34,662,145	$	31,790,353
Other liabilities		2,091,827		306,998
Stockholders’ equity		146,433,504		139,847,991
Total	$	183,187,476	$	171,945,342

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	For the Years Ended December 31,
Condensed Results of Operations	2006			2005			2004
Equity in earnings of subsidiary bank:
Dividends	$	11,210,739		$	15,576,244		$	15,353,514
Earnings retained		7,755,466			(272,183	)		(2,459,608	)
Equity in earnings of subsidiary mortgage bank:
Dividends		—			203,360			853,005
Earnings retained		400,671			118,103			(318,375	)
Income (expenses), net		(1,334,847	)		(615,980	)		(710,316	)
Net income	$	18,032,029		$	15,009,544		$	12,718,220
Condensed Cash Flow
Cash flows from operating activities:
Net income	$	18,032,029		$	15,009,544		$	12,718,220
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(8,156,138	)		154,079			2,777,983
Stock-based compensation expense		21,016			—			—
Premium amortization and discount accretion, net		(2,315	)		(2,248	)		(2,090	)
Gains on sales or calls of securities available for sale		(117,557	)		(147,323	)		—
Decrease (increase) in interest receivable		4,196			—			(711	)
Increase in interest payable		910			—			—
Decrease (increase) in other assets		(3,800	)		69,950			637,544
Increase (decrease) in other liabilities		(299,174	)		118,788			31,562
Net cash provided by operating activities		9,479,167			15,202,790			16,162,508
Cash flows from investing activities:
Proceeds from maturities of securities available for sale		398,118			4,122			204,089
Proceeds from sales of securities available for sale		484,913			280,319			—
Purchases of securities available for sale		(895,027	)		(100,000	)		(700,000	)
Net cash provided (used) by investing activities		(11,996	)		184,441			(495,911	)
Cash flows from financing activities:
Net increase in overnight borrowings		2,871,792			2,962,798			6,411,501
Net proceeds from issuance of common stock		615,199			164,396			933,748
Net dividends paid		(7,485,134	)		(6,979,081	)		(6,621,140	)
Purchases of common stock for treasury		(2,643,410	)		(8,092,457	)		(7,439,376	)
Cash paid for fractional shares		(11,215	)		—			—
Net cash used by financing activities		(6,652,768	)		(11,944,344	)		(6,715,267	)
Net increase in cash		2,814,403			3,442,887			8,951,330
Cash at beginning of year		31,622,272			28,179,385			19,228,055
Cash at end of year	$	34,436,675		$	31,622,272		$	28,179,385
Supplemental disclosure of non-cash transactions:
Cash paid during the year for:
Interest paid	$	1,328,081		$	670,835		$	555,572
Transfer from surplus to common stock due to stock split		3,783,591			—			—

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18. COMMITMENTS AND CONTINGENCIES

The Company’s subsidiaries are parties to financial instruments in the ordinary course of business. The Bank routinely enters into commitments to extend credit and issues standby letters of credit in order to meet the financing needs of its customers. Beginning in late 2002, Granite Mortgage entered into forward commitments and options to sell mortgage-backed securities in an effort to reduce its exposure to interest rate risk resulting from a change in its process of managing its production of mortgage loan originations. The following table presents the contractual or notional amount of these financial instruments as of the dates indicated.

	December 31,
	2006		2005
Financial instruments whose contract amounts represent credit risk
Commitments to extend credit	$	175,874,722	$	158,256,508
Standby letters of credit		5,911,050		3,273,905
Financial instruments whose notional or contract amounts are intended to hedge against interest rate risk
Forward commitments and options to sell mortgage-backed securities	$	9,030,913	$	12,348,187

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.

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.

Forward commitments and options to sell mortgage-backed securities are contracts for delayed delivery of securities in which Granite Mortgage agrees to make delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in the underlying securities’ values and interest rates.

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.

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19. 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. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price if one exists. The following estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

	December 31, 2006				December 31, 2005
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Assets:
Cash and cash equivalents	$	49,981,255	$	49,981,255	$	57,481,919	$	57,481,919
Marketable securities		169,566,168		170,332,477		153,682,706		154,832,437
Loans		896,704,622		892,835,083		818,523,264		813,681,236
Mortgage loans held for sale		11,796,899		12,019,532		14,219,444		14,219,444
Liabilities:
Demand deposits		514,097,492		514,097,492		475,633,396		475,633,396
Time deposits		449,739,200		449,258,732		403,478,029		401,968,659
Overnight borrowings		31,152,468		31,152,468		27,737,643		27,737,643
Other borrowings		43,687,183		43,267,469		49,675,003		49,506,400
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit		—		175,874,722		—		158,256,508
Standby letters of credit		—		5,911,050		—		3,273,905

The book values of cash and due from banks, federal funds sold, interest-bearing deposits, accrued interest receivable, overnight borrowings, 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 marketable securities is based on quoted market prices, dealer quotes and prices obtained from independent pricing services. The fair value of loans, 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.

No adjustment was made to the entry-value interest rates for changes in credit of loans for which there are no known credit concerns. Management segregates loans in appropriate risk categories. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the loan portfolio for which there are no known credit concerns, result in a fair valuation of such loans on an entry-value basis.

Demand deposits are shown at their face value.

The fair values of derivatives are obtained from dealer quotes with whom Granite Mortgage does business.

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20. DERIVATIVE FINANCIAL INSTRUMENTS

The Company’s mortgage banking subsidiary, Granite Mortgage, uses two types of financial instruments to manage interest rate risk. These instruments, commonly referred to as derivatives, consists of contracts to forward sell mortgage-backed securities and options to forward sell securities. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument. Granite Mortgage uses derivatives primarily to hedge the changes in the cash flows that will be realized from sales of the mortgage loans it generates. The following table sets forth certain information about Granite Mortgage’s derivative financial instruments as of December 31, 2006.

Derivative Financial Instruments

	December 31, 2006
			Estimated
	Notional		Fair
	Amount		Value
Mortgage interest rate lock commitments	$	5,836,250	$	(112,427	)
Forward commitments and options to sell mortgage-backed securities		9,030,913		12,311
Total	$	14,867,163	$	(100,116	)

The notional amount of forward commitments and options to sell mortgaged-backed securities was $12,348,187 with an estimated fair value included in other liabilities of $83,865 at December 31, 2005.

Credit risk related to derivatives arises when amounts receivable from a counterparty exceed amounts payable to that counterparty. Because the notional amount of the instrument only serves as a basis for calculating amounts receivable or payable, the risk of loss with any counterparty is limited to a small fraction of the notional amount. Granite Mortgage deals with large institutions with good credit ratings in their derivatives activities. Further, Granite Mortgage has netting arrangements with the dealers with whom it does business. Because of these factors, Granite Mortgage believes its credit risk exposure related to derivative contracts at December 31, 2006 was not material.

21. OPERATING SEGMENTS

The Company’s operations are divided into three reportable business segments: Community Banking, Mortgage Banking and Other. These operating segments have been identified based on the Company’s organizational structure. The segments require unique technology and marketing strategies and offer different products and services. While the Company is managed as an integrated organization, individual executive managers are held accountable for the operations of these business segments.

The Company measures and presents information for internal reporting purposes in a variety of different ways. Information for the Company’s reportable segments is available based on organizational structure, product offerings and customer relationships. The internal reporting system presently utilized by management in the planning and measuring of operating activities, as well as the system to which most managers are held accountable, is based on organizational structure.

The Company emphasizes revenue growth by focusing on client service, sales effectiveness and relationship management. The segment results contained herein are presented based on internal management accounting policies that were designed to support these strategic objectives. Unlike financial accounting, there is no comprehensive authoritative body of guidance for management accounting equivalent to generally accepted accounting principles. Therefore, the performance of the segments is not necessarily comparable with the Company’s consolidated results or with similar information presented by other financial institutions. Additionally, because of the interrelationships of the various segments, the information presented is not indicative of how the segments would perform if they operated as independent entities.

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COMMUNITY BANKING

The Company’s Community Banking segment serves individual and business customers by offering a variety of loan and deposit products and other financial services.

MORTGAGE BANKING

The Mortgage Banking segment originates, retains and sells mortgage loans. Mortgage loan products include fixed-rate and adjustable-rate government and conventional loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. Mortgage loans are typically sold to other financial institutions and government agencies. The Mortgage Banking segment earns interest on loans held in its warehouse and in its portfolio, earns fee income from originations and recognizes gains or losses from the sale of mortgage loans.

OTHER

The Company’s Other segment represents primarily treasury and administration activities. Included in this segment are certain investments and commercial paper issued to the Bank’s commercial sweep account customers.

The following table presents selected financial information for reportable business segments for the years ended December 31, 2006, 2005 and 2004.

	2006			2005			2004
COMMUNITY BANKING
Net interest income	$	52,561,122		$	45,156,254		$	38,754,743
Provision for loan losses		6,365,509			5,157,902			5,431,160
Noninterest income		8,414,578			7,773,274			7,413,753
Noninterest expense		26,031,199			24,803,256			22,057,715
Income before income taxes		28,578,992			22,968,370			18,679,621
Net income		18,966,205			15,304,061			12,893,906
Identifiable segment assets		1,166,170,945			1,074,552,282			991,369,653
MORTGAGE BANKING
Net interest income		3,225,374			3,186,195			3,673,497
Provision for loan losses		48,000			36,000			8,000
Noninterest income		3,974,980			3,990,690			3,844,297
Noninterest expense		6,484,571			6,605,195			6,618,572
Income before income taxes		667,783			535,690			891,222
Net income		400,671			321,463			534,630
Identifiable segment assets		28,557,035			27,522,124			36,326,380
ALL OTHER
Net interest expense		(1,022,943	)		(356,519	)		(270,336	)
Noninterest income		117,557			147,323			(1,327	)
Noninterest expense		429,461			406,784			438,653
Loss before income taxes		(1,334,847	)		(615,980	)		(710,316	)
Net loss		(1,334,847	)		(615,980	)		(710,316	)
Identifiable segment assets		5,044,493			4,649,616			4,542,416
TOTAL SEGMENTS
Net interest income		54,763,553			47,985,930			42,157,904
Provision for loan losses		6,413,509			5,193,902			5,439,160
Noninterest income		12,507,115			11,911,287			11,256,723
Noninterest expense		32,945,231			31,815,235			29,114,940
Income before income taxes		27,911,928			22,888,080			18,860,527
Net income		18,032,029			15,009,544			12,718,220
Identifiable segment assets		1,199,772,473			1,106,724,022			1,032,238,449

* * * * *

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22. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

BANK OF GRANITE CORPORATION AND SUBSIDIARIES

SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
YEARS ENDED DECEMBER 31, 2006 AND 2005

2006	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Interest income	$	19,739,945	$	21,484,708	$	22,445,968	$	22,871,162
Interest expense		6,621,011		7,516,259		8,652,585		8,988,375
Net interest income		13,118,934		13,968,449		13,793,383		13,882,787
Provision for loan losses		1,235,012		1,914,540		1,387,678		1,876,279
Net interest income after provision for loan losses		11,883,922		12,053,909		12,405,705		12,006,508
Other income		3,001,256		3,293,910		3,184,070		3,027,879
Other expense		8,043,318		8,384,795		8,488,501		8,028,617
Income before income taxes		6,841,860		6,963,024		7,101,274		7,005,770
Income taxes		2,395,034		2,501,003		2,519,079		2,464,783
Net income	$	4,446,826	$	4,462,021	$	4,582,195	$	4,540,987
Net income per share
Basic*	$	0.28	$	0.28	$	0.29	$	0.28
Diluted*		0.28		0.28		0.29		0.28
Average shares outstanding
Basic*		16,097,986		16,057,941		16,017,290		16,021,912
Diluted*		16,152,821		16,107,931		16,071,740		16,081,234

2005	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Interest income	$	14,961,878	$	16,313,361	$	17,894,355	$	18,989,480
Interest expense		4,075,652		4,687,864		5,361,342		6,048,286
Net interest income		10,886,226		11,625,497		12,533,013		12,941,194
Provision for loan losses		1,230,119		891,710		1,601,680		1,470,393
Net interest income after provision for loan losses		9,656,107		10,733,787		10,931,333		11,470,801
Other income		2,457,747		3,152,370		3,337,711		2,963,459
Other expense		7,314,624		7,936,945		7,898,217		8,665,449
Income before income taxes		4,799,230		5,949,212		6,370,827		5,768,811
Income taxes		1,613,993		2,041,182		2,231,423		1,991,938
Net income	$	3,185,237	$	3,908,030	$	4,139,404	$	3,776,873
Net income per share
Basic*	$	0.19	$	0.24	$	0.25	$	0.23
Diluted*		0.19		0.24		0.25		0.23
Average shares outstanding
Basic*		16,606,046		16,479,468		16,334,298		16,239,930
Diluted*		16,653,464		16,527,053		16,391,776		16,295,485

The quarterly financial data may not aggregate to annual amounts due to rounding.
*	Amounts reflect the 5-for-4 stock split distributed September 25, 2006.

ITEM 9 — CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no disagreements with accountants on accounting and financial disclosures as described in Item 304 of Regulation S-K.

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ITEM 9A — CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in its periodic reports filed with the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. In addition, no change in the Company’s internal control over financial reporting has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Bank of Granite Corporation and subsidiaries (the Company) is responsible for preparing the Company’s annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting for the Company. Management has evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2006.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s registered public accounting firm that audited the Company’s consolidated financial statements included in this annual report has issued an attestation report on management’s assessment of internal control over financial reporting.

Management is also responsible for compliance with laws and regulations relating to safety and soundness, which are designated by the FDIC and the appropriate federal banking agency. Management assessed its compliance with these designated laws and regulations relating to safety and soundness and believes that the Company complied, in all significant respects, with such laws during the year ended December 31, 2006.

/s/ Bank of GraniteBANK OF GRANITE CORPORATION

Granite Falls, North Carolina

March 9, 2007

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Bank of Granite Corporation
Granite Falls, North Carolina

We have audited management’s assessment, included in the accompanying Management’s Annual Report On Internal Control Over Financial Reporting, that Bank of Granite Corporation and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because management’s assessment and our audit were conducted to also meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management’s assessment and our audit of the Company’s internal control over financial reporting included controls over the preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (form FR Y-9 C). A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

72

In our opinion, management’s assessment that Bank of Granite Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, Bank of Granite Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Bank of Granite Corporation as of and for the year ended December 31, 2006, and our report dated March 9, 2007, expressed an unqualified opinion on those consolidated financial statements.

We do not express an opinion or any other form of assurance on management’s statement referring to compliance with designated laws and regulations related to safety and soundness.

/s/ Dixon Hughes PLLC

DIXON HUGHES PLLC

Charlotte, North Carolina

March 9, 2007

ITEM 9B — OTHER INFORMATION

Not applicable.

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PART III

ITEM 10 — DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item is set forth in the definitive proxy materials of the Company filed in connection with its 2007 ANNUAL MEETING OF STOCKHOLDERS, under the captions “Information About the Board of Directors and Committees of the Board,” “Directors/Nominees and Nondirector Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Ethics Policy.” The information required by this item contained in such definitive proxy materials is incorporated herein by reference.

ITEM 11 — EXECUTIVE COMPENSATION

The information required by this item is set forth in the definitive proxy materials of the Company filed in connection with its 2007 ANNUAL MEETING OF STOCKHOLDERS, under the captions “Summary Compensation Table,” “Option/SAR Grants in Last Fiscal Year,” “Aggregated Option Exercises in Last Fiscal Year and Last Fiscal Year-end Option Values,” “Securities Authorized for Issuance Under Equity Compensation Plans,” “Change-of-Control Agreements and Employment Contracts,” and “Compensation Committee Report on Executive Officer Compensation.” The information required by this item contained in such definitive proxy materials is incorporated herein by reference.

ITEM 12 — SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is set forth in the definitive proxy materials of the Company filed in connection with its 2007 ANNUAL MEETING OF STOCKHOLDERS, under the captions “Principal Holders of Voting Securities,” “Directors/Nominees and Nondirector Executive Officers” and “Securities Authorized for Issuance Under Equity Compensation Plans” and “Change-of-Control Agreements and Employment Contracts.” The information required by this item contained in such definitive proxy materials is incorporated herein by reference.

ITEM 13 — CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information required by this item is set forth in the definitive proxy materials of the Company filed in connection with its 2007 ANNUAL MEETING OF STOCKHOLDERS, under the caption “Transactions With Officers and Directors.” The information required by this item contained in such definitive proxy materials is incorporated herein by reference.

ITEM 14 — PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is set forth in the definitive proxy materials of the Company filed in connection with its 2007 ANNUAL MEETING OF STOCKHOLDERS, under the caption “Ratification of Selection of Accountants.” The information required by this item contained in such definitive proxy materials is incorporated herein by reference.

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PART IV

ITEM 15 — EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

• Exhibits incorporated by reference into this filing were filed with the Securities and Exchange Commission. Bank of Granite Corporation provides these documents through its Internet site at www.bankofgranite.com or by mail upon request to Investor Relations, Bank of Granite Corporation, P.O. Box 128, Granite Falls, North Carolina 28630.

(a)1.	Financial Statements
	The information required by this item is set forth under Item 8.
2.	Financial Statement Schedules
	The information required by this item is set forth in the “Notes to Consolidated Financial Statements” under Item 8.
3.	Exhibits
3.1	Certificate of Incorporation
	Bank of Granite Corporation’s Restated Certificate of Incorporation, as amended, filed as Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 is incorporated herein by reference.
3.2	Bylaws of the Registrant
	Bank of Granite Corporation’s Bylaws, filed as Exhibit 3.2 to the Registrant’s Registration Statement on Form S-4 (Registration Statement No. 333-104233) on April 1, 2003 is incorporated herein by reference.
4.	Instruments defining the rights of holders
4.1	Form of stock certificate for Bank of Granite Corporation’s common stock, filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-4 (Registration Statement No. 333-104233) on 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, as amended, are included in Exhibit 3.1.
10.	Material Contracts
10.1	Bank of Granite Employees’ Profit Sharing Plan and Trust, as amended, filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-8 (Registration Statement No. 333-102383) on January 7, 2003, is incorporated herein by reference.
10.2	Bank of Granite Supplemental Executive Retirement Plan filed as Exhibit 10.2. to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 is incorporated herein by reference.**
10.3	Bank of Granite Corporation’s 1997 Incentive Stock Option Plan, filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-8 (Registration Statement No. 333-29157) on June 13, 1997 is incorporated herein by reference.**

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10.4.	Amended and Restated Employment and Noncompetition Agreement, dated May 1, 2003, between GLL & Associates, Inc and Gary L Lackey filed as Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 is incorporated herein by reference.**
10.5	Bank of Granite Corporation’s 2001 Incentive Stock Option Plan, filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-8 (Registration Statement No. 333-61640) on May 25, 2001 is incorporated herein by reference.**
10.7	Executive Supplemental Retirement Plan Executive Agreement, dated November 15, 2001, between the Bank and Charles M. Snipes filed as Exhibit 10.7 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by reference.**
10.8	Executive Supplemental Retirement Plan Executive Agreement, dated November 15, 2001, between the Bank and Kirby A. Tyndall filed as Exhibit 10.8 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by reference.**
10.9	Executive Supplemental Retirement Plan Executive Agreement, dated March 30, 2005 between the Bank and R. Scott Anderson filed as Exhibit 10.9 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 is incorporated herein by reference.**
10.10	Change of Control Agreement, dated January 1, 2002, between the Company and Charles M. Snipes filed as Exhibit 10.10 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by reference.**
10.11	Change of Control Agreement, dated January 1, 2002, between the Company and Kirby A. Tyndall filed as Exhibit 10.11 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by reference.**
10.12	Change of Control Agreement, dated June 22, 2004, between the Company and R. Scott Anderson filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 is incorporated herein by reference.**
10.13	Written Description of Director Compensation pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K, of the Registrant’s Current Report on Form 8-K, dated April 17, 2006, is incorporated herein by reference.**
10.14	Written Description of Executive Officer Compensation pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K of the Registrant’s Current Report on Form 8-K, dated December 18, 2006, is incorporated herein by reference.**
10.15	Consulting Agreement, dated December 19, 2005, between the Bank and John A. Forlines, Jr. filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated December 19, 2005, is incorporated herein by reference.
10.16	Change of Control Agreement, dated January 1, 2002, between the Company and D. Mark Stephens.**
10.17	Executive Supplemental Retirement Plan Executive Agreement, dated January 26, 2002, Amended December 29, 2005, between the Bank and D. Mark Stephens.**

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14.	Ethics Policy, dated March 8, 2004, filed as Exhibit 14 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 is incorporated herein by reference.
21.	Subsidiaries of the Registrant
	The information required by this item is also set forth under Item 8, Note 1, “Summary of Significant Accounting Policies.”
23.1	Consent of Dixon Hughes PLLC
23.2	Consent of Deloitte & Touche LLP
31.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, 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

** Management Compensatory plan or arrangement

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

BANK OF GRANITE CORPORATION
By:	/s/ Charles M. Snipes
	Charles M. Snipes
	Chairman and Chief Executive Officer
	March 15, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Charles M. SnipesCharles M. Snipes	Chairman and Chief Executive Officer	March 15, 2007
/s/ Kirby A. Tyndall	Secretary, Treasurer,	March 15, 2007
Kirby A. Tyndall	Chief Financial Officer and Principal Accounting Officer
/s/ John N. BrayJohn N. Bray	Director	March 15, 2007
/s/ Joseph D. CrockerJoseph D. Crocker	Director	March 15, 2007
/s/ Leila N. ErwinLeila N. Erwin	Director	March 15, 2007
/s/ Paul M. Fleetwood, IIIPaul M. Fleetwood, III	Director	March 15, 2007
/s/ Hugh R. GaitherHugh R. Gaither	Director	March 15, 2007
/s/ James Y. PrestonJames Y. Preston	Director	March 15, 2007
/s/ Charles M. SnipesCharles M. Snipes	Director	March 15, 2007
/s/ Boyd C. Wilson, Jr.Boyd C. Wilson, Jr.	Director	March 15, 2007

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Bank of Granite Corporation

Exhibit Index

		Begins
Exhibit		on Page
3.1	Bank of Granite Corporation’s Certificate of Incorporation	*
3.2	Bank of Granite Corporation’s Bylaws	*
4.1	Form of stock certificate	*
4.2	Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation	*
10.1	Bank of Granite Employees’ Profit Sharing Plan and Trust	*
10.2	Bank of Granite Supplemental Executive Retirement Plan**	*
10.3	Bank of Granite Corporation’s 1997 Incentive Stock Option Plan	*
10.4	Amended and Restated Employment and Noncompetition Agreement between GLL & Associates, Inc. and Gary L. Lackey**	*
10.5	Bank of Granite Corporation’s 2001 Incentive Stock Option Plan**	*
10.7	Executive Supplemental Retirement Plan Executive Agreement between the Bank and Charles M. Snipes**	*
10.8	Executive Supplemental Retirement Plan Executive Agreement between the Bank and Kirby A. Tyndall**	*
10.9	Executive Supplemental Retirement Plan Executive Agreement between the Bank and R. Scott Anderson**	*
10.10	Change of Control Agreement between the Company and Charles M. Snipes**	*
10.11	Change of Control Agreement between the Company and Kirby A. Tyndall**	*
10.12	Change of Control Agreement between the Company and R. Scott Anderson**	*
10.13	Written Description of Director Compensation**	*
10.14	Written Description of Executive Officer Compensation**	*
10.15	Consulting Agreement between the Company and John A. Forlines, Jr.	*
10.16	Change of Control Agreement between the Company and D. Mark Stephens**	Filed herewith
10.17	Amended Executive Supplemental Retirement Plan Executive Agreement between the Bank and D. Mark Stephens**	Filed herewith
14	Ethics Policy	*
21	Subsidiaries of the Registrant	Filed herewith
23.1	Consent of Independent Auditors	Filed herewith
23.2	Consent of Independent Auditors	Filed herewith
31.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002	Filed herewith
31.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, 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
**	Management compensatory plan or arrangement

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