Bank Of Granite 10-Q 2008 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2008

OR

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

For the transition period from                    to                    

Commission file 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)
Post Office Box 128, Granite Falls, N.C.	28630
(Address of principal executive offices)	(Zip Code)

(828) 496-2000

(Registrant’s telephone number, including area code)

(Former name, former address and former
fiscal year, if changed since last report)

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common stock, $1 par value
15,454,841 shares outstanding as of October 31, 2008

Exhibit Index begins on page 43

Index

	Begins
	on Page
Part I — Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets September 30, 2008 and December 31, 2007		3
Condensed Consolidated Statements of Income Three Months Ended September 30, 2008 and 2007 And Nine Months Ended September 30, 2008 and 2007		4
Condensed Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2008 and 2007 And Nine Months Ended September 30, 2008 and 2007		5
Condensed Consolidated Statements of Changes in Stockholders’ Equity Nine Months Ended September 30, 2008 and 2007		6
Condensed Consolidated Statements of Cash Flows Nine Months Ended September 30, 2008 and 2007		7
Notes to Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		37
Item 4. Controls and Procedures		38
Part II — Other Information
Item 1A. Risk Factors		40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		40
Item 6. Exhibits		41
Signatures		42
Exhibit Index		43
EX-31.1
EX-31.2
EX-32.1
EX-32.2

2

Item 1. Financial Statements

Bank of Granite Corporation

Condensed Consolidated Balance Sheets
   (in thousands except per share data)

	September 30,			December 31,
	2008			2007
	(Unaudited)			(Note 1)
Assets:
Cash and cash equivalents:
Cash and due from banks	$	31,094		$	29,905
Interest-bearing deposits		3,414			3,419
Federal funds sold		4,600			—
Total cash and cash equivalents		39,108			33,324
Investment securities:
Available for sale, at fair value		61,023			112,966
Held to maturity, at amortized cost		23,632			29,656
Loans		951,665			946,326
Allowance for loan losses		(21,553	)		(17,673	)
Net loans		930,112			928,653
Mortgage loans held for sale		14,688			15,319
Premises and equipment, net		19,309			15,462
Accrued interest receivable		5,153			6,949
Investment in bank owned life insurance		30,985			30,090
Intangible assets		10,921			10,969
Other assets		24,986			35,760
Total assets	$	1,159,917		$	1,219,148
Liabilities and stockholders’ equity:
Deposits:
Demand accounts	$	128,811		$	143,945
NOW accounts		138,601			130,354
Money market accounts		213,736			242,872
Savings accounts		21,038			21,169
Time deposits of $100 or more		207,928			208,271
Other time deposits		259,058			225,378
Total deposits		969,172			971,989
Overnight and short-term borrowings		53,172			100,190
Long-term borrowings		16,583			17,607
Accrued interest payable		2,366			3,212
Other liabilities		9,951			10,885
Total liabilities		1,051,244			1,103,883
Stockholders’ equity:
Common stock, $1.00 par value per share
Authorized - 25,000 shares;
Issued - 18,981 shares in 2008 and 18,965 shares in 2007;
Outstanding - 15,454 shares in 2008 and 15,438 shares in 2007		18,981			18,965
Capital surplus		30,176			30,053
Retained earnings		112,261			118,196
Accumulated other comprehensive loss, net of deferred income taxes		(893	)		(97	)
Less: Cost of common stock in treasury; 3,527 shares in 2008 and 3,527 shares in 2007		(51,852	)		(51,852	)
Total stockholders’ equity		108,673			115,265
Total liabilities and stockholders’ equity	$	1,159,917		$	1,219,148

See notes to condensed consolidated financial statements.

3

Bank of Granite Corporation

Condensed Consolidated Statements of Income
   (unaudited — in thousands except per share data)

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2008			2007			2008			2007
Interest income:
Interest and fees from loans	$	14,276		$	18,750		$	45,152		$	57,805
Interest and fees from mortgage banking		1,017			1,289			3,461			3,709
Federal funds sold		21			22			46			92
Interest-bearing deposits		67			72			326			214
Investments:
U.S. Treasury		43			43			129			129
U.S. Government agencies		471			1,198			1,738			3,649
States and political subdivisions		315			380			1,018			1,212
Other		157			150			473			437
Total interest income		16,367			21,904			52,343			67,247
Interest expense:
Time deposits of $100 or more		2,031			2,557			6,837			7,478
Other time and savings deposits		4,084			5,849			13,373			17,216
Overnight and short-term borrowings		588			795			1,915			2,377
Long-term borrowings		178			186			557			468
Total interest expense		6,881			9,387			22,682			27,539
Net interest income		9,486			12,517			29,661			39,708
Provision for loan losses		3,581			42,737			13,437			52,125
Net interest income (loss) after provision for loan losses		5,905			(30,220	)		16,224			(12,417	)
Other income:
Service charges on deposit accounts		1,416			1,500			4,269			4,308
Other service fees and commissions		198			162			557			650
Mortgage banking income		862			1,033			2,891			3,000
Securities losses		(711	)		—			(649	)		—
Other		729			498			1,807			1,686
Total other income		2,494			3,193			8,875			9,644
Other expenses:
Salaries and wages		4,208			4,224			13,574			12,531
Employee benefits		66			1,138			2,497			3,732
Occupancy expense, net		585			610			1,854			1,837
Equipment expense		639			578			1,926			1,687
Other		3,277			2,830			8,992			6,718
Total other expenses		8,775			9,380			28,843			26,505
Loss before income tax benefit		(376	)		(36,407	)		(3,744	)		(29,278	)
Income tax benefit		(105	)		(14,391	)		(1,826	)		(12,043	)
Net loss	$	(271	)	$	(22,016	)	$	(1,918	)	$	(17,235	)
Per share amounts:
Net loss — Basic	$	(0.02	)	$	(1.40	)	$	(0.12	)	$	(1.09	)
Net loss — Diluted		(0.02	)		(1.40	)		(0.12	)		(1.09	)
Cash dividends		—			0.13			0.26			0.39
Book value								7.03			7.48
Tangible book value								6.33			6.77

See notes to condensed consolidated financial statements.

4

Bank of Granite Corporation

Condensed Consolidated Statements of Comprehensive Income
   (unaudited — in thousands)

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2008			2007			2008			2007
Net losses	$	(271	)	$	(22,016	)	$	(1,918	)	$	(17,235	)
Items of other comprehensive income:
Items of other comprehensive income (loss), before tax:
Unrealized gains (losses) on securities available for sale		(179	)		987			(670	)		967
Reclassification adjustment for securities losses included in net income		(716	)		—			(654	)		—
Unrealized gains on mortgage derivative instruments		—			—			—			100
Other comprehensive income (loss), before tax		(895	)		987			(1,324	)		1,067
Change in deferred income taxes related to change in unrealized gains or losses on securities available for sale		357			(394	)		528			(385	)
Change in deferred income taxes related to change in unrealized gains or losses on mortgage derivative instruments		—			—			—			(40	)
Items of other comprehensive income (loss), net of tax		(538	)		593			(796	)		642
Comprehensive loss	$	(809	)	$	(21,423	)	$	(2,714	)	$	(16,593	)

See notes to condensed consolidated financial statements.

5

Bank of Granite Corporation

Condensed Consolidated Statements of Changes in Stockholders’ Equity
   (unaudited — in thousands except per share data)

	Nine Months
	Ended September 30,
	2008			2007
Common stock, $1.00 par value per share
At beginning of period	$	18,965		$	18,922
Par value of shares issued under stock option plan		16			43
At end of period		18,981			18,965
Capital surplus
At beginning of period		30,053			29,524
Surplus of shares issued under stock option plan		104			456
Stock-based compensation expense		11			11
Tax benefit from nonqualifying dispositions of stock options		8			58
At end of period		30,176			30,049
Retained earnings
At beginning of period		118,196			141,662
Net losses		(1,918	)		(17,235	)
Dividends		(4,017	)		(6,162	)
At end of period		112,261			118,265
Accumulated other comprehensive loss, net of deferred income taxes
At beginning of period		(97	)		(974	)
Net change in unrealized gains or losses on securities available for sale, net of deferred income taxes		(796	)		582
Net change in unrealized gains or losses on mortgage derivative instruments, net of deferred income taxes		—			60
At end of period		(893	)		(332	)
Cost of common stock in treasury
At beginning of period		(51,852	)		(42,701	)
Cost of common stock repurchased		—			(8,134	)
At end of period		(51,852	)		(50,835	)
Total stockholders’ equity	$	108,673		$	116,112
Shares issued
At beginning of period		18,965			18,922
Shares issued under stock option plan		16			43
At end of period		18,981			18,965
Common shares in treasury
At beginning of period		(3,527	)		(2,899	)
Common shares repurchased		—			(545	)
At end of period		(3,527	)		(3,444	)
Total shares outstanding		15,454			15,521

See notes to condensed consolidated financial statements.

6

Bank of Granite Corporation

Condensed Consolidated Statements of Cash Flows
   (unaudited — in thousands)

	Nine Months
	Ended September 30,
	2008			2007
Increase (decrease) in cash & cash equivalents:
Cash flows from operating activities:
Net losses	$	(1,918	)	$	(17,235	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		1,433			1,230
Provision for loan losses		13,437			52,125
Stock-based compensation expense		11			11
Investment security premium amortization, net		158			153
Acquisition premium amortization, net		37			64
Deferred income taxes		(2,206	)		(1,594	)
Losses on sales or calls of securities available for sale		5			—
Gains on calls of securities held to maturity		(5	)		—
Impairment losses on securities		649			—
Originations of loans held for sale		(201,872	)		(209,689	)
Proceeds from loans held for sale		205,105			208,204
Gains on loans held for sale		(2,602	)		(2,146	)
Losses on hedged mortgage loan commitments		—			100
Gains on disposal or sale of equipment		(10	)		(2	)
Losses on disposal or sale of premises		39			—
Losses on disposal or sale of other real estate		613			760
Increase in cash surrender value of bank owned life insurance		(895	)		(739	)
Decrease (increase) in other assets		12,040			(20,468	)
Decrease in taxes payable		—			(583	)
Decrease in accrued interest receivable		1,796			1,482
Decrease in accrued interest payable		(846	)		(146	)
Increase (decrease) in other liabilities		1,073			(1,315	)
Net cash provided by operating activities		26,042			10,212
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of securities available for sale		54,652			9,306
Proceeds from maturities, calls and paydowns of securities held to maturity		6,009			5,565
Proceeds from sales of securities available for sale		275			—
Purchase of securities available for sale		(5,100	)		(759	)
Net increase in loans		(14,909	)		(47,536	)
Investment in bank owned life insurance		—			(1,250	)
Capital expenditures		(5,319	)		(2,597	)
Proceeds from sale of fixed assets		10			9
Proceeds from sale of other real estate		855			296
Net cash provided by (used in) investing activities		36,473			(36,966	)
Cash flows from financing activities:
Net increase (decrease) in demand, NOW, money market and savings deposits		(36,154	)		31,775
Net increase (decrease) in time deposits		33,337			(16,247	)
Net increase (decrease) in overnight and short-term borrowings		(47,018	)		3,825
Net increase (decrease) in long-term borrowings		(1,000	)		2,500
Proceeds from shares issued under stock option plan		120			499
Tax benefit on shares issued under stock option plan		8			58
Dividends paid		(6,024	)		(6,221	)
Purchases of common stock for treasury		—			(8,134	)
Net cash provided by (used in) financing activities		(56,731	)		8,055
Net increase (decrease) in cash equivalents		5,784			(18,699	)
Cash and cash equivalents at beginning of period		33,324			49,981
Cash and cash equivalents at end of period	$	39,108		$	31,282

See notes to condensed consolidated financial statements.

7

Bank of Granite Corporation

Notes to Condensed Consolidated Financial Statements
September 30, 2008
   (unaudited)

1. UNAUDITED FINANCIAL STATEMENTS

Bank of Granite Corporation’s (the “Company’s” or the “Holding Company’s”) condensed consolidated balance sheet as of September 30, 2008, and the condensed consolidated statements of income and comprehensive income for the three and and nine-month periods ended September 30, 2008 and 2007, and the condensed consolidated statements of changes in stockholders’ equity and cash flows for the nine-month periods ended September 30, 2008 and 2007 are unaudited and reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the interim period financial statements. Amounts as of December 31, 2007 included in the condensed consolidated financial statements and related notes were derived from the audited consolidated financial statements.

Certain amounts for the periods ended September 30, 2007 have been reclassified to conform to the presentation for the period ended September 30, 2008.

The unaudited interim condensed consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2007 audited consolidated financial statements and notes thereto included in the Company’s 2007 Annual Report on Form 10-K/A.

The consolidated financial statements include the Company’s two wholly owned subsidiaries, Bank of Granite (the “Bank”), a full service commercial bank, and Granite Mortgage, Inc. (“Granite Mortgage”), a mortgage banking company.

The accounting policies followed are set forth in Note 1 to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2007 on file with the Securities and Exchange Commission. There were no changes in significant accounting policies during the nine months ended September 30, 2008, except as described in Note 7 below.

2. EARNINGS PER SHARE

Earnings per share have been computed using the weighted average number of shares of common stock and potentially dilutive common stock equivalents outstanding as follows:

	Three Months				Nine Months
	Ended September 30,				Ended September 30,
(shares in thousands)	2008		2007		2008		2007
Weighted average shares outstanding		15,454		15,694		15,446		15,879
Potentially dilutive effect of stock options		—		—		—		—
Weighted average shares outstanding, including potentially dilutive effect of stock options		15,454		15,694		15,446		15,879

8

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
   (unaudited)

For the three-month periods ended September 30, 2008 and 2007, 68,000 shares and 115,000 shares, respectively, attributable to outstanding stock options, were excluded from the calculation of diluted earnings per common share because their inclusion would have been anti-dilutive. For the nine-month periods ended September 30, 2008 and 2007, 58,000 shares and 74,000 shares, respectively, attributable to outstanding stock options were excluded from the calculation of diluted earnings per common share because their inclusion would have been anti-dilutive.

3. COMMITMENTS AND CONTINGENCIES

In the normal course of business there are various commitments and contingent liabilities such as commitments to extend credit, which are not reflected on the financial statements. Management does not anticipate any significant losses will result from these transactions. The unfunded portion of loan commitments and standby letters of credit as of September 30, 2008 and December 31, 2007 were as follows:

	September 30,		December 31,
	2008		2007
(in thousands)	(Unaudited)		(Note 1)
Financial instruments whose contract amounts represent credit risk
Unfunded commitments to extend credit	$	174,862	$	202,451
Standby letters of credit		5,357		7,839

The Company’s risk management policy provides for the use of derivatives and financial instruments in managing certain risks. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes.

Managed risk includes the risk associated with changes in interest rates associated with mortgage loans held for sale. Granite Mortgage uses two types of financial instruments to manage risk. These financial instruments, commonly referred to as derivatives, consist 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 for sale.

Granite Mortgage has determined that its derivative financial instruments do not qualify for hedge accounting in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” and as such, the changes in the value of the derivatives are recognized in net income.

Forward commitments and options to sell mortgage-backed securities as of September 30, 2008 and December 31, 2007 were $5.8 million and $7.3 million, respectively.

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.

9

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
  (unaudited)

4. STOCK-BASED COMPENSATION

The Company uses the fair value method 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 $3,000 and $5,000 as pre-tax stock-based employee compensation expense for the third quarters of 2008 and 2007, respectively. The pre-tax stock-based employee compensation expense for each of the nine-month periods ended September 30, 2008 and 2007 was $11,000.

The Company computes its fair value of option compensation expense using The Black Scholes Model. The Company granted 2,500 options during the nine-month period ended September 30, 2008, and 3,000 options during the nine-month period ended September 30, 2007.

The following assumptions were used to compute the expense for the options granted during the nine-month periods ended September 30, 2008 and September 30, 2007:

	Nine Months
	Ended September 30,
	2008			2007
Option value, aggregate	$	2.81		$	4.50
Risk-free rate		3.50	%		4.93	%
Average expected term (years)	5.5 years			5.5 years
Expected volatility		34.41	%		33.39	%
Expected dividend yield		3.42	%		2.98	%
Expected turnover		8.76	%		8.80	%

5. GOODWILL AND INTANGIBLE ASSETS

The Company assesses its goodwill for impairment annually as of May 31 and on an interim basis when circumstances or events warrant. The Company completed its annual assessment as of May 31, 2008 and an interim assessment as of September 30, 2008 due to a decline in its stock price. Neither assessment indicated impairment of goodwill. In its determination of the fair value of the Company’s reporting units, management makes certain judgments and assumptions related to various items, including discount rates, future estimates of operating results, etc. Management believes that the estimates and assumptions used in the goodwill impairment analysis for its business units are reasonable; however, if actual results and market conditions differ from the assumptions or estimates used, the fair value of each reporting unit could be different in the future.

6. SEGMENT DISCLOSURES

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. Although the Company is managed as an integrated organization, individual executive managers are held accountable for the operations of these business segments.

10

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
     (unaudited)

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. The Community Banking segment’s assets include all of the goodwill on the Company’s books.

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 and sells mortgage loan products. 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 administrative activities. Included in this segment are certain investments and commercial paper issued to the Bank’s commercial sweep account customers.

11

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
      (unaudited)

The following table presents selected financial information for reportable business segments as of and for the three and nine-month periods ended September 30, 2008 and 2007.

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
(in thousands)	2008			2007			2008			2007
COMMUNITY BANKING
Net interest income	$	8,871		$	11,863		$	27,417		$	37,886
Provision for loan losses		3,556			42,725			13,376			52,089
Noninterest income		2,348			2,160			6,700			6,644
Noninterest expense		6,878			7,584			23,146			21,328
Income (loss) before income taxes (benefits)		785			(36,286	)		(2,405	)		(28,887	)
Net income (loss)		760			(21,830	)		(602	)		(16,598	)
Identifiable segment assets		1,125,669			1,150,641			1,125,669			1,150,641
MORTGAGE BANKING
Net interest income	$	703		$	857		$	2,541		$	2,498
Provision for loan losses		25			12			61			36
Noninterest income		849			1,033			2,878			3,000
Noninterest expense		1,852			1,715			5,415			4,847
Income (loss) before income taxes		(325	)		163			(57	)		615
Net income (loss)		(195	)		98			(34	)		369
Identifiable segment assets		31,055			33,733			31,055			33,733
OTHER
Net interest expense	$	(88	)	$	(203	)	$	(297	)	$	(676	)
Noninterest income (securities losses)		(703	)		—			(703	)		—
Noninterest expense		45			81			282			330
Loss before income taxes (benefits)		(836	)		(284	)		(1,282	)		(1,006	)
Net loss		(836	)		(284	)		(1,282	)		(1,006	)
Identifiable segment assets		3,193			4,802			3,193			4,802
TOTAL SEGMENTS
Net interest income	$	9,486		$	12,517		$	29,661		$	39,708
Provision for loan losses		3,581			42,737			13,437			52,125
Noninterest income		2,494			3,193			8,875			9,644
Noninterest expense		8,775			9,380			28,843			26,505
Loss before income taxes (benefits)		(376	)		(36,407	)		(3,744	)		(29,278	)
Net loss		(271	)		(22,016	)		(1,918	)		(17,235	)
Identifiable segment assets		1,159,917			1,189,176			1,159,917			1,189,176

12

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
     (unaudited)

7. NEW ACCOUNTING STANDARDS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 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. SFAS No. 157 was originally effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position (“FSP”) SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”). FSP SFAS 157-2, which was effective upon issuance, delayed the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for items recognized or disclosed at fair value at least once a year, to fiscal years beginning after November 15, 2008. FSP SFAS No. 157-2 also covers interim periods within the fiscal years for items within the scope of this FSP. In October 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”), effective upon issuance, which is intended to clarify the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. As discussed in Note 8 below, the Company adopted SFAS No. 157 in the first quarter of 2008, and the adoption did not have a material impact on its consolidated financial statements.

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 SFAS 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 SFAS 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 SFAS No. 106 or APB Opinion No. 12. EITF Issue 06-4 is effective for fiscal years beginning after December 15, 2007. The Company does not provide post-employment death benefits; therefore, the adoption of EITF Issue 06-4 did not impact its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including An Amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits an entity to measure certain financial assets and financial liabilities at fair value. Under SFAS No. 159, entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions, as long as it is applied to the instrument in its entirety, and is irrevocable once the election is made. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company adopted SFAS No. 159 in the first quarter of 2008 and elected not to apply the fair value option to its financial assets and liabilities; therefore, the adoption did not have a material impact on the Company’s consolidated financial statements.

13

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
      (unaudited)

In November 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 109, “Accounting for Written Loan Commitments Accounted for at Fair Value” (“SAB No. 109”), which addresses the valuation of written loan commitments accounted for at fair value through earnings. The guidance in SAB No. 109 expresses the staff’s view that the measurement of fair value for a written loan commitment accounted for at fair value through earnings should incorporate the expected net future cash flows related to the associated servicing of the loan. Previously under SAB No. 105, “Application of Accounting Principles to Loan Commitments”, this component of value was not incorporated into the fair value of the loan commitment. SAB No. 109 is effective for written loan commitments entered into or modified in fiscal quarters beginning after December 15, 2007 related to residential and commercial real estate loans held for sale that are accounted for as derivatives under SFAS No. 133. The impact of SAB No. 109 is to accelerate the recognition of the estimated fair value of the servicing inherent in the loan to the commitment date. The Company adopted SAB No. 109 in the first quarter of 2008, and the adoption did not have a material effect on its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which requires all assets acquired and liabilities assumed in a business combination (with a few exceptions, such as deferred tax assets and liabilities) to be measured at fair value in accordance with SFAS No.157. SFAS No. 141(R) is effective prospectively for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact on its financial statements of adopting SFAS No. 141(R).

Also in December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS No. 160”), which amends ARB No. 51 to establish accounting and reporting standards for a noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS No. 141 (revised 2007), “Business Combinations”. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The standard should be applied prospectively. Presentation and disclosure requirements should be applied retrospectively to comparative financial statements. Earlier adoption is prohibited. The Company is currently evaluating the impact on its financial statements of adopting SFAS No. 160.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact on its financial statements of adopting SFAS No. 161.

14

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
      (unaudited)

8. ADOPTION OF FINANCIAL ACCOUNTING STANDARD NUMBER 157

As discussed in Note 6 above, the Company adopted SFAS No. 157, “Fair Value Measurement,” during the first quarter of 2008. The provisions of SFAS No. 157 establish clearer and more consistent criteria for measuring fair value of certain assets and liabilities. In SFAS No. 157,inputsrefer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk, such as the risk inherent in a particular valuation technique used to measure fair value (for example, a pricing model) and/or the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable:

Observable inputsare inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity.

• Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

• Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly through corroboration with observable market data (market-corroborated inputs). If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability.

Unobservable inputsare inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

• Level 3 inputs are unobservable inputs for the asset or liability, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing in the circumstances. Unobservable inputs will be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

Investment Securities Available for Sale

The Company’s securities portfolio available for sale is generally of high credit quality, and most of the fair value measurements were estimated using matrices that were determined to be Level 2 measurements, Significant Other Observable Inputs. Unrealized gains and losses on securities available for sale are reflected in accumulated other comprehensive income and recognized gains and losses are reported as securities gains and losses in noninterest income.

15

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
     (unaudited)

The following table reflects investment securities available for sale measured at fair value on a recurring basis:

			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Fair Value at		Identical Assets		Inputs		Inputs
(Dollars in thousands)	Sept 30, 2008		(Level 1)		(Level 2)		(Level 3)
Investment securities available for sale	$	61,023	$	6,598	$	54,425	$	—

Derivatives

Granite Mortgage, the Company’s mortgage banking subsidiary, enters into interest rate lock commitments on mortgage loans and uses two types of financial instruments to manage interest rate risk. These instruments, commonly referred to as derivatives, consist of contracts to forward sell mortgage-backed securities and options to forward sell securities. The fair value associated with these derivative instruments is considered to be immaterial.

Mortgage Loans Held for Sale

Granite Mortgage’s mortgage loans held for sale are carried at the lower of cost or market or fair value. Under either accounting basis, the value of these loans is susceptible to declines in market value. Recent market events have affected the value and liquidity of mortgage loans, to varying degrees depending on the nature and credit quality of the mortgage loans. The loans held for sale were valued based on observable market data of similar assets, where available, as well as current performance data of the underlying loans. In instances when significant valuation assumptions were not readily observable in the market, instruments were valued based on the best available data in order to approximate fair value. Management limits the size and the Company’s overall exposure to these assets, as well as actively monitoring the estimated market and economic value of these assets and determining the most advantageous approach to managing these assets. The fair value was determined to be Level 2 measurements, Significant Other Observable Inputs. Recognized gains and losses are reported as mortgage banking income in noninterest income.

16

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
September 30, 2008
      (unaudited)

Impaired Loans

The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2008, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS No. 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or is not current, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. At September 30, 2008, all impaired loans were determined to be Level 3 measurements.

The following table reflects certain loans measured at fair value on a nonrecurring basis:

			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Fair Value at		Identical Assets		Inputs		Inputs
(Dollars in thousands)	Sept 30, 2008		(Level 1)		(Level 2)		(Level 3)
Mortgage loans held for sale	$	14,688	$	—	$	14,688	$	—
Impaired loans (1)		18,995		—		—		18,995
Total assets	$	33,683	$	—	$	14,688	$	18,995

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

17

Item 2. 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 our results of operations and financial condition. The following discussion is intended to provide a general overview of our performance for the three-month and nine-month periods ended September 30, 2008. Readers seeking more in-depth information should read the more detailed discussions below as well as the condensed consolidated financial statements and related notes included under Item 1 of this quarterly report. All information presented is consolidated data unless otherwise specified. Uncertainty and future events could cause changes in accounting estimates that have material effects on the financial position and results of operations in future periods.

Our losses decreased in both the three and nine-month periods ended September 30, 2008 when compared to the same periods in 2007, primarily due to lower loan loss provisions, partially offset by decreases in interest and fee income from loans. The decline in loan income was due to a combination of lower loan yields on our variable rate loans and higher levels of nonperforming loans. Our net interest margin decreased as a result of lower loan income without comparable decreases in funding costs. Our other expenses increased for the nine-month period ending September 30, 2008 compared to 2007, primarily due to higher professional fees and FDIC deposit insurance premiums. However, for the three-month period ended September 30, 2008, our other expenses decreased, primarily due to reductions in personnel costs and lower losses on sales of foreclosed properties.

Financial Highlights for	Three Months
the Quarterly Periods	Ended September 30,
(in thousands except per share amounts)	2008			2007			% change
Earnings
Net interest income	$	9,486		$	12,517			-24.2	%
Provision for loan losses		3,581			42,737			-91.6	%
Other income		2,494			3,193			-21.9	%
Other expense		8,775			9,380			-6.4	%
Net loss		(271	)		(22,016	)		-98.8	%
Per share
Net loss
- Basic	$	(0.02	)	$	(1.40	)		-98.6	%
- Diluted		(0.02	)		(1.40	)		-98.6	%
Average for period
Assets	$	1,181,505		$	1,212,281			-2.5	%
Loans		958,033			942,154			1.7	%
Deposits		980,633			977,049			0.4	%
Stockholders’ equity		110,616			143,726			-23.0	%
Ratios
Return on average assets		-0.09	%		-7.21	%
Return on average equity		-0.97	%		-60.77	%
Average equity to average assets		9.36	%		11.86	%
Efficiency ratio (1)		72.22	%		58.94	%

(1) Calculated by dividing noninterest expense by the sum of tax equivalent net interest income and noninterest income.

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Financial Highlights for	Nine Months
the Year-to-Date Periods	Ended September 30,
(in thousands except per share amounts)	2008			2007			% change
Earnings
Net interest income	$	29,661		$	39,708			-25.3	%
Provision for loan losses		13,437			52,125			-74.2	%
Other income		8,875			9,644			-8.0	%
Other expense		28,843			26,505			8.8	%
Net loss		(1,918	)		(17,235	)		-88.9	%
Per share
Net loss
- Basic	$	(0.12	)	$	(1.09	)		-89.0	%
- Diluted		(0.12	)		(1.09	)		-89.0	%
Average for period
Assets	$	1,200,537		$	1,208,255			-0.6	%
Loans		955,173			934,682			2.2	%
Deposits		986,273			969,327			1.7	%
Stockholders’ equity		114,614			147,338			-22.2	%
Ratios
Return on average assets		-0.21	%		-1.91	%
Return on average equity		-2.24	%		-15.64	%
Average equity to average assets		9.55	%		12.19	%
Efficiency ratio (1)		73.80	%		53.00	%

(1) Calculated by dividing noninterest expense by the sum of tax equivalent net interest income and noninterest income.

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 of America and conform to general practices within the banking industry. The critical accounting and reporting policies include our accounting for investment securities, mortgage loans held for sale, derivatives, and the allowance for loan losses. In particular, our accounting policies relating to the allowance for loan losses 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 our consolidated financial position or consolidated results of operations. Please see the discussions below under the captions “Provisions and Allowance for Loan Losses” and “Investment Securities.” See also Note 1 in the “Notes to Consolidated Financial Statements” under Item 8, “Financial Statements & Supplementary Data” in our Annual Report on Form 10-K/A for the year ended December 31, 2007 on file with the Securities and Exchange Commission for additional information regarding all of our 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 a balance considered adequate to absorb probable losses incurred in the portfolio at the date of the financial statements.

19

Management’s determination of the adequacy of the allowance for loan loss is based on ongoing quarterly assessments of the collectibility and historical loss experience of the loan portfolio. We also evaluate other factors and trends in the economy related to specific loan groups in the portfolio, trends in delinquencies and results of periodic loan reviews.

The methodology for determining the allowance for loan losses is based on historical loss rates, current credit grades, specific allocation for impaired loans and an unallocated amount. 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. We periodically revise historical loss factors for different segments of the portfolio to be more reflective of current market conditions.

Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review for impairment. When individual loans are impaired, the impairment allowance is measured in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” The predominant measurement method for the Bank is the evaluation of the fair value of the underlying collateral. Our policy for the recognition of interest income on impaired loans is the same as our interest recognition policy for all non-accrual loans. Accrued interest is reversed to income to the extent it relates to the current year and is charged off otherwise.

The evaluations described above are inherently subjective, as they require the use of material estimates. Unanticipated future adverse changes in borrower or economic conditions could result in material adjustments to our allowance for loan losses that could adversely impact our earnings in future periods.

We have also identified material weaknesses in internal controls relating to lending practices and policies and monitoring controls used to identify and quantify the risk in problem loans. Additional information about our material weaknesses in internal control and our Remediation Plan is provided in Item 4, “Controls and Procedures.”

INVESTMENT SECURITIES — Non-equity 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 our ability and intent 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.

20

MORTGAGE LOANS HELD FOR SALE — We originate 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 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 assets or liabilities related to the loans sold. Gains and losses on sales of mortgage loans are included in other noninterest income.

DERIVATIVES AND HEDGING ACTIVITIES — We enter into derivative contracts to hedge certain assets, liabilities, and probable forecasted transactions. On the date we enter 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”).

Our primary derivative transactions involve risk management derivatives. See “Liquidity, Interest Rate Sensitivity and Other Risks” below.

GOODWILL — See our discussion above on goodwill in Note 5 in the “Notes to Condensed Consolidated Financial Statements.”

Changes in Financial Condition

September 30, 2008 Compared With December 31, 2007

Our total assets decreased $59.2 million, or 4.9%, from December 31, 2007 to September 30, 2008. Earning assets decreased $48.7 million, or 4.4%, over the same nine-month period. As reflected in the table below, loans, our largest earning asset, increased $5.3 million, or 0.6%, primarily due to a $8.6 million increase in loans of the Bank, partially offset by a $3.3 million decrease in construction, bridge, and other loans of Granite Mortgage. Mortgage loans held for sale by Granite Mortgage decreased by $0.6 million, or 4.1%, due to lower mortgage origination activities and refinancing activities, primarily because of a weak housing market. Cash and cash equivalents increased $5.8 million, or 17.4%. Investment securities decreased $58.0 million, or 40.6%, primarily due to $60.6 million in called or matured debt securities, partially offset by purchases of debt and equity securities. Other assets decreased $10.8 million, or 30.1%, due to decreases in income taxes receivable. Accrued interest receivable decreased $1.8 million, or 25.9%, due to lower yields on lower volumes of interest-earning assets.

Loans at September 30, 2008 and December 31, 2007 were as follows:

	September 30,			December 31,
(in thousands)	2008			2007
Real estate — Construction	$	181,661		$	182,457
Real estate — Mortgage		554,459			513,140
Commercial, financial and agricultural		204,000			238,469
Consumer		12,943			13,481
All other loans		268			567
		953,331			948,114
Deferred origination fees, net		(1,666	)		(1,788	)
Total loans	$	951,665		$	946,326
Mortgage loans held for sale	$	14,688		$	15,319

21

Our deposits decreased $2.8 million, or 0.3%, from December 31, 2007 to September 30, 2008. Interest-bearing demand deposits decreased $20.9 million, or 5.6%, reflecting a $29.1 million, or 12% decrease in money market deposits, partially offset by a $8.2 million, or 6.3%, increase in NOW account deposits. Noninterest-bearing demand deposits decreased $15.1 million, or 10.5%. Time deposits increased $33.3 million, or 7.7%, primarily in other time deposits. The Company’s loan to deposit ratio was 98.19% as of September 30, 2008 compared to 97.36% as of December 31, 2007, and the Bank’s loan to deposit ratio was 94.95% compared to 92.93% when comparing the same dates.

In addition to deposits, we have sources of funding in the form of overnight and other short-term borrowings, as well as other longer-term borrowings. Overnight borrowings are primarily in the form of federal funds purchased and commercial deposit products that sweep balances overnight into securities sold under agreements to repurchase or commercial paper issued by us. From December 31, 2007 to September 30, 2008, overnight and short-term borrowings decreased $47.0 million, or 46.9%, primarily due to a decrease of $41.2 million in overnight borrowings of the Bank, a $5.7 million decrease in overnight borrowings of the Company, and a decrease of $5.1 million in other short-term borrowings by Granite Mortgage, partially offset by a $5.0 million increase in other short-term borrowings of the Bank. Long-term borrowings decreased $1.0 million, or 5.8%.

Our total capital decreased $6.6 million, or 5.7% for the nine months ended September 30, 2008. Earnings retained declined $5.9 million for the first nine months of 2008 after paying cash dividends of $4.0 million. During the third quarter of 2008, we suspended our cash dividend in an effort to preserve capital. Accumulated other comprehensive loss related to securities available for sale, net of deferred income taxes, increased $0.8 million from December 31, 2007 to September 30, 2008, largely due to significant declines in market value resulting from thinly traded equity securities, net of realized impairment and other losses.

Liquidity, Interest Rate Sensitivity and Other Risks

The objectives of our 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 needs of our ongoing operations and regulatory requirements. Depositor cash needs, particularly those of commercial depositors, can fluctuate significantly depending on both business and economic cycles, while 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, our 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 September 30, 2008, such unfunded commitments to extend credit were $174.9 million, and commitments in the form of standby letters of credit totaled $5.4 million.

We previously suspended our common stock repurchase plan, which we have historically used (1) to reduce the number of shares outstanding when our share price in the market makes repurchases advantageous and (2) to manage capital levels. Although shares repurchased are available for reissuance, we have not historically reissued, nor do we currently anticipate reissuing, repurchased shares. See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds.”

22

For approximately 50% of its mortgage loans, Granite Mortgage waits until the loans close to arrange for their sale. 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 enters into hedge contracts to “forward sell” mortgage-backed securities at the same time as the rate commitment. When the mortgage loans are ultimately sold, Granite Mortgage then buys the mortgage-backed security, thereby completing the hedge contract.

Except as discussed above regarding Granite Mortgage’s hedging program, neither the Company nor our subsidiaries have historically incurred off-balance sheet obligations through the use of or investment in other off-balance sheet derivative financial instruments or structured finance or special purpose entities. The Bank and Granite Mortgage both had contractual off-balance sheet obligations in the form of noncancelable operating leases as of September 30, 2008, and December 31, 2007, though such obligations and the related lease expenses were not material to our financial condition on such dates or results of operations for the periods then ended.

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 deposits. We consider these to to be a stable portion of the Bank’s liability mix and the result of ongoing consumer and commercial banking relationships. At September 30, 2008, our core deposits, defined as total deposits excluding time deposits of $100,000 or more, totaled $761.2 million, or 78.5% of our total deposits, compared to $763.7 million, or 78.6% of our total deposits as of December 31, 2007.

The other principal methods of funding used by the Bank are 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 because core deposits tend to be a more stable source of funding, and purchased or brokered time deposits often have a higher cost of funds. During periods of weak demand for its deposit products, the Bank maintains credit facilities under which it may borrow on a short-term basis. As of September 30, 2008, the Bank had an unsecured line of overnight borrowing capacity with its correspondent bank, which totaled $15 million. In addition, the Bank uses its capacity to pledge assets to serve as collateral to borrow on a secured basis. As of September 30, 2008, the Bank had investment securities pledged to secure an overnight funding line of approximately $8.3 million with the Federal Reserve Bank. The Bank also has significant capacity to pledge its loans secured by first liens on residential and commercial real estate as collateral for additional borrowings from the Federal Home Loan Bank (“FHLB”) 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 September 30, 2008, the Bank had a line of credit with the FHLB totaling approximately $72.3 million collateralized by its pledged residential and commercial real estate loans with $27 million outstanding, of which $13 million were in overnight and short-term borrowings and $14 million were in long-term borrowings, leaving approximately $45.3 million in remaining capacity to borrow.

Granite Mortgage temporarily funds its mortgages and construction loans, from the time of origination until the time of sale, through the use of a line of credit from one of our correspondent financial institutions. As of September 30, 2008 and December 31, 2007, this line of credit was $35 million and $40 million, respectively. Granite Mortgage requests changes in the amount of the line of credit based on its estimated funding needs. As of September 30, 2008, the line was secured by approximately $21.1 million of the mortgage loans closed by Granite Mortgage. The Company serves as guarantor under the terms of this line. As of September 30, 2008, the Company was not in compliance with all of the financial covenants under this line of credit, but has received waivers from the lender for such noncompliance. As a condition to the waiver, the amount of the line was decreased from $35 million to $30 million.

23

We also have a $10 million unsecured line of credit from one of our correspondent banks. The line matures June 30, 2009, bearing an interest rate of one-month LIBOR plus 120 basis points, with interest payable quarterly. As of September 30, 2008, we owed $2.5 million under this line of credit. The Company was not in compliance with all of the financial covenants under this line of credit as of September 30, 2008, but has received waivers from the lender for such noncompliance.

The majority of our deposits are rate-sensitive instruments with rates that tend to fluctuate with market rates. These deposits, coupled with our short-term certificates of deposit, have increased the opportunities for deposit repricing. We place great significance on monitoring and managing our asset/liability position. Our policy for managing our interest margin (or net yield on interest-earning assets) is to maximize net interest income while maintaining a stable deposit base. Our deposit base is generally not subject to the level of volatility experienced in national financial markets in recent years; however, we do realize the importance of minimizing such volatility while at the same time maintaining and improving earnings. A common method used to manage interest rate sensitivity is to measure 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, on a regular basis, we prepare earnings projections based on a range of interest rate scenarios of rising, flat and declining rates in order to more accurately measure interest rate risk.

Interest-bearing liabilities and variable rate loans are generally repriced to current market rates. Based on our analysis, we believe that our balance sheet is liability-sensitive, meaning that in a given period there will be more liabilities than assets subject to immediate repricing as the market rates change. Because a significant portion of our deposits are variable rate, they generally reprice more rapidly than our rate sensitive assets. During periods of rising rates, this results in decreased net interest income, assuming similar growth rates and stable product mixes in loans and deposits. The opposite occurs during periods of declining rates. While the Bank is liability-sensitive and has the opportunity to reprice its deposits, we decided not to lower our deposit rates during the first nine months of 2008 to the extent asset rates were lowered, due to competitive pressures in the deposit marketplace.

We use interest sensitivity analysis to measure the sensitivity of projected earnings to changes in interest rates. The sensitivity analysis takes into account the current contractual agreements that we have on deposits, borrowings, loans, investments, and any commitments to enter into those transactions. We monitor interest sensitivity by means of computer models that incorporate the current volumes, average rates, scheduled maturities and payments, and repricing opportunities of asset and liability portfolios. Using this information, our model estimates earnings based on projected portfolio balances under multiple interest rate scenarios. In an effort to estimate the effects of pure interest-rate risk, we assume no growth in our balance sheet, because doing otherwise could have the effect of distorting the balance sheet’s sensitivity to changing interest rates. We simulate the effects of interest rate changes on our earnings by assuming no change in interest rates as our base case scenario and either (1) gradually increasing or decreasing interest rates by 3% over a twelve-month period or (2) immediately increasing or decreasing interest rates by 1%, 2%, 3% and 4%, as discussed below. Although these methods are subject to the accuracy of the assumptions that underlie the process and do not take into account the pricing strategies that we would undertake in response to sudden interest rate changes, we believe that these methods provide a better indication of the sensitivity of earnings to changes in interest rates than other analyses.

24

Income simulation through modeling is one tool that we use in the asset/liability management process. We also consider a number of other factors in determining our asset/liability and interest rate sensitivity management strategies. We strive to determine the most likely outlook for the economy and interest rates by analyzing external factors, including published economic projections and data, the effects of likely monetary and fiscal policies, and any enacted or prospective regulatory changes. Our current and prospective liquidity position, current balance sheet volumes and projected growth, and accessibility of funds for short-term needs and capital maintenance are also considered. This data is combined with various interest rate scenarios to provide the information necessary to analyze interest sensitivity and to aid in the development of strategies to manage our balance sheet.

As discussed above, we simulate net interest income under varying interest rate scenarios and the theoretical impact of immediate and sustained rate changes referred to as “rate shocks.” “Rate shocks” measure the estimated theoretical impact on our tax equivalent net interest income and market value of equity from hypothetical immediate changes of plus and minus 1%, 2%, 3% and 4% as compared to the estimated theoretical impact of rates remaining unchanged. The prospective effects of these hypothetical interest rate changes are based upon numerous assumptions including relative and estimated levels of key interest rates. “Rate shocks” modeling is of limited usefulness because it does not take into account the pricing strategies we would undertake in response to the depicted sudden and sustained rate changes.

The following table summarizes the estimated theoretical impact on our 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.

	Estimated Resulting Theoretical Tax Equivalent Net Interest Income
	For the Twelve-months Following
	September 30, 2008					December 31, 2007
(dollars in thousands)	Amount		% Change			Amount		% Change
3% interest rate changes prorated over a twelve-month period
+3%	$	37,884		1.8	%	$	50,368		-2.0	%
0%		37,208		0.0	%		51,411		0.0	%
- 3%		39,134		5.2	%*		49,824		-3.1	%*
Hypothetical immediate and sustained rate changes of 1%, 2%, 3% and 4%
+4%	$	37,191		2.5	%	$	47,885		-4.5	%
+3%		37,011		2.0	%		48,475		-3.3	%
+2%		36,812		1.5	%		49,041		-2.2	%
+1%		36,536		0.7	%		49,602		-1.1	%
0%		36,268		0.0	%		50,141		0.0	%
- 1%		35,895		-1.0	%*		50,510		0.7	%
- 2%		33,842		-6.7	%*		49,753		-0.8	%
- 3%		30,085		-17.0	%*		48,949		-2.4	%*
- 4%		25,629		-29.3	%*		46,252		-7.8	%*

* The Federal Reserve’s overnight federal funds rate target was 2.00% at September 30, 2008 and 4.25% at December 31, 2007. As the overnight federal funds target rate approaches 0%, there is significantly greater compression in the spreads between yields earned on assets and rates paid on interest-bearing liabilities which effectively reduces net interest income.

25

At September 30, 2008, we were well capitalized based on regulatory minimum capital requirements. The minimum capital requirements to be characterized as well capitalized and adequately capitalized, as defined by regulatory guidelines, and our actual capital ratios on a consolidated and Bank-only basis were as follows as of September 30, 2008:

							Minimum Regulatory
	Actual						Requirement
							Adequately			Well
	Consolidated			Bank			Capitalized			Capitalized
Leverage capital ratios		8.39	%		7.96	%		4.00	%		5.00	%
Risk-based capital ratios:
Tier 1 capital		9.58	%		9.02	%		4.00	%		6.00	%
Total capital		10.84	%		10.29	%		8.00	%		10.00	%

Although our ratios remained above levels required to be considered well capitalized at September 30, 2008, we will continue to closely monitor our capital ratios in order to maintain capital at satisfactory levels. One impact of not meeting the regulatory requirements for being classified as well capitalized is that the Bank’s ability to acquire needed funding through sources such as brokered deposits, Federal Home Loan Bank advances and unsecured federal funds credit lines could be limited. In addition, our reputation in our deposit service areas could be damaged, which could further tighten our liquidity. During the third quarter of 2008, we suspended our cash dividend in an effort to preserve approximately $2 million in capital each quarter. If we experience further deterioration in our loan portfolio that requires significant additional increases in our allowance for loan losses, we may need to implement additional steps to improve our capital position.

As filed on the Registrant’s Current Report on Form 8-K dated September 22, 2008, the Board of Directors announced the Company’s plans, subject to regulatory approval, to combine its banking and mortgage subsidiaries, Bank of Granite and Granite Mortgage, Inc., which is expected to increase capital in the Bank subsidiary and provide funding options for the mortgage operations. The Company is anticipating expense reductions of $1.5 million for 2009, as a result of the combination of subsidiaries, a reduction in headcount and a stringent operating expense reduction plan.

The Bank is operating under heightened regulatory scrutiny and has been and will be taking steps to improve its policies and procedures, particularly with respect to maintaining strong levels of capital, improving risk management, managing levels and concentrations of credit risk, and ensuring sufficient liquidity. On September 1, 2008, in connection with the Bank’s most recent examination by the Federal Deposit Insurance Corporation (“FDIC”), the Bank’s Board of Directors entered into a Memorandum of Understanding (“MOU”) with the FDIC addressing matters raised in the examination such as management of capital, liquidity, risk, and asset quality. These matters are a major focus of the attention of the Board of Directors and management.

Results of Operations

For the Three-Month Period Ended September 30, 2008 Compared With
the Same Period in 2007 and for the Nine-Month Period Ended
September 30, 2008 Compared With the Same Period in 2007

During the three-month period ended September 30, 2008, we incurred a net loss of $271,000 compared to a net loss of $22.0 million for the same period of 2007. For the first nine months of 2008, we incurred a net loss of $1.9 million compared to a net loss of $17.2 million for the first nine months of 2007. The reduction in losses incurred for both the three-month and nine-month periods of 2008 compared to the same periods of 2007 were primarily due to significantly lower loan loss provisions, partially offset by decreases in interest and fee income from loans.

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Net Interest Income for the Quarterly Periods

The following table reflects the change in our net interest income for the three-month periods ended September 30, 2008 and 2007. For a discussion of our liability-sensitivity and the related effects on our net interest income and net interest margins, please see “Liquidity, Interest Rate Sensitivity and Other Risks” above.

	Three Months
	Ended September 30,
(in thousands)	2008			2007			$ Change			% Change
Interest income	$	16,367		$	21,904		$	(5,537	)		-25.3	%
Interest expense		6,881			9,387			(2,506	)		-26.7	%
Net interest income		9,486			12,517			(3,031	)		-24.2	%
Net interest margin		3.56	%		4.48	%
Yield on loans		6.26	%		8.28	%
Average prime rate		5.00	%		8.18	%
Cost of interest-bearing deposits		2.87	%		4.04	%
Cost of interest-bearing liabilities		2.96	%		4.12	%
Interest and fees from loans	$	15,293		$	20,039		$	(4,746	)		-23.7	%
Average loans
Bank		942,790			924,909			17,881			1.9	%
Granite Mortgage		29,181			34,719			(5,538	)		-16.0	%
Consolidated		971,971			959,628			12,343			1.3	%
Average loans not earning interest included in consolidated above		45,381			24,908			20,473			82.2	%
Interest on securities and overnight investments		1,074			1,865			(791	)		-42.4	%
Average securities and overnight investments		108,187			167,488			(59,301	)		-35.4	%
Average earning assets		1,080,158			1,127,116			(46,958	)		-4.2	%
Interest on interest-bearing deposits		6,115			8,406			(2,291	)		-27.3	%
Average interest-bearing deposits		848,080			825,408			22,672			2.7	%
Average money market deposits		234,327			250,372			(16,045	)		-6.4	%
Average time deposits		453,884			433,718			20,166			4.6	%
Interest on overnight and short-term borrowings		588			795			(207	)		-26.0	%
Average overnight and short-term borrowings
Bank		13,706			7,806			5,900			75.6	%
Granite Mortgage		22,850			28,381			(5,531	)		-19.5	%
Consolidated		60,928			62,743			(1,815	)		-2.9	%
Interest on long-term borrowings		178			186			(8	)		-4.3	%
Average long-term borrowings
Bank		14,555			14,365			190			1.3	%
Consolidated		17,055			16,851			204			1.2	%

27

Even though we experienced growth in our average loans and deposits during the third quarter of 2008 compared to 2007, our net interest margin declined 92 basis points, primarily due to the lower loan income without comparable decreases in funding costs. We had lower yields on our variable rate loans, and our net interest margin was further compressed from the continued higher levels of nonaccruing loans during the third quarter of 2008 compared to 2007. In addition, our net interest margin decreased due to the lower prime interest rate in the third quarter of 2008 compared to 2007, which resulted from rate reductions by the Federal Reserve Bank, which was partially offset by a 116 basis point decrease in our funding costs.

Mortgage originations declined during the third quarter of 2008, primarily due to higher effective borrowing costs for mortgages and instability in the mortgage credit and housing markets. The levels of mortgage origination and refinancing activities are very sensitive to changes in interest rates in that higher mortgage interest rates generally have the effect of reducing both mortgage originations and refinancings. Periods of declining rates typically result in higher mortgage originations and refinancings, at least temporarily, while sustained low mortgage interest rates eventually have the effect of reducing refinancings as the demand for such refinancings becomes satisfied.

Time deposits generally pay higher rates of interest than most other types of deposits. We believe that the increase in time deposits may be attributable in large part to higher rates on our time deposit products. We have not historically relied upon “out-of-market” or “brokered” deposits as a significant source of funding.

Our overnight borrowings are in the form of commercial paper related to the commercial deposit sweep arrangements of the Bank. Other short-term borrowings were the principal source of funding for Granite Mortgage.

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Net Interest Income for the Year-to-Date Periods

The following table reflects the change in our net interest income for the nine-month periods ended September 30, 2008 and 2007. For a discussion of our liability-sensitivity and the related effects on our net interest income and net interest margins, please see “Liquidity, Interest Rate Sensitivity and Other Risks” above.

	Nine Months
	Ended September 30,
(in thousands)	2008			2007			$ Change			% Change
Interest income	$	52,343		$	67,247		$	(14,904	)		-22.2	%
Interest expense		22,682			27,539			(4,857	)		-17.6	%
Net interest income		29,661			39,708			(10,047	)		-25.3	%
Net interest margin		3.67	%		4.80	%
Yield on loans		6.68	%		8.64	%
Average prime rate		5.43	%		8.23	%
Cost of interest-bearing deposits		3.17	%		4.01	%
Cost of interest-bearing liabilities		3.23	%		4.08	%
Interest and fees from loans	$	48,613		$	61,514		$	(12,901	)		-21.0	%
Average loans
Bank		938,580			917,935			20,645			2.2	%
Granite Mortgage		33,739			33,645			94			0.3	%
Consolidated		972,319			951,580			20,739			2.2	%
Average loans not earning interest included in consolidated above		43,791			18,278			25,513			139.6	%
Interest on securities and overnight investments		3,730			5,733			(2,003	)		-34.9	%
Average securities and overnight investments		126,049			172,046			(45,997	)		-26.7	%
Average earning assets		1,098,368			1,123,626			(25,258	)		-2.2	%
Interest on interest-bearing deposits		20,210			24,694			(4,484	)		-18.2	%
Average interest-bearing deposits		851,108			822,996			28,112			3.4	%
Average money market deposits		244,501			242,870			1,631			0.7	%
Average time deposits		451,228			434,662			16,566			3.8	%
Interest on overnight and short-term borrowings		1,915			2,377			(462	)		-19.4	%
Average overnight and short-term borrowings
Bank		18,358			9,740			8,618			88.5	%
Granite Mortgage		26,900			27,161			(261	)		-1.0	%
Consolidated		71,708			64,879			6,829			10.5	%
Interest on long-term borrowings		557			468			89			19.0	%
Average long-term borrowings
Bank		12,651			11,535			1,116			9.7	%
Consolidated		15,151			14,813			338			2.3	%

Even though we experienced growth in our average loans and deposits during the first nine months of 2008 compared to the same period in 2007, our net interest margin declined 113 basis points, primarily due to lower loan income from the reduction of the prime interest rate during 2008 as a result of rate reductions by the Federal Reserve Bank and higher levels of nonaccruing loans. Our cost of funds decreased 85 basis points in the first nine months of 2008.

29

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

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

We use several measures to assess and monitor the credit risks in our loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectibility becomes doubtful. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of eight risk grades, each grade indicating a different level of risk. 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. Management makes changes in risk grades based upon assessments of third party risk assessment groups (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 risk grade deemed appropriate for the loan. Furthermore, loans and commitments of $1 million or more made during the month, as well as commercial loans past due 30 days or more, are reviewed monthly by the Loan Committee of the Bank’s Board of Directors.

The Bank currently engages third party resources to periodically review samples of loans for underwriting, documentation, risk grading analyses and other loan administration issues. The third party’s evaluation and report is shared with management, the Bank’s Audit Committee and ultimately, the Bank’s Board of Directors. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s loan portfolio. Such agencies may require adjustments to the allowance for loan losses based on their judgments.

Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review for impairment. When individual loans are impaired, the impairment allowance is measured in accordance with SFAS No. 114, “Accounting By Creditors for Impairment of a Loan.” The predominant measurement method for the Bank is the evaluation of the fair value of the underlying collateral. Allowance levels are estimated for other commercial loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. The Bank aggregates non-graded retail type loans into pools of similar credits and reviews the historical loss experience associated with these pools as the criteria to allocate the allowance to each category.

The allowance for loan losses is comprised of three components: specific allowance, general allowance and unallocated allowance. Generally, all loans with outstanding balances of $250,000 or greater that have been identified as impaired are reviewed periodically in order to determine whether a specific allowance is required. 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 allowance. Loans for which specific allowances are provided are excluded from the general allowance calculations as described below.

30

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 adjusted for current conditions over a period of time. The allowance for loan losses for consumer loans, mortgage loans, and leases is determined based on past due levels and historical loss rates relative to each portfolio.

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

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

We consider the allowance for loan losses reasonable to cover the losses estimated to have been incurred in our loan portfolio as of the date of the financial statements. We believe we have 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 we use 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 our operating results.

During the three and nine-month periods ended September 30, 2008, the Bank continued to resolve problem loans identified in 2007 through charge-offs, write-downs, and, in some cases, disposition of underlying collateral and restructure. The increase in nonperforming loans in the period is indicative of the general economic weakness and instability in the mortgage credit and housing markets.

Management evaluated the period activity and the results of its allowance for loan loss estimation process and determined that the $13.4 million provision and resultant allowance for loan loss was reasonable to absorb the probable losses identified in the portfolio at September 30, 2008. The allowance to gross outstanding loans was 2.26% at September 30, 2008, 1.87% at December 31, 2007, and 1.93% at September 30, 2007.

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.

31

The following table and subsequent discussion present an analysis of changes in the allowance for loan losses for the quarter-to-date and year-to-date periods.

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
(in thousands)	2008			2007			2008			2007
Allowance for loan losses, beginning of period	$	18,833		$	22,102		$	17,673		$	15,787
Net charge-offs:
Loans charged off:
Real estate		257			12,561			5,863			13,494
Commercial, financial and agricultural		1,329			34,622			6,216			36,717
Credit cards and related plans		3			2			7			9
Installment loans to individuals		71			61			174			140
Demand deposit overdraft program		52			63			151			163
Total charge-offs		1,712			47,309			12,411			50,523
Recoveries of loans previously charged off:
Real estate		682			1			1,095			—
Commercial, financial and agricultural		134			5			1,617			67
Credit cards and related plans		—			—			1			3
Installment loans to individuals		11			8			67			25
Demand deposit overdraft program		24			25			74			85
Total recoveries		851			39			2,854			180
Net charge-offs		861			47,270			9,557			50,343
Loss provisions charged to operations		3,581			42,737			13,437			52,125
Allowance for loan losses, end of period	$	21,553		$	17,569		$	21,553		$	17,569
Ratio of annualized net charge-offs during the period to average loans during the period		0.36	%		19.91	%		1.34	%		7.20	%
Allowance coverage of annualized net charge-offs		629.23	%		9.37	%		168.83	%		26.10	%
Allowance as a percentage of loans								2.26	%		1.93	%

Nonperforming assets at September 30, 2008 and December 31, 2007 were as follows:

	September 30,			December 31,
(in thousands)	2008			2007
Nonperforming assets:
Nonaccrual loans	$	51,132		$	36,450
Loans past due 90 days or more and still accruing interest		466			162
Total nonperforming loans		51,598			36,612
Foreclosed properties		3,237			2,491
Total nonperforming assets	$	54,835		$	39,103
Nonperforming loans to total loans		5.42	%		3.87	%
Allowance coverage of nonperforming loans		41.77	%		48.27	%
Nonperforming assets to total assets		4.73	%		3.21	%

32

If interest from nonaccrual loans, including impaired loans had been recognized in accordance with the original terms of the loans, the estimated gross interest income for the third quarters of 2008 and 2007 that would have been recorded was approximately $796,000 and $148,000, respectively, while there was no interest income recognized on such loans for the third quarters of 2008 and 2007. For the comparable year-to-date periods, interest income of approximately $1,807,000 in 2008 and $236,000 in 2007 would have been recognized in accordance with the original terms of the nonaccrual loans, while there was no interest income recognized on such loans for the year-to-date periods of 2008 and 2007.

We classify loans as nonaccrual when the loan is statutorily past due, or we believe the loan may be impaired, and the accrual of interest on such loans is discontinued. The recorded accrued interest receivable deemed uncollectible is reversed to the extent it was accrued in the current year or charged-off to the extent it was accrued in previous years. A loan classified as nonaccrual is returned to accrual status when the obligation has been brought current, it has been performed in accordance with its contractual terms, and the ultimate collection of principal and interest is no longer considered doubtful.

All of our investment in impaired loans, $26.7 million at September 30, 2008, is included in nonaccruing loans in the table above, and the related loan loss allowance was $5.7 million. At December 31, 2007 our investment in impaired loans was $27.0 million, and the related loan loss allowance was $3.0 million. The average recorded balance of impaired loans was $26.9 million for the first nine months of 2008, and $20.7 million for the first nine months of 2007.

33

Noninterest Income and Expenses for the Quarterly Periods

The following table reflects the changes in our noninterest income and expenses for the three-month periods ended September 30, 2008 and 2007.

	Three Months
	Ended September 30,
(in thousands)	2008			2007			$ Change			% Change
Total noninterest income
Bank	$	2,348		$	2,160		$	188			8.7	%
Granite Mortgage		849			1,033			(184	)		-17.8	%
Consolidated		2,494			3,193			(699	)		-21.9	%
Fees on deposit accounts		1,416			1,500			(84	)		-5.6	%
Other service fees and commissions		198			162			36			22.2	%
Annuity commissions		61			48			13			27.1	%
Mortgage banking income		861			1,033			(172	)		-16.7	%
Mortgage loan originations		62,579			67,166			(4,587	)		-6.8	%
Securities gains/losses		(711	)		—			(711	)		0.0	%
Other noninterest income		729			498			231			46.4	%
Total noninterest expenses
Bank		6,878			7,584			(706	)		-9.3	%
Granite Mortgage		1,852			1,715			137			8.0	%
Consolidated		8,775			9,380			(605	)		-6.4	%
Personnel expenses
Bank		3,111			4,154			(1,043	)		-25.1	%
Granite Mortgage		1,159			1,203			(44	)		-3.7	%
Consolidated		4,274			5,362			(1,088	)		-20.3	%
Salaries and wages
Bank		3,142			3,116			26			0.8	%
Granite Mortgage		1,066			1,108			(42	)		-3.8	%
Consolidated		4,208			4,224			(16	)		-0.4	%
Employee Benefits
Bank		(31	)		1,038			(1,069	)		-103.0	%
Granite Mortgage		93			95			(2	)		-2.1	%
Consolidated		66			1,138			(1,072	)		-94.2	%
Noninterest expenses other than for personnel
Bank		3,767			3,430			337			9.8	%
Granite Mortgage		693			512			181			35.4	%
Consolidated		4,501			4,018			483			12.0	%
Occupancy expense, net
Bank		448			497			(49	)		-9.9	%
Granite Mortgage		137			113			24			21.2	%
Consolidated		585			610			(25	)		-4.1	%
Equipment expense
Bank		549			478			71			14.9	%
Granite Mortgage		90			100			(10	)		-10.0	%
Consolidated		639			578			61			10.6	%
Other noninterest expenses
Bank		2,770			2,455			315			12.8	%
Granite Mortgage		466			299			167			55.9	%
Consolidated		3,277			2,830			447			15.8	%
Income tax benefit		(105	)		(14,391	)		14,286			-99.3	%
Effective income tax rates		27.93	%		39.53	%

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For the quarter ended September 30, 2008, securities losses increased $711,000, of which $649,000 related to the write-down during the third quarter of the Company’s equity securities available for sale for other than temporary impairment.

The Bank’s employee benefits decreased $1,069,000 for the third quarter of 2008, primarily due to a decrease of $320,000 in employee healthcare benefits and $788,000 in employer’s profit-sharing contribution.

For the third quarter of 2008, the Bank’s other noninterest expenses increased $315,000, primarily due to an increase of $691,000 in FDIC deposit insurance premiums and $127,000 in collection expense, partially offset by decreases in legal fees and write-downs on foreclosed properties.

The decrease in income tax benefit and resultant change in the effective income tax rates for the third quarter of 2008 were due to the cumulative income tax adjustment related to the reduction of the pre-tax loss experienced during the quarter compared to the third quarter of 2007.

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Noninterest Income and Expenses for the Year-to-Date Periods

The following table reflects the changes in our noninterest income and expenses for the nine-month periods ended September 30, 2008 and 2007.

	Nine Months
	Ended September 30,
(in thousands)	2008			2007			$ Change			% Change
Total noninterest income
Bank	$	6,700		$	6,644		$	56			0.8	%
Granite Mortgage		2,878			3,000			(122	)		-4.1	%
Consolidated		8,875			9,644			(769	)		-8.0	%
Fees on deposit accounts		4,269			4,308			(39	)		-0.9	%
Other service fees and commissions		557			650			(93	)		-14.3	%
Annuity commissions		174			193			(19	)		-9.8	%
Mortgage banking income		2,891			3,000			(109	)		-3.6	%
Mortgage loan originations		201,872			209,689			(7,817	)		-3.7	%
Securities gains/losses		(649	)		—			(649	)		0.0	%
Other noninterest income		1,807			1,686			121			7.2	%
Total noninterest expenses
Bank		23,146			21,328			1,818			8.5	%
Granite Mortgage		5,415			4,847			568			11.7	%
Consolidated		28,843			26,505			2,338			8.8	%
Personnel expenses
Bank		12,418			12,801			(383	)		-3.0	%
Granite Mortgage		3,642			3,451			191			5.5	%
Consolidated		16,071			16,263			(192	)		-1.2	%
Salaries and wages
Bank		10,221			9,366			855			9.1	%
Granite Mortgage		3,353			3,165			188			5.9	%
Consolidated		13,574			12,531			1,043			8.3	%
Employee Benefits
Bank		2,197			3,435			(1,238	)		-36.0	%
Granite Mortgage		289			286			3			1.0	%
Consolidated		2,497			3,732			(1,235	)		-33.1	%
Noninterest expenses other than for personnel
Bank		10,728			8,527			2,201			25.8	%
Granite Mortgage		1,773			1,396			377			27.0	%
Consolidated		12,772			10,242			2,530			24.7	%
Occupancy expense, net
Bank		1,461			1,504			(43	)		-2.9	%
Granite Mortgage		393			333			60			18.0	%
Consolidated		1,854			1,837			17			0.9	%
Equipment expense
Bank		1,662			1,415			247			17.5	%
Granite Mortgage		264			272			(8	)		-2.9	%
Consolidated		1,926			1,687			239			14.2	%
Other noninterest expenses
Bank		7,605			5,608			1,997			35.6	%
Granite Mortgage		1,116			791			325			41.1	%
Consolidated		8,992			6,718			2,274			33.8	%
Income tax benefit		(1,826	)		(12,043	)		10,217			-84.8	%
Effective income tax rates		48.77	%		41.13	%

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Of the $1,235,000 decrease in employee benefits, $731,000 was related to the Bank’s reversal of previously accrued employer’s profit sharing contribution for 2008 as a result of the net loss experienced during the nine months of 2008. The remaining decrease relates to the Bank’s lower healthcare costs, and supplemental life and retirement benefits for its officers for the same nine-month period.

The Bank’s other noninterest expenses increased $1,997,000 for the first nine months of 2008, primarily related to the $807,000 increase in FDIC deposit insurance premiums and the $841,000 increase in legal and professional fees and other outside services.

The decrease in income tax benefit and resultant change in the effective income tax rates for the first nine months of 2008 were due to the cumulative income tax adjustment related to the reduction of the pre-tax loss experienced during the nine months ended September 30, 2008.

Off-Balance Sheet Arrangements

We enter 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 September 30, 2008 do not represent the amounts that may ultimately be paid under these contracts. Further discussions of derivative instruments are included above under “Liquidity, Interest Rate Sensitivity And Other Risks” and in Note 3 under “Notes to Consolidated Condensed Financial Statements.”

Contractual Obligations

As of September 30, 2008, there were no material changes to contractual obligations in the form of long-term borrowings and operating lease obligations as compared to those disclosed in our Annual Report on Form 10-K/A for the year ended December 31, 2007. See also Note 3 under “Notes to Condensed Consolidated Financial Statements” for changes in other commitments in the form of commitments to extend credit and standby letters of credit.

In 2004, we 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. Based on a fairness opinion obtained from an independent third party expert, we determined that the leases were on terms comparable to similar properties in the area and that the leases are in the best interests of our community banking and mortgage banking operations. In 2008, the Bank obtained an independent appraisal of this facility and purchased it from Salem Investors, LLC for its appraised value of $3.8 million.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The information required by this item is included in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, above, under the caption “Liquidity, Interest Rate Sensitivity and Other Risks.”

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of September 30, 2008, the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based on that evaluation and the identification of the material weaknesses in our internal control over financial reporting as described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

As disclosed under Item 9A of our 2007 Annual Report on Form 10-K/A, we have identified material weaknesses in internal controls relating to the design and enforcement of policies for lending authorities (including renewals and extensions) and monitoring controls to determine loan advances were properly authorized. We identified material weaknesses in monitoring controls used to identify problem loans and quantify the risk in problem loans, thus causing failures to accurately estimate risk in the portfolio and to determine the appropriate amount of our allowance for loan losses. We also discovered lending practices and monitoring weaknesses that contributed to the characterization of the status of certain loans as performing, when they were not, and failed to evaluate adequately the status of a portfolio of asset-based lending loans.

Remediation Plan

In response to the material weaknesses identified, we have developed the following remediation plan to address the material weaknesses. Certain of the remediation measures were reported in the Forms 10-Q with respect to the quarters ended March 31, 2008 and June 30, 2008. The following summary of activities and procedures indicates the cumulative progress on the remediation of the material weaknesses including changes specifically made during the period covered by this report.

• We have restructured our lending staff, reassigned portfolio responsibilities, and revised loan officer lending authorities.

• Credit Administration has produced more detailed underwriting guidance and conducted related training for the loan officer population.

• We have added additional resources to our Credit Administration staff. These additions have resulted in improving our loan risk grading effectiveness.

• New and renewed loans for large credit lines, real estate acquisition and development loans and classified loans require Credit Administration approval, which improves underwriting.

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• We have developed a more effective process for estimating the allowance for loan losses. The specific elements of improvement are:

• The involvement of more experienced personnel, including the Chief Operating Officer, the Chief Credit Officer and the Chief Financial Officer in the accumulation of information and the development of the estimation of the periodic allowance for loan losses. These individuals evaluate the reasonableness of loan grade factors, the appropriate unallocated amounts and individual loan impairment amounts as part of the process.

• Timely monitoring of past due accounts and customer contacts (primarily by Credit Administration), which increases the early identification of loan grading differences and more timely identification of loans for impairment evaluation.

• We continue to evaluate our personnel resources. If adequate staff is not secured in a timely manner, we plan to use independent third parties to provide assistance in our credit administration and internal control improvement initiatives.

• We continue to assess current lending and credit administration policies and procedures, and are revising them as necessary to develop and implement policies and procedures that will promote a culture of compliance and accountability.

Our Board of Directors is actively monitoring these remediation efforts and may direct additional measures as deemed appropriate from time to time. We cannot be certain how long it will take to fully implement the remediation plan, whether the remediation plan will be effective to maintain adequate controls over our financial process and reporting in the future, or whether the remediation plan will be sufficient to address and eliminate the material weaknesses.

Except for the matters discussed above, which have been identified, planned or implemented as disclosed in our 2007 Annual Report on Form 10-K/A and subsequent quarterly reports on Form 10-Q, there were no changes in our internal control over financial reporting that occurred during, or subsequent to, the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Disclosures About Forward Looking Statements

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

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Part II — Other Information

Item 1A — Risk Factors

There were no significant changes to the Risk Factors included in our 2007 Annual Report on Form 10-K/A.

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

There were no share repurchase transactions for the three months ended September 30, 2008.

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Item 6 — Exhibits

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

3.1	Certificate of Incorporation, as amended
	Bank of Granite Corporation’s Restated Certificate of Incorporation, filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q dated May 9, 2006, is incorporated herein by reference.
3.2	Bylaws of the Registrant, as amended
	Bank of Granite Corporation’s Amended and Restated Bylaws, filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K dated April 28, 2008, is incorporated herein by reference.
4.1	Form of stock certificate for Bank of Granite Corporation’s common stock, filed as Exhibit 4.1 to our Registration Statement on Form S-4 (Registration Statement No. 333-104233) dated April 1, 2003, is incorporated herein by reference.
4.2	Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite Corporation (included in Exhibit 3.1 hereto)
11.	Schedule of Computation of Net Income Per Share
	The information required by this item is set forth under Item 1 of Part I, Note 2.
31.1	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2	Certification Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
32.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Signatures

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

	Bank of Granite Corporation (Registrant)
Date: November 7, 2008	/s/ Kirby A. Tyndall
	Kirby A. Tyndall
	Chief Financial Officer and Principal Accounting Officer

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Exhibit Index

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

*	Incorporated herein by reference.
**	The information required by this item is set forth under Item 1 of Part I, Note 2.

43