10-Q

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 June 30, 2009


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

For the transition period from to

Commission file number 0-15956

Bank of Granite Corporation

(Exact name of registrant as specified in its charter)


Delaware		56-1550545

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

(828) 496-2000

(Registrant’s telephone number, including area code)

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

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

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 filer o

Accelerated filer o

Non-accelerated filer þ
(Do not check if a smaller reporting company)

Smaller reporting company o

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

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 June 30, 2009

Item 1. Financial Statements

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


	June 30,			December 31,
	2009			2008
	(Unaudited)			(Note 1)

Assets:
Cash and cash equivalents:
Cash and due from banks	$	31,070		$	26,164
Interest-bearing deposits		1,892			6,819
Federal funds sold		—			16,000

Total cash and cash equivalents		32,962			48,983


Investment securities:
Available for sale, at fair value		157,975			58,576

Held to maturity, at amortized cost		—			23,627


Loans		872,459			948,149
Allowance for loan losses		(22,787	)		(24,806	)

Net loans		849,672			923,343

Mortgage loans held for sale		—			16,770


Premises and equipment, net		18,125			19,079
Investment in bank owned life insurance		17,671			31,278
Other assets		31,099			25,299

Total assets	$	1,107,504		$	1,146,955


Liabilities and stockholders’ equity:
Deposits:
Demand accounts	$	110,127		$	117,168
NOW accounts		136,635			153,444
Money market accounts		220,918			204,108
Savings accounts		20,751			19,674
Time deposits of $100 or more		201,340			208,002
Other time deposits		284,833			289,426

Total deposits		974,604			991,822
Overnight and short-term borrowings		24,790			48,947
Long-term borrowings		31,058			14,075
Other liabilities		12,302			17,941

Total liabilities		1,042,754			1,072,785


Stockholders’ equity:
Common stock, $1.00 par value per share Authorized — 25,000 shares Issued — 18,981 shares in 2009 and 2008 Outstanding — 15,454 shares in 2009 and 2008		18,981			18,981
Capital surplus		30,195			30,190
Retained earnings		69,182			77,928
Accumulated other comprehensive loss, net of deferred income taxes		(1,756	)		(1,077	)
Less: Cost of common stock in treasury; 3,527 shares in 2009 and 2008		(51,852	)		(51,852	)

Total stockholders’ equity		64,750			74,170

Total liabilities and stockholders’ equity	$	1,107,504		$	1,146,955

See notes to condensed consolidated financial statements.

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


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2009			2008			2009			2008

Interest income:
Interest and fees from loans	$	11,841		$	14,620		$	23,708		$	30,876
Interest and fees from mortgage banking		319			1,292			1,579			2,444
Federal funds sold		2			12			8			25
Interest-bearing deposits		6			147			23			259
Investments:
U.S. Treasury		16			43			17			86
U.S. Government agencies		31			485			429			1,267
States and political subdivisions		65			338			364			703
Other		807			135			952			316

Total interest income		13,087			17,072			27,080			35,976


Interest expense:
Time deposits of $100 or more		1,774			2,253			3,652			4,806
Other time and savings deposits		3,458			4,167			7,542			9,289
Overnight and short-term borrowings		137			603			451			1,327
Long-term borrowings		213			167			408			379

Total interest expense		5,582			7,190			12,053			15,801


Net interest income		7,505			9,882			15,027			20,175
Provision for loan losses		4,333			8,445			8,103			9,856

Net interest income after provision for loan losses		3,172			1,437			6,924			10,319


Other income:
Service charges on deposit accounts		1,360			1,467			2,592			2,853
Other service fees and commissions		162			190			232			359
Mortgage banking income		226			986			850			2,029
Securities gains		1,036			3			1,019			62
Other-than-temporary impairment losses		—			—			(996	)		—
Other		518			457			1,090			1,078

Total other income		3,302			3,103			4,787			6,381


Other expenses:
Salaries and wages		3,433			4,800			8,221			9,366
Employee benefits		887			957			1,867			2,431
Equipment and occupancy expense, net		1,111			1,310			2,267			2,556
FDIC assessments		1,908			146			2,379			175
Other real estate owned expenses		1,128			593			1,326			638
Other		2,528			2,603			4,397			4,902

Total other expenses		10,995			10,409			20,457			20,068


Loss before income tax benefit		(4,521	)		(5,869	)		(8,746	)		(3,368	)
Income tax benefit		—			(2,507	)		—			(1,721	)

Net loss	$	(4,521	)	$	(3,362	)	$	(8,746	)	$	(1,647	)


Per share amounts:
Net loss — Basic	$	(0.29	)	$	(0.22	)	$	(0.57	)	$	(0.11	)
Net loss — Diluted		(0.29	)		(0.22	)		(0.57	)		(0.11	)
Cash dividends		—			0.13			—			0.26

See notes to condensed consolidated financial statements.

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


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2009			2008			2009			2008

Net loss	$	(4,521	)	$	(3,362	)	$	(8,746	)	$	(1,647	)


Items of other comprehensive loss:
Items of other comprehensive loss, before tax:
Unrealized losses on securities available for sale		(1,494	)		(1,193	)		(735	)		(492	)
Reclassification adjustment for available for sale securities gains (losses) included in net income		554			3			(459	)		62
Prior service cost and net actuarial loss — SERP		41			—			83			—


Other comprehensive loss, before tax		(899	)		(1,190	)		(1,111	)		(430	)
Change in deferred income taxes related to change in unrealized gains or losses on securities available for sale		371			474			474			171
Change in deferred income taxes related to prior service cost and net actuarial loss — SERP		(16	)		—			(42	)		—


Items of other comprehensive loss, net of tax		(544	)		(716	)		(679	)		(259	)

Comprehensive loss	$	(5,065	)	$	(4,078	)	$	(9,425	)	$	(1,906	)

See notes to condensed consolidated financial statements.

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


	Six Months
	Ended June 30,
	2009			2008

Common stock, $1.00 par value per share
At beginning of period	$	18,981		$	18,965
Par value of shares issued under stock option plan		—			13

At end of period		18,981			18,978


Capital surplus
At beginning of period		30,190			30,053
Surplus of shares issued under stock option plan		—			86
Stock-based compensation expense		5			8
Tax benefit from nonqualifying dispositions of stock options		—			8

At end of period		30,195			30,155


Retained earnings
At beginning of period		77,928			118,196
Net loss		(8,746	)		(1,647	)
Dividends		—			(4,016	)

At end of period		69,182			112,533


Accumulated other comprehensive loss, net of deferred income taxes
At beginning of period		(1,077	)		(97	)
Net change in unrealized gains or losses on securities available for sale, net of deferred income taxes		(720	)		(259	)
Net change in prior service cost and net actuarial loss — SERP, net of deferred income taxes		41			—

At end of period		(1,756	)		(356	)


Cost of common stock in treasury
At beginning of period		(51,852	)		(51,852	)

At end of period		(51,852	)		(51,852	)


Total stockholders’ equity	$	64,750		$	109,458


Shares issued
At beginning of period		18,981			18,965
Shares issued under stock option plan		—			13

At end of period		18,981			18,978


Common shares in treasury
At beginning of period		(3,527	)		(3,527	)

At end of period		(3,527	)		(3,527	)


Total shares outstanding		15,454			15,451

See notes to condensed consolidated financial statements.

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


	Six Months
	Ended June 30,
	2009			2008

Increase (decrease) in cash & cash equivalents:
Cash flows from operating activities:
Net losses	$	(8,746	)	$	(1,647	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		940			907
Provision for loan losses		8,103			9,856
Stock-based compensation expense		5			8
Investment security premium amortization, net		319			106
Acquisition premium amortization, net		14			27
Deferred income taxes		—			(1,105	)
Gains on sales or calls of securities available for sale		(537	)		(62	)
Gains on sales or calls of securities held to maturity		(482	)		—
Impairment losses on securities		996			—
Originations of loans held for sale		(82,177	)		(139,294	)
Proceeds from loans held for sale		99,924			144,620
Gains on loans held for sale		(977	)		(1,796	)
Gains on disposal or sale of equipment		(4	)		—
Losses on disposal or sale of premises		6			39
Losses on disposal or sale of other real estate		1,115			600
Increase in cash surrender value of bank owned life insurance		(554	)		(574	)
Decrease in other assets		2,912			2,903
Decrease in accrued interest receivable		326			1,916
Decrease in accrued interest payable		(243	)		(626	)
Decrease in other liabilities		(5,314	)		(133	)

Net cash provided by operating activities		15,626			15,745


Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of securities available for sale		32,480			51,652
Proceeds from sales, maturities, calls and paydowns of securities held to maturity		24,103			5,780
Proceeds from sales of securities available for sale		58,488			2,903
Purchase of securities available for sale		(192,334	)		(6,694	)
Net decrease (increase) in loans		51,421			(17,876	)
Proceeds from redemption of bank owned life insurance		14,161			—
Capital expenditures		—			(4,442	)
Proceeds from sale of fixed assets		12			—
Proceeds from sale of other real estate		4,397			242

Net cash provided by (used in) investing activities		(7,272	)		31,565


Cash flows from financing activities:
Net increase (decrease) in demand, NOW, money market and savings deposits		(5,963	)		1,729
Net increase (decrease) in time deposits		(11,255	)		8,495
Net decrease in overnight and short-term borrowings		(24,157	)		(33,097	)
Net increase (decrease) in long-term borrowings		17,000			(2,000	)
Proceeds from shares issued under stock option plan		—			99
Tax benefit on shares issued under stock option plan		—			8
Dividends paid		—			(4,013	)

Net cash used in financing activities		(24,375	)		(28,779	)


Net increase (decrease) in cash equivalents		(16,021	)		18,531
Cash and cash equivalents at beginning of period		48,983			33,324


Cash and cash equivalents at end of period	$	32,962		$	51,855

See notes to condensed consolidated financial statements.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements
June 30, 2009
(Unaudited)

1. UNAUDITED FINANCIAL STATEMENTS

Bank of Granite Corporation’s (the “Company’s” or the “Holding Company’s”) condensed consolidated balance sheet as of June 30, 2009, and the condensed consolidated statements of income and comprehensive income for the three and and six-month periods ended June 30, 2009 and 2008, and the condensed consolidated statements of changes in stockholders’ equity and cash flows for the six-month periods ended June 30, 2009 and 2008 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, 2008 included in the condensed consolidated financial statements and related notes were derived from the audited consolidated financial statements.

Certain amounts for the periods ended June 30, 2008 have been reclassified to conform to the presentation for the periods ended June 30, 2009.

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, 2008 audited consolidated financial statements and notes thereto included in the Company’s 2008 Annual Report on Form 10-K.

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

The accounting policies followed are set forth in Note 1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 on file with the Securities and Exchange Commission. There were no changes in significant accounting policies during the six months ended June 30, 2009 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				Six Months
	Ended June 30,				Ended June 30,
(Shares in thousands)	2009		2008		2009		2008

Weighted average shares outstanding		15,454		15,446		15,454		15,442
Potentially dilutive effect of stock options		—		—		—		—

Weighted average shares outstanding, including potentially dilutive effect of stock options		15,454		15,446		15,454		15,442

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

The levels of outstanding stock options are insignificant and are not included for any period because their inclusion would be 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 June 30, 2009 and December 31, 2008 were as follows:


	June 30,		December 31,
	2009		2008
(In thousands)	(Unaudited)		(Note 1)

Financial instruments whose contract amounts represent credit risk
Unfunded commitments to extend credit	$	136,694	$	162,958
Standby letters of credit		4,549		4,998

During the first quarter of 2009 Granite Mortgage changed its business model from lender/seller to a broker operation. The loan pipeline and related derivative positions were closed as of June 30, 2009.

Granite Mortgage had no forward commitments and options to sell mortgage-backed securities as of June 30, 2009 and $14.7 million as of December 31, 2008.

Subsequent events have been evaluated through July 30, 2009.

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.

4. POSTRETIREMENT EMPLOYEE BENEFIT PLANS

The Bank sponsors a non-tax qualified, unfunded salary continuation plan (“Officers’ SERP”). The Officers’ SERP benefits are generally based on a final pay concept and a first to occur event related to change of control, retirement or death. Components of the net periodic SERP cost for this plan for the three and six months ended June 30, 2009 are as follows:


	Three Months		Six Months
	Ended June 30,		Ended June 30,
(In thousands)	2009		2009

Service cost	$	159	$	318
Interest cost		121		242
Amortization of net obligation at transition		41		82

Total net periodic SERP cost	$	321	$	642

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

Amounts are not set forth for the comparable periods of 2008 as the plan was revised in the fourth quarter of 2008 and comparable amounts were not recorded. The total SERP expense for the three and six-month periods ended June 30, 2008 was $312 thousand and $501 thousand, respectively.

5. REGULATORY RESTRICTIONS

The Company and the Bank were “adequately” capitalized at June 30, 2009. However, the Bank was not in compliance with the 2008 Memorandum of Understanding with the FDIC (“MOU”), which requires the Bank to be “well” capitalized. The Bank has communicated with its regulators about the failure to meet the “well” capitalized level as of December 31, 2008, March 31, 2009 and June 30, 2009. Additionally, in July 2009, the Bank received and replied to a prompt corrective action letter from the FDIC regarding a capital restoration plan to return the Bank to “adequately” capitalized.

The Company’s capital restoration activities in the six-month period ending June 30, 2009 have included a significant balance sheet restructuring to reduce loans and convert existing investments to government- backed securities. The Company also made additional capital investments in the Bank. The Bank improved to “adequately” capitalized at June 30, 2009.

The Company has considered various transactions that might enhance its capital position. To date, that activity has not resulted in any capital enhancements or probable transactions. While activities are ongoing, there can be no assurance that the Company and the Bank can achieve the “well” capitalized level. The Company cannot predict the regulatory response to any continued inability to improve capital levels.

The balance sheet restructuring to address capital discussed above was also directed to improving Bank liquidity. Because the Bank was not “adequately” capitalized at March 31, 2009, the Bank’s ability to obtain brokered deposits and access additional Federal Home Loan Bank (FHLB) borrowings was capped at existing levels. Both the FHLB and the Federal Reserve (Fed) have required securities to be pledged as collateral to support their existing exposure to the Bank. At June 30, 2009, the Company and the Bank did not have access to additional external funding sources other than a $15.0 million temporary line of credit with a correspondent bank. After meeting all pledge requirements, the Bank had in excess of $30 million unpledged government securities at June 30, 2009.

The minimum capital requirements to be characterized as “well” capitalized and “adequately” capitalized, as defined by regulatory guidelines, and the Company’s actual capital ratios on a consolidated and Bank-only basis were as follows as of June 30, 2009:


							Minimum Regulatory
	Actual						Requirement
							Adequately			Well
	Consolidated			Bank			Capitalized			Capitalized

Leverage capital ratios		5.83	%		5.61	%		4.00	%		5.00	%
Risk-based capital ratios:
Tier 1 capital		7.46	%		7.14	%		4.00	%		6.00	%
Total capital		8.74	%		8.41	%		8.00	%		10.00	%

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

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.

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.

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 brokers mortgage loan products for other financial institutions. Mortgage loan products include fixed-rate and adjustable-rate government and conventional loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. The Mortgage Banking segment earns fee income from its mortgage activities. During the first quarter of 2009 Granite Mortgage changed its business model from lender/seller to a broker operation. The loan pipeline and related derivative positions were closed as of June 30, 2009.

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.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

The following table presents selected financial information for reportable business segments as of and for the three and six-month periods ended June 30, 2009 and 2008.


	Three Months						Six Months
	Ended June 30,						Ended June 30,
(In thousands)	2009			2008			2009			2008

COMMUNITY BANKING
Net interest income	$	7,245		$	9,003		$	13,704		$	18,546
Provision for loan losses		4,309			8,421			8,055			9,820
Noninterest income		2,905			2,117			4,250			4,352
Noninterest expense		9,779			8,421			17,038			16,268
Loss before income taxes (benefits)		(3,938	)		(5,722	)		(7,139	)		(3,190	)
Net loss		(3,938	)		(3,183	)		(7,139	)		(1,362	)
Identifiable segment assets		1,101,545			1,154,212			1,101,545			1,154,212

MORTGAGE BANKING
Net interest income	$	266		$	996		$	1,328		$	1,838
Provision for loan losses		24			24			48			36
Noninterest income		225			986			849			2,029
Noninterest expense		1,123			1,878			3,300			3,563
Income (loss) before income taxes		(656	)		80			(1,171	)		268
Net income (loss)		(656	)		48			(1,171	)		161
Identifiable segment assets		5,903			29,114			5,903			29,114

OTHER
Net interest expense	$	(6	)	$	(117	)	$	(5	)	$	(209	)
Noninterest income (securities losses)		172			—			(312	)		—
Noninterest expense		93			110			119			237
Income (loss) before income taxes (benefits)		73			(227	)		(436	)		(446	)
Net income (loss)		73			(227	)		(436	)		(446	)
Identifiable segment assets		56			4,370			56			4,370

TOTAL SEGMENTS
Net interest income	$	7,505		$	9,882		$	15,027		$	20,175
Provision for loan losses		4,333			8,445			8,103			9,856
Noninterest income		3,302			3,103			4,787			6,381
Noninterest expense		10,995			10,409			20,457			20,068
Loss before income taxes (benefits)		(4,521	)		(5,869	)		(8,746	)		(3,368	)
Net loss		(4,521	)		(3,362	)		(8,746	)		(1,647	)
Identifiable segment assets		1,107,504			1,187,696			1,107,504			1,187,696

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

7. NEW ACCOUNTING STANDARDS

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“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, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 141(R) is effective prospectively for fiscal years beginning on or after December 15, 2008. The Company adopted SFAS No. 141(R) during the first quarter of 2009, and the adoption was not applicable to its consolidated financial statements for the periods reported.

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 adopted SFAS No. 160 during the first quarter of 2009, and the adoption was not applicable to its consolidated financial statements for the periods reported.

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 adopted SFAS No. 161 during the first quarter of 2009, and the adoption did not have a material effect on its consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments”, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods. This FSP shall be effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted FSP FAS 107-1 and APB 28-1 during the second quarter of 2009.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”, to amend the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The FSP shall be effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted FSP FAS 115-2 and FAS 124-2 during the second quarter of 2009.

Also in April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”, to provide additional guidance for estimating fair value in accordance with SFAS No. 157, “Fair Value Measurements”, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. It shall be effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. The Company adopted FSP FAS 157-4 during the second quarter of 2009, and the adoption did not have a material effect on its consolidated financial statements.

The Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 111, “Other Than Temporary Impairment of Certain Investments in Equity Securities” (“SAB No. 111”), in April 2009 in response to the FASB’s April 2009 release of Final FSP FAS 115-2 and FAS 124-2. SAB No. 111 amends and replaces “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities”, (“Topic 5.M”), in the SEC’s Staff Accounting Bulletin series. With the amendments in SAB No. 111, debt securities are excluded from the scope of Topic 5.M, but the SEC staff’s views on equity securities are still included within the topic. According to the revision to Topic 5.M, the SEC does not interpret the FASB’s use of the term other-than-temporary to mean permanent. The Company has considered this interpretative guidance for the disclosures in its interim financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”), which sets forth the circumstances under which an entity should recognize events occurring after the balance sheet date and the disclosures that should be made. Also, this statement requires disclosure of the date through which the entity has evaluated subsequent events (for public companies, and other companies that expect to widely distribute their financial statements, this date is the date of financial statement issuance, and for nonpublic companies, the date the financial statements are available to be issued). The effective date is for interim and annual periods ending after June 15, 2009. The Company adopted SFAS No. 165 during the second quarter of 2009, and the adoption did not have a material effect on its consolidated financial statements.

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (“SFAS No. 166”), which is a revision to SFAS No. 140, eliminates the concept of a qualifying special purpose entity (QSPE), changes the requirements for derecognizing financial assets, and requires additional disclosures, including information about continuing exposure to risks related to transferred financial assets. SFAS No. 166 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The disclosure requirements must be applied to transfers that occurred before and after the effective date. The Company is currently evaluating the impact on its financial statements of adopting SFAS No. 166.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”), which revises FIN 46(R), contains new criteria for determining the primary beneficiary, eliminates the exception to consolidating QSPE’s, requires continual reconsideration of conclusions reached in determining the primary beneficiary, and requires additional disclosures. SFAS No. 167 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments (e.g., for newly- consolidated VIE’s). The Company has not evaluated the effect of the adoption of SFAS No. 167 on its consolidated financial statements.

Also in June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 168”). The Codification will become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities and will supersede all non-SEC accounting and reporting standards. This statement is effective for financial statements issued for interim and annual financial statements ending after September 15, 2009. The Company is currently evaluating the impact of adopting SFAS No. 168.

8. FAIR VALUE MEASUREMENTS — SFAS NO. 157

Investment Securities Available for Sale

A significant portion of the Company’s available for sale investment portfolio is government guaranteed, and the fair value measurements for the second quarter of 2009 were estimated using independent pricing sources that were determined to be Level 2 measurements, Significant Other Observable Inputs, for the U.S. Government agency, mortgage-back and equity securities. The remaining U.S. Treasury and equity securities were Level 1 measurements from quoted prices in active markets. Unrealized gains and losses on securities available for sale are reflected in accumulated other comprehensive income and recognized gains and losses are reported as securities gains and losses in noninterest income.

The following table reflects investment securities available for sale measured at fair value on a recurring basis at June 30, 2009:


			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(In thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)

June 30, 2009
U.S. Treasury	$	14,996	$	14,996	$	—	$	—
U.S. Government agency		1,561		—		1,561		—
Mortgage-backed		138,916		—		138,916		—
Equities		2,502		954		1,548		—

Total investment securities available for sale	$	157,975	$	15,950	$	142,025	$	—

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(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 June 30, 2009, 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 June 30, 2009, all impaired loan values were determined to be based on Level 3 measurements.

Other Real Estate Owned

Other real estate owned by the Bank and Granite Mortgage resulting from foreclosures is estimated at the fair value of the collateral based on a current appraised value or other management estimate and is recorded as nonrecurring Level 3. At June 30, 2009, the fair value measurements for other real estate were determined to be Level 3 measurements.

The following table reflects certain loans and other real estate measured at fair value on a nonrecurring basis at June 30, 2009:


			Fair Value Measurements at
			Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(In thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)

June 30, 2009
Impaired loans (1)	$	21,825	$	—	$	—	$	21,825
Other real estate owned		15,437		—		—		15,437


Total assets	$	37,262	$	—	$	—	$	37,262


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

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

9. INVESTMENT SECURITIES

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

(Table in thousands)


	Amortized		Gross Unrealized				Fair
Type and Contractual Maturity	Cost		Gains		Losses		Value

AVAILABLE FOR SALE
At June 30, 2009:

U.S. Treasury due:
Within 1 year	$	14,993	$	3	$	—	$	14,996

U.S. Government agencies due:
After 1 year but within 5 years		1,560		1		—		1,561

Mortgage-backed securities due:
After 10 years		139,836		353		1,273		138,916

Others* due:
Trust preferred stocks due after 10 years		1,229		319		—		1,548
Common stocks and mutual funds		818		136		—		954

Total others		2,047		455		—		2,502


Total available for sale	$	158,436	$	812	$	1,273	$	157,975

Sales and calls of securities available for sale for the six months ended June 30, 2009 resulted in $694 thousand realized gains and $157 thousand realized losses. Sales of securities held to maturity with a carrying amount of $21.1 million resulted in $501 thousand gains and $19 thousand losses in 2009. These held to maturity securities were sold during the period in conjunction with the balance sheet restructuring plan. The amortized costs of certain equity securities were written down by $996 thousand in 2009 for declines deemed to be credit related.

As of June 30, 2009, accumulated other comprehensive losses, net of deferred income taxes, included unrealized net losses of $459 thousand, net of deferred income tax benefits of $181 thousand, related to securities available for sale.

Unrealized losses on securities have not been recognized in the income statement because management has the intent and ability to hold for the foreseeable future, and the decline in fair value is deemed to be interest rate risk related. The unrealized losses are reflected in other comprehensive income.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)

Securities with unrealized losses at June 30, 2009 not recognized in income were as follows:


(In thousands)	June 30, 2009
	Fair		Unrealized
	Value		Loss

U.S. Government mortgage-backed securities:
After 10 years	$	105,676	$	1,273

Total temporarily impaired	$	105,676	$	1,273

Declines in the fair value of available-for-sale and held-to-maturity securities that are deemed to be other-than-temporarily impaired are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of unrealized loss.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate the value, is based upon the characteristics of the instruments and relevant market information. Financial instruments include cash, evidence of ownership in an entity or contracts that convey or impose on an entity the contractual right or obligation to either receive or deliver cash for another financial instrument. These fair value estimates are based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price for which an asset could be sold or liability could be settled. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, it has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The fair value estimates are determined in accordance with SFAS No. 157.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (continued)
June 30, 2009
(Unaudited)


(In thousands)	June 30, 2009
			Estimated
	Carrying		Fair
	Amount		Value

Assets:
Cash and cash equivalents	$	32,962	$	32,962
Marketable securities		157,975		157,975

Loans		849,672		842,303
Market risk/liquidity adjustment		—		(40,000	)
Net loans		849,672		802,303

Liabilities:
Demand deposits		488,431		488,431
Time deposits		486,173		492,799
Overnight and short-term borrowings		24,790		24,790
Long-term borrowings		31,058		32,125


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

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

The Company estimated fair value based on estimated future cash flows discounted at current origination rates for loans with similar terms and credit quality. The estimated values in 2009 are a function of higher credit spreads, partially offset by lower risk-free interest rates. However, the values derived from origination rates at June 30, 2009 likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts ranging from 3% to 25%, depending on the nature of the loans, were subtracted to reflect the illiquid and distressed market conditions as of June 30, 2009. The discounted value is a function of a market participant’s required yield in the current environment and is not a reflection of the expected cumulative losses on the loans. Loan prepayments are used to adjust future cash flows based on historical experience and prepayment model forecasts. The carrying amount of accrued interest approximates its fair value.

Bank of Granite Corporation
Notes to Condensed Consolidated Financial Statements (concluded)
June 30, 2009
(Unaudited)

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

Demand deposits are shown at their face value.

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

Disclosures About Forward Looking Statements

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

Introduction

Management’s Discussion and Analysis is provided to assist in understanding and evaluating our results of operations and financial condition. The following discussion is intended to provide a general overview of our performance for the three and six-month periods ended June 30, 2009. 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.

Overview

The Company continued to operate in a very difficult economic environment in the six months ended June 30, 2009. The unemployment rate has continued to rise throughout the Company’s footprint, and the effect is evidenced in the declining ability of small businesses to service their debt. Real estate sales activity has slowed dramatically which has caused a continued decline in real estate values. Additionally, the Company has taken an aggressive position on resolving problem loan issues. Short-sale and other asset disposition activities have resulted in continued elevated credit loss costs and charge-off levels. Such activity has been significant, with a reduction of loans by approximately $75.7 million in the period.

The Company’s deposit levels have remained consistent at approximately $1.0 billion throughout the period. and loan levels have decreased which has significantly improved liquidity. Additionally, the Company’s operating expenses have decreased, except for FDIC assessments of $2.2 million which have more than offset the improved efficiencies.

The Company’s mortgage subsidiary changed its business model in the first quarter of 2009, as previously reported, primarily because of the difficulty of funding the operation. The level of origination activity has declined throughout the period. The subsidiary reported a net loss of $1.2 million for the first six months of 2009,and the Company continues to evaluate the viability of the operation at June 30, 2009.

Performance Summary

Our earnings decreased in both the three and six-month periods ended June 30, 2009 when compared to the same periods in 2008, primarily due to decreases in interest and fee income from loans. The decline in loan income was principally due to the continuing impact of the Federal Reserve Bank’s reduction of overnight rates through January 2009 as well as higher levels of nonperforming assets. The decline in loan loss provisions was partially offset by the decrease in net interest income for the same periods compared to 2008. Income tax benefits relating to the net losses for the first two quarters of 2009 were not recorded because it is more likely than not that the tax benefits will not be realized.

During the first quarter of 2009 Granite Mortgage changed its business model from lender/seller to a broker operation primarily because of the cost of outside funding. Also, as a result of this change, a significant part of Granite Mortgage’s net loss for the six months ended June 30, 2009 was attributable to severance payments and the final settlement of employment contracts.

Financial Highlights for
the Quarterly Periods
(In thousands except per share amounts)


	Three Months
	Ended June 30,
	2009			2008			% change

Earnings
Net interest income	$	7,505		$	9,882			-24.1	%
Provision for loan losses		4,333			8,445			-48.7	%
Other income		3,302			3,103			6.4	%
Other expense		10,995			10,409			5.6	%
Net loss		(4,521	)		(3,362	)		34.5	%

Per share
Net loss
- Basic	$	(0.29	)	$	(0.22	)		31.8	%
- Diluted		(0.29	)		(0.22	)		31.8	%

Average for period
Assets	$	1,138,662		$	1,205,959			-5.6	%
Loans		899,705			958,754			-6.2	%
Deposits		991,904			989,560			0.2	%
Stockholders’ equity		70,100			115,545			-39.3	%

Ratios
Return on average assets		-1.59	%		-1.12	%
Return on average equity		-25.87	%		-11.70	%
Average equity to average assets		6.16	%		9.58	%
Efficiency ratio (1)		101.41	%		79.05	%


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

Financial Highlights for
the Year-to-Date Periods
(In thousands except per share amounts)


	Six Months
	Ended June 30,
	2009			2008			% change

Earnings
Net interest income	$	15,027		$	20,175			-25.5	%
Provision for loan losses		8,103			9,856			-17.8	%
Other income		4,787			6,381			-25.0	%
Other expense		20,457			20,068			1.9	%
Net loss		(8,746	)		(1,647	)		431.0	%

Per share
Net loss
- Basic	$	(0.57	)	$	(0.11	)		418.2	%
- Diluted		(0.57	)		(0.11	)		418.2	%

Average for period
Assets	$	1,153,163		$	1,210,053			-4.7	%
Loans		919,225			953,743			-3.6	%
Deposits		997,642			989,093			0.9	%
Stockholders’ equity		72,266			116,613			-38.0	%

Ratios
Return on average assets		-1.53	%		-0.27	%
Return on average equity		-24.41	%		-2.84	%
Average equity to average assets		6.27	%		9.64	%
Efficiency ratio (1)		102.23	%		74.51	%


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

Changes in Financial Condition
June 30, 2009 Compared With December 31, 2008

The following table reflects the changes in our assets as of June 30, 2009 compared with December 31, 2008.


	June 30,		December 31,
(In thousands)	2009		2008		$ Change			% Change

Total assets	$	1,107,504	$	1,146,955	$	(39,451	)		-3.4	%
Earning assets		1,032,326		1,069,941		(37,615	)		-3.5	%
Cash and cash equivalents		32,962		48,983		(16,021	)		-32.7	%
Investment securities		157,975		82,203		75,772			92.2	%
Gross loans		872,459		948,149		(75,690	)		-8.0	%
Mortgage loans held for sale		—		16,770		(16,770	)		n/a
Investment in bank owned life insurance		17,671		31,278		(13,607	)		-43.5	%
Other assets		31,099		25,299		5,800			22.9	%

The $13.6 million decrease in investment in bank owned life insurance as of June 30, 2009 compared to December 31, 2008 relates to the overall balance sheet restructuring plan. Of the $5.8 million increase in other assets as of June 30, 2009 compared to December 31, 2008, $8.6 million relates to the increase in foreclosed properties, partially offset by a $2.5 million decrease in income taxes receivable.

Loans at June 30, 2009 and December 31, 2008 were as follows:


	June 30,			December 31,
(In thousands)	2009			2008			$ Change			% Change

Real estate — Construction	$	94,961		$	146,167		$	(51,206	)		-35.0	%
Real estate — Mortgage		599,048			593,233			5,815			1.0	%
Commercial, financial and agricultural		171,176			199,370			(28,194	)		-14.1	%
Consumer		8,356			10,713			(2,357	)		-22.0	%
All other loans		245			258			(13	)		-5.0	%

		873,786			949,741			(75,955	)		-8.0	%
Deferred origination fees, net		(1,327	)		(1,592	)		265			-16.6	%

Total loans	$	872,459		$	948,149		$	(75,690	)		-8.0	%


Mortgage loans held for sale	$	—		$	16,770		$	(16,770	)		n/a

The following table reflects the changes in our liabilities and equity as of June 30, 2009 compared with December 31, 2008.


	June 30,			December 31,
(In thousands)	2009			2008			$ Change			% Change

Total liabilities	$	1,042,754		$	1,072,785		$	(30,031	)		-2.8	%
Deposits		974,604			991,822			(17,218	)		-1.7	%
Non-interest-bearing demand deposits		110,127			117,168			(7,041	)		-6.0	%
Interest-bearing demand deposits		357,553			357,552			1			0.0	%
NOW accounts		136,635			153,444			(16,809	)		-11.0	%
Money market accounts		220,918			204,108			16,810			8.2	%
Savings deposits		20,751			19,674			1,077			5.5	%
Time deposits		486,173			497,428			(11,255	)		-2.3	%
Overnight and short-term borrowings		24,790			48,947			(24,157	)		-49.4	%
Long-term borrowings		31,058			14,075			16,983			120.7	%
Other liabilities		12,302			17,941			(5,639	)		-31.4	%
Total capital		64,750			74,170			(9,420	)		-12.7	%
Retained earnings		69,182			77,928			(8,746	)		-11.2	%
Accumulated other comprehensive loss		(1,756	)		(1,077	)		(679	)		63.0	%

The Company’s loan to deposit ratio was 89.52% as of June 30, 2009 compared to 95.60% as of December 31, 2008, and the Bank’s loan to deposit ratio was 87.90% compared to 93.14% when comparing the same dates.

In addition to deposits, we have overnight borrowings that are primarily in the form of commercial deposit products that sweep balances overnight into commercial paper issued by us. From December 31, 2008 to June 30, 2009, short-term borrowings decreased $20.8 million for Granite Mortgage, $4.0 million for the Bank, and $2.5 million for the holding company, partially offset by $3.1 million increase in commercial paper. The Bank’s long-term borrowings from the Federal Home Loan Bank increased $17.0 million during the first six months of 2009.

Other liabilities of the Bank decreased $3.0 million related to the payout of accrued retirement benefits during the first six months of 2009.

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. 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.

Additionally, 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 June 30, 2009, such unfunded commitments to extend credit were $136.7 million, and commitments in the form of standby letters of credit totaled $4.5 million.

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 June 30, 2009, and December 31, 2008, 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 be a stable portion of the Bank’s liability mix and the result of ongoing consumer and commercial banking relationships. At June 30, 2009, our core deposits, defined as total deposits excluding time deposits of $100 thousand or more, totaled $773.3 million, or 79.3% of our total deposits, compared to $783.8 million, or 79.0%, of our total deposits as of December 31, 2008.

The other principal methods of funding used by the Bank are large denomination certificates of deposit. The Bank participates in the Certificate of Deposit Account Registry Service (“CDARS”) through which the Bank’s customers may obtain fully-insured time deposits distributed among other participating banks while the Bank receives reciprocal deposits from other participating banks. The Bank’s deposits in the CDARS program totaled $38.9 million at June 30, 2009, a decrease of $13.9 million compared to December 31, 2008. Because CDARS program deposits are classified by current regulations as brokered deposits, the Bank’s capital levels have led the regulatory agencies to restrict its continued participation in the program and obtaining other brokered deposits. As of June 30, 2009, the Bank had an unsecured line of overnight borrowing capacity with its correspondent bank, which totaled $15.0 million. In addition, the Bank uses its capacity to pledge assets to serve as collateral to borrow on a secured basis. As of June 30, 2009, the Bank had investment securities pledged to secure an overnight funding line of approximately $14.0 million with the Federal Reserve Bank and borrowings of $40.0 million with the FHLB.

Prior to March 31, 2009, Granite Mortgage temporarily funded 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 December 31, 2008, this line of credit was $30.0 million. The line of credit was terminated and paid in full in April 2009. Granite Mortgage had intercompany borrowings with the Bank of $3.3 million outstanding at June 30, 2009, which were secured by approximately $4.4 million of loans in the Granite Mortgage portfolio.

We also had a $2.5 million unsecured line of credit from one of our correspondent banks that matured and was paid in full during the second quarter of 2009.

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.

We use interest sensitivity analysis to measure the sensitivity of projected earnings to changes in 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%.

These simulations indicate that net interest income will vary by less than four percent when interest rates rise or decline by 300 basis points.

Results of Operations

For the Three-Month Period Ended June 30, 2009 Compared
With the Same Period in 2008 and for the Six-Month Period
Ended June 30, 2009 Compared With the Same Period in 2008

During the three-month period ended June 30, 2009, we incurred a net loss of $4.5 million compared to a net loss of $3.4 million for the same period of 2008. The reduction in earnings for the second quarter of 2009 compared to 2008 was primarily due to lower net interest income, a reduction of income tax benefits, and an increase in FDIC deposit insurance premiums, partially offset by lower provision for loan losses. For the first six months of 2009, we incurred a net loss of $8.7 million compared to a net loss of $1.6 million for the first six months of 2008. The increase in losses incurred for the six-month period of 2009 compared to the same period of 2008 was primarily due to lower net interest income, an increase in FDIC deposit insurance premiums and a reduction of income tax benefits, partially offset by lower provision for loan losses.

Net Interest Income for the Quarterly Periods

The following table reflects the change in our net interest income for the three-month periods ended June 30, 2009 and 2008. For a discussion of our asset-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 June 30,
(In thousands)	2009			2008			$ Change			% Change
Interest income	$	13,087		$	17,072		$	(3,985	)		-23.3	%
Interest expense		5,582			7,190			(1,608	)		-22.4	%
Net interest income		7,505			9,882			(2,377	)		-24.1	%
Net interest margin		2.83	%		3.66	%
Yield on loans		5.41	%		6.54	%
Average prime rate		3.25	%		5.08	%
Cost of interest-bearing deposits		2.38	%		3.02	%
Cost of interest-bearing liabilities		2.38	%		3.07	%

Interest and fees from loans	$	12,160		$	15,912		$	(3,752	)		-23.6	%
Average loans
Bank		896,497			941,858			(45,361	)		-4.8	%
Granite Mortgage		9,944			36,472			(26,528	)		-72.7	%
Consolidated		902,161			978,330			(76,169	)		-7.8	%
Average loans not earning interest included in consolidated above		43,631			39,945			3,686			9.2	%
Interest on securities and overnight investments		927			1,160			(233	)		-20.1	%
Average securities and overnight investments		168,010			126,528			41,482			32.8	%

Average earning assets		1,070,171			1,104,858			(34,687	)		-3.1	%

Interest on interest-bearing deposits		5,232			6,420			(1,188	)		-18.5	%
Average interest-bearing deposits		881,374			854,033			27,341			3.2	%
Average money market deposits		214,014			246,666			(32,652	)		-13.2	%
Average time deposits		502,394			448,934			53,460			11.9	%

Interest on overnight and short-term borrowings		137			603			(466	)		-77.3	%
Average overnight and short-term borrowings
Bank		9,660			14,913			(5,253	)		-35.2	%
Granite Mortgage		6,401			29,503			(23,102	)		-78.3	%
Consolidated		27,400			74,155			(46,755	)		-63.1	%
Interest on long-term borrowings		213			167			46			27.5	%
Average long-term borrowings
Bank		31,090			11,151			19,939			178.8	%
Consolidated		31,090			13,651			17,439			127.7	%

We experienced growth in our average interest-bearing deposits during the second quarter of 2009; however, our average loans decreased compared to the second quarter of 2008. Our net interest margin declined 83 basis points, primarily due to the lower loan prime interest rate in the second quarter of 2009 compared to 2008, which resulted from rate reductions by the Federal Reserve Bank, which was partially offset by a 69 basis point decrease in our funding costs. We had lower yields on our variable rate loans, and our net interest margin was further compressed from the higher levels of nonaccruing loans during the second quarter of 2009 compared to 2008.

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 relative to our other deposit products. We have not historically relied upon “out-of-market” or “brokered” deposits as a significant source of funding although the reciprocal deposits we hold under the CDARS program discussed above are considered “brokered” deposits under regulations.

Our overnight borrowings are in the form of commercial paper related to the commercial deposit sweep arrangements of the Bank. Short-term borrowings from the Bank were the principal source of funding for Granite Mortgage during the second quarter of 2009.

Net Interest Income for the Year-to-Date Periods

The following table reflects the change in our net interest income for the six-month periods ended June 30, 2009 and 2008. For a discussion of our asset-sensitivity and the related effects on our net interest income and net interest margins, please see “Liquidity, Interest Rate Sensitivity and Other Risks” above.


	Six Months
	Ended June 30,
(In thousands)	2009			2008			$ Change			% Change

Interest income	$	27,080		$	35,976		$	(8,896	)		-24.7	%
Interest expense		12,053			15,801			(3,748	)		-23.7	%
Net interest income		15,027			20,175			(5,148	)		-25.5	%

Net interest margin		2.84	%		3.73	%
Yield on loans		5.48	%		6.89	%
Average prime rate		3.25	%		5.65	%
Cost of interest-bearing deposits		2.55	%		3.32	%
Cost of interest-bearing liabilities		2.56	%		3.37	%

Interest and fees from loans	$	25,287		$	33,320		$	(8,033	)		-24.1	%
Average loans
Bank		915,018			936,475			(21,457	)		-2.3	%
Granite Mortgage		20,395			36,018			(15,623	)		-43.4	%
Consolidated		930,565			972,493			(41,928	)		-4.3	%
Average loans not earning interest included in consolidated above		47,281			38,040			9,241			24.3	%

Interest on securities and overnight investments		1,793			2,656			(863	)		-32.5	%
Average securities and overnight investments		151,389			134,980			16,409			12.2	%

Average earning assets		1,081,954			1,107,473			(25,519	)		-2.3	%

Interest on interest-bearing deposits		11,194			14,095			(2,901	)		-20.6	%
Average interest-bearing deposits		885,825			852,622			33,203			3.9	%
Average money market deposits		212,271			249,588			(37,317	)		-15.0	%
Average time deposits		506,933			449,900			57,033			12.7	%

Interest on overnight and short-term borrowings		451			1,327			(876	)		-66.0	%
Average overnight and short-term borrowings
Bank		10,508			20,684			(10,176	)		-49.2	%
Granite Mortgage		14,783			28,925			(14,142	)		-48.9	%
Consolidated		36,686			77,098			(40,412	)		-52.4	%
Interest on long-term borrowings		408			379			29			7.7	%
Average long-term borrowings
Bank		28,642			11,699			16,943			144.8	%
Consolidated		28,642			14,199			14,443			101.7	%

Even though we experienced growth in our average interest-bearing deposits during the first six months of 2009 compared to the same period in 2008, our net interest margin declined 89 basis points, primarily due to lower yields on our variable rate loans, higher levels of nonaccruing loans, and lower prime interest rates during 2009 compared to 2008 without comparable decreases in funding costs. Our cost of funds decreased 81 basis points in the first six months of 2009.

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

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

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

Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review for impairment. When individual loans are impaired, the impairment allowance is measured in accordance with 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 reserves, general reserve and unallocated reserves. Generally, all loans with outstanding balances of $250 thousand or greater that have been identified as impaired are reviewed periodically in order to determine whether a specific allowance is required. When the value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

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

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

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 adequate to cover the estimated losses inherent 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. 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 allowances for loan losses based on their judgments.

During the six-month period ended June 30, 2009, the Bank continued to resolve problem loans through charge-offs, write-downs, and, in some cases, disposition of underlying collateral and restructure. The increased level of charge-offs in the second quarter relate primarily to the determination that estimated impairments on several large loans were determined to be uncollectible amounts and the loans were partially charged off. The charge-offs and transfer of loans to other real estate were the primary reasons the nonaccrual loans decreased in the six-month period.

The following table and subsequent discussion present an analysis of changes in the allowance for loan losses for the second quarters and year-to-date periods of 2009 and 2008, respectively.


	Three Months						Six Months
	Ended June 30,						Ended June 30,
(In thousands)	2009			2008			2009			2008

Allowance for loan losses, beginning of period	$	26,485		$	15,459		$	24,806		$	17,673

Net charge-offs:
Loans charged off:
Real estate		8,866			4,453			10,359			5,606
Commercial, financial and agricultural		746			1,564			2,072			4,888
Credit cards and related plans		10			3			29			5
Installment loans to individuals		15			31			35			103
Demand deposit overdraft program		36			46			83			99

Total charge-offs		9,673			6,097			12,578			10,701

Recoveries of loans previously charged off:
Real estate		487			276			617			414
Commercial, financial and agricultural		1,129			688			1,764			1,484
Credit cards and related plans		2			—			5			—
Installment loans to individuals		10			42			27			57
Demand deposit overdraft program		14			20			43			50

Total recoveries		1,642			1,026			2,456			2,005

Net charge-offs		8,031			5,071			10,122			8,696

Loss provisions charged to operations		4,333			8,445			8,103			9,856

Allowance for loan losses, end of period	$	22,787		$	18,833		$	22,787		$	18,833


Ratio of annualized net charge-offs during the period to average loans during the period		3.58	%		2.13	%		2.22	%		1.83	%
Allowance coverage of annualized net charge-offs		70.74	%		92.34	%		111.64	%		107.69	%
Allowance as a percentage of loans								2.61	%		1.97	%

Nonperforming assets at June 30, 2009 and December 31, 2008 were as follows:


	June 30,			December 31,
(In thousands)	2009			2008

Nonperforming assets:
Nonaccrual loans	$	38,531		$	50,591
Restructured loans		5,679			—
Loans past due 90 days or more and still accruing interest		355			114

Total nonperforming loans		44,565			50,705
Foreclosed properties		15,437			6,805

Total nonperforming assets	$	60,002		$	57,510


Nonperforming loans to total loans		5.11	%		5.35	%
Allowance coverage of nonperforming loans		51.13	%		48.92	%
Nonperforming assets to total assets		5.42	%		5.01	%

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 second quarters of 2009 and 2008 that would have been recorded was approximately $500 thousand and $737 thousand, respectively. The interest income recognized on such loans, prior to being placed on nonaccrual status, was approximately $283 thousand and $52 thousand, for the second quarters of 2009 and 2008, respectively.

For the comparable year-to-date periods, interest income of approximately $838 thousand in 2009 and $1.2 million in 2008 would have been recognized in accordance with the original terms of the nonaccrual loans, while the interest income recognized, prior to being placed on nonaccrual status, for the year-to-date period of 2009 was approximately $188 thousand, and the interest charged off, prior to being placed on nonaccrual status for the year-to-date period of 2008 was approximately $204 thousand.

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.

ll of our investment in impaired loans, $32.0 million at June 30, 2009 is included in nonaccruing loans in the table above, and the related loan loss allowance was $4.9 million. At December 31, 2008 our investment in impaired loans was $42.6 million, and the related loan loss allowance was $5.4 million. The average recorded balance of impaired loans was $37.3 million for the first six months of 2009 and $25.0 million for the first six months of 2008.

In addition to the nonaccrual loans, the Bank has potential problem loans of approximately $46.0 million at June 30, 2009. Potential problem loans are loans as to which management had serious doubts as to the ability of the borrowers to comply with present repayment terms. These loans do not meet the criteria for, and are therefore not included in, nonperforming assets. Management defines potential problem loans as those loans graded substandard in the Bank’s grading system. These loans were considered in determining the adequacy of the allowance for loan losses and are closely and regularly monitored to protect the Bank’s interests. Of the Bank’s $60.0 million nonperforming assets at June 30, 2009, approximately $25.0 million is unimproved land or residential lots in various stages of development.

Changes in foreclosed properties for the six months ended June 30, 2009 were as follows:


	Six Months
	Ended June 30,
(In thousands)	2009

Balance at beginning of period	$	6,805
Additions		14,144
Proceeds from sale		(4,397	)
Write-downs and net gain (loss) on sale		(1,115	)

Balance at end of period	$	15,437

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 June 30, 2009 and 2008.


	Three Months
	Ended June 30,
(In thousands)	2009		2008			$ Change			% Change
Total noninterest income
Bank	$	2,905	$	2,117		$	788			37.2	%
Granite Mortgage		225		986			(761	)		-77.2	%
Consolidated		3,302		3,103			199			6.4	%
Fees on deposit accounts		1,360		1,467			(107	)		-7.3	%
Other service fees and commissions		162		190			(28	)		-14.7	%
Annuity commissions		38		63			(25	)		-39.7	%
Mortgage banking income		226		986			(760	)		-77.1	%
Mortgage loan originations		977		68,097			(67,120	)		-98.6	%
Securities gains/losses		1,036		3			1,033			n/m
Other noninterest income		518		457			61			13.3	%

Total noninterest expenses
Bank		9,779		8,421			1,358			16.1	%
Granite Mortgage		1,123		1,878			(755	)		-40.2	%
Consolidated		10,995		10,409			586			5.6	%
Personnel expenses
Bank		3,803		4,423			(620	)		-14.0	%
Granite Mortgage		514		1,330			(816	)		-61.4	%
Consolidated		4,320		5,757			(1,437	)		-25.0	%
Salaries and wages
Bank		2,950		3,565			(615	)		-17.3	%
Granite Mortgage		483		1,235			(752	)		-60.9	%
Consolidated		3,433		4,800			(1,367	)		-28.5	%
Employee benefits
Bank		853		858			(5	)		-0.6	%
Granite Mortgage		31		95			(64	)		-67.4	%
Consolidated		887		957			(70	)		-7.3	%
Noninterest expenses other than for personnel
Bank		5,976		3,998			1,978			49.5	%
Granite Mortgage		609		548			61			11.1	%
Consolidated		6,675		4,652			2,023			43.5	%
Equipment and occupancy expense, net
Bank		941		1,091			(150	)		-13.7	%
Granite Mortgage		170		219			(49	)		-22.4	%
Consolidated		1,111		1,310			(199	)		-15.2	%
Other noninterest expenses
Bank		5,035		2,907			2,128			73.2	%
FDIC Assessment		1,908		146			1,762			n/m
Other real estate owned expenses		843		593			250			42.2	%
Other		2,284		2,168			116			5.4	%
Granite Mortgage		439		329			110			33.4	%
Other real estate owned expenses		285		—			285			0.0	%
Other		154		329			(175	)		-53.2	%
Consolidated		5,564		3,342			2,222			66.5	%

Income tax benefit		—		(2,507	)		2,507			n/a
Effective income tax rates		—		42.72	%

For the quarter ended June 30, 2009, securities gains increased $1.0 million, primarily from sales of securities available for sale in conjunction with the balance sheet restructuring previously discussed.

Granite Mortgage’s other income decreased $761 thousand, primarily as a result of a $67.1 million decline in mortgage originations as Granite Mortgage reduced its mortgage origination activities. Granite Mortgage’s compensation expense decreased $752 thousand for the second quarter of 2009 due to staff reductions during the first six months of 2009. Also, the Bank’s compensation expense decreased $615 thousand due to reduced staffing in 2009.

For the second quarter of 2009, the Bank’s other noninterest expenses increased $2.1 million, primarily due to an increase of $1.8 million in FDIC deposit insurance premiums including the special assessment imposed by the FDIC on insured institutions during the second quarter of 2009.

An income tax benefit relating to the net loss for the second quarter of 2009 was not recorded because it is more likely than not that the tax benefit will not be realized during the current year.

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

The following table reflects the changes in our noninterest income and expenses for the six-month periods ended June 30, 2009 and 2008.


	Six Months
	Ended June 30,
(In thousands)	2009			2008			$ Change			% Change

Total noninterest income
Bank	$	4,250		$	4,352		$	(102	)		-2.3	%
Granite Mortgage		849			2,029			(1,180	)		-58.2	%
Consolidated		4,787			6,381			(1,594	)		-25.0	%
Fees on deposit accounts		2,592			2,853			(261	)		-9.1	%
Other service fees and commissions		232			359			(127	)		-35.4	%
Annuity commissions		85			113			(28	)		-24.8	%
Mortgage banking income		850			2,029			(1,179	)		-58.1	%
Mortgage loan originations		82,177			139,294			(57,117	)		-41.0	%
Securities gains/losses		1,019			62			957			n/m
Other-than-temporary impairment losses		(996	)		—			(996	)		0.0	%
Other noninterest income		1,090			1,078			12			1.1	%

Total noninterest expenses
Bank		17,038			16,268			770			4.7	%
Granite Mortgage		3,300			3,563			(263	)		-7.4	%
Consolidated		20,457			20,068			389			1.9	%
Personnel expenses
Bank		7,842			9,307			(1,465	)		-15.7	%
Granite Mortgage		2,241			2,483			(242	)		-9.7	%
Consolidated		10,088			11,797			(1,709	)		-14.5	%
Salaries and wages
Bank		6,127			7,079			(952	)		-13.4	%
Granite Mortgage		2,094			2,287			(193	)		-8.4	%
Consolidated		8,221			9,366			(1,145	)		-12.2	%
Employee benefits
Bank		1,715			2,228			(513	)		-23.0	%
Granite Mortgage		147			196			(49	)		-25.0	%
Consolidated		1,867			2,431			(564	)		-23.2	%
Noninterest expenses other than for personnel
Bank		9,196			6,961			2,235			32.1	%
Granite Mortgage		1,059			1,080			(21	)		-1.9	%
Consolidated		10,369			8,271			2,098			25.4	%
Equipment and occupancy expense, net
Bank		1,903			2,126			(223	)		-10.5	%
Granite Mortgage		364			430			(66	)		-15.3	%
Consolidated		2,267			2,556			(289	)		-11.3	%
Other noninterest expenses
Bank		7,293			4,835			2,458			50.8	%
FDIC Assessment		2,379			175			2,204			n/m
Other real estate owned expenses		1,037			628			409			65.1	%
Other		3,877			4,032			(155	)		-3.8	%
Granite Mortgage		695			650			45			6.9	%
Other real estate owned expenses		289			10			279			n/m
Other		406			640			(234	)		-36.6	%
Consolidated		8,102			5,715			2,387			41.8	%

Income tax benefit		—			(1,721	)		1,721			n/a
Effective income tax rates		0.00	%		51.10	%

Net securities gains of $23 thousand for the six-month period of 2009 include $1.0 million of other-than- temporary impairment losses on securities, offset by net gains on the sales of securities available for sale during the period.

Granite Mortgage’s other income decreased $1.2 million, primarily as a result of a $57.1 million decline in mortgage originations as Granite Mortgage’s mortgage origination activities declined during the six-month period of 2009.

Of the $1.1 million decrease in compensation expense for the first six months of 2009 compared to 2008, $1.0 million relates to the Bank’s reduced staffing. The Bank’s employee benefits decreased $513 thousand for the six-month period of 2009 compared to the same period of 2008, primarily due to suspension of the employer’s profit-sharing contribution.

The Bank’s other noninterest expenses increased $2.5 million for the first six months of 2009, primarily related to the $2.2 million increase in FDIC deposit insurance premiums.

An income tax benefit relating to the net loss for the first six months of 2009 was not recorded because it is more likely than not that the tax benefit will not be realized during the current year.

Off-Balance Sheet Arrangements

We have off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. Further discussions of off-balance sheet arrangements are included above under “Liquidity, Interest Rate Sensitivity And Other Risks” and in Note 3 under “Notes to Consolidated Condensed Financial Statements.”

Contractual Obligations

As of June 30, 2009, there were no material changes to contractual obligations in the form of long-term borrowings and operating lease obligations as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008. 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.

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.”

Item 4. Controls and Procedures

As of June 30, 2009, the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based upon, and as of the date of this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. During the period covered by this Quarterly Report, no change in our internal control over financial reporting has occurred that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II — Other Information

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

There were no share repurchase transactions for the three months ended June 30, 2009.

Item 4 — Submission of Matters to a Vote of Security Holders

The following proposals were considered and acted upon at our annual meeting of stockholders held on April 27, 2009:

Proposal 1. To consider the election of eight persons named as director/nominees in the Proxy Statement dated March 31, 2009.


R. Scott Anderson	FOR	11,247,148	WITHHELD	637,065
John N. Bray	FOR	11,251,641	WITHHELD	632,572
Joseph D. Crocker	FOR	11,125,511	WITHHELD	758,702
Leila N. Erwin	FOR	11,152,399	WITHHELD	731,814
Paul M. Fleetwood, III	FOR	11,238,058	WITHHELD	646,155
Hugh R. Gaither	FOR	11,064,015	WITHHELD	820,198
James Y. Preston	FOR	11,263,786	WITHHELD	620,426
Boyd C. Wilson, Jr., CPA	FOR	11,239,697	WITHHELD	644,516

Proposal 2. To consider the ratification of the selection of Dixon Hughes PLLC as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009.


FOR	10,720,622		AGAINST			980,042			ABSTAIN			183,549

Item 6 — Exhibits

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


3.1		Bank of Granite Corporation’s Restated Certificate of Incorporation, filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q dated May 9, 2006, is incorporated herein by reference.

3.2		Bank of Granite Corporation’s Amended and Restated Bylaws, filed as Exhibit 3.1 to our Current Report on Form 8-K dated April 28, 2008, is incorporated herein by reference.

4.1		Form of stock certificate for Bank of Granite Corporation’s common stock, filed as Exhibit 4.1 to our Registration Statement on Form S-4 (Registration Statement No. 333-104233) dated April 1, 2003, is incorporated herein by reference.

4.2		Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite Corporation (included in Exhibit 3.1 hereto)

10.1		Written Description of Director Compensation pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K, dated April 27, 2009.

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

Exhibit Index


		Begins
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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	*

10.1	Written Description of Director Compensation	Filed herewith

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.


	Bank of Granite Corporation (Registrant)
Date: July 30, 2009	By:	/s/ Kirby A. Tyndall
		Kirby A. Tyndall
		Chief Financial Officer and Principal Accounting Officer

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Part I — Financial Information

Item 1. Financial Statements:

Condensed Consolidated Balance Sheets June 30, 2009 and December 31, 2008		3

Condensed Consolidated Statements of Income Three Months Ended June 30, 2009 and 2008 And Six Months Ended June 30, 2009 and 2008		4

Condensed Consolidated Statements of Comprehensive Income Three Months Ended June 30, 2009 and 2008 And Six Months Ended June 30, 2009 and 2008		5

Condensed Consolidated Statements of Changes in Stockholders’ Equity Six Months Ended June 30, 2009 and 2008		6

Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2009 and 2008		7

Notes to Condensed Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21

Item 3. Quantitative and Qualitative Disclosures About Market Risk		37

Item 4. Controls and Procedures		38

Part II — Other Information

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		38

Item 4. Submission of Matters to a Vote of Security Holders		38

Item 6. Exhibits		39

Signatures		40

Exhibit Index		41
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2