##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-K ANNUAL REPORT PURSUANT
TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended           December 31, 2004 Commission file number           0-15956 Bank of Granite Corporation 
  Delaware
    
    56-1550545(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)P.O. Box 128, Granite Falls, N.C.
    
    28630(Address of principal executive offices)
    
    (Zip Code)Registrants telephone number, including area code
    
    (828)496-2000
 Securities registered pursuant to Section 12(b) of the Act: None Title of each class
    
    Name of exchange on which registered
 Securities registered pursuant to Section 12(g) of the Act: Common Stock, $1.00 par value 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
the definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. þ Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12-b-2). Yesþ No o As of March 4, 2005, 13,281,106 shares of common stock, $1 par
value, were outstanding. As of June 30, 2004, the aggregate market value of common stock held by
non-affiliates was $258,532,008. Documents Incorporated by Reference PART III: Definitive Proxy Statement dated March 18, 2005 as filed pursuant to Section 14 of
the Securities Exchange Act of 1934 in connection with the 2005 Annual Meeting of Shareholders.    1




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FORM 10-K CROSS-REFERENCE INDEX 20052004
    
    
    ProxyForm 10-K
    
    
    StatementPage
    
    
    PagePART IItem 1 - Business
    
    
    3
    
    
    
    n/aItem 2 - Properties
    
    
    8
    
    
    
    n/aItem 3 - Legal Proceedings
    
    
    8
    
    
    
    n/aItem 4 - Submission of Matters to a Vote of Security Holders
    
    
    8
    
    
    
    n/aPART IIItem 5 - Market for the Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
    
    
    9
    
    
    
    n/aItem 6 - Selected Financial Data
    
    
    11
    
    
    
    n/aItem 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12
    
    
    
    n/aItem 7A - Quantitative and Qualitative Disclosures about Market Risk
    
    
    37Item 8 - Financial Statements and Supplementary Data
    
    
    38
    
    
    
    n/aItem 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    69
    
    
    
    n/aItem 9A - Controls and Procedures
    
    
    70
    
    
    
    n/aItem 9B - Other Information
    
    
    72
    
    
    
    n/aPART IIIItem 10 - Directors and Executive Officers of the Registrant
    
    
    
    
    
    
    5,873
    
    
    and 20Item 11 - Executive Compensation
    
    
    73
    
    
    
    11, 13 - 17and 19Item 12 - Security Ownership of Certain Beneficial Owners and
    
    
    
    
    
    
    2,8,Management and Related Shareholder Matters
    
    
    73
    
    
    15 and 16Item 13 - Certain Relationships and Related Transactions
    
    
    73
    
    
    
    20Item 14 - Principal Accountant Fees and Services
    
    
    73
    
    
    
    21Item 15 - Exhibits and Financial Statement Schedules*
    
    
    74
    
    
    
    n/aSignatures
    
    
    77
    
    
    
    n/aEX-10.13EX-10.14EX-11EX-14EX-21EX-23EX-31.1EX-31.2EX-32.1EX-32.2
    *
    
    Exhibits and Financial Statement Schedules included in or incorporated by reference into
this filing were filed with the Securities and Exchange Commission. Bank of Granite
Corporation provides these documents through its Internet site at www.bankofgranite.com or
by mail upon request. 2




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##### Table of Contents



PART I 
 ITEM 1  BUSINESS Bank of Granite Corporation (the Company) is a Delaware corporation that was organized June 1,
1987 as a bank holding company. The Company currently engages in no operations other than ownership
and operation of Bank of Granite (the Bank), a state bank chartered under the laws of North
Carolina on August 2, 1906 and Granite Mortgage, Inc. (Granite Mortgage), a mortgage bank
chartered under the laws of North Carolina on June 24, 1985. Granite Mortgage was acquired by the
Company on November 5, 1997. On July 15, 2003, the Company acquired First Commerce Corporation and
its wholly owned subsidiary, First Commerce Bank (referred to herein collectively as First
Commerce), and merged First Commerce Bank into the Bank on July 24, 2003. First Commerce Bank
operated three banking offices in the Charlotte metropolitan area. The Company conducts its
community banking business operations from 20 full-service offices and one loan-production office
located in Caldwell, Catawba, Burke, Watauga, Wilkes, Mecklenburg and Forsyth counties in North
Carolina. According to the Federal Deposit Insurance Corporation (the FDIC), the Bank ranked 10th
in assets and 10th in deposits among North Carolina institutions as of September 30, 2004.
The Company conducts its mortgage banking business operations from 13 offices in the Central and
Southern Piedmont and Catawba Valley regions of North Carolina and in Hilton Head Island, South
Carolina. The Company conducts its business through three reportable business segments: Community Banking,
Mortgage Banking and Other. The Community Banking segment offers a variety of loan and deposit
products and other financial services. The Mortgage Banking segment originates, retains and sells
mortgage loans. The Other segment includes activities at the holding company level such as
corporate and shareholder relations and funding from the issuance of commercial paper and trust
preferred securities. For financial information on the Companys three business segments, see Note
20 Operating Segments of the Notes to Consolidated Financial Statements. GENERAL BUSINESS The Bank is an independent community bank. The Banks principal community banking activities
include the taking of demand and time deposits and the making of loans, secured and unsecured, to
individuals, associations, partnerships and corporations. The majority of its customers are
individuals and small businesses. No material part of its business is dependent upon a single
customer or a few customers whose loss would have an adverse effect on the business of the Bank. No
material portion of the business of the Bank is seasonal. Granite Mortgages principal mortgage banking activities include the origination and underwriting
of mortgage loans to individuals. Granite Mortgage also sells mortgage servicing rights and
appraisal services. Granite Mortgage specializes in government guaranteed mortgage products. The
majority of its customers are individuals. No material part of its business is dependent upon a
single customer or a few customers whose loss would have an adverse effect on the business of
Granite Mortgage. The mortgage business is
sensitive to changes in interest rates in the market. When rates decline, Granite Mortgage
experiences an increase in its mortgage business. When rates rise, Granite Mortgages business
declines. No material portion of the business of Granite Mortgage is seasonal. 3




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##### Table of Contents



GENERAL DESCRIPTION OF ECONOMIC AREAS Prior to 2003, the Company conducted its community banking operations primarily in Caldwell,
Catawba and Burke counties of North Carolina. This area was historically known as a center for the
manufacture of fiber optic and coaxial cable, furniture, and apparel. When the economy began to
weaken in 2001, these counties were significantly impacted with a sudden and sustained rise in
their unemployment rates. All of these industries faced massive layoffs of their workforces. In
2003, as opportunities arose to expand and diversify its market areas, the Company did so by
entering three new markets where the local economies were more diversified and growing. The Bank
opened new banking offices in Watauga County (Boone) and Wilkes County (Wilkesboro) in April and
acquired First Commerce Bank and its three banking offices in Mecklenburg County (Charlotte and
Cornelius) in July. In 2004, the Bank opened a banking office in Forsyth County (Winston-Salem). In
2005, the Bank plans to convert its loan production office in Mecklenburg County (Matthews) to a

full-service banking office. The relative unemployment rates and the population growth in
Mecklenburg County and Forsyth County, each as shown in the tables below, formed the primary basis
for the Companys decision to expand into those new markets. Month of December
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Unemployment Rates*Caldwell County
    
    
    8.30
    %
    
    
    8.90
    %
    
    
    8.30
    %
    
    
    8.50
    %
    
    
    2.60
    %Catawba County
    
    
    6.60
    %
    
    
    8.00
    %
    
    
    9.10
    %
    
    
    9.30
    %
    
    
    2.80
    %Burke County
    
    
    5.90
    %
    
    
    7.30
    %
    
    
    7.80
    %
    
    
    8.30
    %
    
    
    4.20
    %Watauga County
    
    
    2.00
    %
    
    
    2.20
    %
    
    
    2.70
    %
    
    
    2.20
    %
    
    
    1.50
    %Wilkes County
    
    
    6.00
    %
    
    
    6.70
    %
    
    
    7.80
    %
    
    
    7.40
    %
    
    
    3.40
    %Mecklenburg County
    
    
    4.80
    %
    
    
    5.20
    %
    
    
    5.60
    %
    
    
    4.90
    %
    
    
    2.40
    %Forsyth County
    
    
    4.10
    %
    
    
    5.00
    %
    
    
    5.20
    %
    
    
    4.60
    %
    
    
    2.50
    %North Carolina
    
    
    5.20
    %
    
    
    6.10
    %
    
    
    6.70
    %
    
    
    6.60
    %
    
    
    4.20
    %United States
    
    
    5.40
    %
    
    
    5.70
    %
    
    
    6.00
    %
    
    
    5.80
    %
    
    
    3.90
    %
   *Source: Employment Security Commission of North CarolinaThe population projections and estimates for the counties in the Companys primary market areas are as
follows: July 2005
    
    
    July 2003
    
    
    April 2000Projections
    
    
    Estimates
    
    
    CensusPopulation Projections and Estimates*Caldwell County
    
    
    79,172
    
    
    
    78,132
    
    
    
    77,708Catawba County
    
    
    151,169
    
    
    
    146,458
    
    
    
    141,686Burke County
    
    
    91,148
    
    
    
    88,790
    
    
    
    89,145Watauga County
    
    
    43,497
    
    
    
    42,772
    
    
    
    42,695Wilkes County
    
    
    68,112
    
    
    
    66,909
    
    
    
    65,632Mecklenburg County
    
    
    789,940
    
    
    
    750,221
    
    
    
    695,471Forsyth County
    
    
    325,957
    
    
    
    317,643
    
    
    
    306,067North Carolina
    
    
    8,709,947
    
    
    
    8,418,090
    
    
    
    8,046,962
   *Source of projection, estimate and census data: North Carolina Office of State Budget and
Management 4




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TERRITORY SERVED AND COMPETITION The Bank operates community banking offices in the North Carolina cities of Granite Falls, Lenoir,
Hudson, Newton, Morganton, Hickory, Boone, Wilkesboro, Charlotte, Cornelius, Conover and
Winston-Salem, with a total of 20 full-service offices, as well as a loan-production office in
Matthews. The Bank plans to convert its loan-production office in Matthews to a full-service
banking office in 2005. The Federal Deposit Insurance Corporation (the FDIC) collects deposit data from insured
depository institutions as of June 30 of each year as presented below (deposit dollars in
millions). June 30, 2004
    
    
    June 30, 2003Bank of Granite
    
    
    Market
    
    
    Bank of Granite*
    
    
    MarketCounty
    
    Deposits
    
    
    Market Share
    
    
    Deposits
    
    
    No. of Banks
    
    
    Deposits
    
    
    Market Share
    
    
    Deposits
    
    
    No. of BanksCaldwell
    
    $
    278.5
    
    
    
    37.1
    %
    
    $
    751.7
    
    
    
    8
    
    
    $
    271.0
    
    
    
    35.9
    %
    
    $
    754.1
    
    
    
    8Catawba
    
    
    307.5
    
    
    
    13.2
    %
    
    
    2,321.9
    
    
    
    11
    
    
    
    305.6
    
    
    
    13.7
    %
    
    
    2,227.1
    
    
    
    10Burke
    
    
    42.4
    
    
    
    6.4
    %
    
    
    657.6
    
    
    
    8
    
    
    
    38.4
    
    
    
    5.9
    %
    
    
    646.1
    
    
    
    8Watauga
    
    
    7.8
    
    
    
    1.2
    %
    
    
    665.9
    
    
    
    11
    
    
    none
    
    
    0.0
    %
    
    
    585.0
    
    
    
    10Wilkes
    
    
    4.3
    
    
    
    0.7
    %
    
    
    660.4
    
    
    
    10
    
    
    none
    
    
    0.0
    %
    
    
    675.3
    
    
    
    10Mecklenburg*
    
    
    132.7
    
    
    
    0.2
    %
    
    
    72,055.2
    
    
    
    17
    
    
    
    149.2
    
    
    
    0.3
    %
    
    
    59,274.7
    
    
    
    17Forsyth
    
    none
    
    
    0.0
    %
    
    
    9,925.5
    
    
    
    13
    
    
    none
    
    
    0.0
    %
    
    
    9,502.9
    
    
    
    13
   *
    
    June 30, 2003 deposit data for Mecklenburg County reflects deposits of First Commerce
Bank, acquired by by the Bank on July 15, 2003 and is included here to provide meaningful
market share comparisons. The Banks community banking markets are highly competitive. In addition to competing with other
large and small banks, which tend to be numerous, especially in the higher growth markets, the Bank
also competes for both loan and deposit business with thrifts or savings institutions, credit
unions, brokerage and insurance firms and other nonbank businesses, such as manufacturers and
retailers. The mortgage banking business is also highly competitive, with both bank and nonbank mortgage
originators competing in the market. Granite Mortgage conducts its mortgage banking business from
13 offices in the North Carolina cities of Winston-Salem, Hickory, High Point, Lenoir, Morganton,
Newton, Salisbury, Boone, Charlotte and Fayetteville, and from one office in Hilton Head Island,
South Carolina. The Companys community banking and mortgage banking operations are both required to compete based
on price in order to conduct business in each of the Companys markets. However, the Company
believes that its focus on and commitment to providing superior customer service is what
distinguishes it from its competitors. EMPLOYEES As of December 31, 2004, the Bank had 253 and Granite Mortgage had 62 full-time equivalent
employees. Each of the Bank and Granite Mortgage considers its relationship with its employees to
be excellent. 5




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SUPERVISION AND REGULATION The following summaries of statutes and regulations affecting bank holding companies, banks and
mortgage banks do not purport to be complete. Such summaries are qualified in their entirety by
reference to such statutes and regulations. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956,
as amended, and is required to register as such with the Board of Governors of the Federal Reserve
System (the Federal Reserve Board or FRB). A bank holding company is required to file with the FRB annual reports and other information
regarding its business operations and those of its subsidiaries. It is also subject to examination
by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to
acquiring, directly or indirectly, more than 5% of the voting stock of a bank, unless it already
owns a majority of the voting stock of the bank. Furthermore, with limited exceptions, a bank
holding company must engage only in the business of banking or managing or controlling banks or
furnishing services to or performing services for its subsidiary banks. One of the exceptions to
this prohibition is the ownership of shares of a company the activities of which the FRB has
determined to be so closely related to banking or managing or controlling banks as to be a proper
incident thereto. The FRB has cease-and-desist powers over bank holding companies and non-banking subsidiaries where
their action would constitute a serious threat to the safety, soundness or stability of a
subsidiary bank. Although the Company is not presently subject to any regulatory restrictions on dividends, the
Companys ability to pay dividends depends to a large extent on the amount of dividends paid by the
Bank and any other subsidiaries. The Bank, as a North Carolina banking corporation, may pay
dividends only out of undivided profits as determined pursuant to Section 53-87 of the North
Carolina General Statutes. As of December 31, 2004, the Bank had undivided profits of approximately
$94.1 million. Additionally, current federal regulations require that the Bank maintain a ratio of
total capital to assets, as defined by regulatory authorities, in excess of 6%. As of December 31,
2004, this ratio was 13.20% for the Bank, leaving approximately $71.5 million of the Banks
undivided profits available for the payment of dividends. In an effort to achieve a measurement of capital adequacy that is more sensitive to the individual
risk profiles of financial institutions, the various financial institution regulators mandate
minimum capital regulations and guidelines that categorize various components of capital and types
of assets and measure capital adequacy in relation to a particular institutions relative levels of
those capital components and the level of risk associated with various types of assets of that
financial institution. The FDIC and the FRB statements of policy on risk-based capital require
the Company to maintain a level of capital commensurate with the risk profile assigned to its
assets in accordance with the policy statements. The capital standards call for minimum total
capital of 8% of risk-adjusted assets. At December 31, 2004, the Companys tier 1 ratio and total
capital ratio to risk-adjusted assets were 16.0% and 17.2%, respectively. The Companys leverage
ratio at December 31, 2004 was 13.4%. The Company is in compliance with all regulatory capital requirements. The Bank is subject to supervision and regulation, of which regular bank examinations are a part,
by the FDIC and the North Carolina State Banking Commission (the Banking Commission). The Bank is
a member of the FDIC, which currently insures the deposits of each member bank to a maximum of
$100,000 per depositor. For this protection, each bank pays a semi-annual statutory assessment and
is subject to the rules and regulations of the FDIC. 6




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##### Table of Contents



Federal banking laws applicable to all depository financial institutions, among other things, (i)
afford federal bank regulatory agencies with powers to prevent unsafe and unsound banking
practices; (ii) restrict preferential loans by banks to insiders of banks; (iii) require banks to
keep information on loans to major shareholders and executive officers, and (iv) bar certain
director and officer interlocks between financial institutions. The prohibitions against
preferential loans and certain director and officer interlocks may inhibit the ability of the Bank
and the Company to obtain experienced and capable officers and directors, to replace presently
proposed officers and directors, or to add to their number. The Company is an affiliate of the Bank within the meaning of the Federal Reserve Act, which
imposes restrictions on loans by the Bank to the Company and on investments by the Bank in the
stock or securities of the Company, which serve as security for loans by the Bank to any borrower.
The Company is also subject to certain restrictions with respect to engaging in the business of
issuing, underwriting and distributing securities. Shareholders of banks (including bank holding companies which own stock in banks) may be compelled
by bank regulatory authorities to invest additional capital in the event their banks experience
either significant loan losses or rapid growth of loans or deposits. In addition, the Company may
also be required to provide additional capital to any additional banks that it acquires as a
condition to obtaining the approvals and consents of regulatory authorities in connection with such
acquisitions. Granite Mortgage, as a mortgage bank, is regulated by the Banking Commission. Because Granite
Mortgage is a nonbank subsidiary of a bank holding company, it is also regulated by the FRB. In
addition, because Granite Mortgage underwrites mortgages guaranteed by the government, it is
subject to other audits and examinations as required by the government agencies or the investors
who purchase the mortgages. The Company cannot predict what other legislation might be enacted or what other regulation
might be adopted or, if enacted or adopted, the effect thereof. EFFECTS OF GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONTROLS The Company is directly affected by governmental monetary policy and by regulatory measures
affecting the banking industry in general. Of primary importance is the FRB, whose actions directly
affect the money supply and, in general, affect banks lending abilities by increasing or
decreasing the cost and availability of bank credit in order to combat recession and curb
inflationary pressures in the economy by open market operations in the United States government
securities, changes in the discount rate on member bank borrowings, and changes in reserve
requirements against bank deposits. Deregulation of interest rates paid by banks on deposits and the types of deposits that may be
offered by banks have eliminated minimum balance requirements and rate ceilings on various types of
time deposit accounts. The effect of these specific actions and, in general, the deregulation of
deposit interest rates have increased banks costs of funds and made them more sensitive to
fluctuations in money market rates. In view of changing conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, predictions as to possible future changes in interest
rates, deposit levels, loan demand or the business and earnings of the Company are difficult and
have very limited reliability. 7




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##### Table of Contents



INVESTMENT POLICIES For a discussion of the Companys investment policies, see Investment Securities of the
Managements Discussion and Analysis of Financial Condition and Results of Operations section of
this annual report. LOAN PORTFOLIO For a discussion of the Companys loan portfolio, see Loans and Provisions and Allowances for
Loan Losses of the Managements Discussion and Analysis of Financial Condition and Results of
Operations section of this annual report. AVAILABLE INFORMATION Additional information about the Company and its business is available at the Companys website, at
www.bankofgranite.com. The Companys filings with the Securities and Exchange Commission, including
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act of 1934, are available, free of charge, on the Companys website at www.bankofgranite.com under
the heading Investor Relations  SEC Filings. These reports are available as soon as reasonably
practicable after the Company electronically files such material with, or furnishes it to, the
Securities and Exchange Commission. Information included on the Companys website is not
incorporated by reference into this annual report. 
 ITEM 2  PROPERTIES The Company indirectly owns and operates real estate through its ownership of the Bank and Granite
Mortgage. The Bank occupies headquarters, operations and information technology center offices
located in Granite Falls, North Carolina, which are owned. The Bank also owns its banking offices
in the North Carolina cities and communities of Conover, Cornelius, Granite Falls, Hickory, Hudson,
Lenoir, Morganton and Newton. The Bank leases its banking offices in the North Carolina cities and
communities of Boone, Charlotte, Matthews, Wilkesboro and Winston-Salem. Management does not
currently anticipate any problems with the renewal of its operating leases. Granite Mortgage
occupies headquarters offices located in Winston-Salem, North Carolina, which are leased. Granite
Mortgage also occupies mortgage origination offices in the North Carolina cities and communities of
Boone, Charlotte, Conover, Fayetteville, Hickory, High Point, Lenoir, Morganton, Salisbury and
Winston-Salem, and the South Carolina community of Hilton Head Island, all of which are leased.
Management believes that the premises occupied by the Bank and Granite Mortgage are well-located
and suitably equipped to serve and support the Companys community banking and mortgage banking
businesses. See also Note 5 Premises and Equipment of the Notes to Consolidated Financial
Statements. 
 ITEM 3  LEGAL PROCEEDINGS There were no significant legal proceedings as of December 31, 2004. 
 ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of shareholders in the fourth quarter of 2004. 8




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##### Table of Contents



PART II 
   The Companys common stock, $1 par value, trades on The NASDAQ National Market® tier of The NASDAQ
Stock Market® under the symbol GRAN. Price and volume information is contained in The Wall Street
Journal®and most major daily newspapers in the NASDAQ section under the National Market System
listings. During 2004, the market participants making a market in the Companys common stock with the
highest volumes of Company shares traded were Goldman Sachs & Company, the National Stock
Exchange, Knight Equity Markets, LP and Wachovia Capital Markets. As of December 31, 2004, there were 13,316,102 shares outstanding, owned by approximately 2,700
shareholders of record and an estimated 4,200 holders of shares registered in street name or as
beneficial owners. The following table presents the quarterly market sales prices and dividend
information for the two years in the period ended December 31, 2004. Quarterly Common Stock Market Price Ranges and Dividends 2004
    
    Quarter 1
    
    
    Quarter 2
    
    
    Quarter 3
    
    
    Quarter 4Price RangeHigh
    
    $
    22.84
    
    
    $
    21.82
    
    
    $
    20.85
    
    
    $
    22.93Low
    
    
    19.16
    
    
    
    17.67
    
    
    
    17.95
    
    
    
    18.77Close
    
    
    20.67
    
    
    
    20.89
    
    
    
    19.41
    
    
    
    20.90Dividend
    
    
    0.12
    
    
    
    0.12
    
    
    
    0.12
    
    
    
    0.13
 2003
    
    Quarter 1
    
    
    Quarter 2
    
    
    Quarter 3
    
    
    Quarter 4Price Range
High
    
    $
    18.45
    
    
    $
    18.59
    
    
    $
    20.18
    
    
    $
    26.96Low
    
    
    16.52
    
    
    
    16.17
    
    
    
    17.06
    
    
    
    18.75Close
    
    
    16.61
    
    
    
    17.02
    
    
    
    18.75
    
    
    
    21.77Dividend
    
    
    0.11
    
    
    
    0.11
    
    
    
    0.12
    
    
    
    0.12
 The following table sets forth information as of December 31, 2004 regarding shares of the
Companys common stock that may be issued upon exercise of options previously granted and
currently outstanding under the Companys stock option plans, as well as the number of shares
available for the grant of options that had not been granted as of that date. (a) Number of
    
    
    (b) Weighted-
    
    
    (c) Number of SecuritiesSecurities To Be
    
    
    Average Exercise
    
    
    Remaining Available forIssued Upon Exercise
    
    
    Price Of
    
    
    Future Issuance UnderOf Outstanding
    
    
    Outstanding
    
    
    Equity Compensation PlanOptions, Warrants and
    
    
    Options, Warrants
    
    
    (excluding securitiesRights
    
    
    and Rights
    
    
    reflected in column (a))Equity compensation plans Approved by security holders
    
    
    237,812
    
    
    $
    15.67
    
    
    
    234,468Not approved by security holders
    
    
    -0-
    
    
    
    n/a
    
    
    
    n/aTotal
    
    
    237,812
    
    
    $
    15.67
    
    
    
    234,468
 9




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##### Table of Contents



The Company purchases shares of its common stock in open-market and occasional privately
negotiated transactions pursuant to publicly announced share repurchase programs. Share
repurchase transactions for the most recent quarter ended December 31, 2004 are set forth
below. (c) Total
    
    
    (d) MaximumNumber of
    
    
    ApproximateShares
    
    
    Dollar ValuePurchased
    
    
    of Shares(a) Total
    
    
    (b) Average
    
    
    as Part of
    
    
    that May YetNumber of
    
    
    Price
    
    
    Publicly
    
    
    be PurchasedPeriod
    
    
    Shares
    
    
    Paid per
    
    
    Announced
    
    
    Under theBeginning
    
    Ending
    
    
    Purchased
    
    
    Share
    
    
    Programs (1)
    
    
    Programs (2)Oct 1, 2004
    
    Oct 31, 2004
    
    
    20,309
    
    
    $
    19.56
    
    
    
    20,309
    
    
    $
    4,057,200
    (3)Nov 1, 2004
    
    Nov 30, 2004
    
    
    12,534
    
    
    
    21.39
    
    
    
    12,534
    
    
    
    3,789,145
    (3)Dec 1, 2004
    
    Dec 31, 2004
    
    
    35,396
    
    
    
    21.31
    
    
    
    35,396
    
    
    
    3,034,784
    (3)Totals
    
    
    68,239
    
    
    $
    20.80
    
    
    
    68,239
   (1)
    
    For the three months ended December 31, 2004, 68,239 shares were purchased in
open-market transactions. The Company does not repurchase shares in connection with
disqualifying dispositions of shares issued under its stock option plans. Optionees
execute these transactions through independent, third-party brokers.(2)
    
    The Company has not historically established expiration dates for its share
repurchase programs.(3)
    
    Currently active repurchase program in the amount of $10,000,000 announced February
12, 2004. 10




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##### Table of Contents



ITEM 6  SELECTED FINANCIAL DATA The following table presents selected consolidated historical financial data of the Company
for the periods indicated. This financial data should be read in conjunction with the Companys
consolidated financial statements and notes thereto. For the Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Interest income
    
    $
    55,265,889
    
    
    $
    50,696,176
    
    
    $
    45,710,526
    
    
    $
    52,284,219
    
    
    $
    55,269,464Interest expense
    
    
    13,107,985
    
    
    
    11,389,491
    
    
    
    10,802,422
    
    
    
    19,443,569
    
    
    
    19,172,024Net interest income
    
    
    42,157,904
    
    
    
    39,306,685
    
    
    
    34,908,104
    
    
    
    32,840,650
    
    
    
    36,097,440Provision for loan losses
    
    
    5,439,160
    
    
    
    4,764,010
    
    
    
    3,492,382
    
    
    
    4,216,772
    
    
    
    3,893,585Net interest income after
provision for loan losses
    
    
    36,718,744
    
    
    
    34,542,675
    
    
    
    31,415,722
    
    
    
    28,623,878
    
    
    
    32,203,855Other income
    
    
    11,256,723
    
    
    
    14,437,740
    
    
    
    11,397,705
    
    
    
    10,140,060
    
    
    
    8,033,680Other expense
    
    
    29,114,940
    
    
    
    25,862,457
    
    
    
    20,316,234
    
    
    
    18,342,279
    
    
    
    16,778,415Income before income taxes
    
    
    18,860,527
    
    
    
    23,117,958
    
    
    
    22,497,193
    
    
    
    20,421,659
    
    
    
    23,459,120Income taxes
    
    
    6,142,307
    
    
    
    7,810,065
    
    
    
    7,394,893
    
    
    
    6,613,104
    
    
    
    7,884,537Net income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300
    
    
    $
    13,808,555
    
    
    $
    15,574,583Per shareNet incomeBasic*
    
    $
    0.94
    
    
    $
    1.14
    
    
    $
    1.11
    
    
    $
    0.99
    
    
    $
    1.10Diluted*
    
    
    0.94
    
    
    
    1.13
    
    
    
    1.11
    
    
    
    0.99
    
    
    
    1.10Cash dividends*
    
    
    0.49
    
    
    
    0.46
    
    
    
    0.41
    
    
    
    0.37
    
    
    
    0.34Book value*
    
    
    10.59
    
    
    
    10.43
    
    
    
    9.56
    
    
    
    9.09
    
    
    
    8.56Share priceHigh*
    
    
    22.93
    
    
    
    26.96
    
    
    
    21.59
    
    
    
    19.12
    
    
    
    19.60Low*
    
    
    17.67
    
    
    
    16.17
    
    
    
    15.56
    
    
    
    15.09
    
    
    
    12.90Close*
    
    
    20.90
    
    
    
    21.77
    
    
    
    17.50
    
    
    
    15.82
    
    
    
    18.60Average shares outstandingBasic*
    
    
    13,481,397
    
    
    
    13,438,007
    
    
    
    13,547,299
    
    
    
    13,897,764
    
    
    
    14,161,633Diluted*
    
    
    13,531,224
    
    
    
    13,516,700
    
    
    
    13,552,569
    
    
    
    13,900,127
    
    
    
    14,174,268Performance ratiosReturn on average assets
    
    
    1.28
    %
    
    
    1.78
    %
    
    
    2.13
    %
    
    
    2.00
    %
    
    
    2.45
    %Return on average equity
    
    
    9.02
    %
    
    
    11.40
    %
    
    
    11.98
    %
    
    
    11.29
    %
    
    
    13.41
    %Average equity to
average assets
    
    
    14.20
    %
    
    
    15.58
    %
    
    
    17.80
    %
    
    
    17.70
    %
    
    
    18.31
    %Dividend payout
    
    
    52.06
    %
    
    
    40.56
    %
    
    
    37.05
    %
    
    
    37.01
    %
    
    
    30.54
    %Efficiency ratio
    
    
    53.17
    %
    
    
    46.81
    %
    
    
    42.29
    %
    
    
    40.96
    %
    
    
    36.52
    %Balances at year endAssets
    
    $
    1,032,238,449
    
    
    $
    971,382,727
    
    
    $
    742,014,674
    
    
    $
    715,389,907
    
    
    $
    661,622,812Investment securities
    
    
    158,560,042
    
    
    
    159,436,361
    
    
    
    124,924,296
    
    
    
    159,185,159
    
    
    
    167,505,220Loans (gross)
    
    
    778,137,430
    
    
    
    715,844,632
    
    
    
    532,921,937
    
    
    
    488,035,108
    
    
    
    443,918,031Allowance for loan losses
    
    
    13,665,013
    
    
    
    10,798,897
    
    
    
    8,834,611
    
    
    
    6,426,477
    
    
    
    6,351,756Mortgage loans held for sale
    
    
    21,553,548
    
    
    
    23,092,846
    
    
    
    32,452,162
    
    
    
    22,375,840
    
    
    
    6,480,221Liabilities
    
    
    891,222,228
    
    
    
    829,567,628
    
    
    
    614,571,832
    
    
    
    590,608,591
    
    
    
    542,307,475Deposits
    
    
    749,861,552
    
    
    
    735,099,355
    
    
    
    547,249,315
    
    
    
    522,782,719
    
    
    
    517,281,500Shareholders equity
    
    
    141,016,221
    
    
    
    141,815,099
    
    
    
    127,442,842
    
    
    
    124,781,316
    
    
    
    119,315,337Asset quality ratiosNet charge-offs
to average loans
    
    
    0.35
    %
    
    
    0.75
    %
    
    
    0.21
    %
    
    
    0.86
    %
    
    
    0.54
    %Nonperforming assets
to total assets
    
    
    1.18
    %
    
    
    1.35
    %
    
    
    0.76
    %
    
    
    0.70
    %
    
    
    0.55
    %Allowance coverage of
nonperforming loans
    
    
    125.82
    %
    
    
    95.29
    %
    
    
    199.98
    %
    
    
    136.35
    %
    
    
    182.26
    %
   *
    
    Amounts for periods prior to May 31, 2002 have been restated to reflect the 5-for-4 stock split paid May 31, 2002. 11




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Managements Discussion and Analysis is provided to assist in understanding and evaluating the
Companys results of operations and financial condition. The following discussion should be read
in conjunction with the consolidated financial statements and related notes included elsewhere
herein. In 1987, the Company was formed under a plan whereby all previously issued shares of the
Banks stock were exchanged for shares of the Companys stock. The Bank then became a wholly owned
subsidiary of the Company. In 1997, the Company acquired Granite Mortgage, a mortgage bank,
through a merger, which was accounted for as a pooling of interests. In July 2003, the Company
acquired First Commerce Corporation and its subsidiary bank through a merger, which was accounted
for as a purchase transaction. All information presented is consolidated data unless otherwise
specified. This discussion is intended to provide a general overview of the Companys performance in 2004 and
outlook for 2005. Readers seeking a more in-depth discussion of 2004 are invited to read the more
detailed discussions below as well as the consolidated financial statements and related notes
included under Item 8 of this annual report. The Year 2004 in Review Earnings declined in 2004 primarily due to (1) lower profits from mortgage originations, (2)
higher provisions for loan losses due to continued sluggish local economies in the Banks
pre-expansion markets and (3) higher overhead costs in the Banks new markets. As expected, the
Companys mortgage origination volumes in 2004 were significantly lower than the unprecedented
levels of 2003, principally because of lower volumes of refinancing activity. The decline that
began in the fourth quarter of 2003 continued throughout 2004. The Bank continued to experience
elevated levels of nonperforming loans as some of its local economies continued to struggle,
resulting in the need for higher provisions for possible loan losses. In addition, the operating
cost of the six full-service banking offices and one loan production office opened or acquired
in the second, third and fourth quarters of 2003, as well as the full-service banking office
opened in a new market in the fourth quarter of 2004, had a significant impact on the Banks
2004 earnings. Financial highlights are presented in the table below. Financial Highlights($ in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    % changeEarningsNet interest income
    
    $
    42,158
    
    
    $
    39,307
    
    
    
    7.3
    %Provision for loan losses
    
    
    5,439
    
    
    
    4,764
    
    
    
    14.2
    %Other income
    
    
    11,257
    
    
    
    14,438
    
    
    
    -22.0
    %Other expense
    
    
    29,115
    
    
    
    25,862
    
    
    
    12.6
    %Net income
    
    
    12,718
    
    
    
    15,308
    
    
    
    -16.9
    %Per shareNet income- Basic
    
    $
    0.94
    
    
    $
    1.14
    
    
    
    -17.5
    %- Diluted
    
    
    0.94
    
    
    
    1.13
    
    
    
    -16.8
    %At year-endAssets
    
    $
    1,032,238
    
    
    $
    971,383
    
    
    
    6.3
    %Loans
    
    
    778,137
    
    
    
    715,845
    
    
    
    8.7
    %Deposits
    
    
    749,862
    
    
    
    735,099
    
    
    
    2.0
    %RatiosReturn on average assets
    
    
    1.28
    %
    
    
    1.78
    %Return on average equity
    
    
    9.02
    %
    
    
    11.40
    %Average capital to average assets
    
    
    14.20
    %
    
    
    15.58
    %Efficiency ratio
    
    
    53.17
    %
    
    
    46.81
    %
 12




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##### Table of Contents



Lower earnings from mortgage originations contributed to a year of lower earnings for the
Company in 2004. Earnings of $12,718,220 in 2004 decreased 16.9% from the $15,307,893 earned in
2003. On a per share basis, earnings declined to $0.94 in 2004 compared to $1.13 in 2003. In
2004, the Company earned 1.28% on average assets and 9.02% on average equity. Its efficiency
ratio was 53.17%. In 2003, the Companys return on average assets, return on average equity and
efficiency ratio were 1.78%, 11.40% and 46.81%, respectively. Factors that significantly affected 2004 earnings and financial position:  o
    Granite Mortgage, the Companys mortgage banking subsidiary, posted 2004 net income
of only $534,630, a decrease of 76.2% from the $2,244,639 earned in 2003, primarily due to
weak mortgage activity throughout 2004, which management attributes mainly to increases in
mortgage interest rates. Mortgage volumes were $280,898,000 in 2004 compared to
$421,174,000 in 2003, a decline of 33.3%.o
    Net interest income increased $2,851,219, or 7.3%, as a result of growth in loans and
deposits, but net interest margins contracted 36 basis points to 4.70% in 2004 compared to
5.06% in 2003 as the new volumes of loans and deposits were less profitable primarily due
to lower yields on loans and higher costs of borrowings.o
    During 2004, loan loss provisions increased $675,150, or 14.2%, to provide for
possible charge-offs due to continued weak local economies. Total nonperforming loans
improved slightly to $10,861,104 as of December 31, 2004 compared to $11,332,793 as of
December 31, 2003.o
    Other expenses, or operating overhead, increased $3,252,483, or 12.58%, of which
$4,578,466 was related to the overhead costs of community banking operations, including
full-year costs of the banking offices opened and acquired during 2003 and 2004, partially
offset by a $1,501,545 reduction in the cost related to the production of lower volumes of
mortgage originations.o
    Loans grew by $62,292,798 or 8.7%, while deposits grew by $14,762,197, or 2%.o
    During 2004, the Company repurchased 369,720 shares of its common stock for
$7,439,376 or an average cost of $20.12 per share. OUTLOOK FOR 2005 Beginning with its June 2004 meeting, the Federal Open Market Committee (the FOMC) began to
gradually remove its monetary policy accommodation by increasing its overnight rate on funds by
25 basis points at each of its last five meetings of the 2004 calendar year. The FOMC stated in
its December 2004 release that it perceived the upside and downside risks to the attainment of
both sustainable growth and price stability for the next few quarters to be roughly equal, and
hinted that it would continue to remove its monetary policy accommodation at a pace that is
likely to be measured. As a result, some market forecasters are looking for short-term interest
rates to move from the December 2004 level of 2.25% to a level in the range of 3.00% to 3.50% by
the end of 2005. After an economic bottom has occurred, banks may continue to experience higher than normal levels
of nonperforming loans, even into the beginning of the subsequent recovery period. Also, as
short-term interest rates begin to rise, asset-sensitive banks, such as the Bank, may experience
improvement in net interest margins because the interest rates on their variable-rate assets
increase more quickly than the rates on their fixed-rate sources of funding. For the Bank, this
effect has been offset by more aggressive deposit pricing in an effort to more closely align
deposit funding growth with loan growth. The Companys balance sheet remains moderately asset-sensitive because of its significant level of
variable rate loans. Asset-sensitive means that when interest rates in the overall economy change,
interest rates on the Companys variable rate assets, primarily loans, change more rapidly than the
interest rates on its deposits. Therefore, when interest rates rise, the Companys interest income
rises at a faster pace than the interest expense it pays on its time deposits and other fixed rate
funding. Likewise, when interest rates fall, the Companys interest income on loans declines at a
faster pace than the interest it pays on time deposits and other fixed rate funding. In an effort
to reduce its asset sensitivity, the Company has historically placed floors and ceilings on many of
its variable rate commercial loans. Floors lessen the Companys exposure to declining rates, while
ceilings reduce the Companys benefit from rising rates. The Companys asset sensitivity may
potentially be offset by an imbalance of 13




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##### Table of Contents



the demand for deposits with the supply of deposits in the markets in which the Company conducts
its business. If the Company has a need for deposits dollars to fund its loan growth, then it may
raise its rates at a faster pace than it otherwise would raise them, resulting in an offset to the
higher interest earned on its variable rate assets. For 2005, some analysts are predicting an interest rate environment in which short-term interest
rates will gradually rise throughout the year. As in previous periods of gradual interest rate
increases, the Company anticipates it will continue to adjust both the mix and pricing of its
rate-sensitive assets and liabilities so as to improve, to the extent possible, its net interest
margin and spreads. In addition, longer term interest rates are anticipated to remain low
relative to historical levels of the periods preceding the most recent low interest rate cycle.
Granite Mortgage has historically performed better during periods of lower interest rates due to
the effect that low longer term rates tend to have on the housing market, which can serve to
partially offset the effects that asset sensitivity may have on net interest income. Granite
Mortgage believes its mortgage originations in 2005 may meet or slightly exceed such origination
activity in 2004, unless longer term rates rise sharply and thereby reduce the demand for
mortgage financing. The Company also plans to continue to grow its loan portfolio and to use both deposit growth and
alternative borrowing sources to fund the loan growth. The Company believes that its credit
quality controls remain effective and expects to maintain loan loss reserves as are deemed prudent
based on its credit quality analysis. Although 2005 may continue to bring a mixed economic environment, the Company is optimistic
regarding its ability to perform under such varying economic circumstances. Efforts are underway
to introduce the Companys retail and commercial banking services to the Winston-Salem market,
where it already has a significant mortgage presence. Entering into new markets, such as those
added in 2003 and 2004, has a challenging effect on current earnings, but the Company believes
the future benefits will outweigh the present challenges. Over the near term, the Company plans
to focus on improving the profitability of its banking operations in the new markets added in the
last two years. Over the longer term, the Company plans to continue to diversify and broaden its
market and economic base, when determined prudent to do so, as it seeks sustainable earnings
growth for its shareholders. SEGMENT INFORMATION Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an
Enterprise and Related Informationrequires public companies to report certain financial
information about operating segments for which such information is available and utilized by the
chief operating decision maker in determining the allocation of resources and also in assessing
performance. Prior to 2003, the Company presented financial information as one segment as it had
no distinct operating segments based on the requirements of SFAS No. 131. As a result of the 2003
acquisition of First Commerce by the Bank and as a part of the continued integration, management
has re-evaluated its reportable operating segments and determined that it has the following
segments in accordance with SFAS No. 131: Community Banking, Mortgage Banking and Other. The
chief operating decision maker includes certain members of the Companys management and board
committees. CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company and its subsidiaries are in accordance with
accounting principles generally accepted in the United States and conform to general practices
within the banking industry. The more critical accounting and reporting policies include the
Companys accounting for securities, loans, the allowance for loan losses and income taxes. In
particular, the Companys accounting policies relating to the allowance for loan losses,
investment securities and mortgage loans held for sale involve the use of estimates and require
significant judgments to be made by management. Different assumptions in the application of these
policies could result in material changes in the Companys consolidated financial position or
consolidated results of operations. Please see the discussions below under the captions Loans,
Provisions and Allowance for Loan Losses, Investment Securities, Mortgage Loans Held for
Sale and Derivatives and Hedging Activities. Also, please refer to Note 1 Summary Of
Significant Accounting Policies in the Notes to Consolidated Financial Statements under Item
8, Financial Statements & Supplementary Data for additional information regarding all of the
Companys critical and significant accounting policies. LOANS  Loans that management has the intent and ability to hold for the foreseeable future
are reported at their outstanding principal balances adjusted for any deferred fees or
costs. Substantially all loans earn interest on the level yield method based on the daily
outstanding balance. 14




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##### Table of Contents



PROVISIONS AND ALLOWANCE FOR LOAN LOSSES  The provision for loan losses charged to operations is
an amount sufficient to bring the allowance for loan losses to an estimated balance considered
adequate to absorb probable losses in the portfolio. Managements determination of the adequacy of
the allowance is based on an evaluation of the portfolio, current economic conditions, periodic and
systematic loan reviews, historical loan loss experience, value of the collateral and other risk
factors. Specific allowance is made and maintained to absorb losses for individually identified borrowers.
These losses are assessed on an account-by-account basis based on managements current evaluation
of the Companys loss exposure for each credit, given the payment status, financial condition of
the borrower, and value of underlying collateral. Included in the review of individual loans are
those that are impaired as provided in SFAS No. 114,
Accounting for Creditors for Impairment for a Loan.Loans are deemed to be impaired when the
Company determines that it is probable the Company will be unable to collect all amounts due
according to the terms of the loan agreement. Impaired loans are measured based on the present
value of expected future cash flows discounted at the loans effective interest rate or, as a
practical matter, at the loans observable market value or fair value of the collateral if the loan
is collateral dependent. A reserve, recorded as a specific reserve in the allowance for loan
losses, is established to record the difference between the stated loan amount and the present
value or market value of the impaired loan. Impaired loans may be valued on a loan-by-loan basis
(e.g., loans with risk characteristics unique to an individual borrower) or on an aggregate basis
(e.g., loans with similar risk characteristics). The Companys policy for recognition of interest
income on impaired loans is the same as its interest income recognition policy for non-impaired
loans. The Company discontinues the accrual of interest when the collectibility of such interest
becomes doubtful. Recovery of the carrying value of loans is dependent to some extent on future
economic, operating and other conditions that may be beyond the Companys control. For the
homogeneous pools of loans that have not been specifically identified, estimates of losses are
largely based on charge-off trends, expected default rates, general economic conditions and overall
portfolio quality. This evaluation is inherently subjective as it requires material estimates and
unanticipated future adverse changes in such conditions could result in material adjustments to the
allowance for loan losses that could adversely impact earnings in future periods. The Companys
nonperforming assets were $12,140,740 and $13,108,030 as of December 31, 2004 and 2003,
respectively, and its gross charge-offs were $3,038,449, $5,087,661 and $1,555,068 for 2004, 2003
and 2002, respectively. INVESTMENT SECURITIES  Securities not classified as either held to maturity securities or trading
securities, and equity securities not classified as trading securities, are classified as
available for sale securities and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of consolidated shareholders equity.
The fair values of these securities are based on quoted market prices, dealer quotes and prices
obtained from independent pricing services. Available for sale and held to maturity securities are
reviewed quarterly for possible other-than-temporary impairment. The review is inherently
subjective as it requires material estimates and judgments, including an analysis of the facts and
circumstances of each individual investment such as the length of time the fair value has been
below cost, the expectation for that securitys performance, the credit worthiness of the issuer
and the Companys ability to hold the security to maturity.
Declines in the fair value of the individual held to maturity and available for sale securities
below their costs that are other-than-temporary result in write-downs of the individual
securities to their fair value. The related write-downs are included in consolidated earnings as
realized losses. MORTGAGE LOANS HELD FOR SALE  Through its mortgage subsidiary, the Company originates certain
residential mortgage loans with the intent to sell. Mortgage loans held for sale are reported at
the lower of cost or market value on an aggregate loan portfolio basis. Gains or losses realized on
the sales of mortgage loans are recognized at the time of sale and are determined by the difference
between the net sales proceeds and the carrying value of the loans sold, adjusted for any servicing
asset or liability. Gains and losses on sales of mortgage loans are included in noninterest income. DERIVATIVES AND HEDGING ACTIVITIES  The Company enters into derivative contracts to hedge certain
assets, liabilities, and probable forecasted transactions. On the date the Company enters into a
derivative contract, the derivative instrument is designated as: (1) a hedge of the fair value of
a recognized asset or liability or of an unrecognized firm commitment (a fair value hedge); (2)
a hedge of the variability in expected future cash flows associated with an existing recognized
asset or liability or a forecasted transaction (a cash flow hedge); or (3) held for other risk
management purposes (risk management derivatives). The Companys primary transactions involve cash flow hedges. In a cash flow hedge, the effective
portion of the changes in the fair value of the hedging derivative is recorded in accumulated
other comprehensive income and is subsequently reclassified into earnings during the same period
in which the hedged item affects earnings. The change in fair value of any ineffective portion of
the hedging derivative is recognized immediately in earnings. 15




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##### Table of Contents



The Company formally documents the relationship between the hedging instruments and hedged items,
as well as its risk management objective and strategy before undertaking the hedge. To qualify for
hedge accounting, the derivatives and related hedged items must be designated as a hedge. Both at
the inception of the hedge and on an ongoing basis, the Company assesses whether the hedging
relationship is expected to be highly effective in offsetting changes in fair value or cash flows
of hedged items. If it is determined that the derivative instrument is not highly effective as a
hedge, hedge accounting is discontinued. RECENT ACQUISITION On July 15, 2003, the Company completed its acquisition of First Commerce Corporation of
Charlotte, North Carolina. As of July 15, 2003, First Commerce had total assets of approximately
$171,042,000 and operated three banking offices in the Charlotte-Gastonia-Rock Hill metropolitan
statistical area. Under the terms of the transaction, the Company issued 543,217 shares of common
stock and paid $9,829,749 in cash to First Commerce shareholders. The transaction was accounted
for as a purchase and resulted in approximately $11,393,000 in intangible assets. RESULTS OF OPERATIONS The following discussion relates to operations for the year ended December 31, 2004 compared to
the year ended December 31, 2003, the year ended December 31, 2003 compared to the year ended
December 31, 2002, and the year ended December 31, 2002 compared to the year ended December 31,
2001. 2004 COMPARED TO 2003 In 2004, the Company earned $12,718,220, or $0.94 per share, compared to $15,307,893, or $1.13 per
share, in 2003. The earnings provided returns on average assets of 1.28% in 2004 compared to 1.78%
in 2003 and returns on average equity of 9.02% in 2004 compared to 11.40% in 2003. The earnings
decrease was primarily attributable to lower profits from mortgage operations, higher provisions
for loan losses and increased overhead expenses, which were partially offset by higher net interest
income. The Companys net interest income increased $2,851,219, or 7.25%, during 2004 compared to 2003.
This increase was primarily because of increases in net interest income from new volumes, which
were only partially offset by lower net interest income resulting from lower interest rates. The
Companys net interest margin averaged 4.70% for the year-to-date period, down from 5.06% for
2003. For a discussion of the Companys asset-sensitivity and the related effects on the
Companys net interest income and net interest margins, please see Net Interest Income and
Liquidity, Interest Rate Sensitivity and Market Risks below. Higher loan volumes resulted in higher interest income for 2004. Interest income for 2004
increased $4,569,713, or 9.01%, from 2003 primarily because of growth in interest income from
higher volumes of commercial loans, which was only partially offset by reduced interest income
due to lower rates on both loans and investments in general. Interest and fees on loans increased
$5,458,018, or 14.11%, due to higher average volumes during the year. Yields on loans averaged
6.36% for 2004, down from 6.79% for 2003. The prime rate averaged 4.31% during 2004 compared to
4.13% during 2003. Gross loans averaged $762,994,754 in 2004 compared to $654,288,794 in 2003, an
increase of $108,705,960, or 16.61%. Average loans of the Bank were $731,856,005 compared to
$612,278,824 in 2003, an increase of $119,577,181, or 19.53%, while average loans of Granite
Mortgage were $31,138,749 compared to $42,009,970 in 2003, a decrease of $10,871,221, or 25.88%.
The Banks average loans in 2004 reflected a full year of the volumes added by the new banking
offices opened or acquired during 2003, while the 2003 average loans reflected a partial year of
the added loan volumes. The decline in Granite Mortgages average loans resulted from mortgage
originations of approximately $280,898,000 in 2004 compared to approximately $421,174,000 in
2003. The levels of mortgage origination and refinancing activities are very sensitive to changes
in interest rates in that higher mortgage interest rates generally have the effect of reducing
both mortgage originations and refinancings, while sustained low mortgage interest rates
eventually have the effect of reducing refinancings as the demand for such refinancings becomes
satisfied. Interest on securities and overnight investments increased $501,545, or 8.04%, due to
higher average volumes during the period. The yield on investment securities and overnight
investments declined to 5.00% in 2004 from 5.06% in 2003. Investment security yields declined 41
basis points when comparing 2004 and 2003. The decline in yield did not offset the increase in
interest income resulting from higher average volumes of investment securities and overnight
investments. Average securities and overnight investments were $161,737,648 compared to
$153,042,239 in 2003, an increase of $8,695,409, or 5.68%. 16




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##### Table of Contents



Interest expense increased $1,718,494, or 15.09%, primarily because of higher interest expense from
higher volumes of interest-bearing liabilities, which was partially offset by lower rates on
interest-bearing deposits. Rates on interest-bearing deposits averaged 1.73% for 2004, down from
1.83% for 2003. Interest-bearing deposits averaged $617,538,254 in 2004 compared to $530,436,580 in
2003, an increase of $87,101,674, or 16.42%. NOW deposits averaged $117,153,841 compared to
$94,337,036 in 2003, an increase of $22,816,805, or 24.19%. Money market deposits averaged
$152,453,153 in 2004 compared to $115,633,923 last year, an increase of $36,819,230, or 31.84%.
Time deposits averaged $321,027,297 compared to $294,163,967 for the same periods, an increase of
$26,863,330, or 9.13%. The Banks average deposits in 2004 reflected a full year of the volumes
added by the new banking offices opened or acquired during 2003, while the 2003 averages reflected
a partial year of the added deposit volumes. Overnight and other borrowings averaged $99,420,084
compared to $79,683,758 in 2003, an increase of $19,736,326, or 24.77%. Overnight borrowings
averaged $35,575,198 compared to $17,762,252 in 2003, an increase of $17,812,946, or 100.29%. Other
borrowings averaged $63,844,886 compared to $61,921,506 in 2003, an increase of $1,923,380, or
3.11%, primarily due to $5,000,000 in trust preferred debt outstanding the full-year in 2004
compared to less than six months in 2003. Other borrowings were the principal source of funding for
the mortgage origination activities of Granite Mortgage. General economic trends greatly affect loan losses, and no assurances can be made that further
charges to the loan loss allowance may not be significant in relation to the amount provided
during a particular period or that further evaluation of the loan portfolio based on conditions
then prevailing may not require sizable additions to the allowance, thus necessitating similarly
sizable charges to operations. Although the economy in the Catawba Valley region of the Companys
market area began to show signs of slight improvement, levels of nonperforming loans remained high
and the credit quality of nonperforming loans further deteriorated, so management believed it
prudent to charge operations in the amount of $5,439,160 in 2004 compared to $4,764,010 in 2003,
to provide for future losses related to uncollectible loans. While net charge-offs in 2004 were substantially lower than the unusually high level in 2003, the
volume of net charge-offs in 2004 more closely approached the Companys longer-term average
volumes of net charge-offs. Charge-offs, net of recoveries, in 2004 were $2,573,044, a decrease of
$2,089,215 from net charge-offs of $4,662,259 in 2003. The effects of a prolonged recession in the
Companys Catawba Valley market area were also evidenced by increases in the Companys allowance
for loan losses as presented below, nonperforming asset levels as presented below, and loans with
higher risk grades. Nonperforming loans totaled $10,861,104 at the end of 2004 compared with
$11,332,793 at the end of 2003. The amount of loans with the three highest risk grades totaled
$14,245,082 at December 31, 2004 as compared with $12,046,107 at December 31, 2003. Some portions
of the Banks local Catawba Valley economy are beginning to show signs of growth and the new
markets should continue to help diversify the Banks loan base, but it is difficult to determine
if or when the Catawba Valley economy will return to its former strength. For 2004, total noninterest income was $11,256,723, down $3,181,017, or 22.03%, from $14,437,740
earned in 2003, primarily because of lower fees from mortgage originations. Fees on deposit
accounts were $5,359,206 during 2004, down $177,848, or 3.219%, from $5,537,054 in 2003. Also,
other service fees and commissions were $797,961, down $139,826, or 14.91%, from $937,787 in 2003,
primarily due to lower fee income from sales of annuities, which decreased $88,176. A rise in
mortgage rates in 2004 decreased mortgage origination activity. Mortgage origination fee income was
$3,844,297 for 2004, down $3,047,874, or 44.22%, from $6,892,171 earned in 2003. Mortgage loans
originated during 2004 and 2003 were approximately $280,898,000 and $421,174,000, respectively. The
levels of mortgage origination and refinancing activities are very sensitive to changes in interest
rates in that higher mortgage interest rates generally have the effect of reducing both mortgage
originations and refinancings, while sustained low mortgage interest rates eventually have the
effect of reducing refinancings as the demand for such refinancings becomes satisfied. There were
no significant gains or losses on sales of securities in 2004 or 2003. Although management
continued to emphasize other nontraditional banking services, 2004 income from the sales of
annuities and life insurance fell short of Company goals. Total noninterest expenses were $29,114,940 during 2004, up $3,252,483, or 12.58%, from $25,862,457
in 2003. The changes in the various overhead categories included costs associated with higher
operating expenses of the Bank, partially offset by lower cost of mortgage origination activities.
Total personnel costs, the largest of the overhead expenses, were $17,898,831 during 2004, up
$1,427,550, or 8.67%, from $16,471,281 in 2003. Of the $1,427,550 increase, $2,843,432 of increased
personnel cost of banking operations were partially offset by a $1,415,892 reduction in the
personnel cost of mortgage operations. 17




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##### Table of Contents



Noninterest expenses other than for personnel increased 19.43% to $11,216,109 during 2004 from the
$9,391,176 incurred in 2003. Of the $1,824,933 increase, the Banks nonpersonnel costs increased
$1,735,024, while Granite Mortgages nonpersonnel costs decreased $85,653. Occupancy expenses were
$1,729,986 in 2004, up $524,180, or 43.47%, from $1,205,806 in 2003, primarily reflecting the
additional costs associated with a full year of occupancy cost in the Banks new markets in 2004
compared to less than a full year of such costs in 2003 and higher occupancy cost associated with
mortgage operations. Equipment costs rose to $1,958,106 during 2004, up $570,128, or 41.08%, from
$1,387,978 in 2003, as both the Bank and Granite Mortgage invested in the technology needed to
support expanded market operations. Other noninterest expenses were $7,528,017 in 2004, up
$730,625, or 10.75%, from $6,797,392 in 2003. Of the $730,625 increase in other noninterest
expenses, $818,214 in increased cost related to banking operations and $175,562 in increased
general corporate cost were partially offset by $263,151 in decreased cost related to mortgage
operations. Income tax expenses were $6,142,307 in 2004, down $1,667,758, or 21.35%, from
$7,810,065 in 2003. The effective tax rates were 32.57% and 33.78% for 2004 and 2003,
respectively, with the decrease in 2004 being primarily attributable to lower relative levels of
income taxable at the statutory tax rates. 2003 COMPARED TO 2002 In 2003, the Company earned $15,307,893, or $1.13 per share, compared to $15,102,300, or $1.11
per share, in 2002. The earnings provided returns on average assets of 1.78% in 2003 compared to
2.13% in 2002 and returns on average equity of 11.40% in 2003 compared to 11.98% in 2002. The
earnings increase was primarily attributable to higher net interest income and income from
mortgage originations, which were mostly offset by higher loan loss provisions and overhead
costs. The Companys net interest income increased $4,398,581, or 12.60%, during 2003 compared to 2002.
This increase was primarily because increases in net interest income from new volumes were only
partially offset by lower net interest income resulting from lower interest rates. The Companys
net interest margin averaged 5.06% for 2003, down from 5.50% for 2002. For a discussion of the
Companys asset-sensitivity and the related effects on the Companys net interest income and net
interest margins, please see Net Interest Income and Liquidity, Interest Rate Sensitivity and
Market Risks below. Higher loan volumes led to higher interest income for 2003. Interest income for 2003 increased
$4,985,650, or 10.91%, from 2002 primarily because of the growth in interest income from higher
volumes of commercial and mortgage loans, which was only partially offset by reduced interest
income due to lower rates on both loans and investments in general. Interest and fees on loans
increased $5,781,538, or 14.95%, due to higher average volumes and rates during the year. Yields
on loans averaged 6.79% for 2003, down from 7.34% for 2002. The prime rate averaged 4.13% during
2003 compared to 4.69% during 2002. Gross loans averaged $654,288,794 in 2003 compared to
$526,758,803 in 2002, an increase of $127,529,991, or 24.21%. Average loans of the Bank were
$612,278,824 compared to $504,520,592 in 2002, an increase of $107,758,232, or 21.36%, while
average loans of Granite Mortgage were $42,009,970 compared to $22,238,211 in 2002, an increase
of $19,771,759, or 88.91%. The growth in the Banks average loans was effected by $115,427,028 in
loans acquired on July 15, 2003 from First Commerce and $40,963,425 in loans originated by the
other Bank offices opened during 2003, although these loan volumes were included in the Banks
averages for only a portion of the year. The growth in Granite Mortgages average loans resulted
from mortgage originations of approximately $421,174,000 in 2003 compared to approximately
$271,267,000 in 2002. Declining rates generally cause an increase in mortgage refinancings and,
to a lesser extent, mortgage originations. Interest on securities and overnight investments
decreased $795,888, or 11.31%, due to lower average yields earned during the period. The yield on
investment securities and overnight investments declined to 5.06% in 2003 from 6.27% in 2002.
Investment security yields declined 98 basis points when comparing 2003 and 2002. The decline in
the yield more than offset the increase in the average balances for investment securities and
overnight investments. Average securities and overnight investments were $153,042,239 compared to
$139,926,649 last year, an increase of $13,115,590, or 9.37%. The Bank acquired investment
securities of $27,240,789 in the First Commerce acquisition, which effected average investment
balances for the last six months of 2003. 18




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##### Table of Contents



Interest expense increased $587,069, or 5.43%, primarily because higher interest expense from
higher volumes of interest-bearing liabilities was partially offset by lower interest expense from
lower rates on interest-bearing deposits and other borrowings. Rates on interest-bearing deposits
averaged 1.83% for 2003, down from 2.26% for 2002. Interest-bearing deposits averaged $530,436,580
in 2003 compared to $429,933,109 in 2002, an increase of $100,503,471, or 23.38%. NOW deposits
averaged $94,337,036 compared to $83,761,379 in 2002, an increase of $10,575,657, or 12.63%. Money
market deposits averaged $115,633,923 in 2003 compared to $53,107,539 in 2002, an increase of
$62,526,384, or 117.74%. Time deposits averaged $294,163,967 compared to $266,835,606 for the same
periods, an increase of $27,328,361, or 10.24%. The growth in the Banks average deposits was
effected by $131,068,621 in deposits acquired on July 15, 2003 from First Commerce and $10,002,597
in deposits received by the other Bank offices opened during 2003, although these deposit volumes
were included in the Banks averages for only a portion of the year. Overnight and other
borrowings averaged $79,683,758 compared to $53,980,926 in 2002, an increase of $25,702,832, or
47.61%. Overnight borrowings averaged $17,762,252 compared to $33,426,013 in 2002, a decrease of
$15,663,761, or 46.86%, reflecting a decrease of $17,215,106, or 85.81%, in average overnight
borrowings in the form of federal funds purchased and securities sold under agreements to
repurchase of the Bank, partially offset by an increase of $1,551,345, or 11.61%, in average
overnight borrowings in the form of commercial paper related to the commercial deposit sweep
arrangements of the Bank. Other borrowings averaged $61,921,506 compared to $20,554,913 in 2002,
an increase of $41,366,593, or 201.25%, reflecting an increase of $20,463,181, or 1131.68%, in
average borrowings of the Bank and an increase of $18,588,344, or 99.16%, in temporary borrowings
of Granite Mortgage primarily due to higher mortgage origination activity. Other borrowings were
the principal source of funding for the mortgage origination activities of Granite Mortgage.
Included in average borrowings for the last six months of the year were $27,000,000 in borrowings
assumed in the acquisition of First Commerce. General economic trends greatly affect loan losses, and no assurances can be made that further
charges to the loan loss allowance may not be significant in relation to the amount provided
during a particular period or that further evaluation of the loan portfolio based on conditions
then prevailing may not require sizable additions to the allowance, thus necessitating similarly
sizable charges to operations. Due to continued unfavorable economic trends in the Catawba Valley
region of the Companys market area and due to higher levels of nonperforming loans resulting from
the weakened local economy, management believed it prudent to charge operations in the amount of
$4,764,010 in 2003 compared to $3,492,382 in 2002, to provide for future losses related to
uncollectible loans. Also due to the continued weak local economy, charge-offs in 2003 were substantially higher than
in 2002. Charge-offs, net of recoveries, in 2003 were $4,662,259, an increase of $3,578,011 over
net charge-offs of $1,084,248 in 2002, of which $2,098,499 were related to commercial loans in
default. The effects of a prolonged recession in the Companys Catawba Valley market area were
also evidenced by increases in the Companys allowance for loan losses as presented below,
nonperforming asset levels as presented below, and loans with higher risk grades. Nonperforming
loans totaled $11,332,793 at the end of 2003 compared with $4,417,845 at the end of 2002.
Nonperforming loans as of December 31, 2003 included $3,268,082 of loans where 80% of the balance
is guaranteed under the federal governments small business lending programs. The amount of loans
with the three highest risk grades totaled $12,046,107 at December 31, 2003 as compared with
$6,554,602 at December 31, 2002. Included in these three highest risk grades were the unguaranteed
portions of approximately $1,136,000 of loans made under the federal governments small business
loan programs. Some portions of the Catawba Valley economy are beginning to show signs of growth
and the new markets should help diversify the Companys loan base, but it is difficult to
determine if or when the Catawba Valley economy will return to its former strength. 19




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##### Table of Contents



For 2003, total noninterest income was $14,437,740, up $3,040,035, or 26.67%, from $11,397,705
earned in 2002, primarily because of higher fees from mortgage originations. Fees on deposit
accounts were $5,537,054 during 2003, up $134,764, or 2.49%, from $5,402,290 in 2002. Also,
other service fees and commissions were $937,787, down $82,151, or 8.05%, from $1,019,938 in
2002, primarily due to lower fee income from sales of loans and annuities, which decreased
$328,404. A further drop in mortgage rates in 2003 increased mortgage origination activity.
Mortgage origination fee income was $6,892,171 for 2003, up $2,942,817, or 74.51%, from
$3,949,354 earned in 2002. Mortgage loans originated during 2003 and 2002 were approximately
$421,174,000 and $271,267,000, respectively. There were no significant gains or losses on sales
of securities in the year-to-date periods of 2003 or 2002. Although management continued to
emphasize other nontraditional banking services, 2003 income from the sales of annuities and
life insurance fell short of Company goals. Total noninterest expenses were $25,862,457 during 2003, up $5,546,223, or 27.30%, from $20,316,234
in 2002. The changes in the various overhead categories included costs associated with the increase
in mortgage origination activities and the addition of newly opened banking offices and the banking
offices acquired in the First Commerce transaction. Total personnel costs, the largest of the
overhead expenses, were $16,471,281 during 2003, up $3,570,532, or 27.68%, from $12,900,749 in
2002. Of the $3,570,532 increase, $2,228,175 were related to mortgage operations, while $1,342,357
were related to banking operations. Noninterest expenses other than for personnel increased 26.64% to $9,391,176 during 2003 from the
$7,415,485 incurred in 2002. Of the $1,975,691 increase, the Banks nonpersonnel costs increased
$1,227,573, while Granite Mortgages nonpersonnel costs increased $736,023. Occupancy expenses
were $1,205,806 in 2003, up $295,578, or 32.47%, from $910,228 in 2002, primarily reflecting the
additional occupancy costs associated with the newly opened banking offices and the banking
offices acquired from First Commerce. Other noninterest expenses were $6,797,392 in 2003, up
$1,680,807, or 32.85%, from $5,116,585 in 2002. Of the $1,680,807 increase in other noninterest
expenses, $1,052,525 were related to banking operations, while $616,187 were related to mortgage
operations. Year-to-date income tax expense was $7,810,065 in 2003, up $415,172, or 5.61%, from
$7,394,893 in 2002. The year-to-date effective tax rates were 33.78% and 32.87% for 2003 and 2002,
respectively, with the increase in 2003 being primarily attributable to lower relative levels of
income from tax-exempt loans and investments. 2002 COMPARED TO 2001 In 2002, the Company earned $15,102,300, or $1.11 per share, compared to $13,808,555, or $0.99 per
share, in 2001. The earnings provided returns on average assets of 2.13% in 2002 compared to 2.00%
in 2001 and returns on average equity of 11.98% in 2002 compared to 11.29% in 2001. The earnings
increase was primarily attributable to higher net interest income, lower loan loss provisions and
increased income from mortgage originations, partially offset by increases in operating costs. Net interest income, the Companys largest source of revenues, increased 6.3% to $34,908,104 in
2002 from $32,840,650 in 2001. Interest income was $45,710,526 in 2002, down 12.6% from $52,284,219
in 2001, primarily due to lower interest rates from the previous year. The average yield on
interest-earning assets was 7.12% in 2002 compared with 8.27% in 2001. Average interest-earning
assets grew by $12,288,466, or 1.9%, primarily because average loans, the highest yielding asset
category, grew by $47,027,071, or 9.8%. Interest expense decreased 44.4% to $10,802,422 in 2002
compared to $19,443,569 in 2001. The average cost of funds was 2.23% in 2001 compared with 4.11% in
2001. Lower rates on time deposits resulted in the significantly lower interest expense. Average
balances in transaction accounts, such as noninterest-bearing demand accounts and interest-bearing
savings, NOW and money market accounts, increased $30,090,980, or 13.3%, to $256,945,371 in 2002
from $226,854,391 in 2001. Average balances in time deposits decreased $35,338,224, or 11.7%, to
$266,835,606 in 2002 from $302,173,830 in 2001. Average overnight borrowings, principally
commercial account balances which are swept into the Companys commercial paper overnight, grew by
$19,238,103, or 135.6%, to $33,426,013 in 2002 from $14,187,910 in 2001. Average other borrowings,
which are principally used to fund mortgage banking activities, increased $1,276,667, or 6.6%, to
$20,554,913 in 2002 from $16,278,246 in 2001. Such other borrowings had maturities of less than one
year. 20




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##### Table of Contents



Primarily because of a recessionary economy, which was particularly severe in the Companys local
banking markets, the Company provided $3,492,382 for possible loan losses in 2002 compared with
$4,216,772 in 2001. Although the 2002 provision was lower than the 2001 provision, it increased
the Companys allowance or reserve for loan losses to 1.59% of net loans outstanding at December
31, 2002 compared to 1.28% at December 31, 2001. Charge-offs, net of recoveries totaled $1,084,248
for 2002 compared with $4,142,051 for 2001.
Nonperforming loans totaled $4,417,845 at the end of 2002 compared with $4,713,204 at the end of
2001. Other income was $11,397,705 in 2002, an increase of $1,257,645, or 12.4%, from such revenues of
$10,140,060 in 2001. Continued low interest rates resulted in increases in fees from both mortgage
originations and annuity sales. Fee income from mortgage originations increased $827,202, or
26.5%, to $3,949,354 in 2002 from $3,122,152 in 2001. Also contributing to the increase in fee
income was an increase of $214,140 in deposit fees. Mortgage origination activities have a
tendency to increase during periods of sustained low interest rates, as was the case during 2002. Other expenses, or overhead, increased $1,973,955, or 10.8%, to $20,316,234 in 2002 from
$18,342,279 in 2001, primarily due to increased costs associated with higher mortgage origination
activity. Personnel expenses, the largest component of overhead, increased to $12,900,749 in 2002
from $11,408,477 in 2001, primarily due to increases in expenses related to profit sharing,
healthcare and higher production-related compensation resulting from increased mortgage
origination activity. 21




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##### Table of Contents



NET INTEREST INCOME Net interest income (the difference between interest earned on interest-earning assets, primarily
loans in the Bank, and interest paid on interest-bearing liabilities, primarily deposits in the
Bank) represents the most significant portion of the Companys earnings. It is managements
on-going policy to optimize net interest income. Net interest income totaled $42,157,904,
$39,306,685, and $34,908,104 for 2004, 2003 and 2002 respectively, representing an increase of
7.3% for 2004 over 2003, an increase of 12.6% for 2003 over 2002, and an increase of 6.3% for 2002
from 2001. Interest rate spreads have been at least 4.25% over the last three years, and the
Company continues efforts to optimize these favorable spreads by managing both loan and deposit
rates in order to support the overall earnings growth. The following table presents the daily
average balances, interest income and expense and average rates earned and paid on
interest-earning assets and interest-bearing liabilities of the Company for the last three years. AVERAGE BALANCES AND INTEREST INCOME ANALYSIS
for the years ended December 31, 2004
    
    
    2003
    
    
    2002Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    InterestAverage
    
    
    Yield/
    
    
    Income/
    
    
    Average
    
    
    Yield/
    
    
    Income/
    
    
    Average
    
    
    Yield/
    
    
    Income/dollars in thousands
    
    Balance
    
    
    Cost
    
    
    Expense
    
    
    Balance
    
    
    Cost
    
    
    Expense
    
    
    Balance
    
    
    Cost
    
    
    ExpenseAssetsLoans (1)
    
    $
    762,995
    
    
    
    6.36
    %
    
    $
    48,524
    
    
    $
    654,289
    
    
    
    6.79
    %
    
    $
    44,456
    
    
    $
    526,759
    
    
    
    7.34
    %
    
    $
    38,674Taxable securities
    
    
    104,334
    
    
    
    4.06
    %
    
    
    4,232
    
    
    
    81,384
    
    
    
    4.11
    %
    
    
    3,342
    
    
    
    68,745
    
    
    
    5.54
    %
    
    
    3,811Nontaxable securities (2)
    
    
    56,849
    
    
    
    6.77
    %
    
    
    3,851
    
    
    
    62,565
    
    
    
    6.89
    %
    
    
    4,310
    
    
    
    70,271
    
    
    
    7.04
    %
    
    
    4,946Federal funds sold
    
    
    555
    
    
    
    1.26
    %
    
    
    7
    
    
    
    9,093
    
    
    
    1.07
    %
    
    
    97
    
    
    
    910
    
    
    
    1.10
    %
    
    
    10Total interest-earning assets
    
    
    924,733
    
    
    
    6.12
    %
    
    
    56,614
    
    
    
    807,331
    
    
    
    6.47
    %
    
    
    52,205
    
    
    
    666,685
    
    
    
    7.12
    %
    
    
    47,441Cash and due from banks
    
    
    26,103
    
    
    
    
    
    
    
    
    
    
    
    24,487
    
    
    
    
    
    
    
    
    
    
    
    22,045All other assets
    
    
    42,185
    
    
    
    
    
    
    
    
    
    
    
    30,052
    
    
    
    
    
    
    
    
    
    
    
    19,509Total assets
    
    $
    993,021
    
    
    
    
    
    
    
    
    
    
    $
    861,870
    
    
    
    
    
    
    
    
    
    
    $
    708,239Liabilities and
shareholders equityNOW deposits
    
    $
    117,154
    
    
    
    0.82
    %
    
    
    958
    
    
    $
    94,337
    
    
    
    0.65
    %
    
    
    615
    
    
    $
    83,761
    
    
    
    0.53
    %
    
    
    443Money market deposits
    
    
    152,453
    
    
    
    1.70
    %
    
    
    2,587
    
    
    
    115,634
    
    
    
    1.79
    %
    
    
    2,066
    
    
    
    53,108
    
    
    
    2.07
    %
    
    
    1,097Savings deposits
    
    
    26,904
    
    
    
    0.16
    %
    
    
    42
    
    
    
    26,302
    
    
    
    0.14
    %
    
    
    38
    
    
    
    26,229
    
    
    
    0.43
    %
    
    
    112Time deposits of $100,000
or more
    
    
    142,261
    
    
    
    2.55
    %
    
    
    3,622
    
    
    
    160,781
    
    
    
    2.16
    %
    
    
    3,471
    
    
    
    121,644
    
    
    
    2.91
    %
    
    
    3,536Other time deposits
    
    
    178,766
    
    
    
    1.96
    %
    
    
    3,503
    
    
    
    133,383
    
    
    
    2.64
    %
    
    
    3,524
    
    
    
    145,192
    
    
    
    3.12
    %
    
    
    4,530Interest-bearing deposits
    
    
    617,538
    
    
    
    1.73
    %
    
    
    10,712
    
    
    
    530,437
    
    
    
    1.83
    %
    
    
    9,714
    
    
    
    429,934
    
    
    
    2.26
    %
    
    
    9,718Overnight borrowings
    
    
    35,575
    
    
    
    1.39
    %
    
    
    493
    
    
    
    17,762
    
    
    
    1.26
    %
    
    
    224
    
    
    
    33,426
    
    
    
    1.91
    %
    
    
    638Other borrowings
    
    
    63,845
    
    
    
    2.98
    %
    
    
    1,903
    
    
    
    61,922
    
    
    
    2.34
    %
    
    
    1,451
    
    
    
    20,555
    
    
    
    2.17
    %
    
    
    446Total interest-bearing liabilities
    
    
    716,958
    
    
    
    1.83
    %
    
    
    13,108
    
    
    
    610,121
    
    
    
    1.87
    %
    
    
    11,389
    
    
    
    483,915
    
    
    
    2.23
    %
    
    
    10,802Noninterest-bearing deposits
    
    
    128,942
    
    
    
    
    
    
    
    
    
    
    
    109,834
    
    
    
    
    
    
    
    
    
    
    
    93,848Other liabilities
    
    
    6,098
    
    
    
    
    
    
    
    
    
    
    
    7,612
    
    
    
    
    
    
    
    
    
    
    
    4,429Shareholders equity
    
    
    141,023
    
    
    
    
    
    
    
    
    
    
    
    134,303
    
    
    
    
    
    
    
    
    
    
    
    126,047Total liabilities and
shareholders equity
    
    $
    993,021
    
    
    
    
    
    
    
    
    
    
    $
    861,870
    
    
    
    
    
    
    
    
    
    
    $
    708,239Net yield on earning assets and
net interest income (2)(3)
    
    
    
    
    
    
    4.70
    %
    
    $
    43,506
    
    
    
    
    
    
    
    5.06
    %
    
    $
    40,816
    
    
    
    
    
    
    
    5.50
    %
    
    $
    36,639Interest rate spread (4)
    
    
    
    
    
    
    4.29
    %
    
    
    
    
    
    
    
    
    
    
    4.60
    %
    
    
    
    
    
    
    
    
    
    
    4.89
    %
   (1)
    
    Non-accrual loans have been included.(2)
    
    Yields and interest income on tax-exempt investments have been adjusted to tax
equivalent basis using 35% for 2004, 2003 and 2002.(3)
    
    Net yield on earning assets is computed by dividing net interest earned by average
earning assets.(4)
    
    The interest rate spread is the interest earning assets rate less the interest
earning liabilities rate. 22




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##### Table of Contents



Changes in interest income and interest expense can result from changes in both volume and rates.
The following table sets forth the dollar amount of increase (decrease) in interest income and
interest expense resulting from changes in the volume of interest earning assets and interest
bearing liabilities and from changes in yields and rates. INTEREST RATE AND VOLUME VARIANCE ANALYSIS
for the years ended December 31, 2004 compared to 2003
    
    
    2003 compared to 2002Change
    
    
    
    
    
    
    ChangeAttributable to
    
    
    
    
    
    
    Attributable todollars in thousands
    
    Volume(1)
    
    
    Rate(1)
    
    
    Total
    
    
    Volume(1)
    
    
    Rate(1)
    
    
    TotalLoans
    
    $
    7,150
    
    
    $
    (3,082
    )
    
    $
    4,068
    
    
    $
    9,014
    
    
    $
    (3,232
    )
    
    $
    5,782Taxable securities
    
    
    937
    
    
    
    (47
    )
    
    
    890
    
    
    
    610
    
    
    
    (1,079
    )
    
    
    (469
    )Nontaxable securities
    
    
    (390
    )
    
    
    (69
    )
    
    
    (459
    )
    
    
    (537
    )
    
    
    (99
    )
    
    
    (636
    )Federal funds sold
    
    
    (99
    )
    
    
    9
    
    
    
    (90
    )
    
    
    89
    
    
    
    (2
    )
    
    
    87Interest-earning assets
    
    $
    7,598
    
    
    $
    (3,189
    )
    
    $
    4,409
    
    
    $
    9,176
    
    
    $
    (4,412
    )
    
    $
    4,764NOW deposits
    
    $
    168
    
    
    $
    175
    
    
    $
    343
    
    
    $
    62
    
    
    $
    110
    
    
    $
    172Money market deposits
    
    
    641
    
    
    
    (120
    )
    
    
    521
    
    
    
    1,204
    
    
    
    (235
    )
    
    
    969Savings deposits
    
    
    1
    
    
    
    3
    
    
    
    4
    
    
    
    
    
    
    
    (74
    )
    
    
    (74
    )Time deposits of $100,000
or more
    
    
    (436
    )
    
    
    587
    
    
    
    151
    
    
    
    991
    
    
    
    (1,056
    )
    
    
    (65
    )Other time deposits
    
    
    1,044
    
    
    
    (1,065
    )
    
    
    (21
    )
    
    
    (340
    )
    
    
    (666
    )
    
    
    (1,006
    )Interest-bearing deposits
    
    
    1,418
    
    
    
    (420
    )
    
    
    998
    
    
    
    1,917
    
    
    
    (1,921
    )
    
    
    (4
    )Overnight borrowings
    
    
    236
    
    
    
    33
    
    
    
    269
    
    
    
    (248
    )
    
    
    (166
    )
    
    
    (414
    )Other borrowings
    
    
    51
    
    
    
    401
    
    
    
    452
    
    
    
    933
    
    
    
    72
    
    
    
    1,005Interest-bearing liabilities
    
    $
    1,705
    
    
    $
    14
    
    
    $
    1,719
    
    
    $
    2,602
    
    
    $
    (2,015
    )
    
    $
    587
   (1)
    
    The rate/volume variance for each category has been allocated equally on a
consistent basis between rate and volume variances. LIQUIDITY, INTEREST RATE SENSITIVITY AND MARKET RISKS  The objectives of the Companys liquidity management policy include providing adequate funds to
meet the cash needs of both depositors and borrowers, as well as providing funds to meet the basic
needs for on-going operations of the Company and regulatory requirements. Depositor cash needs,
particularly those of commercial depositors, can fluctuate significantly depending on both
business and economic cycles, while both retail and commercial deposits can fluctuate
significantly based on the yields and returns available from alternative investment opportunities.
Borrower cash needs are also often dependent upon business and economic cycles. In addition, the
Companys liquidity is affected by off-balance sheet commitments to lend in the forms of unfunded
commitments to extend credit and standby letters of credit. As of December 31, 2004 and 2003, such
unfunded commitments to extend credit were $138,012,770 and $120,746,272, respectively, while
commitments in the form of standby letters of credit totaled $4,580,138 and $6,133,695,
respectively. The Company has a common stock repurchase plan, which it uses (1) to reduce the number of shares
outstanding when its share price in the market makes repurchases advantageous and (2) to manage
capital levels. The Company repurchases its shares in the open market, subject to legal
requirements and the repurchase rules of the Nasdaq Stock Market®, the stock market on which the
Companys common stock is listed, and through unsolicited privately negotiated transactions. The
Companys share repurchases are funded through the payment of dividends to the Company by its subsidiaries, principally the Bank. Because such dividend
payments have the effect of reducing its subsidiaries capital and liquidity positions, the
subsidiaries consider both capital and liquidity levels needed to support current and future
business activities when deciding the dividend amounts appropriate to fund share repurchases. The
Company plans to continue to repurchase its shares, subject to regulatory requirements and market
conditions, for the foreseeable future, while maintaining a well capitalized level. Although shares
repurchased are available for reissuance, the Company has not historically reissued, nor does it
currently anticipate reissuing, repurchased shares. During 2004, the Company repurchased 369,720
shares of its common stock at an average price of $20.12. Granite Mortgage arranges for the sale of most of the mortgage loans it originates after the
mortgage loan closes, rather than obtaining purchase commitments from mortgage investors at the
time the mortgage commitment is made to the mortgage customer. This method allows Granite Mortgage
to bundle mortgage loans and obtain better pricing 23




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##### Table of Contents



compared with the sale of individual mortgage loans. However, this method also introduces interest
rate risk to Granite Mortgages loans in process since rates may fluctuate subsequent to Granite
Mortgages rate commitment to the mortgage customer. In order to minimize the risk that interest
rates may move against Granite Mortgage subsequent to the rate commitment, Granite Mortgage began
entering into hedge contracts to forward sell mortgage-backed securities at the same time as the
rate commitment. When the mortgage loan is ultimately sold, Granite Mortgage then buys the
mortgage-backed security, thereby completing the hedge contract. Granite Mortgage classifies all of
its hedge contracts in accordance with SFAS No. 133 as a hedge of an exposure to changes in cash
flows from forecasted transactions, referred to as a cash flow hedge. As of December 31, 2004,
Granite Mortgage held $14,605,060 in open mortgage-backed security commitments with an estimated
market value of $14,508,827, an unrealized loss of $96,233. For 2004, there were realized losses on
hedged mortgage loan commitments of $824,204 and realized losses of $126,924 on commitments to sell
mortgage-backed securities. In addition to the improved spreads resulting from more advantageous
pricing from bundling mortgage loans for sale, Granite Mortgage production also believes that this
management method increases production efficiencies. Through its 2003 acquisition of First Commerce, the Company acquired a statutory business trust,
First Commerce Capital Trust I, created by First Commerce in 2001 to facilitate the issuance of a
$5,000,000 trust preferred security through a pooled trust preferred securities offering. First
Commerce issued this security to increase its regulatory capital. This security bears a variable
interest rate based on the sixty-day LIBOR plus 375 basis points, matures in 2031 and is callable
at par in 2006. Except for the hedging strategy, neither the Company nor its subsidiaries have historically
incurred off-balance sheet obligations through the use of or investment in off-balance sheet
derivative financial instruments or structured finance or special purpose entities organized as
corporations, partnerships or limited liability companies or trusts. The Bank and Granite Mortgage
both had contractual off-balance sheet obligations in the form of noncancelable operating leases
with unrelated vendors. As of December 31, 2004, payments due under such operating lease
arrangements are $896,264 in 2005, $1,380,681 in the years 2006 through 2007, $1,029,709 in the
years 2008 through 2009 and $1,451,978 in the years 2010 and thereafter. Further discussions are
included under Off-Balance Sheet Arrangements below. Liquidity requirements of the Bank are primarily met through two categories of funding. The first
is core deposits, which includes demand deposits, savings accounts and certificates of deposit.
The Bank considers these to be a stable portion of the Banks liability mix and the result of
ongoing stable consumer and commercial banking relationships. As of December 31, 2004, the Banks
core deposits, defined as total deposits excluding time deposits of $100,000 or more, totaled
$607,600,241, or 81.0%, of the Banks total deposits. The other principal method of funding used by the Bank is through large denomination certificates
of deposit, federal funds purchased, repurchase agreements and other short and intermediate term
borrowings. The Banks policy is to emphasize core deposit growth rather than growth through
purchased or brokered time deposits as the cost of purchased or brokered time deposits is greater.
During periods of weak demand for its deposit products, the Bank maintains several credit
facilities under which it may borrow on a short-term basis. As of December 31, 2004, the Bank had
three unsecured lines of overnight borrowing capacity with its correspondent banks, which totaled $21,000,000. In addition the Bank uses its capacity to pledge assets to serve
as collateral to borrow on a secured basis. As of December 31, 2004, the Bank had investment
securities pledged to secure overnight funding lines in the approximate amounts of $8,250,000 with
the Federal Reserve Bank. As of December 31, 2004, the Bank had no securities pledged to the
Federal Home Loan Bank. The Bank also has pledged its loans secured by first liens on residential
and commercial real estate as collateral for additional borrowings from the Federal Home Loan Bank
during periods when loan demand exceeds deposit growth or when the interest rates on such
borrowings compare favorably to interest rates on deposit products. As of December 31, 2004, the
Bank had the capacity to borrow approximately $100,175,000 from the Federal Home Loan Bank against
its pledged residential and commercial real estate loans. Overnight borrowings were $71,748,432 as
of December 31, 2004, an increase of $46,543,261 from the $25,205,171 in overnight borrowings at
December 31, 2003, as the Bank temporarily funded its loan growth, which outpaced its deposit
growth, with overnight borrowings. Granite Mortgage temporarily funds its mortgages, from the time of origination until the time of
sale, through the use of a one-year warehouse line of credit from one of the Companys
correspondent financial institutions. For the years ended December 31, 2004 and 2003, this line
of credit was $40,000,000 and $50,000,000, of which $29,478,614 and $26,107,383, respectively,
were outstanding at year end. Granite Mortgage requests of credit based on its estimated funding
needs for the year. The line is secured by the mortgage loans originated, and the Company serves
as guarantor on this borrowing. 24




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##### Table of Contents



The Company has an unsecured line of credit from one of the Banks correspondent banks for
general corporate purposes, which expires June 30, 2006. The line is in the amount of
$10,000,000 and bears an interest rate of one-month LIBOR plus 120 basis points, with interest
payable quarterly. As of December 31, 2004 and 2003, the Company had not borrowed any funds
against this line of credit. The majority of the Companys deposits are rate-sensitive instruments with rates which tend to
fluctuate with market rates. These deposits, coupled with the Companys short-term certificates of
deposit, have increased the opportunities for deposit repricing. The Company places great
significance on monitoring and managing the Companys asset/liability position. The Companys
policy of managing its interest margin (or net yield on interest-earning assets) is to optimize
net interest income while maintaining a stable deposit base. Because the Company has historically
relied on deposits from its local market areas as its primary sources of funding, it has not
historically sought out-of-market or brokered time deposits as a funding source, resulting in a
deposit base that has not generally been subject to the volatility experienced in national
financial markets in recent years. However, the Company does realize the importance of minimizing
such funding volatility while at the same time maintaining and improving earnings. A common method
used to manage interest rate sensitivity is to measure, over various time periods, the difference
or gap between the volume of interest-earning assets and interest-bearing liabilities repricing
over a specific time period. However, this method addresses only the magnitude of funding
mismatches and does not address the magnitude or relative timing of rate changes. Therefore,
management prepares on a regular basis earnings projections based on a range of interest rate
scenarios of rising, flat and declining rates in order to more accurately measure interest rate
risk. Interest-bearing liabilities and the loan portfolio are generally repriced to current market
rates. The Companys balance sheet is asset-sensitive, meaning that in a given period there will
be more assets than liabilities subject to immediate repricing as the market rates change.
Because most of the Companys loans are at variable rates, they reprice more rapidly than rate
sensitive interest-bearing deposits. During periods of rising rates, this results in increased
net interest income. The opposite occurs during periods of declining rates. INTEREST RATE SENSITIVITY (GAP ANALYSIS)
As of December 31, 2004 Non-sensitiveInterest Sensitive Within
    
    
    Total
    
    
    or Sensitive1 to
    
    
    91 to
    
    
    181 to
    
    
    Within
    
    
    Beyonddollars in thousands
    
    90 Days
    
    
    180 Days
    
    
    365 Days
    
    
    1 Year
    
    
    1 Year
    
    
    TotalInterest-earning AssetsInterest-bearing due from banks
    
    $
    3,577
    
    
    
    
    
    
    
    
    
    
    $
    3,577
    
    
    
    
    
    
    $
    3,577Securities (at amortized cost) (1):U.S. Treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    5,250
    
    
    
    5,250U.S. Government agencies
    
    
    2,700
    
    
    $
    
    
    
    
    
    
    
    
    2,700
    
    
    
    77,744
    
    
    
    80,444States and political subdivisions
    
    
    2,260
    
    
    
    3,686
    
    
    
    
    
    
    
    5,946
    
    
    
    48,174
    
    
    
    54,120Other (including equity securities)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,243
    
    
    
    18,243Loans (gross):Real estate  Construction
    
    
    98,395
    
    
    
    939
    
    
    
    628
    
    
    
    99,962
    
    
    
    5,149
    
    
    
    105,111Real estate  Mortgage
    
    
    356,345
    
    
    
    4,035
    
    
    
    5,182
    
    
    
    365,562
    
    
    
    55,298
    
    
    
    420,860Commercial, financial and agricultural
    
    
    198,964
    
    
    
    1,676
    
    
    
    3,362
    
    
    
    204,002
    
    
    
    19,603
    
    
    
    223,605Consumer
    
    
    4,471
    
    
    
    407
    
    
    
    1,032
    
    
    
    5,910
    
    
    
    23,105
    
    
    
    29,015All other
    
    
    
    
    
    
    
    
    
    
    120
    
    
    
    120
    
    
    
    584
    
    
    
    704Mortgages held for sale
    
    
    21,554
    
    
    
    
    
    
    
    
    
    
    
    21,554
    
    
    
    
    
    
    
    21,554Total interest-earning assets
    
    $
    688,266
    
    
    $
    10,743
    
    
    
    10,324
    
    
    $
    709,333
    
    
    $
    253,150
    
    
    $
    962,483Interest-bearing LiabilitiesInterest-bearing deposits:Savings and NOW accounts
    
    $
    147,368
    
    
    
    
    
    
    
    
    
    
    $
    147,368
    
    
    
    
    
    
    $
    147,368Money market accounts
    
    
    161,141
    
    
    
    
    
    
    
    
    
    
    
    161,141
    
    
    
    
    
    
    
    161,141Time deposits of $100,000 or more
    
    
    58,241
    
    
    $
    31,152
    
    
    
    22,323
    
    
    
    111,716
    
    
    $
    30,545
    
    
    
    142,261Other time deposits
    
    
    34,650
    
    
    
    38,244
    
    
    
    47,052
    
    
    
    119,946
    
    
    
    51,467
    
    
    
    171,413Overnight borrowings
    
    
    71,748
    
    
    
    
    
    
    
    
    
    
    
    71,748
    
    
    
    
    
    
    
    71,748Other borrowings
    
    
    32,586
    
    
    
    10,000
    
    
    
    6,000
    
    
    
    48,586
    
    
    
    15,000
    
    
    
    63,586Total interest-bearing liabilities
    
    $
    505,734
    
    
    $
    79,396
    
    
    
    75,375
    
    
    $
    660,505
    
    
    $
    97,012
    
    
    $
    757,517Interest sensitivity gap
    
    $
    182,532
    
    
    $
    (68,653
    )
    
    
    (65,051
    )
    
    $
    48,828Cumulative interest sensitivity gap
    
    
    182,532
    
    
    
    113,879
    
    
    
    48,828
    
    
    
    48,828Interest earning-assets as a percentage
of interest-bearing liabilities
    
    
    136
    %
    
    
    14
    %
    
    
    14
    %
    
    
    107
    %
   (1)
    
    Interest sensitivity periods for debt securities are based on contractual maturities. 25




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##### Table of Contents



The Company uses several modeling techniques to measure interest rate risk including the gap
analysis previously discussed, the simulation of net interest income under gradual interest rate
changes and the theoretical impact of immediate and sustained rate changes referred to as rate
shocks. The following table summarizes the estimated theoretical impact on the Companys tax equivalent
net interest income from a gradual interest rate increase and decrease of 3%, prorated over a
twelve-month period, and from hypothetical immediate and sustained interest rate increases and
decreases of 1%, 2%, 3% and 4%, as compared to the estimated theoretical impact of rates
remaining unchanged. The theoretical effects of these hypothetical interest rate changes are
based upon numerous assumptions including relative and estimated levels of key interest rates.
While such simulation modeling is useful in estimating interest rate risk inherent in the
Companys asset and liability positions, it is of limited usefulness because it does not take
into account the asset and liability mix decisions and pricing strategies management would
undertake in response to the depicted rate changes. Estimated Resulting Theoretical Tax Equivalent Net Interest IncomeFor the Twelve-month Periods FollowingDecember 31, 2004
    
    
    December 31, 2003dollars in thousands
    
    Amount
    
    
    % Change
    
    
    Amount
    
    
    % Change3% interest rate changes prorated over a twelve-month period+3%
    
    $
    47,196
    
    
    
    4.2
    %
    
    $
    43,839
    
    
    
    5.4
    %0%
    
    
    45,279
    
    
    
    0.0
    %
    
    
    41,599
    
    
    
    0.0
    %-3%
    
    
    40,176
    
    
    
    -11.3
    %*
    
    
    36,083
    
    
    
    -13.3
    %*Hypothetical immediate and sustained rate changes of 1%, 2%, 3% and 4%+4%
    
    $
    48,110
    
    
    
    10.5
    %
    
    $
    45,953
    
    
    
    16.1
    %+3%
    
    
    47,032
    
    
    
    8.1
    %
    
    
    44,355
    
    
    
    12.0
    %+2%
    
    
    45,909
    
    
    
    5.5
    %
    
    
    42,720
    
    
    
    7.9
    %+1%
    
    
    44,703
    
    
    
    2.7
    %
    
    
    41,098
    
    
    
    3.8
    %0%
    
    
    43,520
    
    
    
    0.0
    %
    
    
    39,596
    
    
    
    0.0
    %-1%
    
    
    39,492
    
    
    
    -9.3
    %
    
    
    36,189
    
    
    
    -8.6
    %-2%
    
    
    36,386
    
    
    
    -16.4
    %
    
    
    32,264
    
    
    
    -18.5
    %*-3%
    
    
    33,592
    
    
    
    -22.8
    %*
    
    
    28,737
    
    
    
    -27.4
    %*-4%
    
    
    30,438
    
    
    
    -30.1
    %*
    
    
    25,789
    
    
    
    -34.9
    %*
   *
    
    The Federal Reserves overnight federal funds rate target was 2.25% at December 31,
2004 and 1.00% at December 31, 2003. Since it is unlikely that the Federal Reserve would
reduce its overnight federal funds target rate to 0%, it is difficult to draw meaningful
conclusions from theoretical rate reductions equal to or exceeding the overnight federal
funds target rate. The following table presents the maturity distribution of the Companys loans by type,
including fixed rate loans. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES  Within
    
    
    One to
    
    
    FiveOne
    
    
    Five
    
    
    Years ordollars in thousands
    
    Year
    
    
    Years
    
    
    More
    
    
    TotalReal estate  Construction
    
    $
    35,259
    
    
    $
    46,252
    
    
    $
    23,600
    
    
    $
    105,111Real estate  Mortgage
    
    
    73,607
    
    
    
    228,053
    
    
    
    119,200
    
    
    
    420,860Commercial, financial and agricultural
    
    
    136,025
    
    
    
    77,354
    
    
    
    10,226
    
    
    
    223,605Consumer
    
    
    4,666
    
    
    
    23,632
    
    
    
    717
    
    
    
    29,015All other
    
    
    439
    
    
    
    265
    
    
    
    
    
    
    
    704Total
    
    $
    249,996
    
    
    $
    375,556
    
    
    $
    153,743
    
    
    $
    779,295Predetermined rate, maturity
greater than one year
    
    $
    
    
    
    $
    85,554
    
    
    $
    9,851
    
    
    $
    95,405Variable rate or maturing within
one year
    
    
    249,996
    
    
    
    290,001
    
    
    
    143,893
    
    
    
    683,890Total
    
    $
    249,996
    
    
    $
    375,555
    
    
    $
    153,744
    
    
    $
    779,295
 26




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##### Table of Contents



The Companys rate paid on interest-bearing deposits declined to 1.73% in 2004 compared to
1.83% in 2003. The Companys deposit growth was primarily reflected in transaction deposits,
which increased $35,252,860. Rate sensitive consumers chose to place funds in transaction deposit accounts because of increased
liquidity and lower interest rate differentials to time deposits. Increased customer awareness of
interest rates increases the importance of rate management by the Company. The Companys management
continuously monitors market pricing, competitor rates, and internal interest rate spreads in an
effort to maintain the Companys growth and profitability. Deposits continue to be the principal source of funds for continued growth, so the
Company attempts to structure its rates so as to promote deposit and asset growth while at the same
time increasing the overall profitability of the Company. The daily average amounts of deposits of
the Bank are summarized below. AVERAGE DEPOSITS
for the years ended December 31, dollars in thousands
    
    2004
    
    
    2003
    
    
    2002Non-interest-bearing demand deposits
    
    $
    128,942
    
    
    $
    109,834
    
    
    $
    93,848Interest-bearing demand deposits
    
    
    269,607
    
    
    
    209,971
    
    
    
    136,869Savings deposits
    
    
    26,904
    
    
    
    26,302
    
    
    
    26,229Time deposits
    
    
    321,027
    
    
    
    294,164
    
    
    
    266,836Total
    
    $
    746,480
    
    
    $
    640,271
    
    
    $
    523,782
 The preceding table includes certificates of deposits $100,000 and over, which at December 31, 2004 totaled
approximately $142,261,000. The following table presents the maturities of these time deposits of $100,000
or more. MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE
As of December 31, 2004 Within
    
    
    Three to
    
    
    Six to
    
    
    Within
    
    
    One toThree
    
    
    Six
    
    
    Twelve
    
    
    One
    
    
    Fivedollars in thousands
    
    Months
    
    
    Months
    
    
    Months
    
    
    Year
    
    
    Years
    
    
    TotalTime deposits of $100,000 or more
    
    $
    58,241
    
    
    $
    31,152
    
    
    $
    22,323
    
    
    $
    111,716
    
    
    $
    30,545
    
    
    $
    142,261
 CAPITAL RESOURCES Funding for the future growth and expansion of the Company is dependent upon earnings of the
Companys subsidiaries. As of December 31, 2004, the Companys ratio of total capital to
risk-adjusted assets was 17.25%. The Company fully expects to be able to meet future capital needs
caused by growth and expansion as well as regulatory capital requirements. The Company is not aware
of any current recommendation by regulatory authorities which if implemented would materially
affect the Companys liquidity, capital resources or operations. The Company currently plans no
significant capital expenditures in 2005. 27




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##### Table of Contents



LOANS Historically, the Company makes loans within its market area. It makes consumer and commercial
loans through the Bank and mortgage loans through Granite Mortgage. The Bank generally considers
its primary markets to be Burke, Caldwell, Catawba, Mecklenburg, Watauga and Wilkes counties of
North Carolina. Granite Mortgage considers its market area to be the central and southern Piedmont
and Catawba Valley regions of North Carolina and Hilton Head Island, South Carolina. Total loans at
December 31, 2004 were $778,137,430, which compares with $715,844,632 at December 31, 2003, for an
increase of $62,292,798 or 8.70%. The Company places emphasis on consumer based installment loans
and commercial loans to small and medium sized businesses. The Company has a diversified loan
portfolio with no concentrations to any one borrower, industry or market region. The amounts and
types of loans outstanding for the past five years ended December 31 are shown on the following
table. LOANS
As of December 31, 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % ofTotal
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Totaldollars in thousands
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    LoansLoansReal estate -
Construction
    
    $
    105,111
    
    
    
    13.5
    %
    
    $
    90,176

    
    
    
    12.6
    %
    
    $
    75,383
    
    
    
    14.1
    %
    
    $
    72,418
    
    
    
    14.2
    %
    
    $
    62,093
    
    
    
    13.8
    %Mortgage
    
    
    420,860
    
    
    
    54.0
    %
    
    
    377,956
    
    
    
    52.7
    %
    
    
    245,496
    
    
    
    46.0
    %
    
    
    243,067
    
    
    
    47.4
    %
    
    
    200,945
    
    
    
    44.5
    %Commercial,
financial and
agricultural
    
    
    223,605
    
    
    
    28.7
    %
    
    
    211,477
    
    
    
    29.5
    %
    
    
    175,409
    
    
    
    32.9
    %
    
    
    166,980
    
    
    
    32.7
    %
    
    
    156,297
    
    
    
    34.6
    %Consumer
    
    
    29,015
    
    
    
    3.7
    %
    
    
    35,981
    
    
    
    5.0
    %
    
    
    37,046
    
    
    
    6.9
    %
    
    
    28,441
    
    
    
    5.6
    %
    
    
    31,501
    
    
    
    7.0
    %All other
    
    
    704
    
    
    
    0.1
    %
    
    
    1,206
    
    
    
    0.2
    %
    
    
    449
    
    
    
    0.1
    %
    
    
    282
    
    
    
    0.1
    %
    
    
    248
    
    
    
    0.1
    %Total loans
    
    
    779,295
    
    
    
    100.0
    %
    
    
    716,796
    
    
    
    100.0
    %
    
    
    533,783
    
    
    
    100.0
    %
    
    
    511,188
    
    
    
    100.0
    %
    
    
    451,084
    
    
    
    100.0
    %Deferred origination
fees, net
    
    
    (1,158
    )
    
    
    
    
    
    
    (951
    )
    
    
    
    
    
    
    (860
    )
    
    
    
    
    
    
    (777
    )
    
    
    
    
    
    
    (685
    )Total loans, net of
deferred fees
    
    $
    778,137
    
    
    
    
    
    
    $
    715,845
    
    
    
    
    
    
    $
    532,923
    
    
    
    
    
    
    $
    510,411
    
    
    
    
    
    
    $
    450,399
 Real estate loans comprised 67.5% of the portfolio in 2004 compared to 65.3% in 2003.
Commercial loans comprised 28.7% of the portfolio in 2004 compared to 29.5% in 2003, while consumer
loans comprised 3.7% in 2004 compared to 5.0% in 2003. Commercial loans of $223,605,232, consumer
loans of $29,014,711 and real estate mortgage loans of $420,860,460 are loans for which the
principal source of repayment is derived from the ongoing cash flow of the business or the
borrower. Real estate construction loans of $105,110,671 are loans for which the principal source
of repayment comes from the sale of real estate or from obtaining permanent financing. December 31, 2003 balances of approximately $32,948,000, $7,061,000 and $551,000, in real estate,
commercial and consumer loans, respectively, were from the three offices opened during 2003.
December 31, 2003 balances of approximately $90,463,000, $17,512,000 and $558,000, in real estate,
commercial and consumer loans, respectively, were from the three offices acquired from First
Commerce in July 2003. NONPERFORMING LOANS AND NONPERFORMING ASSETS
As of December 31, dollars in thousands
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Nonperforming assetsNonaccrual loans
    
    $
    6,634
    
    
    $
    8,115
    
    
    $
    3,265
    
    
    $
    2,944
    
    
    $
    1,502Loans past due 90 days or more
and still accruing interest
    
    
    4,227
    
    
    
    3,218
    
    
    
    1,153
    
    
    
    1,769
    
    
    
    1,983Foreclosed properties
    
    
    1,280
    
    
    
    1,775
    
    
    
    1,203
    
    
    
    323
    
    
    
    134Total
    
    $
    12,141
    
    
    $
    13,108
    
    
    $
    5,621
    
    
    $
    5,036
    
    
    $
    3,619Nonperforming loans to total loans
    
    
    1.40
    %
    
    
    1.58
    %
    
    
    0.83
    %
    
    
    0.97
    %
    
    
    0.79
    %Allowance for loan losses to nonperforming loans
    
    
    125.82
    %
    
    
    95.29
    %
    
    
    199.98
    %
    
    
    136.35
    %
    
    
    182.26
    %Nonperforming loans to total assets
    
    
    1.05
    %
    
    
    1.17
    %
    
    
    0.60
    %
    
    
    0.66
    %
    
    
    0.53
    %Nonperforming assets to total assets
    
    
    1.18
    %
    
    
    1.35
    %
    
    
    0.76
    %
    
    
    0.70
    %
    
    
    0.55
    %
 28




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##### Table of Contents



Certain loans are classified as nonaccrual, meaning that interest is not being accrued on these
instruments. Accrual of interest on loans is discontinued when management believes that such
interest will not be collected in a reasonable period of time. The recorded accrued interest is
also reversed or charged off. A loan classified as nonaccrual is returned to accrual status when
the obligation has been brought current, has performed in accordance with its contractual terms
over an extended period of time, and the ultimate collectibility of the total contractual
principal and interest is no longer in doubt. The decline in nonperforming assets as of December
31, 2004 was primarily attributable to the repayment of $2,894,000 nonaccruing loan, which was
substantially offset by other loans added to nonaccruing status during 2004 and an increase in loans past due 90 days
or more and still accruing interest. The Companys investment in impaired loans for the past five years ended December 31 was as
follows: IMPAIRED LOANS
As of December 31, dollars in thousands
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Investment in impaired loans:Impaired loans still accruing interest
    
    $
    5,237
    
    
    $
    3,114
    
    
    $
    1,890
    
    
    $
    1,274
    
    
    $
    545Accrued interest on accruing impaired loans
    
    
    116
    
    
    
    90
    
    
    
    56
    
    
    
    38
    
    
    
    24Impaired loans not accruing interest
    
    
    6,634
    
    
    
    8,115
    
    
    
    3,265
    
    
    
    2,944
    
    
    
    1,502Accrued interest on nonaccruing impaired loans
    
    
    151
    
    
    
    215
    
    
    
    127
    
    
    
    131
    
    
    
    53Total investment in impaired loans
    
    $
    12,138
    
    
    $
    11,534
    
    
    $
    5,338
    
    
    $
    4,387
    
    
    $
    2,124Loan loss allowance related to impaired loans
    
    $
    4,325
    
    
    $
    2,412
    
    
    $
    2,196
    
    
    $
    1,372
    
    
    $
    1,010
 Impaired loans are measured based on the present value of expected future cash flows
discounted at the loans effective interest rate or, as a practical matter, at the loans
observable market value or fair value of the collateral if the loan is collateral dependent. Most
of the loans measured by fair value of the underlying collateral are commercial loans, while
others consist of small balance homogenous loans and are measured collectively. The Bank
classifies a loan as impaired when, based on current information and events, management believes
it is probable that the Bank will be unable to collect all amounts due according to the
contractual terms of the loan agreement. At December 31, 2004 and 2003, the recorded investment
in loans that were considered to be impaired, including accrued interest, was $12,137,624
($6,784,846 of which was on a nonaccrual basis) and $11,534,862 ($8,330,334 of which was on a
nonaccrual basis), respectively. The average recorded balance of impaired loans during 2004 and
2003 was not significantly different from the balance at December 31, 2004 and 2003. The related
allowance for loan losses for these loans was $4,324,669 and $2,412,366 at December 31, 2004 and
2003, respectively. The allowance for impaired loans increased $1,912,303, or 79.27%, while the
total balance of impaired loans increased $602,762, or 5.23%. This disparity is primarily
attributable to the further deterioration in the credit quality of loans previously categorized
as impaired. The loan loss allowance related to impaired loans was 35.63% as of December 31, 2004
compared to 20.91% as of December 31, 2003. For the years ended December 31, 2004, 2003 and 2002,
the Bank recognized interest income on those impaired loans of approximately $266,829, $305,865
and $183,405, respectively. For the years ended December 31, 2004 and 2003, the estimated gross interest income that would have
been recorded had the nonaccruing loans been current in accordance with their original terms was
approximately $408,114 and $294,726, respectively, while the interest recognized on such loans was
$65,024 and $197,453, respectively. For the year ended December 31, 2002, management determined
that the gross interest income that would have been recorded had the nonaccruing loans been current
in accordance with their original terms and the amount of interest income on those loans that was
included in net income was not material to the Companys earnings. 29




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##### Table of Contents



PROVISIONS AND ALLOWANCES FOR LOAN LOSSES The risks inherent in the Companys loan portfolio, including the adequacy of the allowance or
reserve for loan losses, are significant estimates that are based on managements assumptions
regarding, among other factors, general and local economic conditions, which are difficult to
predict and are beyond the Companys control. In estimating these risks and the related loss
reserve levels, management also considers the financial conditions of specific borrowers and
credit concentrations with specific borrowers, groups of borrowers and industries. Management uses several measures to assess and monitor the credit risks in the loan portfolio,
including a loan grading system that begins upon loan origination and continues until the loan is collected or
collectibility becomes doubtful. Upon loan origination, the Banks originating loan officer
evaluates the quality of the loan and assigns one of seven risk grades, each grade indicating a
different level of loss reserves. The loan officer monitors the loans performance and credit
quality and makes changes to the credit grade as conditions warrant. When originated or renewed,
all loans over a certain dollar amounts receive in-depth reviews and risk assessments by the Banks
Credit Administration. Before making any changes in these risk grades, management considers
assessments as determined by the third party risk assessment group (as described below), regulatory
examiners and the Banks Credit Administration. Any issues regarding the risk assessments are
addressed by the Banks senior credit administrators and factored into managements decision to
originate or renew the loan as well as the level of reserves deemed appropriate for the loan.
Furthermore, loans and commitments of $500,000 or more made during the month, as well as commercial
loans past due 30 days or more, are reviewed monthly by the Banks Board of Directors. The Banks
Board of Directors also reviews, on a monthly basis, an analysis of the Banks reserves relative to
the range of reserves estimated by the Banks Credit Administration. As an additional measure, the Bank engages an independent third party risk assessment group to
review the underwriting, documentation, risk grading analyses and the methodology of determining
the adequacy of the allowance for losses. This independent third party determines its own
selection criteria to select loan relationships for review and evaluation. The third partys
evaluation and report is shared with management, the Banks Audit Committee and ultimately, the
Banks Board of Directors. Management considers certain commercial loans with weak credit risk grades to be individually
impaired and measures such impairment based upon available cash flows and the value of the
collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio
based on their assigned credit risk grade, type of loan and other matters related to credit risk.
In estimating reserve levels, the Bank also aggregates non-graded loans into pools of similar
credits and reviews the historical loss experience associated with these pools as additional
criteria to allocate the allowance to each category. Management uses the information developed from the procedures described above in evaluating and
grading the loan portfolio. This continual grading process is used to monitor the credit quality
of the loan portfolio and to assist management in determining the appropriate levels of the
allowance for loan losses. The allowance for loan losses is comprised of three components: specific reserves, general reserves
and unallocated reserves. Generally, all loans with outstanding balances of $10,000 or greater that
have been identified as impaired are reviewed on a monthly basis in order to determine whether a
specific allowance is required. After a loan has been identified as impaired, management measures
impairment in accordance with SFAS No. 114, Accounting By Creditors for Impairment of a Loan.
When the measure of the impaired loan is less than the recorded investment in the loan, the amount
of the impairment is recorded as a specific reserve. These specific reserves are determined on an
individual loan basis based on managements current evaluation of the Companys loss exposure for
each credit, given the payment status, financial condition of the borrower, and value of any
underlying collateral. Loans for which specific reserves are provided are excluded from the general
allowance calculations as described below. 30




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##### Table of Contents



The general allowance reflects the best estimate of probable losses that exist within the
portfolios of loans that have not been specifically identified. The general allowance for the
commercial loan portfolio is established considering several factors including: current loan
grades, historical loss rates, estimated future cash flows available to service the loan, and the
results of individual loan reviews and analyses. Commercial loans are assigned a loan grade and the
loss percentages assigned for each loan grade are determined based on periodic evaluation of actual
loss experience over a period of time and managements estimate of probable incurred losses as well
as other factors that are known at the time when the appropriate level for the allowance for loan
losses is assessed, including the average term of the portfolio. The allowance for loan losses for
consumer loans, mortgage loans, and leases is determined based on past due levels and historical
and projected loss rates relative to each portfolio. The unallocated allowance is determined through managements assessment of probable losses that are
in the portfolio but are not adequately captured by the other two components of the allowance,
including consideration of current economic and business conditions and regulatory requirements.
The unallocated allowance also reflects managements acknowledgement of the imprecision and subjectivity that underlie the
modeling of credit risk. Management considers the allowance for loan losses adequate to cover the estimated losses inherent
in the Companys loan portfolio as of the date of the financial statements. Management believes it
has established the allowance in accordance with accounting principles generally accepted in the
United States of America and in consideration of the current economic environment. Although
management uses the best information available to make evaluations, significant future additions to
the allowance may be necessary based on changes in economic and other conditions, thus adversely
affecting the operating results of the Company. There were no significant changes in the estimation
methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the
year ended December 31, 2004 as compared to the year ended December 31, 2003. Such revisions,
estimates and assumptions are made in any period in which the supporting factors indicate that loss
levels may vary from the previous estimates. Additionally, various regulatory agencies, as an integral part of their examination process,
periodically review the Banks allowances for loan losses. Such agencies may require adjustments
to the allowances based on their judgments of information available to them at the time of their
examinations. The allowance for loan losses is created by direct charges to operations. Losses on loans are
charged against the allowance for loan losses in the accounting period in which they are
determined by management to be uncollectible. Recoveries during the period are credited to the
allowance for loan losses. General economic trends greatly affect loan losses, and no assurances can be made that further
charges to the loan loss allowance will not be significant in relation to the amount provided
during a particular period or that further evaluation of the loan portfolio based on conditions
then prevailing may not require sizable additions to the allowance, thus necessitating similarly
sizable charges to operations. Due to continued unfavorable economic trends in the Catawba Valley
region of the Companys market area and due to continued high levels of nonperforming loans
resulting from the weakened local economy, management believed it prudent to charge operations in
the amounts of $5,439,160 in 2004 compared to $4,764,010 in 2003 and $3,492,382 in 2002 to provide
for future losses related to uncollectible loans. At December 31, 2004, the loan loss reserve was
1.79% of net loans outstanding compared to 1.53% as of December 31, 2003. Approximately $685,000
of the provision for loan losses was attributable to loan growth, while $4,754,000 was
attributable to declining credit quality. 31




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##### Table of Contents



The following table presents an analysis of changes in the allowance for loan losses for years
indicated. CHANGES IN THE ALLOWANCE FOR LOAN LOSSES for the years ended December 31, dollars in thousands
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Balance at beginning of year
    
    $
    10,799
    
    
    $
    8,835
    
    
    $
    6,426
    
    
    $
    6,352
    
    
    $
    4,747Loans charged off:Real estate
    
    
    930
    
    
    
    1,616
    
    
    
    329
    
    
    
    1,474
    
    
    
    1,305Commercial, financial and agricultural
    
    
    1,040
    
    
    
    2,275
    
    
    
    538
    
    
    
    2,123
    
    
    
    613Credit cards and related plans
    
    
    88
    
    
    
    41
    
    
    
    57
    
    
    
    19
    
    
    
    13Installment loans to individuals
    
    
    683
    
    
    
    767
    
    
    
    260
    
    
    
    468
    
    
    
    280Demand deposit overdraft program
    
    
    297
    
    
    
    389
    
    
    
    371
    
    
    
    417
    
    
    
    395Total charge-offs
    
    
    3,038
    
    
    
    5,088
    
    
    
    1,555
    
    
    
    4,501
    
    
    
    2,606Recoveries of loans previously charged off:Real estate
    
    
    24
    
    
    
    3
    
    
    
    78
    
    
    
    52
    
    
    
    89Commercial, financial and agricultural
    
    
    70
    
    
    
    176
    
    
    
    168
    
    
    
    53
    
    
    
    80Credit cards and related plans
    
    
    4
    
    
    
    5
    
    
    
    2
    
    
    
    5
    
    
    
    3Installment loans to individuals
    
    
    220
    
    
    
    71
    
    
    
    59
    
    
    
    39
    
    
    
    82Demand deposit overdraft program
    
    
    147
    
    
    
    170
    
    
    
    165
    
    
    
    209
    
    
    
    63Total recoveries
    
    
    465
    
    
    
    425
    
    
    
    472
    
    
    
    358
    
    
    
    317Net charge-offs
    
    
    2,573
    
    
    
    4,663
    
    
    
    1,083
    
    
    
    4,143
    
    
    
    2,289Additions charged to operations
    
    
    5,439
    
    
    
    4,764
    
    
    
    3,492
    
    
    
    4,217
    
    
    
    3,894Allowance of loans acquired in purchase transaction
    
    
    
    
    
    
    1,863
    
    
    
    
    
    
    
    
    
    
    
    Balance at end of year
    
    $
    13,665
    
    
    $
    10,799
    
    
    $
    8,835
    
    
    $
    6,426
    
    
    $
    6,352Ratio of net charge-offs during the year to
average loans outstanding during the year
    
    
    0.35
    %
    
    
    0.75
    %
    
    
    0.21
    %
    
    
    0.86
    %
    
    
    0.54
    %Allowance coverage of net charge-offs
    
    
    531.08
    %
    
    
    231.62
    %
    
    
    814.81
    %
    
    
    155.15
    %
    
    
    277.55
    %Allowance as a percentage of gross loans
    
    
    1.76
    %
    
    
    1.51
    %
    
    
    1.66
    %
    
    
    1.32
    %
    
    
    1.43
    %Allowance as a percentage of net loans
    
    
    1.79
    %
    
    
    1.53
    %
    
    
    1.69
    %
    
    
    1.33
    %
    
    
    1.45
    %
 The allowance for loan losses acquired in the purchase transaction represents general
loan loss reserves. Any specific reserves were evaluated and recorded in the fair value
adjustment for the applicable loan. The following table presents the allocation of the allowance for loan losses by category. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
As of December 31, 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % ofTotal
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Totaldollars in thousands
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    LoansReal estate
    
    $
    5,782
    
    
    
    67.5
    %
    
    $
    4,602
    
    
    
    65.3
    %
    
    $
    3,564
    
    
    
    60.1
    %
    
    $
    2,397
    
    
    
    61.6
    %
    
    $
    2,399
    
    
    
    58.3
    %Commercial, financial
and agricultural
    
    
    6,759
    
    
    
    28.7
    %
    
    
    5,226
    
    
    
    29.5
    %
    
    
    4,410
    
    
    
    32.9
    %
    
    
    3,306
    
    
    
    32.7
    %
    
    
    3,144
    
    
    
    34.6
    %Consumer
    
    
    617
    
    
    
    3.7
    %
    
    
    684
    
    
    
    5.0
    %
    
    
    649
    
    
    
    6.9
    %
    
    
    540
    
    
    
    5.6
    %
    
    
    626
    
    
    
    7.0
    %All other loans
    
    
    
    
    
    
    0.1
    %
    
    
    
    
    
    
    0.2
    %
    
    
    
    
    
    
    0.1
    %
    
    
    
    
    
    
    0.1
    %
    
    
    
    
    
    
    0.1
    %Unallocated
    
    
    507
    
    
    
    n/a
    
    
    
    287
    
    
    
    n/a
    
    
    
    212
    
    
    
    n/a
    
    
    
    183
    
    
    
    n/a
    
    
    
    183
    
    
    
    n/aTotal loans
    
    $
    13,665
    
    
    
    100.0
    %
    
    $
    10,799
    
    
    
    100.0
    %
    
    $
    8,835
    
    
    
    100.0
    %
    
    $
    6,426
    
    
    
    100.0
    %
    
    $
    6,352
    
    
    
    100.0
    %
 The allowance for loan losses was 1.76%, 1.51% and 1.66% of loans outstanding at December
31, 2004, 2003 and 2002, respectively, which was consistent with managements assessment of the
credit quality of the loan portfolio. The ratios of net charge-offs during the year to average
loans outstanding during the period were 0.35%, 0.75% and 0.21% at December 31, 2004, 2003 and
2002, respectively. Management believes these ratios reflect managements conservative lending
and effective efforts to recover credit losses. Charge-offs in 2004 were $3,038,449, of which $1,040,391 were related to commercial loans in
default. The effects of a prolonged recession in the Companys Catawba Valley market area were also
evidenced by increases in the Companys allowance for loan losses as presented above, nonperforming
asset levels as presented below, and the increase in loans with higher risk grades. The amount of
loans with the three highest risk grades totaled $14,245,082 at December 31, 2004 as compared with
$12,046,107 at December 31, 2003 and $6,554,602 at December 31, 2002. 32




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##### Table of Contents



INVESTMENT SECURITIES The Company invests in securities as permitted under bank regulations. These securities include all
obligations of the U.S. Treasury, agencies of the U.S. government, including mortgage-backed
securities and certain derivatives, bank eligible obligations of any state or political
subdivision, bank eligible corporate obligations, including commercial paper, negotiable
certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. The Companys investment activities are governed internally by a written, board-approved
policy. Investment policy is carried out by the Companys Asset/Liability Committee (ALCO),
which meets regularly to review the economic environment, assess current activities for
appropriateness and establish investment strategies. Investment strategies are established by the ALCO in consideration of the interest rate
environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the
overall interest rate sensitivity of the Company. In general, the investment portfolio is managed
in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient
margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds
management objectives; (ii) to provide eligible securities to secure public funds, trust deposits
as prescribed by law and other borrowings; and (iii) to earn the maximum return on funds invested
that is commensurate with meeting the requirements of (i) and (ii). At December 31, 2004, the securities classified as available for sale, carried at market value,
totaled $107,358,249, with an amortized cost of $106,854,579, compared to a December 31, 2003 total
market value of $97,666,795 with an amortized cost of $96,284,809. Securities available for sale
are securities that will be held for an indefinite period of time, including securities that
management intends to use as a part of its asset/liability strategy, or that may be sold in
response to changes in interest rates, changes in prepayment risk or the need to increase
regulatory capital or other similar factors. Securities available for sale consist of securities of
U.S. Government agencies with an average life of 3.7 years and other bonds, notes and debentures
with an average life of 17.6 years. There have been no transfers or sales of securities classified
as held to maturity. Securities classified as held to maturity totaled $51,201,793, with a market
value of $53,527,673 at December 31, 2004. Management determined that it has both the ability and
intent to hold those securities classified as investment securities until maturity. Securities held
to maturity consist of securities of U.S. Government agencies with an average life of 11 days and
municipal bonds with an average life of 4.3 years. During 2004, $40,082,048 in securities matured
and $5,885,000 in proceeds were collected from securities sold. The proceeds from maturities were
reinvested along with funds in excess of loan demand. CONTRACTUAL MATURITIES AND YIELDS OF DEBT SECURITIES
As of December 31, 2004 After One Year but
    
    
    After Five Years butWithin One Year
    
    
    Within Five Years
    
    
    Within Ten Years
    
    
    After Ten Yearsdollars in thousands
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    YieldAvailable for sale: (1)U.S. Treasury
    
    
    
    
    
    
    
    
    
    $
    5,250
    
    
    
    3.33
    %U.S. government agency
    
    
    
    
    
    
    
    
    
    
    74,741
    
    
    
    3.68
    %
    
    $
    3,003
    
    
    
    4.84
    %State and political subdivisions (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,342
    
    
    
    5.11
    %
    
    $
    3,276
    
    
    
    5.89
    %Other
    
    
    
    
    
    
    
    
    
    
    200
    
    
    
    7.13
    %
    
    
    
    
    
    
    
    
    
    
    8,370
    
    
    
    6.17
    %Total
    
    
    
    

    
    
    
    
    
    $
    80,191
    
    
    
    3.67
    %
    
    $
    5,345
    
    
    
    4.96
    %
    
    $
    11,646
    
    
    
    6.09
    %Held to maturity:U.S. government agency
    
    $
    2,700
    
    
    
    5.73
    %State and political subdivisions (2)
    
    
    5,946
    
    
    
    6.66
    %
    
    $
    25,104
    
    
    
    6.70
    %
    
    $
    13,849
    
    
    
    6.77
    %
    
    $
    3,603
    
    
    
    7.39
    %Total
    
    $
    8,646
    
    
    
    6.37
    %
    
    $
    25,104
    
    
    
    6.70
    %
    
    $
    13,849
    
    
    
    6.77
    %
    
    $
    3,603
    
    
    
    7.39
    %
   (1)
    
    Securities available for sale are stated at amortized cost.(2)
    
    Yields on tax-exempt investments have been adjusted to tax equivalent basis using 35%
for 2004. 33




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##### Table of Contents



The following table provided information regarding the composition of the Companys investment
securities portfolio at the end of each of the past three years. COMPOSITION OF INVESTMENT SECURITIES PORTFOLIO
As of December 31, dollars in thousands
    
    2004
    
    
    2003
    
    
    2002Available for sale (at estimated fair value):U.S. Treasury
    
    $
    5,238
    
    
    $
    5,372
    
    
    $
    U.S. government agency
    
    
    77,410
    
    
    
    68,783
    
    
    
    45,281State and political subdivisions
    
    
    5,606
    
    
    
    5,594
    
    
    
    Other
    
    
    19,104
    
    
    
    17,918
    
    
    
    6,983Total
    
    $
    107,358
    
    
    $
    97,667
    
    
    $
    52,264Held to maturity (at amortized cost):U.S. government agency
    
    $
    2,700
    
    
    $
    5,209
    
    
    $
    5,225State and political subdivisions
    
    
    48,502
    
    
    
    56,560
    
    
    
    67,435Total
    
    $
    51,202
    
    
    $
    61,769
    
    
    $
    72,660
 CONTRACTUAL OBLIGATIONS The Companys contractual obligations and other commitments are summarized in the table below. Other
commitments include commitments to extend credit. Because not all of these commitments to extend credit will be
drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other
commitments below. CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
As of December 31, 2004 Within
    
    
    One to
    
    
    Three to
    
    
    FiveOne
    
    
    Three
    
    
    Five
    
    
    Years ordollars in thousands
    
    Year
    
    
    Years
    
    
    Years
    
    
    More
    
    
    TotalContractual Cash ObligationsLong-term borrowings
    
    $
    14,000
    
    
    $
    5,000
    
    
    
    
    
    
    $
    15,000
    
    
    $
    34,000Operating lease obligations
    
    
    896
    
    
    
    1,381
    
    
    $
    1,030
    
    
    
    1,452
    
    
    
    4,759Total
    
    $
    14,896
    
    
    $
    6,381
    
    
    $
    1,030
    
    
    $
    16,452
    
    
    $
    38,759Other CommitmentsCommitments to extend credit
    
    $
    64,256
    
    
    $
    25,293
    
    
    $
    7,266
    
    
    $
    41,198
    
    
    $
    138,013Standby letters of credit
    
    
    4,708
    
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    4,795Total
    
    $
    68,964
    
    
    $
    25,380
    
    
    $
    7,266
    
    
    $
    41,198
    
    
    $
    142,808
 OFF-BALANCE SHEET ARRANGEMENTS The Company enters into derivative contracts to manage various financial risks. A derivative is a
financial instrument that derives its cash flows, and therefore its value, by reference to an
underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair
value on the consolidated balance sheet with the fair value representing the net present value of
expected future cash receipts or payments based on market interest rates as of the balance sheet
date. Derivative contracts are written in amounts referred to as notional amounts, which only
provide the basis for calculating payments between counterparties and are not a measure of
financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December
31, 2004 do not represent the amounts that may ultimately be paid under these contracts. In
addition, the Company has off-balance sheet commitments to lend in the forms of unfunded
commitments to extend credit and standby letters of credit. As of December 31, 2004 and 2003, such
unfunded commitments to extend credit were $138,012,770 and $120,746,272, respectively, while
commitments in the form of standby letters of credit totaled $4,580,138 and $6,133,695,
respectively. Further discussions of derivative instruments are included under Liquidity,
Interest Rate Sensitivity And Market Risks above and under Note 1 Summary Of Significant
Accounting Policies, Note 17 Commitments And Contingencies, Note 18 Fair Value Of Financial
Instruments and Note 19 Derivative Financial Instruments in the Notes to Consolidated
Financial Statements. 34




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##### Table of Contents



RELATED PARTY TRANSACTIONS The Company has no material related party transactions. The Company may extend credit to certain
directors and officers in the ordinary course of business. These extensions of credit are made
under substantially the same terms as comparable third-party lending arrangements and are in
compliance with applicable banking regulations and federal securities laws. SEGMENT RESULTS The Companys operations are divided into three reportable business segments: Community Banking,
Mortgage Banking, and Other. These operating segments have been identified based primarily on the
Companys existing organizational structure. See Note 20 Operating Segments, in the Notes to
Consolidated Financial Statements herein, for a full discussion of the segments, the internal
accounting and reporting practices utilized by the Company to manage these segments and financial
disclosures by segment as required by SFAS No. 131. Fluctuations in noninterest income and
expense earned and incurred related to external customers are more fully discussed in the
Noninterest Income and Noninterest Expense sections of this discussion and analysis. Community Banking The Community Banking segment was comprised of 20 banking offices at the end of 2004, up from 19
banking offices at December 31, 2003. Net interest income from Community Banking activities
totaled $38,754,743 in 2004, an increase of $4,392,466 or 12.78%, compared to 2003. Net interest
income in 2003 increased $2,778,327, or 8.09%, compared to 2002. The 2004 provision for loan losses increased $667,150, or 14.00%, from 2003. This increase
reflects the increase in levels of loans during 2004 with the three highest risk grades.
The 2003 provision increased $1,341,628 or 39.20%, compared to 2002. Noninterest income produced from Community Banking customers decreased $152,326, or 2.01% in
2004 from the noninterest income produced in 2003. Comparing 2003 to 2002, noninterest income
increased $23,948, or 0.32%. Noninterest expenses related to Community Banking activities
increased $4,578,466, or 26.19%, because of the increased overhead expenses, in particular
personnel expenses, associated with a full year of operations of the new banking offices opened
or acquired during 2003. Comparing 2003 to 2002, noninterest expense increased $2,569,930, or
17.24%. The provision for income taxes allocated to the Community Banking segment decreased $527,832,
or 8.36%, because of a 5.11% decrease in pretax income and a lower effective tax rates.
Effective tax rates decreased to 30.98% in 2004 from 32.07% in 2003. The 2003 provision for
income taxes decreased $276,471, or 4.20%, compared to 2002 because of a decrease in pretax
income partially offset by a higher effective tax rate. Total identifiable assets for Community Banking increased $57,461,708, or 6.15%, to a total of
$991,369,653, compared to 2003. Mortgage Banking The Companys Mortgage Banking segments net income contracted during 2004 compared to 2003
because of higher mortgage interest rates. The Companys mortgage originations totaled
approximately $280,898,000 in 2004, down $140,276,000, or 33.31%, from originations of
approximately $421,174,000 in 2003. Net interest income for the Mortgage Banking segment totaled $3,673,497 in 2004, down
$1,295,606, or 26.07%, compared to 2003. The 2003 amount reflected an increase of 51.09% when
compared to net interest income in 2002. These 2004 decrease reflected the decline in mortgage
originations as a result of higher mortgage interest rates during the period. The continued
strong credit quality of the mortgage portfolio has resulted in the Mortgage Banking segments
provision for loan losses being relatively stable during the years ended December 31, 2004,
2003, and 2002. Noninterest income in 2004 decreased $3,047,874, or 44.22%, compared to 2003,
also reflecting the 2004 decline in mortgage originations. Noninterest income in 2003
increased $2,942,817, or 74.51%, from 2002, as the result of record origination volumes in
2003. Noninterest expenses incurred in 2004 within the Mortgage Banking segment decreased $1,501,545,
or 18.49%, compared to 2003 as a result of lower costs associated with substantially lower
origination activity. Comparing 2003 and 2002, noninterest expenses increased $2,964,198, or
57.49%, due to the unprecedented origination activity in 2003. 35




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##### Table of Contents



The provision for income taxes allocated to the Mortgage Banking segment decreased $1,139,926,
or 76.173%, due to lower pretax income. For 2003, the provision for income taxes increased
$691,643, or 85.93%, compared to 2002 due to the record mortgage origination activity in 2003. Other The Companys Other segment represents primarily treasury and administration activities.
Included in this segment are certain investments, commercial paper issued to the Banks
commercial sweep account customers, trust preferred securities and shareholder communications,
reporting and record keeping. NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entitiesan Interpretation of Accounting Research Bulletin 51Consolidated
Financial Statements.This interpretation provides guidance related to identifying variable
interest entities and determining whether such entities should be consolidated. FIN 46 requires
an enterprise to consolidate a variable interest entity when the enterprise (a) absorbs a
majority of the variable interest entitys expected losses, (b) receives a majority of the
entitys expected residual returns, or both, as a result of ownership, contractual or other
financial interests in the entity. Prior to the effective date of FIN 46, entities were
generally consolidated by an enterprise that had control through ownership of a majority voting
interest in the entity. FIN 46 originally applied immediately to variable interest entities
created or obtained after January 31, 2003. During 2003, the Bank did not participate in the
creation of, or obtain a new variable interest in, any variable interest entity. In December
2003, the FASB issued FIN 46R, a revision to FIN 46, which modified certain requirements of FIN
46 and allowed for the optional deferral of the effective date of FIN 46R for annual or interim
periods ending after March 15, 2004. As disclosed in the Quarterly Report on Form 10-Q for the
period ended September 30, 2003, the Company completed its assessment of the trust preferred
securities and determined that these statutory business trusts should no longer be consolidated
entities. Accordingly, the statutory business trusts were reclassified to debt in accordance with FIN
46. The remaining provisions of FIN 46R did not have a material impact on the consolidated
results of operations or consolidated financial condition of the Company. On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, Application of
Accounting Principles to Loan Commitments(SAB 105). SAB 105 clarifies existing accounting
practices relating to the valuation of issued loan commitments, including interest rate lock
commitments (IRLC), subject to SFAS No. 149 and Derivative Implementation Group Issue C13,
Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133.
Furthermore, SAB 105 disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC valuation. The
provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The
Company adopted the provisions of SAB 105 effective April 1, 2004. Since the provisions of SAB
105 affect only the timing of the recognition of mortgage banking income, they have not had, nor
does management anticipate that they will have, a material effect on either the Companys
consolidated financial position or consolidated results of operations. In the second quarter of 2004, the Emerging Issues Task Force (EITF) released EITF Issue
03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments.EITF Issue 03-01 provided guidance for evaluating whether an investment is
other-than-temporarily impaired and requires certain disclosures with respect to these
investments. On September 30, 2004, the EITF delayed the effective date of paragraphs 10-20 of
EITF Issue 03-01. As of September 30, 2004, the Company held certain investment positions that
it purchased at premiums with unrealized losses that, in the aggregate, were not material to the
Companys consolidated financial position or consolidated results of operations. These
investments were in U.S. government agency obligations and local government obligations, the
cash flows of which are guaranteed by the U.S. government agencies or the taxing authority of
the local government and, therefore, it is expected that the securities would not be settled at
a price less than their amortized cost. Because the decline in market value was caused by interest rate increases and not credit
quality, and because the Company has the ability and intent to hold these investments until a
recovery of fair value, which may be maturity, the Company has not recognized any
other-than-temporary impairment in connection with these investments. 36




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In December 2004, the FASB issued revised SFAS No. 123R, Share-Based Payment(SFAS No. 123R).
SFAS No. 123R sets accounting requirements for share-based compensation to employees and
requires companies to recognize in the income statement the grant-date fair value of stock options
and other equity-based compensation. SFAS No. 123R is effective in interim or annual periods
beginning after June 30, 2005. The Company will be required to adopt SFAS No. 123R in its second
quarter of 2005 and currently discloses the effect on net income and earnings per share of the
fair value recognition provisions of SFAS No. 123 Accounting for Stock-Based Compensation.The
Company is currently evaluating the impact of the adoption of SFAS No. 123R on its financial
position and results of operations, including the valuation methods and support for the
assumptions that underlie the valuation of the awards. INFLATION Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed,
determinable amounts), the performance of a bank is affected more by changes in interest rates
than by inflation. Interest rates generally increase as the rate of inflation increases, but the
magnitude of the change in rates may not be the same. Although the effect of inflation is normally not as significant as is the influence on those
businesses that have large investments in plant and inventories, it does have an effect on the
Companys operations. In times of higher inflation, there are normally corresponding increases in
the money supply, and banks will normally experience above average growth in assets, loans and
deposits. Also, general increases in the prices of goods and services will result in increased
operating expenses. FORWARD LOOKING STATEMENTS The discussions presented in this annual report contain statements that could be deemed forward
looking statements within the meaning of the Securities Exchange Act of 1934 and the Private
Securities Litigation Reform Act of 1995, which statements are inherently subject to risks and
uncertainties. Forward looking statements are statements that include projections, predictions,
expectations or beliefs about future events or results or otherwise are not statements of
historical fact. Such statements are often characterized by the use of qualifying words (and their
derivatives) such as expects, anticipates, believes, estimates, plans, projects, or
other statements concerning opinions or judgments of the Company and its management about future
events. Factors that could influence the accuracy of such forward looking statements include, but
are not limited to, the financial success or changing strategies of the Companys customers or
vendors, the Companys level of success in integrating acquisitions, actions of government
regulators, the level of market interest rates, and general economic conditions. 
 ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information responsive to this item is contained in Item 7 above under the caption
Liquidity, Interest Rate Sensitivity and Market Risks. 37




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##### Table of Contents



ITEM 8  FINANCIAL STATEMENTS & SUPPLEMENTARY DATA Index to Consolidated Financial Statements and Supplementary Financial Data Begins onPageReport Of Independent Registered Public Accounting Firm
    
    
    39Financial Statements:Consolidated Balance Sheets
    
    
    40December 31, 2004 and 2003Consolidated Statements Of Income
    
    
    41Years Ended December 31, 2004, 2003 and 2002Consolidated Statements Of Comprehensive Income
    
    
    42Years Ended December 31, 2004, 2003 and 2002Consolidated Statements Of Changes In Shareholders Equity
    
    
    43Years Ended December 31, 2004, 2003 and 2002Consolidated Statements Of Cash Flows
    
    
    44Years Ended December 31, 2004, 2003 and 2002Notes To Consolidated Financial Statements
    
    

    46Years Ended December 31, 2004, 2003 and 2002Supplementary Financial Data:Selected Quarterly Financial Data (Unaudited)
    
    
    69Years Ended December 31, 2004 and 2003
 38




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and
Shareholders of Bank of Granite
Corporation Granite Falls, North
Carolina We have audited the accompanying consolidated balance sheets of Bank of Granite
Corporation and its subsidiaries (the Company) as of December 31, 2004 and 2003, and
the related consolidated statements of income, comprehensive income, changes in
shareholders equity, and cash flows for each of the three years in the period ended
December 31, 2004. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements
and financial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2004 and 2003, and
the results of its operations and its cash flows for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004, based on the criteria established in
Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations
of the Treadway Commission and our report dated March 10, 2005 expressed an unqualified
opinion on managements assessment of the effectiveness of the Companys internal control
over financial reporting and an unqualified opinion on the effectiveness of the Companys
internal control over financial reporting. /s/ Deloitte & Touche LLPDELOITTE & TOUCHE LLPHickory, North CarolinaMarch 10,2005
    
    (DELOITTE & TOUCHE LOGO)
 39




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE
SHEETS
 DECEMBER 31, 2004 AND
2003
 2004
    
    
    2003ASSETS:Cash and cash equivalents (Notes 1 and 18):Cash and due from banks
    
    $
    27,993,385
    
    
    $
    29,492,515Interest-bearing deposits
    
    
    3,577,447
    
    
    
    4,103,319Total cash and cash equivalents
    
    
    31,570,832
    
    
    
    33,595,834Investment securities (Notes 1, 2 and 18):Available for sale, at fair value (amortized cost of $106,854,579 and
$96,284,809 at December 31, 2004 and 2003, respectively)
    
    
    107,358,249
    
    
    
    97,666,795Held to maturity, at amortized cost (fair value of $53,527,673 and
$65,275,625 at December 31, 2004 and 2003, respectively)
    
    
    51,201,793
    
    
    
    61,769,566Loans (Notes 1, 3 and 18)
    
    
    778,137,430
    
    
    
    715,844,632Allowance for loan losses (Notes 1 and 4)
    
    
    (13,665,013
    )
    
    
    (10,798,897
    )Net loans
    
    
    764,472,417
    
    
    
    705,045,735Mortgage loans held for sale (Note 1)
    
    
    21,553,548
    
    
    
    23,092,846Premises and equipment, net (Notes 1, 5 and 10)
    
    
    13,074,186
    
    
    
    12,218,566Accrued interest receivable
    
    
    5,681,091
    
    
    
    5,620,834Investment in bank owned life insurance (Notes 1 and 9)
    
    
    17,703,961
    
    
    
    13,360,278Intangible assets (Note 1)
    
    
    11,227,365
    
    
    
    11,420,092Other assets
    
    
    8,395,007
    
    
    
    7,592,181Total assets
    
    $
    1,032,238,449
    
    
    $
    971,382,727LIABILITIES AND SHAREHOLDERS EQUITY:Deposits (Notes 13 and 18):Demand
    
    $
    127,678,055
    
    
    $
    136,978,161NOW accounts
    
    
    121,617,228
    
    
    
    102,932,609Money market accounts
    
    
    161,140,509
    
    
    
    135,045,811Savings
    
    
    25,750,982
    
    
    
    25,977,333Time deposits of $100,000 or more
    
    
    142,261,311
    
    
    
    160,780,970Other time deposits
    
    
    171,413,467
    
    
    
    173,384,471Total deposits
    
    
    749,861,552
    
    
    
    735,099,355Overnight borrowings (Notes 11 and 18)
    
    
    71,748,432
    
    
    
    25,205,171Other borrowings (Notes 12 and 18)
    
    
    63,585,577
    
    
    
    65,294,540Accrued interest payable
    
    
    1,388,929
    
    
    
    1,296,539Other liabilities
    
    
    4,637,738
    
    
    
    2,672,023Total liabilities
    
    
    891,222,228
    
    
    
    829,567,628COMMITMENTS AND CONTINGENCIES (Notes 10 and 17)SHAREHOLDERS EQUITY (Notes 1, 7, 8 and 15):Common stock, $1.00 par value, authorized - 25,000,000 shares;
issued - 15,079,133 shares in 2004 and 14,993,493 shares in 2003;
outstanding - 13,316,102 shares in 2004 and 13,600,182 shares in 2003
    
    
    15,079,133
    
    
    
    14,993,493Additional paid-in capital
    
    
    32,478,404
    
    
    
    31,497,057Retained earnings
    
    
    125,178,824
    
    
    
    119,081,744Accumulated other comprehensive income, net of
deferred income taxes of $200,867 and $551,097 at
December 31, 2004 and 2003, respectively
    
    
    245,076
    
    
    
    768,645Less: Cost of common stock in treasury;
1,763,031 shares in 2004 and 1,393,311 shares in 2003
    
    
    (31,965,216
    )
    
    
    (24,525,840
    )Total shareholders equity
    
    
    141,016,221
    
    
    
    141,815,099Total liabilities and shareholders equity
    
    $
    1,032,238,449
    
    
    $
    971,382,727
 See notes to consolidated financial statements. 40




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME  YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
 
 2004
    
    
    2003
    
    
    2002INTEREST INCOME:Interest and fees from loans
    
    $
    44,151,806
    
    
    $
    38,693,788
    
    
    $
    34,972,976Interest and fees from mortgage banking
    
    
    4,372,182
    
    
    
    5,762,032
    
    
    
    3,701,306Federal funds sold
    
    
    6,747
    
    
    
    96,598
    
    
    
    10,453Interest-bearing deposits
    
    
    71,861
    
    
    
    79,896
    
    
    
    39,175Investments:U.S. Treasury
    
    
    173,011
    
    
    
    69,235
    
    
    
    77,513U.S. Government agencies
    
    
    3,155,472
    
    
    
    2,604,432
    
    
    
    3,167,345States and political subdivisions
    
    
    2,502,988
    
    
    
    2,801,332
    
    
    
    3,215,203Other
    
    
    831,822
    
    
    
    588,863
    
    
    
    526,555Total interest income
    
    
    55,265,889
    
    
    
    50,696,176
    
    
    
    45,710,526INTEREST EXPENSE:Time deposits of $100,000 or more
    
    
    3,622,035
    
    
    
    3,471,492
    
    
    
    3,535,887Other time and savings deposits
    
    
    7,090,697
    
    
    
    6,243,594
    
    
    
    6,181,936Overnight borrowings
    
    
    492,728
    
    
    
    223,516
    
    
    
    638,327Other borrowed funds
    
    
    1,902,525
    
    
    
    1,450,889
    
    
    
    446,272Total interest expense
    
    
    13,107,985
    
    
    
    11,389,491
    
    
    
    10,802,422NET INTEREST INCOME
    
    
    42,157,904
    
    
    
    39,306,685
    
    
    
    34,908,104PROVISION FOR LOAN LOSSES (Notes 1 and 4)
    
    
    5,439,160
    
    
    
    4,764,010
    
    
    
    3,492,382NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
    
    
    36,718,744
    
    
    
    34,542,675
    
    
    
    31,415,722OTHER INCOME:Service charges on deposit accounts (Note 6)
    
    
    5,359,206
    
    
    
    5,537,054
    
    
    
    5,402,290Other service charges, fees and commissions
    
    
    797,961
    
    
    
    937,787
    
    
    
    1,019,938Mortgage banking income
    
    
    3,844,297
    
    
    
    6,892,171
    
    
    
    3,949,354Securities gains (Note 2)
    
    
    14,347
    
    
    
    8,533
    
    
    
    3,170Other
    
    
    1,240,912
    
    
    
    1,062,195
    
    
    
    1,022,953Total other income
    
    
    11,256,723
    
    
    
    14,437,740
    
    
    
    11,397,705OTHER EXPENSES:Salaries and wages
    
    
    14,668,944
    
    
    
    13,881,228
    
    
    
    10,338,438Employee benefits (Note 9)
    
    
    3,229,887
    
    
    
    2,590,053
    
    
    
    2,562,311Occupancy expense, net
    
    
    1,729,986
    
    
    
    1,205,806
    
    
    
    910,228Equipment rentals, depreciation and
maintenance (Notes 1 and 5)
    
    
    1,958,106
    
    
    
    1,387,978
    
    
    
    1,388,672Other (Note 6)
    
    
    7,528,017
    
    
    
    6,797,392
    
    
    
    5,116,585Total other expenses
    
    
    29,114,940
    
    
    
    25,862,457
    
    
    
    20,316,234INCOME BEFORE INCOME TAXES
    
    
    18,860,527
    
    
    
    23,117,958
    
    
    
    22,497,193INCOME TAXES (Note 1 and 7)
    
    
    6,142,307
    
    
    
    7,810,065
    
    
    
    7,394,893NET INCOME
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300PER SHARE AMOUNTS (Notes 1 and 14):Net income - Basic
    
    $
    0.94
    
    
    $
    1.14
    
    
    $
    1.11- Diluted
    
    
    0.94
    
    
    
    1.13
    
    
    
    1.11Cash dividends
    
    
    0.49
    
    
    
    0.46
    
    
    
    0.41Book value
    
    
    10.59
    
    
    
    10.43
    
    
    
    9.56
 See notes to consolidated financial statements. 41




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
 
 2004
    
    
    2003
    
    
    2002NET INCOME
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300ITEMS OF OTHER COMPREHENSIVE INCOME:Items of other comprehensive income,
before tax:Unrealized gains (losses) on securities
available for sale
    
    
    (878,316
    )
    
    
    (265,303
    )
    
    
    733,118Less: Reclassification adjustment for
gains included in net income
    
    
    --
    
    
    
    8,533
    
    
    
    3,170Unrealized gains (losses) on mortgage
derivative instruments
    
    
    7,529
    
    
    
    (103,740
    )
    
    
    Other comprehensive income (loss),
before tax
    
    
    (870,787
    )
    
    
    (377,576
    )
    
    
    729,948Less: Changes in deferred income taxes
related to change in unrealized gains
or losses on securities available for sale
    
    
    (350,230
    )
    
    
    (109,186
    )
    
    
    291,057Less: Changes in deferred income taxes
related to change in unrealized gains
or losses on mortgage derivative instruments
    
    
    3,012
    
    
    
    (41,496
    )
    
    
    Other comprehensive income (loss),
net of tax
    
    
    (523,569
    )
    
    
    (226,894
    )
    
    
    438,891COMPREHENSIVE INCOME
    
    $
    12,194,651
    
    
    $
    15,080,999
    
    
    $
    15,541,191
 See notes to consolidated financial statements. 42




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY  YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
 
 2004
    
    
    2003
    
    
    2002COMMON STOCK, $1.00 par valueAt beginning of year
    
    $
    14,993,493
    
    
    $
    14,420,986
    
    
    $
    11,537,515Par value of shares issued for First Commerce acquisition
    
    
    
    
    
    
    543,217
    
    
    
    Par value of shares issued under stock option plan
    
    
    85,640
    
    
    
    29,290
    
    
    
    Transfer from surplus to common stock due to split
    
    
    
    
    
    
    
    
    
    
    2,883,471At end of year
    
    
    15,079,133
    
    
    
    14,993,493
    
    
    
    14,420,986ADDITIONAL PAID-IN CAPITALAt beginning of year
    
    
    31,497,057
    
    
    
    20,694,133
    
    
    
    23,577,604Surplus of shares issued for First Commerce acquisition
    
    
    
    
    
    
    10,417,467
    
    
    
    Surplus of shares issued under stock option plan
    
    
    848,108
    
    
    
    310,671
    
    
    
    Tax benefit from nonqualifying dispositions of stock option
    
    
    133,239
    
    
    
    74,786
    
    
    
    Transfer from surplus to common stock due to split
    
    
    
    
    
    
    
    
    
    
    (2,883,471
    )At end of year
    
    
    32,478,404
    
    
    
    31,497,057
    
    
    
    20,694,133RETAINED EARNINGSAt beginning of year
    
    
    119,081,744
    
    
    
    109,982,826
    
    
    
    100,492,853Net income
    
    
    12,718,220
    
    
    
    15,307,893
    
    
    
    15,102,300Cash dividends
    
    
    (6,621,140
    )
    
    
    (6,208,975
    )
    
    
    (5,594,799
    )Cash paid for fractional shares
    
    
    
    
    
    
    
    
    
    
    (17,528
    )At end of year
    
    
    125,178,824
    
    
    
    119,081,744
    
    
    
    109,982,826ACCUMULATED OTHER
COMPREHENSIVE INCOME,
NET OF DEFERRED INCOME TAXESAt beginning of year
    
    
    768,645
    
    
    
    995,539
    
    
    
    556,648Net change in unrealized gains or losses on securities
available for sale, net of deferred income taxes
    
    
    (528,086
    )
    
    
    (164,650
    )
    
    
    438,891Net change in unrealized gains or losses on mortgage
derivative instruments, net of deferred income taxes
    
    
    4,517
    
    
    
    (62,244
    )
    
    
    At end of year
    
    
    245,076
    
    
    
    768,645
    
    
    
    995,539COST OF COMMON STOCK
IN TREASURYAt beginning of year
    
    
    (24,525,840
    )
    
    
    (18,650,642
    )
    
    
    (11,383,304
    )Cost of common stock repurchased
    
    
    (7,439,376
    )
    
    
    (5,875,198
    )
    
    
    (7,267,338
    )At end of year
    
    
    (31,965,216
    )
    
    
    (24,525,840
    )
    
    
    (18,650,642
    )Total shareholders equity (Notes 1, 7 and 15)
    
    $
    141,016,221
    
    
    $
    141,815,099
    
    
    $
    127,442,842Shares issuedAt beginning of year
    
    
    14,993,493
    
    
    
    14,420,986
    
    
    
    11,537,515Shares issued for First Commerce acquisition
    
    
    
    
    
    
    543,217
    
    
    
    Shares issued under incentive stock option plans
    
    
    85,640
    
    
    
    29,290
    
    
    
    Shares issued due to stock splits
    
    
    
    
    
    
    
    
    
    
    2,883,471At end of year
    
    
    15,079,133
    
    
    
    14,993,493
    
    
    
    14,420,986Common shares in treasuryAt beginning of year
    
    
    (1,393,311
    )
    
    
    (1,087,312
    )
    
    
    (550,430
    )Common shares repurchased
    
    
    (369,720
    )
    
    
    (305,999
    )
    
    
    (368,737
    )Shares issued due to stock splits
    
    
    
    
    
    
    
    
    
    
    (168,145
    )At end of year
    
    
    (1,763,031
    )
    
    
    (1,393,311
    )
    
    
    (1,087,312
    )Total shares outstanding
    
    
    13,316,102
    
    
    
    13,600,182
    
    
    
    13,333,674
 See notes to consolidated financial statements. 43




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
 
 2004
    
    
    2003
    
    
    2002INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:Cash flows from operating activities:Net Income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300Adjustments
to reconcile net income to net cash provided by operating activities:Depreciation
    
    
    1,344,432
    
    
    
    895,421
    
    
    
    984,695Provision for loan loss
    
    
    5,439,160
    
    
    
    4,764,010
    
    
    
    3,492,382Investment security premium amortization, net
    
    
    489,703
    
    
    
    442,226
    
    
    
    156,266Acquisition discount accretion, net
    
    
    (150,565
    )
    
    
    (177,483
    )
    
    
    Deferred income taxes
    
    
    (1,517,901
    )
    
    
    82,827
    
    
    
    (1,159,425
    )Losses (gains) on sales or calls of securities
available for sale
    
    
    
    
    
    
    2,698
    
    
    
    (3,170
    )Gains on calls of securities
held to maturity
    
    
    (14,347
    )
    
    
    (11,231
    )
    
    
    Net decrease in mortgage loans held for sale
    
    
    1,643,060
    
    
    
    9,043,168
    
    
    
    Gains on disposal or sale of equipment
    
    
    (1,500
    )
    
    
    (38,255
    )
    
    
    (2,157
    )Loss (gain) on sale of other real estate
    
    
    (77,310
    )
    
    
    353,867
    
    
    
    5,513Increase (decrease) in taxes payable
    
    
    1,191,228
    
    
    
    (1,209,631
    )
    
    
    175,045Decrease (increase) in interest receivable
    
    
    (60,257
    )
    
    
    (227,882
    )
    
    
    393,596Increase (decrease) in interest payable
    
    
    92,390
    
    
    
    (333,949
    )
    
    
    (657,129
    )Increase in cash surrender value of bank
owned life insurance
    
    
    (598,683
    )
    
    
    (489,038
    )
    
    
    (390,493
    )Decrease (increase) in other assets
    
    
    437,418
    
    
    
    (1,566,475
    )
    
    
    (1,041,652
    )Increase (decrease) in other liabilities
    
    
    864,686
    
    
    
    (3,445,394
    )
    
    
    1,196,366Net cash provided by
operating activities
    
    
    21,799,734
    
    
    
    23,392,772
    
    
    
    18,252,137CASH FLOWS FROM INVESTING ACTIVITIES:Proceeds from maturities, calls and paydowns of
securities available for sale
    
    
    29,570,573
    
    
    
    33,867,957
    
    
    
    31,522,750Proceeds from maturities, calls and paydowns of
securities held to maturity
    
    
    10,511,475
    
    
    
    10,801,300
    
    
    
    13,747,875Proceeds from sales of securities available for sale
    
    
    5,885,000
    
    
    
    1,207,210
    
    
    
    918,899Purchases of securities available for sale
    
    
    (46,444,401
    )
    
    
    (53,855,273
    )
    
    
    (11,351,809
    )Net increase in loans
    
    
    (65,194,466
    )
    
    
    (72,391,674
    )
    
    
    (55,773,417
    )Increases (decreases) in unrealized gains or losses
on hedged mortgage loan commitments
    
    
    (96,233
    )
    
    
    273,982
    
    
    
    (273,982
    )Increases (decreases) in unrealized gains or losses
on contracts to sell mortgage-backed securities
    
    
    
    
    
    
    (218,084
    )
    
    
    218,084Investment in bank owned life insurance
    
    
    (3,745,000
    )
    
    
    
    
    
    
    (514,000
    )Capital expenditures
    
    
    (2,277,650
    )
    
    
    (2,409,757
    )
    
    
    (737,018
    )Proceeds from sales of fixed assets
    
    
    72,807
    
    
    
    235,909
    
    
    
    1,399Proceeds from sales of other real estate
    
    
    835,424
    
    
    
    967,105
    
    
    
    164,471Net cash received in acquisition
    
    
    
    
    
    
    13,272,682
    
    
    
    Net cash used by investing activities
    
    
    (70,882,471
    )
    
    
    (68,248,643
    )
    
    
    (22,076,748
    )
 See notes to consolidated financial statements. (continued on next page) 44




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##### Table of Contents



BANK OF GRANITE CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
    
    (concluded from previous page)
 
 2004
    
    
    2003
    
    
    2002CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in demand deposits, NOW and
savings accounts
    
    
    35,252,860
    
    
    
    47,031,803
    
    
    
    58,204,912Net increase (decrease) in time deposits
    
    
    (19,982,849
    )
    
    
    9,200,623
    
    
    
    (33,738,316
    )Net increase (decrease) in overnight borrowings
    
    
    46,543,261
    
    
    
    8,148,807
    
    
    
    (23,855,923
    )Net increase (decrease) in other borrowings
    
    
    (1,628,769
    )
    
    
    (7,569,928
    )
    
    
    22,420,202Net proceeds from issuance of common stock
    
    
    933,748
    
    
    
    339,961
    
    
    
    Dividends paid
    
    
    (6,621,140
    )
    
    
    (6,208,975
    )
    
    
    (5,594,799
    )Purchases of common stock for treasury
    
    
    (7,439,376
    )
    
    
    (5,875,198
    )
    
    
    (7,267,338
    )Cash paid for fractional shares
    
    
    
    
    
    
    
    
    
    
    (17,528
    )Net cash provided by financing activities
    
    
    47,057,735
    
    
    
    45,067,093
    
    
    
    10,151,210NET INCREASE (DECREASE) IN
CASH EQUIVALENTS
    
    
    (2,025,002
    )
    
    
    211,222
    
    
    
    6,326,599CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR
    
    
    33,595,834
    
    
    
    33,384,612
    
    
    
    27,058,013CASH AND CASH EQUIVALENTS
AT END OF YEAR
    
    $
    31,570,832
    
    
    $
    33,595,834
    
    
    $
    33,384,612SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the year for:Interest
    
    $
    13,015,595
    
    
    $
    11,282,316
    
    
    $
    11,459,551Income taxes
    
    
    5,014,227
    
    
    
    8,929,881
    
    
    
    8,379,273Noncash investing and financing activities:Transfer from surplus to common
stock due to stock split
    
    
    
    
    
    
    
    
    
    
    2,883,471Transfer from loans to other real
estate owned
    
    
    905,609
    
    
    
    2,595,819
    
    
    
    1,023,005
 See notes to consolidated financial statements. 45




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BANK OF GRANITE CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION  Bank of Granite Corporation is a bank holding company with two wholly owned
subsidiaries, Bank of Granite (the Bank), a state chartered commercial bank incorporated in North Carolina
on August 2, 1906 and Granite Mortgage, Inc., formerly GLL & Associates, Inc., a mortgage banking
company incorporated in North Carolina on June 24, 1985. Bank of Granite Corporation and its two
subsidiaries, Bank of Granite and Granite Mortgage, Inc. are referred to herein collectively as the Company.
On July 15, 2003, the Company acquired First Commerce Corporation and its wholly owned subsidiary,
First Commerce Bank (referred to herein collectively as First Commerce), and merged First Commerce Bank
into Bank of Granite on July 24, 2003. First Commerce Bank operated three banking offices in the Charlotte
metropolitan area. The Bank is headquartered in Granite Falls, North Carolina and provides consumer and
commercial banking services in the Blue Ridge foothills through the southern Piedmont areas of North Carolina
through twenty banking offices. Granite Mortgage is headquartered in Winston-Salem, North Carolina and
provides mortgage origination services in the central and southern Piedmont areas of North Carolina and Hilton
Head Island, South Carolina, through fourteen mortgage offices. Granite Mortgage was acquired by Bank of
Granite Corporation on November 5, 1997. BASIS OF PRESENTATION  The consolidated financial statements include the accounts of Bank of Granite
Corporation and its wholly owned subsidiaries, Bank of Granite and Granite Mortgage, Inc. All significant
intercompany accounts and transactions have been eliminated. All amounts reflect the July 15, 2003
acquisition
of First Commerce Corporation, which was accounted for using the purchase method of accounting. USE OF ESTIMATES  The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates. CASH AND CASH EQUIVALENTS  Cash and cash equivalents include cash on hand, amounts due from
banks, short-term interest bearing deposits, and federal funds sold. Generally, federal funds are purchased and
sold for one-day periods. INVESTMENT SECURITIES  Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities
that are bought and held principally for the purpose of selling in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses included in consolidated earnings. Debt
securities not classified as either held to maturity securities or trading securities, and equity securities not
classified as trading securities, are classified as available for sale securities and reported at fair value, with
unrealized gains and losses excluded from earnings and reported as a separate component of consolidated
shareholders equity and as an item of other comprehensive income. Gains and losses on held for investment
securities are recognized at the time of sale based upon the specific identification method. Declines in the fair
value of individual held to maturity and available for sale securities below their cost that are other than
temporary result in write-downs of the individual securities to their fair value. The related write-downs are
included in consolidated earnings as realized losses. Premiums and discounts are recognized in interest income
using the interest method over the period to maturity. Transfers of securities between classifications are
accounted for at fair value. No securities have been classified as trading securities. LOANS  Loans that management has the intent and ability to hold for the foreseeable future are reported
at their outstanding principal balances adjusted for any deferred fees or costs. Substantially all loans earn
interest on the level yield method based on the daily outstanding balance. 46




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Loans that are deemed to be impaired (i.e., probable that the Company will be unable to collect all amounts due
according to the terms of the loan agreement) are measured based on the present value of expected future cash
flows discounted at the loans effective interest rate or, as a practical matter, at the loans observable market
value or fair value of the collateral if the loan is collateral dependent. A valuation reserve is established to
record the difference between the stated loan amount and the present value or market value of the impaired loan.
Impaired loans may be valued on a loan-by-loan basis (e.g., loans with risk characteristics unique to an
individual borrower) or on an aggregate basis (e.g., loans with similar risk characteristics). The Companys
policy for recognition of interest income on impaired loans is the same as its interest income recognition policy
for non-impaired loans. The Company discontinues the accrual of interest when the collectibility of such
interest becomes doubtful. The total of impaired loans, impaired loans on a nonaccrual basis, the related
allowance for loan losses and interest income recognized on impaired loans is disclosed in Note 4. ALLOWANCE FOR LOAN LOSSES  The provision for loan losses charged to operations is an amount
sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb potential
losses in the portfolio. Managements determination of the adequacy of the allowance is based on an evaluation
of the portfolio, current economic conditions, historical loan loss experience and other risk factors. Recovery
of the carrying value of loans is dependent to some extent on future economic, operating and other conditions
that may be beyond the Companys control. Unanticipated future adverse changes in such conditions could
result in material adjustments to the allowance for loan losses. REAL ESTATE ACQUIRED BY FORECLOSURE  Real estate acquired by foreclosure is stated at the lower
of cost or fair value. Any initial losses at the time of foreclosure are charged against the allowance for loan
losses with any subsequent losses or write-downs included in the consolidated statements of income as a
component of other expenses. PREMISES AND EQUIPMENT AND OTHER LONG-LIVED ASSETS  Premises and equipment are stated
at cost less accumulated depreciation and amortization. Depreciation and amortization, computed by the
straight-line method, are charged to operations over the properties estimated useful lives, which range from 25
to 50 years for buildings and 5 to 15 years for furniture and equipment or, in the case of leasehold
improvements, the term of the lease if shorter. Maintenance and repairs are charged to operations in the year
incurred. Gains and losses on dispositions are included in current operations. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate
that the carrying amounts of such assets may not be recoverable. If the sum of the expected future cash flows is
less than the stated amount of the asset, an impairment loss is recognized for the difference between the fair
value of the asset and its carrying amount. GOODWILL AND OTHER INTANGIBLES  During 2003, the Companys acquisition of First Commerce
generated goodwill of $10,763,447 and core deposit intangible assets of $630,013. Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assetsuses a non-amortization
approach to account for purchased goodwill and other intangible assets with indefinite useful lives. Intangible
assets with finite useful lives are amortized over their useful lives. The carrying value of the core deposit
intangible asset totaled $463,918, net of accumulated amortization of $166,095, as of December 31, 2004.
This intangible asset was determined by management to meet the criteria for recognition apart from goodwill
and to have a finite life of 10 years. Amortization expense associated with the core deposit intangible asset was
$108,819 for the year ended December 31, 2004. Annual amortization expense is expected to range from
approximately $97,000 in 2005 to $52,000 in 2009. INCOME TAXES  Provisions for income taxes are based on amounts reported in the consolidated statements
of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include
changes in deferred income taxes. Deferred taxes are computed using the asset and liability approach. The tax
effects of differences between the tax and financial accounting basis of assets and liabilities are reflected in the
balance sheets at the tax rates expected to be in effect when the differences reverse. INCOME AND EXPENSES  The Company uses the accrual method of accounting, except for immaterial
amounts of loan income and other fees which are recorded as income when collected. The recognition of
certain loan origination fee income and certain loan origination costs is deferred when such loans are originated
and amortized over the life of the loan. 47




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PER SHARE AMOUNTS  Per share amounts have been computed using both the weighted average
number of shares outstanding of common stock for the purposes of computing basic earnings
per share and the weighted average number of shares outstanding of common stock plus
dilutive common stock equivalents for the purpose of computing diluted earnings per share.
See Note 14 for further information regarding the computation of earnings per share. STOCK-BASED COMPENSATION  The Company measures compensation costs related to employee
incentive stock options using the intrinsic value of the equity instrument granted (i.e.,
the excess of the market price of the stock to be issued over the exercise price of the
equity instrument at the date of grant) rather than the fair value of the equity instrument.
Therefore, no compensation cost has been recognized for stock option awards because the
options are granted at exercise prices based on the market value of the Companys stock on
the date of grant. Had compensation cost for the Companys employee stock option plan been
determined using the fair value method, the Companys pro forma net income and earnings per
share for the years ended December 31, 2004, 2003 and 2002 would have been as follows: 2004
    
    
    2003
    
    
    2002Net income as reported
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
    
    
    (40,991
    )
    
    
    (170,543
    )
    
    
    (63,248
    )Pro forma net income
    
    $
    12,677,229
    
    
    $
    15,137,350
    
    
    $
    15,039,052Net income per share as reported  Basic
    
    $
    0.94
    
    
    $
    1.14
    
    
    $
    1.11 Diluted
    
    
    0.94
    
    
    
    1.13
    
    
    
    1.11Pro forma net income per share  Basic
    
    
    0.94
    
    
    
    1.13
    
    
    
    1.11 Diluted
    
    
    0.94
    
    
    
    1.12
    
    
    
    1.11
 The Company estimated aggregate option values of $6.00, $8.52 and $6.68 for 2004, 2003 and
2002, respectively, in order to compute its estimation of option compensation expense
associated with the fair value method, using The Black Scholes Model. The following
assumptions were used: 2004
    
    2003
    
    2002Risk-free rate
    
    3.45%
    
    3.45%
    
    2.92%Average expected term (years)
    
    5.6 years
    
    5.7 years
    
    5.6 yearsExpected volatility
    
    41.04%
    
    44.61%
    
    44.63%Expected dividend yield
    
    2.61%
    
    2.53%
    
    2.28%Expected turnover
    
    8.96%
    
    9.26%
    
    2.07%
 LOANS HELD FOR SALE AND DERIVATIVE FINANCIAL INSTRUMENTS  Loans held for sale primarily
consist of one to four family residential loans originated for sale in the secondary market
and are carried at the lower of cost or fair value determined on an aggregate basis. Gains
and losses on sales of loans held for sale are included in mortgage banking income in the
consolidated statement of income. Granite Mortgage uses two types of financial instruments
to manage risk. These financial instruments, commonly referred to as derivatives, consists
of contracts to forward sell mortgage-backed securities and options to forward sell
securities. A derivative is a financial instrument that derives its cash flows, and
therefore its value, by reference to an underlying instrument. Granite Mortgage uses
derivatives primarily to hedge against changes in the market values of the mortgage loans it
generates and sells. As required by SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities,Granite Mortgage classifies its derivative financial instruments as a hedge of
an exposure to changes in cash flow from forecasted transactions (sales of loans to third
parties) (cash flow hedge). For a qualifying cash flow hedge, changes in the value of the
derivatives that have been highly effective as hedges are recognized in other comprehensive
income. For cash flow hedges, net income may be affected to the extent that changes in the
value of the derivative instruments do not perfectly offset changes in the cash flow of the
hedged asset or liability. See Notes 17, 18 and 19 for further information regarding
derivative financial instruments. 48




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NEW ACCOUNTING STANDARDS  In January 2003, the FASB issued FASB Interpretation No. 46 (FIN
46), Consolidation of Variable Interest Entitiesan Interpretation of Accounting Research
Bulletin 51Consolidated Financial Statements.This interpretation provides guidance
related to identifying variable interest entities and determining whether such entities
should be consolidated. FIN 46 requires an enterprise to consolidate a variable interest
entity when the enterprise (a) absorbs a majority of the variable interest entitys expected
losses, (b) receives a majority of the entitys expected residual returns, or both, as a
result of ownership, contractual or other financial interests in the entity. Prior to the
effective date of FIN 46, entities were generally consolidated by an enterprise that had
control through ownership of a majority voting interest in the entity. FIN 46 originally
applied immediately to variable interest entities created or obtained after January 31,
2003. During 2003, the Bank did not participate in the creation of, or obtain a new variable
interest in, any variable interest entity. In December 2003, the FASB issued FIN 46R, a
revision to FIN 46, which modified certain requirements of FIN 46 and allowed for the
optional deferral of the effective date of FIN 46R for annual or interim periods ending
after March 15, 2004. As disclosed in the Quarterly Report on Form 10-Q for the period ended
September 30, 2003, the Company completed its assessment of the trust preferred securities
(see Note 12) and determined that these statutory business trusts should no longer be
consolidated entities. Accordingly, the statutory business trusts were reclassified to debt
in accordance with FIN 46. The remaining provisions of FIN 46R did not have a material
impact on the consolidated results of operations or consolidated financial condition of the
Company. On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, Application of
Accounting Principles to Loan Commitments(SAB 105). SAB 105 clarifies existing
accounting practices relating to the valuation of issued loan commitments, including
interest rate lock commitments (IRLC), subject to SFAS No. 149 and Derivative
Implementation Group Issue C13, Scope Exceptions: When a Loan Commitment is included in the
Scope of Statement 133.Furthermore, SAB 105 disallows the inclusion of the values of a
servicing component and other internally developed intangible assets in the initial and
subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments
entered into after March 31, 2004. The Company adopted the provisions of SAB 105 effective
April 1, 2004. Since the provisions of SAB 105 affect only the timing of the recognition of
mortgage banking income, they have not had, nor does management anticipate that they will
have, a material effect on either the Companys consolidated financial position or
consolidated results of operations. In the second quarter of 2004, the Emerging Issues Task Force (EITF) released EITF
Issue 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.
EITF Issue 03-01 provided guidance for evaluating whether an investment is
other-than-temporarily impaired and requires certain disclosures with respect to these
investments. On September 30, 2004, the EITF delayed the effective date of paragraphs
10-20 of EITF Issue 03-01. As of September 30, 2004, the Company held certain investment
positions that it purchased at premiums with unrealized losses that, in the aggregate,
were not material to the Companys consolidated financial position or consolidated
results of operations. These investments were in U.S. government agency obligations and
local government obligations, the cash flows of which are guaranteed by the U.S.
government agencies or the taxing authority of the local government and, therefore, it is
expected that the securities would not be settled at a price less than their amortized
cost. Because the decline in market value was caused by interest rate increases and not
credit quality, and because the Company has the ability and intent to hold these
investments until a recovery of fair value, which may be maturity, the Company has not
recognized any other-than-temporary impairment in connection with these investments. In December 2004, the FASB issued revised SFAS No. 123R, Share-Based Payment(SFAS No.
123R). SFAS No. 123R sets accounting requirements for share-based compensation to employees
and requires companies to recognize in the income statement the grant-date fair value of stock
options and other equity-based compensation. SFAS No. 123R is effective in interim or annual
periods beginning after June 30, 2005. The Company will be required to adopt SFAS No. 123R in
its second quarter of 2005 and currently discloses the effect on net income and earnings per
share of the fair value recognition provisions of SFAS No. 123 Accounting for Stock-Based
Compensation.The Company is currently evaluating the impact of the adoption of SFAS No. 123R
on its financial position and results of operations, including the valuation methods and
support for the assumptions that underlie the valuation of the awards. 49




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2. INVESTMENT SECURITIES The amortized cost, gross unrealized gains and losses and fair values of investment
securities at December 31, 2004 and 2003 are as follows: Amortized
    
    
    Gross Unrealized
    
    
    FairType and Contractual Maturity
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueAVAILABLE FOR SALEAt December 31, 2004:U. S. Treasury due:After 1 year but within 5 years
    
    $
    5,249,802
    
    
    $
    
    
    
    $
    11,520
    
    
    $
    5,238,282Total U.S. Treasury
    
    
    5,249,802
    
    
    
    
    
    
    
    11,520
    
    
    
    5,238,282U. S. Government agencies due:After 1 year but within 5 years
    
    
    74,740,442
    
    
    
    147,276
    
    
    
    466,667
    
    
    
    74,421,051After 5 years but within 10 years
    
    
    3,003,155
    
    
    
    1,752
    
    
    
    16,236
    
    
    
    2,988,671Total U.S. Government agencies
    
    
    77,743,597
    
    
    
    149,028
    
    
    
    482,903
    
    
    
    77,409,722State and local due:After 5 years but within 10 years
    
    
    2,341,845
    
    
    
    14,681
    
    
    
    1,410
    
    
    
    2,355,116After 10 years
    
    
    3,275,725
    
    
    
    1,664
    
    
    
    26,070
    
    
    
    3,251,319Total state and local
    
    
    5,617,570
    
    
    
    16,345
    
    
    
    27,480
    
    
    
    5,606,435Others due:After 1 year but within 5 years
    
    
    199,793
    
    
    
    8,302
    
    
    
    
    
    
    
    208,095After 10 years
    
    
    8,370,818
    
    
    
    401,637
    
    
    
    23,162
    
    
    
    8,749,293Equity securities
    
    
    9,672,999
    
    
    
    535,449
    
    
    
    62,026
    
    
    
    10,146,422Total others
    
    
    18,243,610
    
    
    
    945,388
    
    
    
    85,188
    
    
    
    19,103,810Total available for sale
    
    $
    106,854,579
    
    
    $
    1,110,761
    
    
    $
    607,091
    
    
    $
    107,358,249HELD TO MATURITYAt December 31, 2004:U. S. Government agencies due:Within 1 year
    
    $
    2,700,106
    
    
    $
    1,770
    
    
    $
    
    
    
    $
    2,701,876Total U.S. Government agencies
    
    
    2,700,106
    
    
    
    1,770
    
    
    
    
    
    
    
    2,701,876State and local due:Within 1 year
    
    
    5,945,556
    
    
    
    36,462
    
    
    
    
    
    
    
    5,982,018After 1 year but within 5 years
    
    
    25,103,992
    
    
    
    1,070,610
    
    
    
    
    
    
    
    26,174,602After 5 years but within 10 years
    
    
    13,849,218
    
    
    
    931,995
    
    
    
    
    
    
    
    14,781,213After 10 years
    
    
    3,602,921
    
    
    
    285,043
    
    
    
    
    
    
    
    3,887,964Total state and local
    
    
    48,501,687
    
    
    
    2,324,110
    
    
    
    
    
    
    
    50,825,797Total held to maturity
    
    $
    51,201,793
    
    
    $
    2,325,880
    
    
    $
    
    
    
    $
    53,527,673
 Sales and calls of securities available for sale for the year ended December 31, 2004
resulted in no realized gains or losses. Calls of securities held to maturity resulted
in gross gains of $14,347 and no losses in 2004. 50




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Amortized
    
    
    Gross Unrealized
    
    
    FairType and Contractual Maturity
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueAVAILABLE FOR SALEAt December 31, 2003:U. S. Treasury due:After 1 year but within 5 years
    
    $
    5,314,460
    
    
    $
    57,415
    
    
    $
    
    
    
    $
    5,371,875Total U.S. Treasury
    
    
    5,314,460
    
    
    
    57,415
    
    
    
    
    
    
    
    5,371,875U. S. Government agencies due:Within 1 year
    
    
    3,055,026
    
    
    
    80,826
    
    
    
    
    
    
    
    3,135,852After 1 year but within 5 years
    
    
    50,341,935
    
    
    
    675,061
    
    
    
    264,326
    
    
    
    50,752,670After 5 years but within 10 years
    
    
    14,837,733
    
    
    
    64,461
    
    
    
    7,904
    
    
    
    14,894,290Total U.S. Government agencies
    
    
    68,234,694
    
    
    
    820,348
    
    
    
    272,230
    
    
    
    68,782,812State and local due:After 5 years but within 10 years
    
    
    1,918,431
    
    
    
    15,645
    
    
    
    539
    
    
    
    1,933,537After 10 years
    
    
    3,733,046
    
    
    
    
    
    
    
    72,503
    
    
    
    3,660,543Total state and local
    
    
    5,651,477
    
    
    
    15,645
    
    
    
    73,042
    
    
    
    5,594,080Others due:After 1 year but within 5 years
    
    
    199,596
    
    
    
    18,844
    
    
    
    
    
    
    
    218,440After 10 years
    
    
    11,065,026
    
    
    
    371,464
    
    
    
    31,205
    
    
    
    11,405,285Equity securities
    
    
    5,819,556
    
    
    
    537,303
    
    
    
    62,556
    
    
    
    6,294,303Total others
    
    
    17,084,178
    
    
    
    927,611
    
    

    
    93,761
    
    
    
    17,918,028Total available for sale
    
    $
    96,284,809
    
    
    $
    1,821,019
    
    
    $
    439,033
    
    
    $
    97,666,795HELD TO MATURITYAt December 31, 2003:U. S. Government agencies due:Within 1 year
    
    $
    2,505,151
    
    
    $
    55,176
    
    
    $
    
    
    
    $
    2,560,327After 1 year but within 5 years
    
    
    2,704,301
    
    
    
    120,960
    
    
    
    
    
    
    
    2,825,261Total U.S. Government agencies
    
    
    5,209,452
    
    
    
    176,136
    
    
    
    
    
    
    
    5,385,588State and local due:Within 1 year
    
    
    6,608,675
    
    
    
    73,727
    
    
    
    
    
    
    
    6,682,402After 1 year but within 5 years
    
    
    25,285,769
    
    
    
    1,347,306
    
    
    
    
    
    
    
    26,633,075After 5 years but within 10 years
    
    
    20,159,085
    
    
    
    1,548,569
    
    
    
    
    
    
    
    21,707,654After 10 years
    
    
    4,506,585
    
    
    
    360,321
    
    
    
    
    
    
    
    4,866,906Total state and local
    
    
    56,560,114
    
    
    
    3,329,923
    
    
    
    
    
    
    
    59,890,037Total held to maturity
    
    $
    61,769,566
    
    
    $
    3,506,059
    
    
    $
    
    
    
    $
    65,275,625
 Sales of securities available for sale for the year ended December 31, 2003 resulted in no
gross gains and realized gross losses of $17,756. Calls of securities available for sale for
the year ended December 31, 2003 resulted in realized gross gains of $15,887 and realized
gross losses of $829. Calls of securities held to maturity for the year ended December 31,
2003 resulted in realized gross gains of $11,231 and no gross losses. Sales of securities available for sale for the year ended December 31, 2002 resulted in
realized gross gains of $3,170 and no gross losses. Calls of securities did not result in
any gains or losses in 2002. Securities with an amortized cost of $55,160,492 and $54,769,851 were pledged as
collateral for public deposits and for other purposes as required by law at December
31, 2004 and 2003, respectively. 51




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##### Table of Contents



3. LOANS Loans are made primarily to customers in the Companys market area. Loans at December 31,
2004 and 2003, classified by type, are as follows: 2004
    
    
    2003Real estate:Construction
    
    $
    105,110,671
    
    
    $
    90,175,534Mortgage
    
    
    420,860,460
    
    
    
    377,955,786Commercial, financial and agricultural
    
    
    223,605,232
    
    
    
    211,476,974Consumer
    
    
    29,014,711
    
    
    
    35,980,704All other loans
    
    
    704,247
    
    
    
    1,206,202779,295,321
    
    
    
    716,795,200Deferred origination fees, net
    
    
    (1,157,891
    )
    
    
    (950,568
    )Total
    
    $
    778,137,430
    
    
    $
    715,844,632
 Nonperforming assets at December 31, 2004 and 2003 are as follows: 2004
    
    
    2003Nonaccrual loans
    
    $
    6,633,924
    
    
    $
    8,114,914Loans 90 days or more and still
accruing interest
    
    
    4,227,180
    
    
    
    3,217,879Foreclosed properties
    
    
    1,279,636
    
    
    
    1,775,237Total
    
    $
    12,140,740
    
    
    $
    13,108,030
 If interest from nonaccrual loans had been recognized in accordance with the original
terms of the loans, interest income would have been higher by $408,114 in 2004 and
$294,726 in 2003. Interest income
recognized on nonaccrual loans for 2004 and 2003 was $65,024 and $197,453, respectively.
For 2002, interest income from nonaccrual loans that would have been recognized in
accordance with the original terms was not materially different from interest actually
recorded on nonaccrual loans. Directors and officers of the Company and companies with which they are affiliated are
customers of and borrowers from the Bank in the ordinary course of business. At December
31, 2004 and 2003, directors and principal officers direct and indirect indebtedness to
the Bank aggregated $2,912,276 and $4,554,411, respectively. During 2004, additions to
such loans were $1,250,872 and repayments totaled $2,893,007. In the opinion of
management, these loans do not involve more than normal risk of collectibility, nor do
they present other unfavorable features. 52




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4. ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the years ended December 31, 2004, 2003
and 2002 are as follows: 2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    $
    10,798,897
    
    
    $
    8,834,611
    
    
    $
    6,426,477Loans charged off:Real estate
    
    
    929,609
    
    
    
    1,615,998
    
    
    
    328,731Commercial, financial and agricultural
    
    
    1,040,391
    
    
    
    2,274,594
    
    
    
    538,069Credit cards and related plans
    
    
    87,711
    
    
    
    41,229
    
    
    
    56,607Installment loans to individuals
    
    
    683,282
    
    
    
    766,818
    
    
    
    260,198Demand deposit overdraft program
    
    
    297,456
    
    
    
    389,022
    
    
    
    371,463Total charge-offs
    
    
    3,038,449
    
    
    
    5,087,661
    
    
    
    1,555,068Recoveries of loans previously charged off:Real estate
    
    
    23,675
    
    
    
    3,100
    
    
    
    77,612Commercial, financial and agricultural
    
    
    70,245
    
    
    
    176,095
    
    
    
    168,349Credit cards and related plans
    
    
    3,925
    
    
    
    5,471
    
    
    
    2,321Installment loans to individuals
    
    
    220,389
    
    
    
    70,606
    
    
    
    58,642Demand deposit overdraft program
    
    
    147,171
    
    
    
    170,130
    
    
    
    163,896Total recoveries
    
    
    465,405
    
    
    
    425,402
    
    
    
    470,820Net charge-offs
    
    
    2,573,044
    
    
    
    4,662,259
    
    
    
    1,084,248Additions charged to operations
    
    
    5,439,160
    
    
    
    4,764,010
    
    
    
    3,492,382Allowance acquired in purchase transaction
    
    
    
    
    
    
    1,862,535
    
    
    
    Balance at end of year
    
    $
    13,665,013
    
    
    $
    10,798,897
    
    
    $
    8,834,611Ratio of net charge-offs during the year to
average loans outstanding during the year
    
    
    0.35
    %
    
    
    0.75
    %
    
    
    0.21
    %
 At December 31, 2004 and 2003, the recorded investment in loans that are considered to be
impaired, including accrued interest, was $12,137,624 ($6,784,846 of which is on a
nonaccrual basis) and $11,534,862 ($8,330,334 of which is on a nonaccrual basis),
respectively. The average recorded balance of impaired loans during 2004 and 2003 is not
significantly different from the balance at December 31, 2004 and 2003. The related
allowance for loan losses for these loans was $4,324,669 and $2,412,366 at December 31,
2004 and 2003, respectively. The allowance for impaired loans increased $1,912,303, or
79.27%, while the total investment in impaired loans increased $602,762, or 5.23%. For the
years ended December 31, 2004, 2003 and 2002, the Bank recognized interest income on those
impaired loans of $266,829, $305,865 and $183,405, respectively. Charge-offs totaled $3,038,449 in 2004 compared to $5,087,661 in 2003, a decrease of
$2,049,212, or 40.28%, primarily due to a reduction in charge-offs related to commercial
loans. The average charge-off for 2004 was less than $15,000. 53




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5. PREMISES AND EQUIPMENT Summaries of premises and equipment at December 31, 2004 and 2003 follow: Premises andAccumulated
    
    
    Equipment,Cost
    
    
    Depreciation
    
    
    NetAt December 31, 2004:Land
    
    $
    2,331,599
    
    
    $
    
    
    
    $
    2,331,599Buildings
    
    
    9,969,561
    
    
    
    3,537,098
    
    
    
    6,432,463Leasehold improvements
    
    
    299,316
    
    
    
    58,074
    
    
    
    241,242Furniture, equipment and vehicles
    
    
    11,449,981
    
    
    
    8,358,697
    
    
    
    3,091,284Construction in progress
    
    
    977,598
    
    
    
    
    
    
    
    977,598Total
    
    $
    25,028,055
    
    
    $
    11,953,869
    
    
    $
    13,074,186At December 31, 2003:Land
    
    $
    2,331,599
    
    
    $
    
    
    
    $
    2,331,599Buildings
    
    
    9,362,796
    
    
    
    3,268,058
    
    
    
    6,094,738Leasehold improvements
    
    
    29,242
    
    
    
    5,551
    
    
    
    23,691Furniture, equipment and vehicles
    
    
    9,891,539
    
    
    
    7,662,769
    
    
    
    2,228,770Construction in progress
    
    
    1,539,768
    
    
    
    
    
    
    
    1,539,768Total
    
    $
    23,154,944
    
    
    $
    10,936,378
    
    
    $
    12,218,566
 6. OTHER INCOME AND EXPENSES For the years ended December 31, 2004, 2003 and 2002, items included in service charges on
deposit accounts and other expenses that exceeded 1% of total revenues are set forth below. 2004
    
    
    2003
    
    
    2002Items included in service charges on deposit accounts
Fees from demand deposit overdrafts
    
    $
    3,740,312
    
    
    $
    3,895,535
    
    
    $
    3,688,116Items included in other expensesTelephone
    
    
    768,781
    
    
    
    608,687
    
    
    
    466,196Marketing
    
    
    820,892
    
    
    
    805,117
    
    
    
    526,635
 7. INCOME TAXES The components of the income tax provision for the years ended December 31, 2004, 2003 and 2002
follow. 2004
    
    
    2003
    
    
    2002Income tax provisionCurrent
    
    $
    7,660,208
    
    
    $
    7,768,734
    
    
    $
    8,554,318Deferred
    
    
    (1,517,901
    )
    
    
    41,331
    
    
    
    (1,159,425
    )Total
    
    $
    6,142,307
    
    
    $
    7,810,065
    
    
    $
    7,394,893
 Changes in deferred taxes of $(350,230), $(109,186) and $291,057 related to unrealized
gains and losses on securities available for sale during 2004, 2003 and 2002,
respectively, were allocated to other comprehensive income in the respective years.
Changes in deferred taxes of $3,012 and $(41,496) related to unrealized gains and losses
on mortgages held for sale were allocated to other comprehensive income during 2004 and
2003, respectively. 54




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A reconciliation of reported income tax expense for the years ended December 31, 2004, 2003
and 2002 to the amount of tax expense computed by multiplying income before income taxes by
the statutory federal income tax rate follows. 2004
    
    
    2003
    
    
    2002Statutory federal income tax rate
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %Tax provision at statutory rate
    
    $
    6,601,184
    
    
    $
    8,091,285
    
    
    $
    7,874,018Increase (decrease) in income taxes
resulting from:Tax-exempt interest income
    
    
    (888,588
    )
    
    
    (995,475
    )
    
    
    (1,139,942
    )State income taxes net of federal tax benefit
    
    
    606,663
    
    
    
    795,840
    
    
    
    728,299Other
    
    
    (176,952
    )
    
    
    (81,585
    )
    
    
    (67,482
    )Income tax provision
    
    $
    6,142,307
    
    
    $
    7,810,065
    
    
    $
    7,394,893
 The tax effect of the cumulative temporary differences and carryforwards that gave rise to the deferred tax
assets and liabilities at December 31, 2004 and 2003 are as follows: December 31, 2004Assets
    
    
    Liabilities
    
    
    TotalExcess book over tax bad debt expense
    
    $
    5,391,179
    
    
    $
    
    
    
    $
    5,391,179Excess tax over book depreciation
    
    
    
    
    
    
    (530,778
    )
    
    
    (530,778
    )Unrealized gains on securities
available for sale
    
    
    
    
    
    
    (200,867
    )
    
    
    (200,867
    )Unrealized losses on mortgage
derivative instruments
    
    
    38,484
    
    
    
    
    
    
    
    38,484Other, net
    
    
    1,407,225
    
    
    
    (1,004,644
    )
    
    
    402,581Total
    
    $
    6,836,888
    
    
    $
    (1,736,289
    )
    
    $
    5,100,599
 December 31, 2003Assets
    
    
    Liabilities
    
    
    TotalExcess book over tax bad debt expense
    
    $
    4,250,088
    
    
    $
    
    
    
    $
    4,250,088Excess tax over book depreciation
    
    
    
    
    
    
    (495,175
    )
    
    
    (495,175
    )Unrealized gains on securities
available for sale
    
    
    
    
    
    
    (551,097
    )
    
    
    (551,097
    )Unrealized losses on mortgage
derivative instruments
    
    
    41,496
    
    
    
    
    
    
    
    41,496Other, net
    
    
    969,110
    
    
    
    (978,942
    )
    
    
    (9,832
    )Total
    
    $
    5,260,694
    
    
    $
    (2,025,214
    )
    
    $
    3,235,480
 The net deferred tax asset is included in other assets on the balance sheet. Although realization of the deferred tax assets is not assured, management believes it is
more likely than not that all of the deferred tax assets will be realized. 8. STOCK OPTIONS At December 31, 2004, 2003 and 2002, 237,812, 340,157 and 189,017 shares of common stock,
respectively, were reserved for stock options outstanding under the Companys stock option
plans. Shares available for grants under the Companys stock option plans were 234,468
shares at December 31, 2004, 217,763 shares at December 31, 2003, and 215,498 shares at
December 31, 2002. Option prices are established at market value on the dates granted by the
Board of Directors. 55




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A summary of the status of the Companys incentive stock option plans at December 31, 2004,
2003 and 2002 and changes during the years then ended are presented below: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding at beginning of year
    
    
    340,157
    
    
    $
    14.58
    
    
    
    189,017
    
    
    $
    19.11
    
    
    
    179,221
    
    
    $
    19.15Issued in purchase transactions
    
    
    
    
    
    
    
    
    
    
    182,695
    
    
    
    9.58
    
    
    
    
    
    
    
    Granted
    
    
    9,000
    
    
    
    18.13
    
    
    
    7,000
    
    
    
    18.03
    
    
    
    13,000
    
    
    
    18.37Exercised
    
    
    85,640
    
    
    
    10.90
    
    
    
    29,290
    
    
    
    11.61
    
    
    
    
    
    
    
    Expired, forfeited or canceled
    
    
    25,705
    
    
    
    17.92
    
    
    
    9,265
    
    
    
    18.78
    
    
    
    3,204
    
    
    
    18.78Outstanding at end of year
    
    
    237,812
    
    
    $
    15.67
    
    
    
    340,157
    
    
    $
    14.58
    
    
    
    189,017
    
    
    $
    19.11Options exercisable at end of year
    
    
    211,630
    
    
    $
    15.41
    
    
    
    297,222
    
    
    $
    14.14
    
    
    
    121,688
    
    
    $
    19.49
 For various price ranges, weighted average characteristics of outstanding stock options at
December 31, 2004 follow. Outstanding Options
    
    
    
    
    
    
    Exercisable OptionsWeightedShares
    
    
    Average
    
    
    Weighted
    
    
    Shares
    
    
    WeightedOutstanding at
    
    
    Remaining
    
    
    Average
    
    
    Exercisable at
    
    
    AverageRange of
    
    December 31,
    
    
    Contractual
    
    
    Exercise
    
    
    December 31,
    
    
    ExerciseExercise Prices
    
    2004
    
    
    Life (years)
    
    
    Price
    
    
    2004
    
    
    Price$      0.00 - 8.25
    
    
    31,037
    
    
    
    5.4
    
    
    $
    7.66
    
    
    
    31,037
    
    
    $
    7.668.26 - 10.75
    
    
    28,487
    
    
    
    2.6
    
    
    
    9.64
    
    
    
    28,487
    
    
    
    9.6410.76 - 15.75
    
    
    29,150
    
    
    
    5.7
    
    
    
    11.33
    
    
    
    29,150
    
    
    
    11.3315.76 - 17.75
    
    
    58,511
    
    
    
    2.1
    
    
    
    16.75
    
    
    
    49,636
    
    
    
    16.7617.76 - 18.25
    
    
    24,799
    
    
    
    1.2
    
    
    
    18.08
    
    
    
    17,492
    
    
    
    18.1018.26 - 26.50
    
    
    65,828
    
    
    
    3.3
    
    
    
    22.12
    
    
    
    55,828
    
    
    
    22.737.18 - 26.20
    
    
    237,812
    
    
    
    3.3
    
    
    $
    15.67
    
    
    
    211,630
    
    
    $
    15.41
 Options granted become exercisable in accordance with the vesting schedule specified by the
Board of Directors in the grant. Options granted prior to January 1, 1997 and after December 31, 1997 become
exercisable over a five-year period at the rate of 20% per year beginning one-year from the
date of grant. Options granted during 1997 became exercisable over a four-year period at the
rate of 20% after six-months from the date of grant and 20% per year beginning one-year from
the date of grant. The Company issued options to purchase shares of its common stock in
exchange for the First Commerce stock options that were outstanding at the time the merger
was completed. First Commerces stock option plans provided that all of the outstanding
options were vested as of the acquisition date and thus the Company included them as part of
the purchase price. There is no change in the aggregate intrinsic value of the options issued
compared to the intrinsic value of the options held immediately before the exchange, nor does
the ratio of the exercise price per option to the market value per share change. The option
plans assumed in the acquisition of First Commerce are exercisable for ten-years after the
date of grant and became fully vested as of the July 15, 2003 acquisition date. No other
options may be exercisable more than five-years after the date of grant, unless the exercise
date is extended by the Board of Directors. The Board of Directors extended the exercise
period to ten years for options granted during 1997 and 1998 because the exercise prices of
such grants exceeded the market price resulting in no value to the Company or the optionee. 56




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9. EMPLOYEE BENEFIT PLANS The Bank sponsors a tax-qualified profit-sharing retirement plan covering substantially all
employees. Contributions to the plan are made at the discretion of the Board of Directors but may not
exceed the maximum amount allowable for federal income tax purposes. Contributions totaled
$676,507, $599,693 and $855,767 for the years ended December 31, 2004, 2003 and 2002,
respectively. The Bank sponsors non-tax qualified supplemental executive retirement plans for both its
chairman and chief executive officer, which allow the Bank to supplement the level of the
two executive officers retirement incomes over that which is obtainable through the
tax-qualified profit sharing retirement plan sponsored by the Bank. Contributions totaled
$16,609, $15,790 and $24,930 for the years ended December 31, 2004, 2003 and 2002,
respectively. During 2001, the Bank replaced its split-dollar life insurance arrangements with its
officers by adopting a non-tax qualified Supplemental Executive Retirement Plan for its
officers (Officers SERP) to supplement the benefit each officer can receive under the
Banks tax-qualified profit sharing retirement plan. Once the officer has completed 7 full
years of service with the Bank, the Officers SERP is designed to provide a benefit to the
officer at the normal retirement age of 65, or thereafter, or an early retirement age of 50.
Benefits are payable for 10 years for certain officers or life for certain officers. Actual
retirement benefits payable under the Officers SERP are dependent on an indexed retirement
benefit formula, which accrues benefits equal to the excess of the aggregate annual
after-tax income from associated life insurance contracts over the Banks opportunity costs
related to the Officers SERP. Retirement benefits payable under the Officers SERP are
dependent on the performance of insurance contracts, which is not guaranteed by the Bank. In
the event of an officers termination of employment for any reason, other than for cause,
the officer is 100% vested after 7 or more full years of service with the Bank after the
officer has attained the age of 18. In the event of the officers termination of employment
due to disability or change of control of the Company or the Bank, payments from the plan
would begin at the officers normal or early retirement age and the officer would be 100%
vested in the entire retirement benefit amount. The present value of the post retirement
benefits for each participant are accounted for in a rational and systematic manner over the
working life of each participant. In connection with the Officers SERP, the Bank has also entered into Life Insurance
Endorsement Method Split Dollar Agreements (the Agreements) with the participants covered
under the Officers SERP. Under the Agreements, in the event of the officers death, the
officers beneficiary will receive the lesser of 2 times the officers salary at the time
of death or 100% of the net-at-risk life insurance of the policy, which is defined as the
death benefit in excess of cash value, together with any remaining balance in the liability
reserve account. In 2001, the Bank purchased bank-owned life insurance (BOLI), which may be used, at the
Banks sole discretion, to fund the benefits payable under the Officers SERP. In the third
quarter of 2001, the Bank invested $7,984,500 in BOLI policies that, if the Bank so elects,
may be used to fund the death and/or retirement benefits payable under the Officers SERP.
During 2004, an additional $3,745,000 was invested in BOLI for four participants added
during the year. During 2003, the Bank made no additional investments in BOLI, although it acquired $3,764,492 in BOLI in its acquisition of First Commerce. As of
December 31, 2004 and 2003, cash values from the BOLI policies equaled $17,703,961 and
$13,360,278, respectively. For 2004 and 2003, $661,451 and $414,910, respectively, was
accrued in retirement benefits and plan related costs. As of December 31, 2004, the
Officers SERP had 43 participants. Granite Mortgage sponsors a retirement plan for its employees under Section 401(k) of the
Internal Revenue Code. The plan covers all employees over 21 years of age who have
completed 1,000 hours of service. At its discretion, Granite Mortgage may make matching
contributions to the plan. Contributions totaled $132,104, $128,649 and $97,518 for the
years ended December 31, 2004, 2003 and 2002, respectively. 57




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10. LEASES LESSEE  OPERATING  The Companys subsidiaries lease certain premises and equipment under
operating lease agreements. As of December 31, 2004, future minimum lease payments under
noncancelable operating leases are as follows: Year
    
    Payments2005
    
    $
    896,2642006
    
    
    722,8852007
    
    
    657,7962008
    
    
    515,6112009
    
    
    514,0982010 and thereafter
    
    
    1,451,978Total
    
    $
    4,758,632
 Rental expense charged to operations under all operating lease agreements was
$882,086, $512,680 and $291,771 for the years ended December 31, 2004, 2003 and 2002,
respectively. In September 2003, the Company entered into commercial leases with Salem Investors, LLC, a
company jointly owned by the chief executive officer and a senior vice president of Granite
Mortgage, for the purpose of providing a community banking facility to the Bank and a
mortgage banking facility to Granite Mortgage in Winston-Salem, North Carolina. Facility
construction was completed in the third quarter of 2004. The leases commenced on September
1, 2004 and have an initial lease term of seven years. Based on a fairness opinion obtained
from an independent third party expert, the Company has determined that the leases are on
terms comparable to similar properties in the area and that the leases are in the best
interests of the Companys community banking and mortgage banking operations. 11. OVERNIGHT BORROWINGS Federal funds purchased generally represent overnight borrowings by the Bank for
temporary funding requirements. Securities sold under agreements to repurchase represent
short-term borrowings by the Bank collateralized by U.S. Treasury and U.S. Government
agency securities. The Bank also borrows funds on an overnight basis from the Federal
Home Loan Bank. Following is a summary of these borrowings: 2004
    
    
    2003Federal funds purchased:Balance at end of year
    
    $
    5,500,000
    
    
    $
    5,950,000Weighted average interest rate at end of year
    
    
    2.50
    %
    
    
    1.15
    %Maximum amount outstanding at any month-end during the year
    
    $
    5,500,000
    
    
    $
    5,950,000Average daily balance outstanding during the year
    
    $
    1,586,885
    
    
    $
    434,932Average annual interest rate paid during the year
    
    
    1.68
    %
    
    
    1.37
    %Securities sold under agreements to repurchase:Balance at end of year
    
    $
    1,520,877
    
    
    $
    1,839,117Weighted average interest rate at end of year
    
    
    1.60
    %
    
    
    0.35
    %Maximum amount outstanding at any month-end during the year
    
    $
    2,163,506
    
    
    $
    2,262,318Average daily balance outstanding during the year
    
    $
    1,891,372
    
    
    $
    2,019,718Average annual interest rate paid during the year
    
    
    0.66
    %
    
    
    0.50
    %
 58




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##### Table of Contents



2004
    
    
    2003Overnight borrowings from the Federal Home Loan Bank:Balance at end of year
    
    $
    40,900,000
    
    
    $
    Weighted average interest rate at end of year
    
    
    2.44
    %
    
    
    Maximum amount outstanding at any month-end during the year
    
    $
    40,900,000
    
    
    $
    10,500,000Average daily balance outstanding during the year
    
    $
    9,939,208
    
    
    $
    392,329Average annual interest rate paid during the year
    
    
    1.74
    %
    
    
    1.49
    %
 The Bank offers a commercial sweep product whereby qualifying amounts are swept
overnight from a commercial deposit account into commercial paper issued by the
Company. 2004
    
    
    2003Commercial deposits swept into commercial paper:Balance at end of year
    
    $
    23,827,555
    
    
    $
    17,416,054Weighted average interest rate at end of year
    
    
    1.25
    %
    
    
    1.50
    %Maximum amount outstanding at any month-end during the year
    
    $
    23,827,555
    
    
    $
    15,524,583Average daily balance outstanding during the year
    
    $
    22,157,733
    
    
    $
    14,915,273Average annual interest rate paid during the year
    
    
    1.26
    %
    
    
    1.35
    %
 12. OTHER BORROWINGS The Bank also borrows funds with maturities of one year or less from the Federal Home Loan
Bank and assumed borrowings of $22,000,000 with an average remaining maturity of 5.7 years
in its acquisition of First Commerce. 2004
    
    
    2003Federal Home Loan Bank borrowings:Balance at end of year
    
    $
    29,106,963
    
    
    $
    34,187,157Weighted average interest rate at end of year
    
    
    3.43
    %
    
    
    2.95
    %Maximum amount outstanding at any month-end during the year
    
    $
    34,000,000
    
    
    $
    34,225,310Average daily balance outstanding during the year
    
    $
    31,636,612
    
    
    $
    22,175,343Average annual interest rate paid during the year
    
    
    3.18
    %
    
    
    2.61
    %
 Granite Mortgage temporarily funds its mortgages, from the time of origination until the
time of sale, through the use of a one-year warehouse line of credit from one of the
Companys correspondent financial institutions. For the years ended December 31, 2004 and
2003, this line of credit was $40,000,000 and $50,000,000, of which $29,478,614 and
$26,107,383, respectively, were outstanding at year end. Granite Mortgage requests the line
of credit based on its estimated funding needs for the year. Outstanding balances under this
line of credit accrue interest at a rate of the 30-day LIBOR plus 115 basis points to fund
mortgages originated and sold and construction loans. The line is secured by the mortgage
loans originated and the Company serves as guarantor on Granite Mortgages borrowings under
this arrangement. Under the terms of the loan agreement, Granite Mortgage is required to
meet certain financial conditions regarding adjusted tangible net worth and interest
coverage. Granite Mortgage was in compliance with all financial conditions as of December
31, 2004. The Company has an unsecured line of credit from one of the Banks correspondent banks
for general corporate purposes, which expires June 30, 2006. The line is in the amount of
$10,000,000 and bears an interest rate of one-month LIBOR plus 120 basis points, with
interest payable quarterly. As of December 31, 2004 and 2003, the Company had not
borrowed any funds against this line of credit. Through its acquisition of First Commerce, the Company acquired a statutory business trust,
First Commerce Capital Trust I, created by First Commerce in 2001 to facilitate the issuance
of a $5,000,000 trust preferred security through a pooled trust preferred securities
offering. This security bears a variable interest rate based on the sixty-day LIBOR plus 375
basis points, matures in 2031 and is callable at par every six months beginning December 8,
2006. 59




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13. MATURITIES OF TIME DEPOSITS Principal maturities of the Banks time deposits as of December 31, 2004 are as follows: Year
    
    Maturities2005
    
    $
    231,492,1332006
    
    
    47,259,6562007
    
    
    19,844,1942008
    
    
    15,078,795Total
    
    $
    313,674,778
 14. RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE Basic earnings per share (EPS) is computed by dividing net income by the weighted average
number of common shares outstanding for the period. Basic EPS excludes the dilutive effect
that could occur if any securities or other contracts to issue common stock were exercised
or converted into or resulted in the issuance of common stock. Diluted EPS is computed by
dividing net income by the sum of the weighted average number of common shares outstanding
for the period plus the number of additional common shares that would have been outstanding
if the potentially dilutive common shares had been issued. Options to purchase 45,860,
47,175 and 80,081 common shares were excluded from the computation of diluted net income
per share for the years ended December 31, 2004, 2003 and 2002, respectively, because the
options exercise prices were greater than the average market price of common shares.
Following is the reconciliation of EPS for the years ended December 31, 2004, 2003 and
2002. 2004
    
    
    2003
    
    
    2002BASIC EARNINGS PER SHARENet income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300Divide by: Weighted average shares outstanding
    
    
    13,481,397
    
    
    
    13,438,007
    
    
    
    13,547,299Basic earnings per share
    
    $
    0.94
    
    
    $
    1.14
    
    
    $
    1.11DILUTED EARNINGS PER SHARENet income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300Divide by: Weighted average shares outstanding
    
    
    13,481,397
    
    
    
    13,438,007
    
    
    
    13,547,299Potentially dilutive effect of
stock options
    
    
    49,827
    
    
    
    78,693
    
    
    
    5,270Weighted average shares outstanding,
including potentially dilutive effect
of stock options
    
    
    13,531,224
    
    
    
    13,516,700
    
    
    
    13,552,569Diluted earnings per share
    
    $
    0.94
    
    
    $
    1.13
    
    
    $
    1.11
 60




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15. REGULATION AND REGULATORY RESTRICTIONS The Company is regulated by the Board of Governors of the Federal Reserve System (FRB) and
is subject to securities registration and public reporting regulations of the Securities and
Exchange Commission. The Bank is regulated by the Federal Deposit Insurance Corporation
(FDIC), the North Carolina State Banking Commission and the FRB. The primary source of funds for the payment of dividends by the Company is dividends
received from its subsidiaries, the Bank and Granite Mortgage. The Bank, as a North
Carolina banking corporation, may pay dividends only out of undivided profits as
determined pursuant to North Carolina General Statutes Section 53-87. As of December 31,
2004, the Bank had undivided profits, as defined, of $94,091,303. The Bank is subject to various regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary, actions by regulators that, if undertaken,
could have a direct material effect on the Banks assets,
liabilities, and certain off-balance-sheet items calculated under regulatory accounting
practices. The Banks capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital (as
defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31, 2004, that
the Company and the Bank meet all capital adequacy requirements to which it is subject. As of December 31, 2004, the most recent regulatory notifications categorized both the
Company and the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Company and the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table. Management is not aware of conditions or events subsequent to such
notifications that would cause a change in the Companys or the Banks capital categories. The Companys actual capital amounts and ratios are also presented in the table: To Be WellCapitalizedUnder PromptFor Capital
    
    
    CorrectiveAdequacy
    
    
    ActionActual
    
    
    Purposes
    
    
    Provisions(dollars in thousands)
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioAs of December 31, 2004Total capital to risk weighted assets
    
    $
    145,328
    
    
    
    17.25
    %
    
    $
    67,405
    
    
    
    8.00
    %
    
    $
    84,256
    
    
    
    10.00
    %Tier I capital to risk weighted assets
    
    
    134,544
    
    
    
    15.97
    %
    
    
    33,702
    
    
    
    4.00
    %
    
    
    50,553
    
    
    
    6.00
    %Tier I capital to average assets
    
    
    134,544
    
    
    
    13.39
    %
    
    
    40,190
    
    
    
    4.00
    %
    
    
    50,238
    
    
    
    5.00
    %As of December 31, 2003Total capital to risk weighted assets
    
    $
    144,694
    
    
    
    18.38
    %
    
    $
    62,992
    
    
    
    8.00
    %
    
    $
    78,739
    
    
    
    10.00
    %Tier I capital to risk weighted assets
    
    
    134,626
    
    
    
    17.10
    %
    
    
    31,496
    
    
    
    4.00
    %
    
    
    47,244
    
    
    
    6.00
    %Tier I capital to average assets
    
    
    134,626
    
    
    
    14.05
    %
    
    
    38,324
    
    
    
    4.00
    %
    
    
    47,905
    
    
    
    5.00
    %
 The average reserve balance required to be maintained under the requirements of the
Federal Reserve was approximately $3,882,000 for the year ended December 31, 2004. The
Bank maintained average reserve balances in excess of the requirements. 61




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16. PARENT COMPANY CONDENSED FINANCIAL INFORMATION Condensed financial data for Bank of Granite Corporation (parent company only) follows: December 31,Condensed Balance Sheets
    
    2004
    
    
    2003Assets:Cash on deposit with bank subsidiary
    
    $
    28,179,385
    
    
    $
    19,228,055Investment in subsidiary bank at equity
    
    
    130,853,334
    
    
    
    133,845,184Investment in subsidiary mortgage bank at equity
    
    
    5,881,093
    
    
    
    6,196,011Other investments
    
    
    4,959,501
    
    
    
    4,452,823Other assets
    
    

    158,673
    
    
    
    665,728Total
    
    $
    170,031,986
    
    
    $
    164,387,801Liabilities and Shareholders Equity:Other borrowings
    
    $
    28,827,555
    
    
    $
    22,416,054Other liabilities
    
    
    188,210
    
    
    
    156,648Shareholders equity
    
    
    141,016,221
    
    
    
    141,815,099Total
    
    $
    170,031,986
    
    
    $
    164,387,801
 For the Years Ended December 31,Condensed Results of Operations
    
    2004
    
    
    2003
    
    
    2002Equity in earnings of subsidiary bank:Dividends
    
    $
    15,353,514
    
    
    $
    22,287,838
    
    
    $
    8,627,072Earnings retained
    
    
    (2,459,608
    )
    
    
    (8,916,288
    )
    
    
    5,577,290Equity in earnings of subsidiary mortgage bank:Dividends
    
    
    853,005
    
    
    
    449,155
    
    
    
    326,155Earnings retained
    
    
    (318,375
    )
    
    
    1,795,484
    
    
    
    881,165Income (expenses), net
    
    
    (710,316
    )
    
    
    (308,296
    )
    
    
    (309,382
    )Net income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300
 62




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For the Years Ended December 31,Condensed Cash Flow
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    12,718,220
    
    
    $
    15,307,893
    
    
    $
    15,102,300Adjustments to reconcile net income to net
cash provided by operating activities:Equity in undistributed earnings of subsidiaries
    
    
    2,777,983
    
    
    
    7,120,804
    
    
    
    (6,458,455
    )Premium amortization and discount
accretion, net
    
    
    (2,090
    )
    
    
    (1,890
    )
    
    
    (1,761
    )Losses (gains) on sales or calls of
securities available for sale
    
    
    
    
    
    
    17,756
    
    
    
    (3,170
    )Decrease (increase) in interest receivable
    
    
    (711
    )
    
    
    (867
    )
    
    
    8,670Decrease in interest payable
    
    
    
    
    
    
    (25,386
    )
    
    
    Decrease (increase) in other assets
    
    
    637,544
    
    
    
    (414,706
    )
    
    
    61,949Increase (decrease) in other liabilities
    
    
    31,562
    
    
    
    (450,106
    )
    
    
    224,184Net cash provided by operating activities
    
    
    16,162,508
    
    
    
    21,553,498
    
    
    
    8,933,717Cash flows from investing activities:Proceeds from maturities of securities
available for sale
    
    
    204,089
    
    
    
    300,000
    
    
    
    300,000Proceeds from sales of securities
available for sale
    
    
    
    
    
    
    682,210
    
    
    
    56,599Purchases of securities available for sale
    
    
    (700,000
    )
    
    
    (537,628
    )
    
    
    (500,749
    )Net cash paid in acquisition
    
    
    
    
    
    
    (9,317,616
    )
    
    
    Net cash used by investing activities
    
    
    (495,911
    )
    
    
    (8,873,034
    )
    
    
    (144,150
    )Cash flows from financing activities:Net increase in overnight borrowings
    
    
    6,411,501
    
    
    
    2,400,362
    
    
    
    1,724,205Net proceeds from issuance of common stock
    
    
    933,748
    
    
    
    339,961
    
    
    
    Net dividends paid
    
    
    (6,621,140
    )
    
    
    (6,208,975
    )
    
    
    (5,594,799
    )Cash paid for fractional shares
    
    
    
    
    
    
    
    
    
    
    (17,528
    )Purchases of common stock for treasury
    
    
    (7,439,376
    )
    
    
    (5,875,198
    )
    
    
    (7,267,338
    )Net cash used by financing activities
    
    
    (6,715,267
    )
    
    
    (9,343,850
    )
    
    
    (11,155,460
    )Net increase (decrease) in cash
    
    
    8,951,330
    
    
    
    3,336,614
    
    
    
    (2,365,893
    )Cash at beginning of year
    
    
    19,228,055
    
    
    
    15,891,441
    
    
    
    18,257,334Cash at end of year
    
    $
    28,179,385
    
    
    $
    19,228,055
    
    
    $
    15,891,441Supplemental disclosure of non-cash transactions:Cash paid during the year for:Interest paid
    
    $
    555,572
    
    
    $
    339,840
    
    
    $
    262,350Noncash investing and financing activities:Transfer from surplus to common
stock due to stock split
    
    
    
    
    
    
    
    
    
    
    2,883,471
 63




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17. COMMITMENTS AND CONTINGENCIES The Companys subsidiaries are parties to financial instruments in the ordinary course of
business. The Bank routinely enters into commitments to extend credit and issues standby
letters of credit in order to meet the financing needs of its customers. Beginning in late
2002, Granite Mortgage entered into forward commitments and options to sell mortgage-backed
securities in an effort to reduce its exposure to interest rate risk resulting from a
change in its process of managing its production of mortgage loan originations. The
following table presents the contractual or notional amount of these financial instruments
as of the dates indicated. December 31,2004
    
    
    2003Financial instruments whose contract amounts represent credit riskCommitments to extend credit
    
    $
    138,012,770
    
    
    $
    120,746,272Standby letters of credit
    
    
    4,580,138
    
    
    
    6,133,695Financial instruments whose notional or contract amounts are
intended to hedge against interest rate riskForward commitments and options to sell mortgage-backed securities
    
    $
    14,605,060
    
    
    $
    16,032,147
 Commitments to extend credit are legally binding agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts outstanding do not
necessarily represent future cash requirements. Standby letters of credit represent
conditional commitments issued by the Bank to assure the performance of a customer to a third
party. The Banks exposure to credit loss for commitments to extend credit and standby letters of
credit is the contractual amount of those financial instruments. The Bank uses the same
credit policies for making commitments and issuing standby letters of credit as it does for
on-balance sheet financial instruments. Each customers creditworthiness is evaluated on an
individual case-by-case basis. The amount and type of collateral, if deemed necessary by
management, is based upon this evaluation of creditworthiness. Collateral held varies, but
may include marketable securities, deposits, property, plant and equipment, investment
assets, inventories and accounts receivable. Management does not anticipate any significant
losses as a result of these financial instruments. Forward commitments and options to sell mortgage-backed securities are contracts for
delayed delivery of securities in which Granite Mortgage agrees to make delivery at a
specified future date of a specified instrument, at a specified price or yield. Risks
arise from the possible inability of counterparties to meet the terms of their contracts
and from movements in the underlying securities values and interest rates. Legal Proceedings The nature of the businesses of the Companys subsidiaries ordinarily results in a certain
amount of litigation. The Companys subsidiaries are involved in various legal
proceedings, all of which are considered incidental to the normal conduct of business.
Management believes that the liabilities, if any, arising from these proceedings will not
have a material adverse effect on the consolidated financial position or consolidated
results of operations of the Company. 64




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18. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value information about financial instruments, whether or not recognized in the balance
sheet, for which it is practical to estimate the value, is based upon the characteristics of
the instruments and relevant market information. Financial instruments include cash,
evidence of ownership in an entity or contracts that convey or impose on an entity the
contractual right or obligation to either receive or deliver cash for another financial
instrument. Fair value is the amount at which a financial instrument could be exchanged in a
current transaction between willing parties, other than in a forced sale or liquidation, and
is best evidenced by a quoted market price if one exists. The following estimated fair value
amounts have been determined by the Company, using available market information and
appropriate valuation methodologies. However, considerable judgment is necessarily required
to interpret market data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company could realize in
a current market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts. December 31, 2004
    
    
    December 31, 2003Estimated
    
    
    
    
    
    
    EstimatedCarrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    ValueAssets:Cash and cash equivalents
    
    $
    31,570,832
    
    
    $
    31,570,832
    
    
    $
    33,595,834
    
    
    $
    33,595,834Marketable securities
    
    
    158,560,042
    
    
    
    160,885,922
    
    
    
    159,436,361
    
    
    
    162,942,420Loans
    
    
    764,472,417
    
    
    
    763,843,986
    
    
    
    705,045,735
    
    
    
    704,473,897Mortgage loans held for sale
    
    
    21,553,548
    
    
    
    21,553,548
    
    
    
    23,092,846
    
    
    
    23,092,846Liabilities:Demand deposits
    
    
    436,186,774
    
    
    
    436,186,774
    
    
    
    400,933,914
    
    
    
    400,933,914Time deposits
    
    
    313,674,778
    
    
    
    313,382,562
    
    
    
    334,165,441
    
    
    
    337,278,070Overnight borrowings
    
    
    71,748,432
    
    
    
    71,748,432
    
    
    
    25,205,171
    
    
    
    25,205,171Other borrowings
    
    
    63,585,577
    
    
    
    63,700,817
    
    
    
    65,294,540
    
    
    
    65,855,821Financial instruments whose contract
amounts represent credit risk:Commitments to extend credit
    
    
    
    
    
    
    138,012,770
    
    
    
    
    
    
    
    120,746,272Standby letters of credit
    
    
    
    
    
    
    4,580,138
    
    
    
    
    
    
    
    6,133,695
 The book values of cash and due from banks, federal funds sold, interest-bearing deposits,
accrued interest receivable, overnight borrowings, accrued interest payable and other
liabilities are considered to be equal to fair values as a result of the short-term nature
of these items. The fair values of marketable securities is based on quoted market prices,
dealer quotes and prices obtained from independent pricing services. The fair value of
loans, time deposits, other borrowings, commitments and guarantees is estimated based on
present values using applicable risk-adjusted spreads to the U.S. Treasury curve to
approximate current entry-value interest rates applicable to each category of such financial
instruments. No adjustment was made to the entry-value interest rates for changes in credit of loans for
which there are no known credit concerns. Management segregates loans in appropriate risk
categories. Management believes that the risk factor embedded in the entry-value interest
rates, along with the general reserves applicable to the loan portfolio for which there are
no known credit concerns, result in a fair valuation of such loans on an entry-value basis. Demand deposits are shown at their face value. 65




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The fair values for forward commitments and options to sell mortgage-backed securities
are estimated based on quoted prices and are set forth in the following table. December 31, 2004
    
    
    December 31, 2003Estimated
    
    
    
    
    
    
    EstimatedNotional
    
    
    Fair
    
    
    Notional
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    ValueForward commitments and options
to sell mortgage-backed securities
    
    $
    14,605,060
    
    
    $
    14,508,827
    
    
    $
    16,032,147
    
    
    $
    15,928,407
 The fair value estimates presented herein are based on pertinent information available to
management as of December 31, 2004 and 2003. Although management is not aware of any factors
that would significantly affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the amounts
presented herein. 19. DERIVATIVE FINANCIAL INSTRUMENTS The Companys mortgage banking subsidiary, Granite Mortgage, uses two types of financial
instruments to manage interest rate risk. These instruments, commonly referred to as
derivatives, consists of contracts to forward sell mortgage-backed securities and options to
forward sell securities. A derivative is a financial instrument that derives its cash flows,
and therefore its value, by reference to an underlying instrument. Granite Mortgage uses
derivatives primarily to hedge the changes in the cash flows that will be realized from
sales of
the mortgage loans it generates. The following table sets forth certain information about
Granite Mortgages derivative financial instruments as of December 31, 2004. December 31, 2004EstimatedNotional
    
    
    FairAmount
    
    
    ValueForward commitments and options to sell mortgage-backed securities
    
    $
    14,605,060
    
    
    $
    14,508,827
 Granite Mortgage classifies its derivatives in accordance with SFAS No. 133 as a hedge of
an exposure to changes in the cash flows from forecasted transactions (cash flow hedge).
As of December 31, 2004, all of Granite Mortgages derivative financial instruments were
designated as cash flow hedges. These instruments had net unrealized losses of $96,233,
which were recorded in other liabilities. Credit risk related to derivatives arises when amounts receivable from a counterparty
exceed amounts payable to that counterparty. Because the notional amount of the instrument
only serves as a basis for calculating amounts receivable or payable, the risk of loss with
any counterparty is limited to a small fraction of the notional amount. Granite Mortgage
deals with large institutions with good credit ratings in their derivatives activities.
Further, Granite Mortgage has netting arrangements with the dealers with whom it does
business. Because of these factors, Granite Mortgage believes its credit risk exposure
related to derivative contracts at December 31, 2004 was not material. 66




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20. OPERATING SEGMENTS The Companys operations are divided into three reportable business segments: Community
Banking, Mortgage Banking and Other. These operating segments have been identified based on
the Companys organizational structure. The segments require unique technology and marketing
strategies and offer different products and services. While the Company is managed as an
integrated organization, individual executive managers are held accountable for the
operations of these business segments. The Company measures and presents information for internal reporting purposes in a variety
of different ways. Information for the Companys reportable segments is available based on
organizational structure, product offerings and customer relationships. The internal
reporting system presently utilized by management in the planning and measuring of operating
activities, as well as the system to which most managers are held accountable, is based on
organizational structure. The Company emphasizes revenue growth by focusing on client service, sales effectiveness
and relationship management. The segment results contained herein are presented based on
internal management accounting policies that were designed to support these strategic
objectives. Unlike financial accounting, there is no comprehensive authoritative body of
guidance for management accounting equivalent to generally accepted accounting
principles. Therefore, the performance of the segments is not necessarily comparable with
the Companys consolidated results or with similar information presented by other
financial institutions. Additionally, because of the interrelationships of the various segments, the
information presented is not indicative of how the segments would perform if they
operated as independent entities. COMMUNITY BANKING The Companys Community Banking segment serves individual and business customers by
offering a variety of loan and deposit products and other financial services. MORTGAGE BANKING The Mortgage Banking segment originates, retains and sells mortgage loans. Mortgage loan
products include fixed-rate and adjustable-rate government and conventional loans for the
purpose of constructing, purchasing or refinancing owner-occupied properties. Mortgage loans
are typically sold to other financial institutions and government agencies. The Mortgage
Banking segment earns interest on loans held in its warehouse and in its portfolio, earns
fee income from originations and recognizes gains or losses from the sale of mortgage loans. OTHER The Companys Other segment represents primarily treasury and administration activities.
Included in this segment are certain investments and commercial paper issued to the
Banks commercial sweep account customers. 67




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The following table presents selected financial information for reportable business
segments for the years ended December 31, 2004, 2003 and 2002. 2004
    
    
    2003
    
    
    2002COMMUNITY BANKINGNet interest income
    
    $
    38,754,743
    
    
    $
    34,362,277
    
    
    $
    31,583,950Provision for loan losses
    
    
    5,431,160
    
    
    
    4,764,010
    
    
    
    3,422,382Noninterest income
    
    
    7,413,753
    
    
    
    7,566,079
    
    
    
    7,542,131Noninterest expense
    
    
    22,057,715
    
    
    
    17,479,249
    
    
    
    14,909,319Income before income taxes
    
    
    18,679,621
    
    
    
    19,685,097
    
    
    
    20,794,380Net income
    
    
    12,893,906
    
    
    
    13,371,550
    
    
    
    14,204,362Identifiable segment assets
    
    
    991,369,653
    
    
    
    933,907,945
    
    
    
    698,602,213MORTGAGE BANKINGNet interest income
    
    
    3,673,497
    
    
    
    4,969,103
    
    
    
    3,288,760Provision for loan losses
    
    
    8,000
    
    
    
    
    
    
    
    70,000Noninterest income
    
    
    3,844,297
    
    
    
    6,892,171
    
    
    
    3,949,354Noninterest expense
    
    
    6,618,572
    
    
    
    8,120,117
    
    
    
    5,155,919Income before income taxes
    
    
    891,222
    
    
    
    3,741,157
    
    
    
    2,012,195Net income
    
    
    534,630
    
    
    
    2,244,639
    
    
    
    1,207,320Identifiable segment assets
    
    
    36,326,380
    
    
    
    32,609,851
    
    
    
    39,137,923ALL OTHERNet interest income (expense)
    
    
    (270,336
    )
    
    
    (24,695
    )
    
    
    35,394Noninterest income
    
    
    (1,327
    )
    
    
    (20,510
    )
    
    
    (93,780
    )Noninterest expense
    
    
    438,653
    
    
    
    263,091
    
    
    
    250,996Loss before income taxes
    
    
    (710,316
    )
    
    
    (308,296
    )
    
    
    (309,382
    )Net loss
    
    
    (710,316
    )
    
    
    (308,296
    )
    
    
    (309,382
    )Identifiable segment assets
    
    
    4,542,416
    
    
    
    4,864,931
    
    
    
    4,274,538TOTAL SEGMENTSNet interest income
    
    
    42,157,904
    
    
    
    39,306,685
    
    
    
    34,908,104Provision for loan losses
    
    
    5,439,160
    
    
    
    4,764,010
    
    
    
    3,492,382Noninterest income
    
    
    11,256,723
    
    
    
    14,437,740
    
    
    
    11,397,705Noninterest expense
    
    
    29,114,940
    
    
    
    25,862,457
    
    
    
    20,316,234Income before income taxes
    
    
    18,860,527
    
    
    
    23,117,958
    
    
    
    22,497,193Net income
    
    
    12,718,220
    
    
    
    15,307,893
    
    
    
    15,102,300Identifiable segment assets
    
    
    1,032,238,449
    
    
    
    971,382,727
    
    
    
    742,014,674
 * * * * * 68




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BANK OF GRANITE CORPORATION AND SUBSIDIARIES 
 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) YEARS ENDED DECEMBER 31, 2004 AND 2003
 2004
    
    Quarter 1
    
    
    Quarter 2
    
    
    Quarter 3
    
    
    Quarter 4Interest income
    
    $
    13,310,997
    
    
    $
    13,678,282
    
    
    $
    13,779,407
    
    
    $
    14,497,203Interest expense
    
    
    3,078,488
    
    
    
    3,073,389
    
    
    
    3,258,965
    
    
    
    3,697,143Net interest income
    
    
    10,232,509
    
    
    
    10,604,893
    
    
    
    10,520,442
    
    
    
    10,800,060Provision for loan losses
    
    
    1,244,687
    
    
    
    1,104,325
    
    
    
    1,677,889
    
    
    
    1,412,259Net interest income after
provision for loan losses
    
    
    8,987,822
    
    
    
    9,500,568
    
    
    
    8,842,553
    
    
    
    9,387,801Other income
    
    
    2,648,548
    
    
    
    2,875,142
    
    
    
    2,850,046
    
    
    
    2,882,987Other expense
    
    
    7,208,060
    
    
    
    7,475,157
    
    
    
    7,075,974
    
    
    
    7,355,749Income before income taxes
    
    
    4,428,310
    
    
    
    4,900,553
    
    
    
    4,616,625
    
    
    
    4,915,039Income taxes
    
    
    1,436,983
    
    
    
    1,584,863
    
    
    
    1,498,707
    
    
    
    1,621,754Net income
    
    $
    2,991,327
    
    
    $
    3,315,690
    
    
    $
    3,117,918
    
    
    $
    3,293,285Net income per shareBasic
    
    $
    0.22
    
    
    $
    0.25
    
    
    $
    0.23
    
    
    $
    0.25Diluted
    
    
    0.22
    
    
    
    0.24
    
    
    
    0.23
    
    
    
    0.25Average shares outstandingBasic
    
    
    13,622,566
    
    
    
    13,521,847
    
    
    
    13,426,381
    
    
    
    13,351,883Diluted
    
    
    13,683,212
    
    
    
    13,568,718
    
    
    
    13,468,457
    
    
    
    13,401,346
 2003
    
    Quarter 1
    
    
    Quarter 2
    
    
    Quarter 3
    
    
    Quarter 4Interest income
    
    $
    11,362,194
    
    
    $
    12,075,230
    
    
    $
    13,682,909
    
    
    $
    13,575,843Interest expense
    
    
    2,386,474
    
    
    
    2,674,476
    
    
    
    3,173,288
    
    
    
    3,155,253Net interest income
    
    
    8,975,720
    
    
    
    9,400,754
    
    
    
    10,509,621
    
    
    
    10,420,590Provision for loan losses
    
    
    1,135,852
    
    
    
    1,148,529
    
    
    
    1,139,250
    
    
    
    1,340,379Net interest income after
provision for loan losses
    
    
    7,839,868
    
    
    
    8,252,225
    
    
    
    9,370,371
    
    
    
    9,080,211Other income
    
    
    3,333,205
    
    
    
    3,817,255
    
    
    
    4,283,688
    
    
    
    3,003,592Other expense
    
    
    5,370,422
    
    
    
    6,136,225
    
    
    
    7,170,306
    
    
    
    7,185,504Income before income taxes
    
    
    5,802,651
    
    
    
    5,933,255
    
    
    
    6,483,753
    
    
    
    4,898,299Income taxes
    
    
    1,965,468
    
    
    
    2,014,098
    
    
    
    2,252,662
    
    
    
    1,577,837Net income
    
    $
    3,837,183
    
    
    $
    3,919,157
    
    
    $
    4,231,091
    
    
    $
    3,320,462Net income per shareBasic
    
    $
    0.29
    
    
    $
    0.30
    
    
    $
    0.31
    
    
    $
    0.24Diluted
    
    
    0.29
    
    
    
    0.30
    
    
    
    0.31
    
    
    
    0.24Average shares outstandingBasic
    
    
    13,291,744
    
    
    
    13,197,696
    
    
    
    13,617,019
    
    
    
    13,640,301Diluted
    
    
    13,293,767
    
    
    
    13,200,134
    
    
    
    13,692,410
    
    
    
    13,739,912
   The quarterly financial data may not aggregate to annual amounts due to rounding. 
 ITEM 9 - CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE There have been no disagreements with accountants on accounting and financial disclosures
as defined by Item 304 of Regulation S-K. 69




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ITEM 9A - CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Companys management carried out an
evaluation, under the supervision and with the participation of the Companys chief executive
officer and chief financial officer, of the effectiveness of the design and operation of the
Companys disclosure controls and procedures. Based on this evaluation, the Companys chief
executive officer and chief financial officer concluded that the Companys disclosure controls and
procedures are effective in timely alerting them to material information required to be included in
its periodic reports filed with the Securities and Exchange Commission. It should be noted that the
design of any system of controls is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions, regardless of how remote. In addition, no change in
the Companys internal control over financial reporting has occurred during, or subsequent to, the
period covered by this report that has materially affected, or is reasonably likely to materially
affect, its internal control over financial reporting. MANAGEMENTS ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Bank of Granite Corporation and its subsidiaries (the Company) is
responsible for establishing and maintaining adequate internal control over financial reporting.
Internal control over financial reporting is defined in Rule 13a-15(f) or Rule 15d-15(f)
promulgated under the Securities Exchange Act of 1934. The Companys internal control system was
designed to provide reasonable assurance to the Companys management and board of directors
regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore,
even those systems determined to be effective can provide only reasonable assurance with respect
to financial statement preparation and presentation. Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate. The Companys management assessed the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004. In making this assessment, the management used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal ControlIntegrated Framework.Based on our assessment management believes that, as of
December 31, 2004, the Companys internal control over financial reporting is effective based on
those criteria. The Companys independent auditors have issued an attestation report on our assessment of the
Companys internal control over financial reporting. Their report appears below. /s/ Charles M. Snipes
    
    /s/ Kirby A. TyndallCHARLES M. SNIPES
    
    KIRBY A. TYNDALLChief Executive Officer
    
    Chief Financial OfficerMarch 10, 2005
    
    March 10, 2005
 70




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders
of Bank of Granite Corporation Granite
Falls, North Carolina We have audited managements assessment, included in the accompanying Managements Annual Report On
Internal Control Over Financial Reporting, that Bank of Granite Corporation and subsidiaries (the
Company) maintained effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Because managements assessment and our audit were
conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance
Corporation Improvement Act (FDICIA), managements assessment and our audit of the Banks internal
control over financial reporting included controls over the preparation of the schedules equivalent
to the basic financial statements in accordance with the instructions for the Federal Financial
Institutions Examination Council Instructions for Consolidated Reports of Condition and Income
(Call Report instructions). The Companys management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on managements
assessment and an opinion on the effectiveness of the Companys internal control over financial
reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due
to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. 71




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In our opinion, managements assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on
the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2004, based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have not examined and, accordingly, we do not express an opinion or any other form of
assurance on managements statement referring to compliance with laws and regulations. We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements as of and for the year ended December
31, 2004 of the Company and our report dated March 10, 2005 expressed an unqualified opinion on
those consolidated financial statements. /s/ Deloitte & Touche LLP
    
    (DELOITTE AND TOUCHE LOGO)DELOITTE & TOUCHE LLPHickory, North CarolinaMarch 10, 2005
 
 ITEM 9B - OTHER INFORMATION Entry into a Material Definitive Agreement On December 13, 2004, the Board of Directors of the Bank approved changes in the Banks base
salaries paid to its named executive officers, effective January 1, 2005, as recommended by the
Board of Directors Compensation Committee. The base salaries are $311,100 for the chief executive
officer, $296,504 for the chairman, $160,000 for the chief operating officer and $135,600 for the
chief financial officer. The base salary for the chief executive officer of the Companys mortgage banking subsidiary,
Granite Mortgage, Inc., is $144,600 in accordance with the executives employment agreement. A summary of executive officer compensation is attached hereto as Exhibit 10.14 to this Annual
Report on Form 10-K. 72




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PART III 
 ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is set forth in the definitive proxy materials of the Company
filed in connection with its 2005 ANNUAL MEETING OF SHAREHOLDERS, under the captions Information
About the Board of Directors and Committees of the Board, Directors/Nominees and Nondirector
Executive Officers, Section 16(a) Beneficial Ownership Reporting Compliance, and Ethics
Policy. The information required by this item contained in such definitive proxy materials is
incorporated herein by reference. 
 ITEM 11 - EXECUTIVE COMPENSATION The information required by this item is set forth in the definitive proxy materials of the
Company filed in connection with its 2005 ANNUAL MEETING OF SHAREHOLDERS, under the captions
Summary Compensation Table, Option/SAR Grants in Last Fiscal Year, Aggregated Option
Exercises in Last Fiscal Year and Last Fiscal Year-end Option Values, Securities Authorized for
Issuance Under Equity Compensation Plans, Change-of-Control Agreements and Employment
Contracts, Compensation Committee Report on Executive Officer Compensation, and Shareholder
Performance Graph. The information required by this item contained in such definitive proxy
materials is incorporated herein by reference. 
 ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is set forth in the definitive proxy materials of the Company
filed in connection with its 2005 ANNUAL MEETING OF SHAREHOLDERS, under the captions Principal
Holders of Voting Securities, Directors/Nominees and Nondirector Executive Officers and
Securities Authorized for Issuance Under Equity Compensation Plans and Change-of-Control
Agreements and Employment Contracts. The information required by this item contained in such definitive proxy
materials is incorporated herein by reference. 
 ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is set forth in the definitive proxy materials of the
Company filed in connection with its 2005 ANNUAL MEETING OF SHAREHOLDERS, under the caption
Transactions With Officers and Directors. The information required by this item contained in
such definitive proxy materials is incorporated herein by reference. 
 ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is set forth in the definitive proxy materials of the
Company filed in connection with its 2005 ANNUAL MEETING OF SHAREHOLDERS, under the caption
Ratification of Selection of Accountants. The information required by this item contained in
such definitive proxy materials is incorporated herein by reference. 73




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PART IV 
 ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORMS 8-K * * Exhibits and Financial Statement Schedules included in or incorporated by reference into this
filing were filed with the Securities and Exchange Commission. Bank of Granite Corporation
provides these documents through its Internet site at www.bankofgranite.com or request to
Investor Relations, Bank of Granite Corporation, P.O. Box 128, Granite Falls, North Carolina
28630. a.1.
    
    Financial Statements
The information required by this item is set forth under Item 8.2.
    
    Financial Statement Schedules
The information required by this item is set forth in the Notes to Consolidated Financial
Statements under Item 8.3.
    
    Exhibits3.1
    
    Certificate of Incorporation
Bank of Granite Corporations Restated Certificate of Incorporation, as amended, filed as
Exhibit 3.1 to the Registrants Registration Statement on Form S-4 (Registration Statement
No. 333-104233) on April 1, 2003 is incorporated herein by reference.3.2
    
    Bylaws of the Registrant
Bank of Granite Corporations Bylaws, filed as Exhibit 3.2 to the Registrants Registration
Statement on Form S-4 (Registration Statement No. 333-104233) on April 1, 2003 is
incorporated herein by reference.4.
    
    Instruments defining the rights of holders4.1
    
    Form of stock certificate for Bank of Granite Corporations common stock, filed as Exhibit
4.1 to the Registrants Registration Statement on Form S-4 (Registration Statement No.
333-104233) on April 1, 2003 is incorporated herein by reference.4.2
    
    Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite
Corporation, as amended (included in Exhibit 3.1 hereto)10.
    
    Material Contracts10.1.
    
    Bank of Granite Employees Profit Sharing Plan and Trust, as amended, filed as
Exhibit 4.1 to the Registrants Registration Statement on Form S-8 (Registration Statement
No. 333-102383) on January 7, 2003, is incorporated herein by reference10.2.
    
    Bank of Granite Supplemental Executive Retirement Plan filed as Exhibit 10.2. to the
Registrants Annual Report on Form 10-K for the fiscal year ended December 31, 2000 is
incorporated herein by reference10.3.
    
    Bank of Granite Corporations 1997 Incentive Stock Option Plan, filed as Exhibit 4.1 to the
Registrants Registration Statement on Form S-8 (Registration Statement No. 333-29157) on
June 13, 1997 is incorporated herein by reference
 74




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##### Table of Contents



10.4.
    
    Amended and Restated Employment and Noncompetition Agreement, dated May 1, 2003,
between GLL & Associates, Inc and Gary L Lackey filed as Exhibit 10.4 to the Registrants
Annual Report on Form 10-K for the fiscal year ended December 31, 2003 is incorporated
herein by reference10.5.
    
    Bank of Granite Corporations 2001 Incentive Stock Option Plan, filed as Exhibit 4.1 to the
Registrants Registration Statement on Form S-8 (Registration Statement No. 333-61640) on
May 25, 2001 is incorporated herein by reference10.6.
    
    Executive Supplemental Retirement Plan Executive Agreement, dated November 15, 2001,
between the Bank and John A. Forlines, Jr. filed as Exhibit 10.6 to the Registrants Annual
Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by
reference10.7.
    
    Executive Supplemental Retirement Plan Executive Agreement, dated November 15, 2001,
between the Bank and Charles M. Snipes filed as Exhibit 10.7 to the Registrants Annual
Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by
reference10.8.
    
    Executive Supplemental Retirement Plan Executive Agreement, dated November 15, 2001,
between the Bank and Kirby A. Tyndall filed as Exhibit 10.8 to the Registrants Annual
Report on Form 10-K for the fiscal year ended December 31, 2001 is incorporated herein by
reference10.9.
    
    Change of Control Agreement, dated January 1, 2002, between the Company and
John A. Forlines, Jr. filed as Exhibit 10.9 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 is incorporated herein by reference10.10.
    
    Change of Control Agreement, dated January 1, 2002, between the Company and
Charles M. Snipes filed as Exhibit 10.10 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 is incorporated herein by reference10.11.
    
    Change of Control Agreement, dated January 1, 2002, between the Company and
Kirby A. Tyndall filed as Exhibit 10.11 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 is incorporated herein by reference10.12.
    
    Change of Control Agreement, dated June 22, 2004, between the Company and
R. Scott Anderson filed as Exhibit 10.1 to the Registrants Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004 is incorporated herein by reference10.13.
    
    Written Description of Director Compensation pursuant to
Item 601(b)(10)(iii)(A) of Regulation S-K10.14.
    
    Written Description of Executive Officer Compensation pursuant to
Item 601(b)(10)(iii)(A) of Regulation S-K
 75




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##### Table of Contents



11.
    
    Schedule of Computation of Net Income Per ShareThe information required by this item is also set forth under Item 8, Note 1. Summary
Of Significant Accounting Policies and Item 8, Note 14. Reconciliation Of Basic And
Diluted Earnings Per Share14.
    
    Ethics Policy21.
    
    Subsidiaries of the Registrant
The information required by this item is also set forth under Item 8, Note 1. Summary
Of Significant Accounting Policies23.
    
    Consent of Independent Auditors31.1
    
    Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 200231.2
    
    Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 200232.1
    
    Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    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
 76




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

/s/ Charles M. SnipesSnipes Charles M. SnipesPresident and Chief Executive
OfficerMarch 14, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated. Signature
    
    Title
    
    Date/s/ Charles M. Snipes

Charles M. Snipes
    
    President and Chief Executive Officer
    
    March 14, 2005/s/ Kirby A. Tyndall

Kirby A. Tyndall
    
    Secretary, Treasurer,
Chief Financial
Officer and Principal
Accounting Officer
    
    March 14, 2005/s/ John N. Bray

John N. Bray
    
    Director
    
    March 14, 2005/s/ Paul M. Fleetwood, III

Paul M. Fleetwood, III
    
    Director
    
    March 14, 2005/s/ John A. Forlines, Jr.

John A. Forlines, Jr.
    
    Chairman and Director
    
    March 14, 2005/s/ Barbara F. Freiman

Barbara F. Freiman
    
    Director
    
    March 14, 2005/s/ Hugh R. Gaither

Hugh R. Gaither
    
    Director
    
    March 14, 2005/s/ James Y. Preston

James Y. Preston
    
    Director
    
    March 14, 2005/s/ Charles M. Snipes

Charles M. Snipes
    
    Director
    
    March 14, 2005/s/ Boyd C. Wilson, Jr.

Boyd C. Wilson, Jr.
    
    Director
    
    March 14, 2005
 77




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##### Table of Contents



Bank of Granite Corporation 
  BeginsExhibit
    
    
    
    on Page3.1
    
    Bank of Granite Corporations Certificate of Incorporation
    
    *3.2
    
    Bank of Granite Corporations Bylaws
    
    *4.1
    
    Form of stock certificate
    
    *4.2
    
    Articles 5, 6, 7, 10 and 13 of the Restated Certificate of
Incorporation
    
    *10.1
    
    Bank of Granite Employees Profit Sharing Plan and Trust
    
    *10.2
    
    Bank of Granite Supplemental Executive Retirement Plan
    
    *10.3
    
    Bank of Granite Corporations 1997 Incentive Stock
Option Plan
    
    *10.4
    
    Amended and Restated Employment and Noncompetition
Agreement between GLL & Associates, Inc. and
Gary L. Lackey
    
    *10.5
    
    Bank of Granite Corporations 2001 Incentive Stock
Option Plan
    
    *10.6
    
    Executive Supplemental Retirement Plan Executive
Agreement between the Bank and John A. Forlines, Jr.
    
    *10.7
    
    Executive Supplemental Retirement Plan Executive
Agreement between the Bank and Charles M. Snipes
    
    *10.8
    
    Executive Supplemental Retirement Plan Executive
Agreement between the Bank and Kirby A. Tyndall
    
    *10.9
    
    Change of Control Agreement between the Company and
John A. Forlines, Jr.
    
    *10.10
    
    Change of Control Agreement between the Company and
Charles M. Snipes
    
    *10.11
    
    Change of Control Agreement between the Company and
Kirby A. Tyndall
    
    *10.12
    
    Change of Control Agreement between the Company and
R. Scott Anderson
    
    *10.13
    
    Written Description of Director Compensation
    
    Filed herewith10.14
    
    Written Description of Executive Officer Compensation
    
    Filed herewith11
    
    Schedule of Computation of Net Income Per Share
    
    Filed herewith14
    
    Ethics Policy
    
    Filed herewith21
    
    Subsidiaries of the Registrant
    
    Filed herewith23
    
    Consent of Independent Auditors
    
    Filed herewith31.1
    
    Chief Executive Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002
    
    Filed herewith31.2
    
    Chief Financial Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002
    
    Filed herewith32.1
    
    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 herewith32.2
    
    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 78