Financial Highlights                                    2008            2007          % change
(Table dollars in thousands except per share data)
Earnings
Net interest income                                  $    37,170     $    52,467          -29.2 %
Provision for loan losses                                 30,228          55,131          -45.2 %
Other income                                              10,378          13,179          -21.3 %
Other expense                                             48,974          37,001           32.4 %
Net loss                                                 (36,251 )       (15,303 )        136.9 %

Per share
Net loss
- Basic                                              $     (2.35 )   $     (0.97 )        142.3 %
- Diluted                                                  (2.35 )         (0.97 )        142.3 %

At year-end
Assets                                               $ 1,146,955     $ 1,219,148           -5.9 %
Loans                                                    948,149         946,326            0.2 %
Deposits                                                 991,822         971,989            2.0 %

Ratios
Return on average assets                                   -3.05 %         -1.27 %
Return on average equity                                  -32.01 %        -10.95 %
Average equity to average assets                            9.52 %         11.59 %
Efficiency ratio (1)                                      101.46 %         55.64 %

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

Significant Factors Affecting Earnings and Financial Position in 2008 Realizability of Net Deferred Tax Assets We use the asset and liability method of accounting for income taxes pursuant to SFAS No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under this method, deferred tax assets and liabilities are recognized based upon the expected future tax consequences of existing temporary differences between the financial reporting and the tax reporting basis of assets and liabilities using enacted statutory tax rates. Valuation allowances are recorded to reduce net deferred tax assets when it is more likely than not that a tax benefit will not be realized. The realization of these net deferred tax assets is dependent upon the generation of sufficient taxable income, the availability of prior year carry back of taxes previously paid, or the implementation of tax strategies to increase the likelihood of realization. In the fourth quarter, we considered all evidence currently available, both positive and negative, in determining whether, based on the weight of that evidence, it is more likely than not that the net deferred tax assets will be realized. For more information about the evidence that management considers, see Note 7, "Income Taxes" in the "Notes to Consolidated Financial Statements."

As described in Note 7, our management determined that, as of December 31, 2008, it was more likely than not that we would not realize the portion of our net deferred tax assets that is dependent upon the generation of future taxable income. As a result, we recorded a valuation allowance of $13.0 million against these net deferred tax assets at December 31, 2008. The valuation allowance recorded in the fourth quarter had a material effect on our financial position as of December 31, 2008 and our results of operations for 2008. It is possible that, in future periods, the uncertainties regarding our future operations and profitability could be resolved such that it could become more likely than not that these net deferred tax assets would be realized due to the generation of sufficient taxable income. If that were to occur, our management would assess the need for a reduction of the valuation allowance, which could have a material effect on our financial position and results of operations in the period of the reduction.
Valuation of Goodwill
Management believes that the accounting for goodwill and other intangible assets involves a higher degree of judgment than most other significant accounting issues. SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill. Goodwill arising from business combinations represents the value attributed to unidentifiable intangible assets in the business acquired. The Company's goodwill arises from a prior bank combination, and the Company is the reporting unit of measure.
SFAS No. 142 requires a company to perform an impairment test on goodwill annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired, by comparing the fair value of such goodwill to its recorded or carrying amount. If the carrying amount of the goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess.
We have typically evaluated goodwill for impairment during May of each year. A determination was made during May of 2008 and at September 30, 2008 that our goodwill was not impaired. These evaluations primarily relied on fair value calculations based on estimated cash flows and investor views on terminal values.
During the fourth quarter of 2008, we made an initial assessment of the goodwill by updating our prior assumptions and evaluations and concluded that the goodwill was not impaired. However, as the completion of the financial statements proceeded and the pressures on the financial services sector became more apparent, primarily evidenced by the level of our stock price, we determined it was likely that the goodwill was impaired. We then conducted fair value evaluations of the Bank's assets and liabilities and determined based on the factors cited above and the write-down of the fair value of our loans, see Note 20, "Fair Value of Financial Instruments" in the "Notes to Consolidated Financial Statements," that the value of the goodwill was impaired in the total amount of $10.8 million. Therefore, the goodwill was written off. Additional factors that significantly affected our earnings and financial position in 2008 were:
o Our 2008 provision for loan losses was $30.2 million. Of this amount, $16.8 million was recognized in the fourth quarter, resulting from the continuing deterioration in our loan portfolio, as discussed above. Nonaccruing loans increased to $50.6 million as of December 31, 2008 compared to $36.5 million as of December 31, 2007.

o Net interest income decreased $15.3 million, primarily related to multiple rate reductions by the Federal Reserve during 2008, and the continued aggressive competition for deposits in our market. Three of the Federal rate reductions in 2008 occurred during the fourth quarter. Our net interest margin was further compressed by increasing levels of nonperforming assets throughout 2008. Our net interest margin decreased 129 basis points to 3.48% in 2008 compared to 4.77% in 2007.

o Other income decreased $2.8 million, primarily related to $1.9 million in other-than-temporary impairment losses in 2008 on investments in securities available for sale, of which $1.3 million was recognized in the fourth quarter.

o Excluding goodwill impairment, other expenses, or operating overhead, increased $1.2 million compared to 2007. The Bank's increase in overhead expenses was driven by a $1.1 million increase in FDIC deposit insurance premiums and a $1.5 million increase in salaries and other expenses, partially offset by a $1.7 million decrease in employee benefit costs, which included suspension of performance based incentives and profit sharing contributions. Total overhead expenses excluding goodwill impairment decreased $1.1 million for the fourth quarter of 2008 compared to 2007, primarily in personnel expenses.

Outlook for 2009
In response to the current economic recession, the Federal Reserve cut its benchmark overnight interest rates to near zero percent in 2008, and these rates have remained steady through the first quarter of 2009. The Federal Reserve, in conjunction with the U. S. Treasury and other regulators, is moving forward with various credit market support programs intended to encourage a reduction in mortgage rates and borrowing costs for commercial banks and other business. In 2009, we plan to focus on maintaining an appropriate level of liquidity, on restoring our total risk-based capital ratio to the "well" capitalized level, on improving our asset quality by being selective regarding the loans we add and renew and by reducing our nonperforming assets, and on increasing our profitability. Although the current economic environment is relatively illiquid, we plan to continue to fund our assets, to the extent possible, with core deposits gathered in our markets. We also plan to maintain liquid assets at levels higher than our historical practices. We anticipate a continued suspension of our stock repurchase activity and our cash dividend as we work to build our capital through the retention of earnings. We expect to continue to evaluate and seek opportunities to issue new capital in the form of subordinated debt, common equity, or preferred equity securities, however current markets have limited investor demand for such offerings. We are also evaluating measures to reduce the size of our balance sheet, but there is also limited demand in the markets for the sales of assets such as securities and loans. It is also likely we will seek opportunities to reduce our asset levels relative to our capital levels by paying down our higher cost funding from deposits and borrowings. We expect to see relatively little or no loan growth in the near term as we continue our focus on credit quality, and working to resolve our problem loans. We will work to improve our profitability by taking a number of steps, to the extent possible, such as increasing our loan rates, decreasing our funding costs, reducing our loan loss provisions, increasing our fee income, and controlling our operating costs.
On February 27, 2009, the Board of Directors of the FDIC voted to amend the restoration plan for the Deposit Insurance Fund. The Board took action by imposing a special assessment on insured institutions of 20 basis points, implementing changes to the risk-based assessment system, and increasing regular premium rates for 2009, which banks must pay on top of the special assessment. The 20 basis point special assessment would be payable on September 30, 2009. On March 5, 2009, the FDIC Chairman announced that the FDIC would be willing, under certain circumstances, to lower the special assessment from 20 basis points to 10 basis points. The approval of the cutback is contingent on whether Congress passes legislation that would expand the FDIC's line of credit with the Treasury to $100 billion. Legislation to increase the FDIC's borrowing authority on a permanent basis is also expected to advance to Congress, which should aid in reducing the burden on the industry. If the 20 basis point special assessment is retained, we project we will experience an increase in FDIC assessment expense of approximately $2.0 million from 2008 to 2009. If the special assessment is lowered to 10 basis points, our increase in FDIC assessment expense will be approximately $1.0 million in 2009.
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 our accounting for securities, loans, the allowance for loan losses, goodwill and income taxes. In particular, our 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 to our consolidated financial position or consolidated results of operations. Please see the discussions below under the captions "Provisions and Allowance for Loan Losses," "Investment Securities-Valuation," "Mortgage Loans Held for Sale," "Derivatives and Hedging Activities" and "Goodwill." Also, please refer to Note 1, "Summary of Significant Accounting Policies" in the "Notes to Consolidated Financial Statements" for additional information regarding all of our critical and significant accounting policies.
PROVISIONS AND ALLOWANCE FOR LOAN LOSSES - The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to a balance considered adequate to absorb probable losses incurred in the portfolio at the date of the financial statements.
Management's determination of the adequacy of the allowance for loan loss is based on ongoing quarterly assessments of the collectibility and historical loss experience of the loan portfolio. We also evaluate other factors and trends in the economy related to specific loan groups in the portfolio, trends in delinquencies and results of periodic loan reviews.

The methodology for determining the allowance for loan losses is based on historical loss rates, current credit grades, specific allocation for impaired loans and an unallocated amount. The allowance for loan losses is created by direct charges to operations. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by management to be uncollectible. We periodically revise historical loss factors for different segments of the portfolio to be more reflective of current market conditions.
Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review for impairments. When individual loans are impaired, the impairment allowance is measured in accordance with FASB No. 114, "Accounting by Creditors for Impairment of a Loan." The predominant measurement method for the Bank is the evaluation of the fair value of the underlying collateral. Our policy for the recognition of interest income on impaired loans is the same as our interest recognition policy for all non-accrual loans. Accrued interest is reversed to income to the extent it relates to the current year and charged off otherwise.
The evaluations described above are inherently subjective, as they require the use of material estimates. Unanticipated future adverse changes in borrower or economic conditions could result in material adjustments to our allowance for loan losses that could adversely impact our earnings in future periods. INVESTMENT SECURITIES-VALUATION - Securities not classified as either held to maturity securities or trading securities, and equity securities not classified as trading securities, are classified as "available for sale securities" and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated stockholders' equity. The fair values of these securities are based on quoted market prices, dealer quotes and prices obtained from independent pricing services. Available for sale and held to maturity securities are reviewed quarterly for possible other-than-temporary impairment. The review is inherently subjective as it requires material estimates and judgments, including an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security's performance, the creditworthiness of the issuer and our intent and ability to hold the security to maturity. Declines in the fair value of the individual 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 - We originate certain residential mortgage loans with the intent to sell. Mortgage loans held for sale are reported at the lower of cost or market value on an aggregate loan portfolio basis. Gains or losses realized on sales of mortgage loans are recognized at the time of sale and are determined by the difference between the net sales proceeds and the carrying value of the loans sold, adjusted for any servicing assets or liabilities related to the loans sold. Gains and losses on sales of mortgage loans are included in other noninterest income.
DERIVATIVES AND HEDGING ACTIVITIES - We enter into derivative contracts to hedge certain assets, liabilities, and probable forecasted transactions. On the date we enter into a derivative contract, the derivative instrument is designated as:
(1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a "fair value" hedge); (2) a hedge of the variability in expected future cash flows associated with an existing recognized asset or liability or a forecasted transaction (a "cash flow" hedge); or
(3) held for other risk management purposes ("risk management derivatives"). Our primary derivative transactions involve risk management derivatives. See "Liquidity, Interest Rate Sensitivity and Market Risks" below. GOODWILL - We use a non-amortization approach to account for purchased goodwill and perform annual impairment tests, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Management has typically evaluated goodwill for impairment during May of each year. A determination was made in May of 2008 and September 30, 2008 that our goodwill was not impaired. These evaluations primarily relied on fair value calculations based on estimated cash flows and investor views on terminal values. As noted above, during the fourth quarter of 2008, we made an initial assessment of the goodwill by updating our prior assumptions and evaluations and concluded that the goodwill was not impaired. However, as the completion of the financial statements proceeded and the pressures on the financial services sector became more apparent, primarily evidenced by the level of our stock price, we determined it was likely that the goodwill was impaired. We then conducted fair value evaluations of the Bank's assets and liabilities and determined based on the factors cited above and the write-down of the fair value of our loans, see Note 20, "Fair Value of Financial Instruments" in the "Notes to Consolidated Financial Statements," that the value of the goodwill was impaired in the total amount. Therefore, the goodwill was written off.

                             2008 COMPARED TO 2007
The following table reflects the comparison of 2008 to 2007.

(Table dollars in thousands except per share amounts)      2008          2007        $ Change      % Change
Net loss                                                $ (36,251 )   $ (15,303 )   $ (20,948 )      136.9 %
Net loss per share                                          (2.35 )       (0.97 )       (1.38 )      142.3 %

Interest income                                            66,923        89,315       (22,392 )      -25.1 %
Interest expense                                           29,753        36,848        (7,095 )      -19.3 %
Net interest income                                        37,170        52,467       (15,297 )      -29.2 %

Interest and fees from loans                               57,953        77,066       (19,113 )      -24.8 %
Average gross loans
Bank                                                      939,777       916,294        23,483          2.6 %
Granite Mortgage                                           31,867        33,385        (1,518 )       -4.5 %
Consolidated                                              971,560       949,574        21,986          2.3 %

Provision for loan losses                                  30,228        55,131       (24,903 )      -45.2 %
Charge-offs, net of recoveries                             23,095        53,245       (30,150 )      -56.6 %
Nonperforming loans                                        50,705        36,612        14,093         38.5 %

Interest on securities and overnight investments            5,353         8,266        (2,913 )      -35.2 %
Average securities and overnight investments              118,672       167,457       (48,785 )      -29.1 %

Average interest-bearing deposits                         850,900       823,348        27,552          3.3 %
Average NOW deposits                                      134,919       122,345        12,574         10.3 %
Average money market deposits                             233,782       244,361       (10,579 )       -4.3 %
Average savings deposits                                   21,567        22,677        (1,110 )       -4.9 %
Average time deposits                                     460,632       433,965        26,667          6.1 %
Average deposits                                          982,463       969,911        12,552          1.3 %

Average overnight and short-term borrowings
Bank                                                       17,296        14,610         2,686         18.4 %
Granite Mortgage                                           24,910        26,809        (1,899 )       -7.1 %
Holding Company                                            24,696        27,922        (3,226 )      -11.6 %
Consolidated                                               66,902        69,341        (2,439 )       -3.5 %

Total other income                                         10,378        13,179        (2,801 )      -21.3 %
Mortgage banking income                                     3,573         3,916          (343 )       -8.8 %
Total other expenses                                       48,974        37,001        11,973         32.4 %
Personnel expenses                                         21,497        22,296          (799 )       -3.6 %
Noninterest expenses other than for personnel              27,477        14,705        12,772         86.9 %
Goodwill impairment                                        10,763             -        10,763          n/a

Income tax expense (benefit)                                4,597       (11,183 )      15,780       -141.1 %

Net interest margin                                          3.48 %        4.77 %
Average prime rate                                           5.09 %        8.05 %
Yield on loans                                               6.41 %        8.63 %
Yield on securities and overnight investments                4.51 %        4.94 %
Cost of interest-bearing deposits                            3.13 %        3.99 %

The increase in our 2008 net loss, as compared to 2007, was primarily attributable to the decline in net interest income, the inability to recognize tax benefits for operating losses which necessitated the recording of a valuation allowance for deferred tax benefits, and the impairment of goodwill, partially offset by lower provisions for loan losses, as discussed above. Our decrease in net interest income resulted from multiple interest rate reductions by the Federal Reserve during the year, the continued aggressive competition for deposits in our market, and increasing levels of nonperforming assets throughout 2008. For a discussion of our asset sensitivity and the related effects on our net interest income and net interest margin, please see "Net Interest Income" and "Liquidity, Interest Rate Sensitivity and Market Risks" below.
The decrease in interest income for 2008 was primarily because of lower yields on loans, and lower levels of investments. Loan yields for 2008 were lower than 2007 due to narrower spreads to the prime rate on loan volumes and the cessation of interest accruals on increased amounts of nonperforming loans. Mortgage rates at the end of 2008 were lower than they were at the end of 2007. The lower average levels of securities and overnight investments primarily resulted from a 2.3% growth rate in average loans, which outpaced a 1.3% growth rate in average deposits.
Our decrease in interest expense was primarily from lower rates on interest-bearing deposits and borrowings, partially offset by slightly higher volumes of interest-bearing liabilities. The decline in rates on interest-bearing deposits was primarily due to decreased rates on time deposits and money market deposits.
Mortgage banking income decreased slightly due to lower originations. The decrease in Granite Mortgage's average loans resulted from mortgage originations of $255 million in 2008 compared to $267 million in 2007. In general, the levels of mortgage origination and refinancing activities are very sensitive to changes in interest rates. Rising mortgage interest rates generally have the effect of reducing both mortgage originations and refinancings, falling mortgage interest rates generally have the effect of increasing mortgage originations and refinancings, and sustained low mortgage interest rates eventually have the effect of reducing refinancings as the demand for such refinancings becomes satisfied. Mortgage fees and origination volumes may not move together or even in the same direction because mortgage fees can vary as a function of origination volumes and/or as a function of differences in the demand for and the supply of mortgage loans in specific markets.
Based upon our evaluation of goodwill during the fourth quarter of 2008, we concluded it was likely our goodwill was impaired, and the total amount of goodwill, $10.8 million, was written off in 2008.
Salaries increased $0.9 million, or 5.5% during the year, while employee benefits decreased $1.7 million, or 31.2%, primarily related to suspension of the Bank's profit sharing contributions, a savings of $0.9 million, and . . .