Summary of BANK OF GRANITE CORP

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Disclosures About Forward Looking Statements The discussions included in Part I of this document contain statements that may be deemed forward looking statements within the meaning of the Private Securities Litigation Act of 1995, including Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from these statements. For the purposes of these discussions, any statements that are not statements of historical fact may be deemed to be forward looking statements. Such statements are often characterized by the use of qualifying words such as "expects," "anticipates," "believes," "estimates," "plans," "projects," or other statements concerning opinions or judgments of our Company and our management about future events. The accuracy of such forward looking statements could be affected by certain factors, including but not limited to, the financial success or changing conditions or strategies of our customers or vendors, fluctuations in interest rates, actions of government regulators, the availability of capital and personnel, and general economic conditions. For additional factors that could affect the matters discussed in forward looking statements, see the "Risk Factors" section in the Company's most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission. Introduction
Management's Discussion and Analysis is provided to assist in understanding and evaluating our results of operations and financial condition. The following discussion is intended to provide a general overview of our performance for the three and six-month periods ended June 30, 2009. Readers seeking more in-depth information should read the more detailed discussions below as well as the condensed consolidated financial statements and related notes included under Item 1 of this quarterly report. All information presented is consolidated data unless otherwise specified. Uncertainty and future events could cause changes in accounting estimates that have material effects on the financial position and results of operations in future periods. Overview
The Company continued to operate in a very difficult economic environment in the six months ended June 30, 2009. The unemployment rate has continued to rise throughout the Company's footprint, and the effect is evidenced in the declining ability of small businesses to service their debt. Real estate sales activity has slowed dramatically which has caused a continued decline in real estate values. Additionally, the Company has taken an aggressive position on resolving problem loan issues. Short-sale and other asset disposition activities have resulted in continued elevated credit loss costs and charge-off levels. Such activity has been significant, with a reduction of loans by approximately $75.7 million in the period.
The Company's deposit levels have remained consistent at approximately $1.0 billion throughout the period. and loan levels have decreased which has significantly improved liquidity. Additionally, the Company's operating expenses have decreased, except for FDIC assessments of $2.2 million which have more than offset the improved efficiencies.
The Company's mortgage subsidiary changed its business model in the first quarter of 2009, as previously reported, primarily because of the difficulty of funding the operation. The level of origination activity has declined throughout the period. The subsidiary reported a net loss of $1.2 million for the first six months of 2009,and the Company continues to evaluate the viability of the operation at June 30, 2009.

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Performance Summary
Our earnings decreased in both the three and six-month periods ended June 30, 2009 when compared to the same periods in 2008, primarily due to decreases in interest and fee income from loans. The decline in loan income was principally due to the continuing impact of the Federal Reserve Bank's reduction of overnight rates through January 2009 as well as higher levels of nonperforming assets. The decline in loan loss provisions was partially offset by the decrease in net interest income for the same periods compared to 2008. Income tax benefits relating to the net losses for the first two quarters of 2009 were not recorded because it is more likely than not that the tax benefits will not be realized.
During the first quarter of 2009 Granite Mortgage changed its business model from lender/seller to a broker operation primarily because of the cost of outside funding. Also, as a result of this change, a significant part of Granite Mortgage's net loss for the six months ended June 30, 2009 was attributable to severance payments and the final settlement of employment contracts.

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

                                                  Three Months
                                                 Ended June 30,
                                              2009            2008         % change

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

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

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

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

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

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

                                                   Six Months
                                                 Ended June 30,
                                              2009            2008         % change

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

The Company's loan to deposit ratio was 89.52% as of June 30, 2009 compared to 95.60% as of December 31, 2008, and the Bank's loan to deposit ratio was 87.90% compared to 93.14% when comparing the same dates.
In addition to deposits, we have overnight borrowings that are primarily in the form of commercial deposit products that sweep balances overnight into commercial paper issued by us. From December 31, 2008 to June 30, 2009, short-term borrowings decreased $20.8 million for Granite Mortgage, $4.0 million for the Bank, and $2.5 million for the holding company, partially offset by $3.1 million increase in commercial paper. The Bank's long-term borrowings from the Federal Home Loan Bank increased $17.0 million during the first six months of 2009.
Other liabilities of the Bank decreased $3.0 million related to the payout of accrued retirement benefits during the first six months of 2009.

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Liquidity, Interest Rate Sensitivity and Other Risks The objectives of our liquidity management policy include providing adequate funds to meet the cash needs of both depositors and borrowers, as well as providing funds to meet the needs of our ongoing operations. Depositor cash needs, particularly those of commercial depositors, can fluctuate significantly depending on both business and economic cycles, while both retail and commercial deposits can fluctuate significantly based on the yields and returns available from alternative investment opportunities.

Additionally, our liquidity is affected by off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. As of June 30, 2009, such unfunded commitments to extend credit were $136.7 million, and commitments in the form of standby letters of credit totaled $4.5 million.

Neither the Company nor our subsidiaries have historically incurred off-balance sheet obligations through the use of or investment in other off-balance sheet derivative financial instruments or structured finance or special purpose entities. The Bank and Granite Mortgage both had contractual off-balance sheet obligations in the form of noncancelable operating leases as of June 30, 2009, and December 31, 2008, though such obligations and the related lease expenses were not material to our financial condition on such dates or results of operations for the periods then ended.

Liquidity requirements of the Bank are primarily met through two categories of funding. The first is core deposits, which includes demand deposits, savings accounts and certificates of deposits. We consider these to be a stable portion of the Bank's liability mix and the result of ongoing consumer and commercial banking relationships. At June 30, 2009, our core deposits, defined as total deposits excluding time deposits of $100 thousand or more, totaled $773.3 million, or 79.3% of our total deposits, compared to $783.8 million, or 79.0%, of our total deposits as of December 31, 2008.

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

Prior to March 31, 2009, Granite Mortgage temporarily funded its mortgages and construction loans, from the time of origination until the time of sale, through the use of a line of credit from one of our correspondent financial institutions. As of December 31, 2008, this line of credit was $30.0 million. The line of credit was terminated and paid in full in April 2009. Granite Mortgage had intercompany borrowings with the Bank of $3.3 million outstanding at June 30, 2009, which were secured by approximately $4.4 million of loans in the Granite Mortgage portfolio.

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

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We place great significance on monitoring and managing our asset/liability position. Our policy for managing our interest margin (or net yield on interest-earning assets) is to maximize net interest income while maintaining a stable deposit base. Our deposit base is generally not subject to the level of volatility experienced in national financial markets in recent years; however, we do realize the importance of minimizing such volatility while at the same time maintaining and improving earnings. A common method used to manage interest rate sensitivity is to measure the difference or gap between the volume of interest-earning assets and interest-bearing liabilities repricing over a specific time period. However, this method addresses only the magnitude of funding mismatches and does not address the magnitude or relative timing of rate changes. Therefore, on a regular basis, we prepare earnings projections based on a range of interest rate scenarios of rising, flat and declining rates in order to more accurately measure interest rate risk.
We use interest sensitivity analysis to measure the sensitivity of projected earnings to changes in interest rates. We simulate the effects of interest rate changes on our earnings by assuming no change in interest rates as our base case scenario and either (1) gradually increasing or decreasing interest rates by 3% over a twelve-month period or (2) immediately increasing or decreasing interest rates by 1%, 2%, 3% and 4%.
These simulations indicate that net interest income will vary by less than four percent when interest rates rise or decline by 300 basis points. Results of Operations
For the Three-Month Period Ended June 30, 2009 Compared With the Same Period in 2008 and for the Six-Month Period Ended June 30, 2009 Compared With the Same Period in 2008 During the three-month period ended June 30, 2009, we incurred a net loss of $4.5 million compared to a net loss of $3.4 million for the same period of 2008. The reduction in earnings for the second quarter of 2009 compared to 2008 was primarily due to lower net interest income, a reduction of income tax benefits, and an increase in FDIC deposit insurance premiums, partially offset by lower provision for loan losses. For the first six months of 2009, we incurred a net loss of $8.7 million compared to a net loss of $1.6 million for the first six months of 2008. The increase in losses incurred for the six-month period of 2009 compared to the same period of 2008 was primarily due to lower net interest income, an increase in FDIC deposit insurance premiums and a reduction of income tax benefits, partially offset by lower provision for loan losses.

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

                                                       Three Months
                                                      Ended June 30,
(In thousands)                                   2009               2008            $ Change          % Change
Interest income                               $    13,087        $    17,072        $  (3,985 )           -23.3 %
Interest expense                                    5,582              7,190           (1,608 )           -22.4 %
Net interest income                                 7,505              9,882           (2,377 )           -24.1 %
Net interest margin                                  2.83 %             3.66 %
Yield on loans                                       5.41 %             6.54 %
Average prime rate                                   3.25 %             5.08 %
Cost of interest-bearing deposits                    2.38 %             3.02 %
Cost of interest-bearing liabilities                 2.38 %             3.07 %

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

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

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

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

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We experienced growth in our average interest-bearing deposits during the second quarter of 2009; however, our average loans decreased compared to the second quarter of 2008. Our net interest margin declined 83 basis points, primarily due to the lower loan prime interest rate in the second quarter of 2009 compared to 2008, which resulted from rate reductions by the Federal Reserve Bank, which was partially offset by a 69 basis point decrease in our funding costs. We had lower yields on our variable rate loans, and our net interest margin was further compressed from the higher levels of nonaccruing loans during the second quarter of 2009 compared to 2008.
Time deposits generally pay higher rates of interest than most other types of deposits. We believe that the increase in time deposits may be attributable in large part to higher rates on our time deposit products relative to our other deposit products. We have not historically relied upon "out-of-market" or "brokered" deposits as a significant source of funding although the reciprocal deposits we hold under the CDARS program discussed above are considered "brokered" deposits under regulations.
Our overnight borrowings are in the form of commercial paper related to the commercial deposit sweep arrangements of the Bank. Short-term borrowings from the Bank were the principal source of funding for Granite Mortgage during the second quarter of 2009.

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

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

. . .