BANK OF GRANITE CORP - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


(mark one)
[x]		Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
		For the quarterly period ended September 30, 2003
OR
[ ]		Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
		For the transition period from ___________ to _______________

Commission file number 0-15956

Bank of Granite Corporation

(Exact name of registrant as specified in its charter)


Delaware		56-1550545

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

Post Office Box 128, Granite Falls, N.C.		28630

(Address of principal executive offices)		(Zip Code)

(828) 496-2000

(Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes [x] No [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common stock, $1 par value
13,654,762 shares outstanding as of October 31, 2003

Exhibit Index begins on page 35

Index


		Begins
		on Page

Part I - Financial Information
Item 1. Financial Statements:
	Consolidated Balance Sheets September 30, 2003 and December 31, 2002		3
	Consolidated Statements of Income Three Months Ended September 30, 2003 and 2002 And Nine Months Ended September 30, 2003 and 2002		4
	Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2003 and 2002 And Nine Months Ended September 30, 2003 and 2002		5
	Consolidated Statements of Changes in Shareholders’ Equity Nine Months Ended September 30, 2003 and 2002		6
	Consolidated Statements of Cash Flows Nine Months Ended September 30, 2003 and 2002		7
	Notes to Consolidated Financial Statements		9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3. Quantitative and Qualitative Disclosures About Market Risk			31
Item 4. Controls and Procedures			31
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K			32
Signatures			34
Exhibit Index			35

Item 1. Financial Statements

Bank of Granite Corporation
Consolidated Balance Sheets
(unaudited)


		September 30,			December 31,
		2003			2002
Assets:
Cash and cash equivalents:
	Cash and due from banks	$	29,310,984		$	24,829,541
	Interest-bearing deposits		5,942,594			2,655,071
	Federal funds sold		5,400,000			5,900,000

Total cash and cash equivalents			40,653,578			33,384,612

Investment securities:
	Available for sale, at fair value		96,975,689			52,264,131
	Held to maturity, at amortized cost		62,040,819			72,660,165
Loans			694,464,512			532,921,937
Allowance for loan losses			(11,237,904	)		(8,834,611	)

Net loans			683,226,608			524,087,326

Mortgage loans held for sale			37,866,479			32,452,162

Premises and equipment, net			11,475,626			8,170,150
Accrued interest receivable			5,974,491			4,791,422
Investment in bank owned life insurance			13,185,813			9,106,748
Intangible assets			10,829,694			—
Other assets			9,415,457			5,097,958

Total assets		$	971,644,254		$	742,014,674

Liabilities and shareholders’ equity:
Deposits:
	Demand accounts	$	131,227,538		$	100,281,675
	NOW accounts		97,357,942			89,142,366
	Money market accounts		135,805,911			84,874,514
	Savings accounts		27,024,974			25,793,477
	Time deposits of $100,000 or more		161,407,344			114,696,822
	Other time deposits		175,510,444			132,460,461

	Total deposits		728,334,153			547,249,315
Overnight borrowings			18,056,913			16,720,407
Other borrowings			77,519,654			45,677,313
Accrued interest payable			1,303,375			1,189,364
Other liabilities			4,668,115			3,735,433

Total liabilities			829,882,210			614,571,832

Shareholders’ equity:
Common stock, $1 par value
	Authorized - 25,000,000 shares
	Issued - 14,980,885 shares in 2003 and 14,420,986 shares in 2002
	Outstanding - 13,673,401 shares in 2003 and 13,333,674 shares in 2002		14,980,885			14,420,986
Capital surplus			31,261,752			20,694,133
Retained earnings			117,402,595			109,982,826
Accumulated other comprehensive income, net of deferred income taxes			730,015			995,539
Less: Cost of common stock in treasury; 1,307,484 shares in 2003 and 1,087,312 shares in 2002			(22,613,203	)		(18,650,642	)

Total shareholders’ equity			141,762,044			127,442,842

Total liabilities and shareholders’ equity		$	971,644,254		$	742,014,674

See notes to consolidated financial statements.

Bank of Granite Corporation
Consolidated Statements of Income
(unaudited)


		Three Months				Nine Months
		Ended September 30,				Ended September 30,
		2003		2002		2003		2002
Interest income:
Interest and fees from loans		$	10,206,814	$	8,840,894	$	28,078,919	$	25,980,329
Interest and fees from mortgage banking			1,839,981		808,888		4,547,208		2,482,025
Federal funds sold			40,409		—		84,190		—
Interest-bearing deposits			19,092		7,986		61,740		19,855
Investments:
	U.S. Treasury		25,779		19,781		25,779		77,513
	U.S. Government agencies		699,702		730,081		1,864,889		2,558,397
	States and political subdivisions		685,510		778,117		2,110,913		2,452,703
	Other		165,622		116,719		346,695		431,087

Total interest income			13,682,909		11,302,466		37,120,333		34,001,909

Interest expense:
Time deposits of $100,000 or more			994,498		879,293		2,510,463		2,731,593
Other deposits			1,592,807		1,547,782		4,565,057		4,726,563
Overnight borrowings			52,641		150,634		159,772		544,092
Other borrowings			533,342		90,209		998,946		266,613

Total interest expense			3,173,288		2,667,918		8,234,238		8,268,861

Net interest income			10,509,621		8,634,548		28,886,095		25,733,048
Provision for loan losses			1,139,250		896,782		3,423,631		2,695,066

Net interest income after provision for loan losses			9,370,371		7,737,766		25,462,464		23,037,982

Other income:
Service charges on deposit accounts			1,402,915		1,411,872		4,173,977		3,948,605
Other service charges, fees and commissions			251,066		266,829		696,339		820,172
Mortgage banking income			2,408,487		963,729		5,823,648		2,524,568
Securities gains			297		—		12,665		3,170
Other			220,923		282,834		727,519		746,806

Total other income			4,283,688		2,925,264		11,434,148		8,043,321

Other expenses:
Salaries and wages			3,991,940		2,540,057		10,351,168		7,469,836
Employee benefits			586,163		604,374		1,848,937		1,871,252
Occupancy expense, net			344,625		228,604		843,084		672,190
Equipment expense			377,465		325,054		976,686		1,070,889
Other			1,870,113		1,319,704		4,657,078		3,844,117

Total other expenses			7,170,306		5,017,793		18,676,953		14,928,284

Income before income taxes			6,483,753		5,645,237		18,219,659		16,153,019
Income taxes			2,252,662		1,962,653		6,232,228		5,236,561

Net income		$	4,231,091	$	3,682,584	$	11,987,431	$	10,916,458

Per share amounts:
Net income - Basic		$	0.31	$	0.27	$	0.90	$	0.80
Net income - Diluted			0.31		0.27		0.89		0.80
Cash dividends			0.12		0.11		0.34		0.30
Book value							10.37		9.47

See notes to consolidated financial statements.

Bank of Granite Corporation
Consolidated Statements of
Comprehensive Income
(unaudited)


		Three Months					Nine Months
		Ended September 30,					Ended September 30,
		2003			2002		2003			2002
Net income		$	4,231,091		$	3,682,584	$	11,987,431		$	10,916,458

Items of other comprehensive income:
Items of other comprehensive income (losses), before tax:
	Unrealized gains (losses) on securities available for sale		(868,997	)		1,139,280		(403,990	)		1,481,870
	Less: Reclassification adjustments for securities gains included in net income		297			—		12,665			3,170
	Unrealized gains (losses) on mortgages held for sale		(405,023	)		—		(25,010	)		—

Items of other comprehensive income (losses), before tax			(1,274,317	)		1,139,280		(441,665	)		1,478,700
	Less: Change in deferred income taxes related to change in unrealized gains or losses on securities available for sale		(346,630	)		454,280		(166,137	)		589,620
	Less: Change in deferred income taxes related to change in unrealized gains or losses on mortgages held for sale		(162,008	)		—		(10,004	)		—

Other comprehensive income (losses), net of tax			(765,679	)		685,000		(265,524	)		889,080

Comprehensive income		$	3,465,412		$	4,367,584	$	11,721,907		$	11,805,538

See notes to consolidated financial statements.

Bank of Granite Corporation
Consolidated Statements of Changes in
Shareholders’ Equity (unaudited)


		Nine Months
		Ended September 30,
		2003			2002
Common stock, $1 par value
At beginning of period		$	14,420,986		$	11,537,515
Par value of shares issued in purchase accounting merger			543,217			—
Par value of shares issued under stock option plans			16,682			—
Transferred from capital surplus for shares issued due to stock splits			—			2,883,471

At end of period			14,980,885			14,420,986

Capital surplus
At beginning of period			20,694,133			23,577,604
Surplus of shares issued in purchase accounting merger			10,417,467			—
Surplus of shares issued under stock option plans			150,152			—
Transferred to common stock for shares issued due to stock splits			—			(2,883,471	)

At end of period			31,261,752			20,694,133

Retained earnings
At beginning of period			109,982,826			100,492,853
Net income			11,987,431			10,916,458
Cash dividends paid			(4,567,662	)		(4,114,507	)
Cash paid for fractional shares			—			(17,528	)

At end of period			117,402,595			107,277,276

Accumulated other comprehensive income, net of deferred income taxes
At beginning of period			995,539			556,648
Net change in unrealized gains or losses on securities
	available for sale, net of deferred income taxes		(250,518	)		889,080
Net change in unrealized gains or losses on mortgages held for sale, net of deferred income taxes			(15,006	)		—

At end of period			730,015			1,445,728

Cost of common stock in treasury
At beginning of period			(18,650,642	)		(11,383,304	)
Cost of common stock repurchased			(3,962,561	)		(4,964,659	)

At end of period			(22,613,203	)		(16,347,963	)

Total shareholders’ equity		$	141,762,044		$	127,490,160

Shares issued
At beginning of period			14,420,986			11,537,515
Shares issued in purchase accounting merger			543,217			—
Shares issued under stock option plans			16,682			—
Shares issued due to stock splits			—			2,883,471

At end of period			14,980,885			14,420,986

Common shares in treasury
At beginning of period			(1,087,312	)		(550,430	)
Common shares repurchased			(220,172	)		(413,357	)

At end of period			(1,307,484	)		(963,787	)

Total shares outstanding			13,673,401			13,457,199

See notes to consolidated financial statements.

Bank of Granite Corporation
Consolidated Statements of Cash Flows
(unaudited)


			Nine Months
			Ended September 30,
			2003			2002
Increase (decrease) in cash & cash equivalents:
Cash flows from operating activities:
	Net Income		$	11,987,431		$	10,916,458
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation		641,251			776,755
		Provision for loan loss		3,423,631			2,695,066
		Investment security premium amortization, net		298,536			89,020
		Acquisition discount accretion, net		(100,944	)		—
		Deferred income taxes		(85,769	)		(832,224	)
		Gains on sales or calls of securities available for sale		(2,278	)		(3,170	)
		Gains on calls of securities held to maturity		(9,965	)		—
		Losses (gains) on disposal or sale of equipment		(38,255	)		1,986
		Losses on disposal or sale of other real estate		33,858			9,293
		Increase in taxes payable		55,160			126,657
		Increase in accrued interest receivable		(581,539	)		(126,828	)
		Decrease in accrued interest payable		(327,113	)		(621,054	)
		Increase in cash surrender value of bank owned life insurance		(314,573	)		(280,230	)
		Increase in other assets		(2,189,745	)		(1,458,504	)
		Increase (decrease) in other liabilities		(2,159,461	)		11,132,554

		Net cash provided by operating activities		10,630,225			22,425,779

Cash flows from investing activities:
	Proceeds from maturities, calls and paydowns of securities available for sale			22,932,567			20,322,750
	Proceeds from maturities, calls and paydowns of securities held to maturity			10,549,425			13,747,875
	Proceeds from sales of securities available for sale			812,635			56,599
	Purchase of securities available for sale			(41,848,999	)		(11,021,062	)
	Net increase in loans			(48,998,095	)		(30,904,604	)
	Net increase in mortgage loans held for sale			(5,083,116	)		(1,844,459	)
	Unrealized gains on hedged mortgage loan commitments			(356,212	)		(84,283	)
	Unrealized hedging losses on contracts to sell mortgage-backed securities			—			48,962
	Investment in bank owned life insurance			—			(430,000	)
	Capital expenditures			(1,412,647	)		(368,059	)
	Proceeds from sale of fixed assets			235,909			917
	Proceeds from sale of other real estate			243,854			97,197
	Cash received in acquisition, net of cash paid			13,272,682			—

		Net cash used in investing activities		(49,651,997	)		(10,378,167	)

Cash flows from financing activities:
	Net increase in demand, NOW, money market and savings deposits			37,514,254			32,708,932
	Net increase (decrease) in time deposits			11,522,294			(17,735,160	)
	Net increase (decrease) in overnight borrowings			1,000,549			(12,863,909	)
	Net increase in other borrowings			4,617,030			1,195,866
	Net proceeds from shares issued under stock option plans			166,834			—
	Dividends paid			(4,567,662	)		(4,114,507	)
	Purchases of common stock for treasury			(3,962,561	)		(4,964,659	)
	Cash paid in lieu of issuing fractional shares			—			(17,528	)

		Net cash provided by (used in) financing activities		46,290,738			(5,790,965	)

Net increase in cash equivalents				7,268,966			6,256,647
Cash and cash equivalents at beginning of period				33,384,612			27,058,013

Cash and cash equivalents at end of period			$	40,653,578		$	33,314,660

See notes to consolidated financial statements.
(continued on next page)

Bank of Granite Corporation
Consolidated Statements of Cash Flows
(unaudited) - (concluded)


		Nine Months
		Ended September 30,
		2003			2002
Supplemental disclosure of non-cash transactions:
	Increase (decrease) in unrealized gains or losses on securities available for sale	$	(416,655	)	$	1,478,700
	Increase (decrease) in deferred income taxes on unrealized gains or losses on securities available for sale		(166,137	)		589,620
	Decrease in unrealized gains or losses on mortgages held for sale		(25,010	)		—
	Decrease in deferred income taxes on unrealized gains or losses on mortgages held for sale		(10,004	)		—
	Transfer from surplus to common stock for stock split		—			2,883,471
	Transfer from loans to other real estate owned		2,134,038			910,825

See notes to consolidated financial statements.

Bank of Granite Corporation
Notes to Consolidated Financial Statements
September 30, 2003

1. UNAUDITED FINANCIAL STATEMENTS

The consolidated balance sheet as of September 30, 2003, the consolidated statements of income and comprehensive income for the three and nine month periods ended September 30, 2003 and 2002, and the consolidated statements of changes in shareholders’ equity and cash flows for the nine month periods ended September 30, 2003 and 2002 are unaudited and reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the interim period financial statements.

The unaudited interim consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These interim consolidated financial statements should be read in conjunction with the Company’s December 31, 2002 audited consolidated financial statements and notes thereto included in the Company’s 2002 Annual Report on Form 10-K.

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

The financial statements for the period ended September 30, 2003 reflect the activities of First Commerce Corporation acquired in July 2003. (See Note 5)

The accounting policies followed are set forth in Note 1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 on file with the Securities and Exchange Commission. There were no changes in significant accounting policies during the nine months ended September 30, 2003.

2. EARNINGS PER SHARE

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

Three Months

Nine Months

Ended September 30,

(in shares)

2003

2002

2003

2002

Weighted average shares outstanding

13,617,019

13,494,158

13,369,884

13,594,635

Potentially dilutive effect of stock options

75,391

7,474

67,136

4,758

Weighted average shares outstanding, including potentially dilutive effect of stock options

13,692,410

13,501,632

13,437,020

13,599,393

(continued on next page)

Bank of Granite Corporation
Notes to Consolidated Financial Statements (continued)
September 30, 2003

3. COMMITMENTS AND CONTINGENCIES

In the normal course of business there are various commitments and contingent liabilities such as commitments to extend credit, which are not reflected on the financial statements. Management does not anticipate any significant losses will result from these transactions. The unfunded portion of loan commitments and standby letters of credit as of September 30, 2003 and December 31, 2002 were as follows:

September 30,

December 31,

2003

2002

Financial instruments whose contract amounts represent credit risk

Unfunded commitments

121,823,448

87,675,231

Letters of credit

6,440,629

6,664,731

Financial instruments whose notional or contract amounts are intended to hedge against interest rate risk

Forward commitments and options to sell mortgage-backed securities

21,931,185

17,981,335

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

Managed risk includes the risk associated with changes in interest rates associated with mortgage loans held for sale. In accordance with our risk management policy, such risk is hedged by entering into forward sale instruments. The instruments designated in these fair value hedges include forward sale agreements that are carried at market value with all changes in fair value recorded as adjustments to the basis of the hedged borrowings based on changes in the fair value of the derivative instrument with changes in the fair value of the hedging instrument and the hedged item being recorded in the Company’s statement of income in accordance with SFAS No. 133.

4. STOCK-BASED COMPENSATION

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the underlying effect of the method used on reported results until exercised.

(continued on next page)

Bank of Granite Corporation
Notes to Consolidated Financial Statements (continued)
September 30, 2003

The Company accounts for compensation costs related to the Company’s employee stock option plan using the intrinsic value method. 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 would have been as follows:


		Three Months						Nine Months
		Ended September 30,						Ended September 30,
		2003			2002			2003			2002
Net income as reported		$	4,231,091		$	3,682,584		$	11,987,431		$	10,916,458
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(40,855	)		(15,668	)		(122,565	)		(31,337	)

Pro forma net income		$	4,190,236		$	3,666,916		$	11,864,866		$	10,885,121

Net income per share as reported - Basic		$	0.31		$	0.27		$	0.90		$	0.80
	- Diluted		0.31			0.27			0.89			0.80
Pro forma net income per share - Basic			0.31			0.27			0.89			0.80
	- Diluted		0.31			0.27			0.88			0.80

The Company computes its estimation of option compensation expense associated with the fair value method using The Black Scholes Model. The following assumptions were used:


	2003			2002
Option value, aggregate	$	8.52		$	6.68
Risk-free rate		3.35	%		2.92	%
Average expected term (years)		6.1 years			5.6 years
Expected volatility		43.35	%		44.63	%
Expected dividend yield		2.56	%		2.28	%
Expected turnover		7.91	%		2.07	%

5. MERGER

On July 15, 2003, the Company completed its acquisition of First Commerce Corporation (“First Commerce”) of Charlotte, North Carolina. First Commerce was merged into the Bank and will be operated as part of the Bank. At the date of the acquisition, First Commerce operated three banking offices and had total assets of approximately $172,568,000, loans of approximately $113,565,000 and deposits of approximately $132,048,000.

Under the terms of the acquisition agreement, the Company issued 543,217 shares of common stock and paid $9,829,749 in cash to acquire all of the outstanding common stock of First Commerce.

(continued on next page)

Bank of Granite Corporation
Notes to Consolidated Financial Statements (continued)
September 30, 2003

The transaction was accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of First Commerce were recorded based on preliminary estimates of fair values of such assets and liabilities at July 15, 2003. The consolidated financial statements include the results of operations of First Commerce since July 15, 2003. Although management does not expect that the preliminary estimates of fair value will change significantly, subsequent information received may result in an adjustment to these estimates.

On June 30, 2003, the Company obtained an unsecured three-year line of credit from one of the Bank’s correspondent banks to fund the cash portion of the consideration to be paid in the Company’s acquisition of First Commerce Corporation. 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 September 30, 2003, the Company had not borrowed any funds against this line of credit because the Company had sufficient liquidity to pay the cash portion of the merger consideration. The estimated fair values of the assets acquired and liabilities assumed at the date of acquisition are as follows:

The estimated fair values of the assets acquired and liabilities assumed at the date of acquisition are as follows:


	July 15, 2003
Assets
Cash and cash equivalents	$	23,102,431
Investment securities		27,240,788
Loans		113,564,818
Premises and equipment		2,731,734
Intangible assets		10,858,332
Other assets acquired		5,927,891

Total assets acquired	$	183,425,994

Liabilities
Deposits	$	132,048,290
Borrowed funds		27,561,268
Other liabilities		3,026,003

Total liabilities assumed		162,635,561

Net Assets Acquired and Purchase Price	$	20,790,433

The portion of the purchase price allocated to intangible assets is presented below:


	July 15, 2003
Purchase price	$	20,790,433
Fair value of net tangible assets acquired		10,180,862

Excess of purchase price over fair value of net tangible assets acquired		10,609,571
Less: Core deposit intangible		630,013
Deferred income taxes		(248,761	)

Core deposit intangible, net of deferred taxes		381,252

Goodwill recorded		10,228,319

Direct acquisition costs		673,364
Deferred income taxes		(54,328	)

Goodwill generated	$	10,847,355

(continued on next page)

Bank of Granite Corporation
Notes to Consolidated Financial Statements (continued)
September 30, 2003

The intangible assets consist of goodwill and a core deposit intangible. The core deposit intangible represents $630,013 of the intangible assets and is being amortized over ten years.

The following unaudited pro forma financial information presents the combined results of operations of the Company and First Commerce as if the merger had occurred as of the beginning of the period for each period presented. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and First Commerce constituted a single entity during such periods.

Three Months

Nine Months

Ended September 30,

2003

2002

2003

2002

Net interest income

14,052,211

13,599,730

41,725,466

40,482,344

Other income

4,324,595

3,180,264

12,124,962

8,754,321

Net income

3,081,319

4,332,360

11,342,056

12,090,570

Net income per common share - Basic

0.22

0.31

0.82

0.86

- Diluted

0.22

0.31

0.82

0.85

5. NEW ACCOUNTING STANDARDS

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This interpretation expands the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees and requires the guarantor to recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to guarantees. In general, FIN 45 applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying that is related to an asset, liability, or equity security of the guaranteed party. Certain guarantee contracts are excluded from both the disclosure and recognition requirements of this interpretation, including, among others, guarantees relating to employee compensation, residual value guarantees under capital lease arrangements, commercial letters of credit, loan commitments, subordinated interests in an SPE, and guarantees of a company’s own future performance. Other guarantees are subject to the disclosure requirements of FIN 45 but not to the recognition provisions and include, among others, a guarantee accounted for as a derivative instrument under SFAS No. 133, a parent’s guarantee of debt owed to a third party by its subsidiary or vice versa, and a guarantee which is based on performance not price. The disclosure requirements of FIN 45 are effective for the Company as of December 31, 2002, and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. The recognition requirements of FIN 45 are to be applied prospectively to guarantees issued or modified after December 31, 2002. Significant guarantees that have been entered into by the Company are disclosed in Note 3. The adoption of FIN 45 did not have a material impact on results of operations or financial position.

(continued on next page)

Bank of Granite Corporation
Notes to Consolidated Financial Statements (concluded)
September 30, 2003

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin 51—Consolidated Financial Statements to those entities (defined as “Variable Interest Entities” or “VIE’s”) in which equity investors do not have the characteristics of a “controlling financial interest” or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires consolidation of VIE’s by the Primary Beneficiary. The Primary Beneficiary is defined as the party who has exposure to the majority of the expected losses and/or expected residual returns of the VIE. This interpretation applies immediately to all VIE’s created after January 31, 2003, and no later than the end of the first interim or annual reporting period ending after December 15, 2003 for VIE’s created prior to February 1, 2003. The Company’s preliminary assessment under FIN 46 reflects that the statutory business trusts (First Commerce Capital Trust I) created to issue trust preferred securities will no longer be consolidated entities. This should have an insignificant impact on the financial statements and the Federal Reserve Board has indicated that these instruments will continue to be eligible for inclusion in Tier I capital under the capital adequacy standards. The evaluation of the effect of FIN 46 on the Company’s financial statements is continuing but no material impact on the consolidated results of operations or consolidated financial condition of the Company is expected.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 clarifies the conditions under which a contract with an initial net investment meets the characteristic of a derivative; clarifies when a derivative contains a financing component; amends the definition of “an underlying” to conform it to language used in FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others;” and amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified by the Company after June 30, 2003. All provisions of this Statement will be applied prospectively. The application of this Statement is not expected to have a material effect on the Company’s results of operations or financial position.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. It clarifies when an issuer must classify certain financial instruments as liabilities (or as assets, in some circumstances), rather than including them within stockholders’ equity or separately classifying them as mezzanine equity. This Statement was effective for the Company for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for the Company in the third quarter of 2003. The Company has not issued any financial instruments within the scope of SFAS No. 150; therefore, the application of SFAS No. 150 is not expected to affect the Company’s results of operations, financial position or disclosures.

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

Critical Accounting Policies

The accounting and reporting policies of the Company and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The critical accounting and reporting policies include the Company’s accounting for securities and the allowance for loan losses. In particular, the Company’s accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position or consolidated results of operations. Please see the discussions below under the captions “Provisions and Allowance for Loan Losses” and “Investment Securities Available for Sale.” Also, please refer to Note 1 in the “Notes to Consolidated Financial Statements” under Item 8, “Financial Statements & Supplementary Data” in the Company’s “Annual Report for the year ended December 31, 2002 on Form 10-K on file with the Securities and Exchange Commission for additional information regarding all of the Company’s 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 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 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 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. 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.

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 includes 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. This review is inherently subjective as it requires material estimates regarding credit quality and assumptions regarding future interest rates. Unanticipated future adverse changes in credit conditions or significantly higher sustained interest rates could result in material adjustments to the value of the security that could adversely impact earnings in future periods should the security become uncollectible or have to be sold after a decline in its value.

Recent Acquisition

On July 15, 2003, the Company completed its merger with First Commerce Corporation (“First Commerce”) 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 merger agreement, as amended on January 22, 2003, 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 $11,229,000 in intangible assets.

Changes in Financial Condition

September 30, 2003 Compared With December 31, 2002

Total assets increased $229,629,580, or 30.95%, from December 31, 2002 to September 30, 2003. Assets increased $58,588,012, or 7.90%, excluding assets of $171,041,568 acquired in the First Commerce merger. Earning assets increased $203,836,627, or 29.17%, over the same nine month period, of which $161,995,357 were from the First Commerce acquisition. As reflected in the table below, loans, the largest earning asset, increased $161,542,575, or 30.31%, over the same period, primarily because of a $159,610,110, or 30.21%, increase as of September 30, 2003 in loans of the Bank and a $1,669,087, or 34.86%, increase in the level of construction and bridge loans of GLL. Loans grew $47,201,817, or 8.86%, excluding loans of $114,340,758 acquired from First Commerce Bank. Mortgage loans held for sale by GLL increased by $5,677,695, or 17.64%, as of September 30, 2003, due to higher mortgage origination and refinancing activities relative to December 31, 2002, primarily because of favorable mortgage interest rates. Investment securities increased $34,092,212, or 27.29%, including $27,240,789 acquired in the First Commerce merger. Cash and cash equivalents increased $7,268,966, or 21.77%. Cash and cash equivalents acquired from First Commerce were $23,102,431, the majority of which has been reinvested in available for sale securities. The Company’s investment in bank owned life insurance increased $4,079,065, or 44.79%, primarily due to bank owned life insurance of $3,764,492 acquired in the First Commerce acquisition. The increase of $10,829,694 in intangible assets was entirely attributable to the acquisition. Also during this period, other assets increased $4,317,499, or 84.69%, of which $1,800,897 was due to an increase in foreclosed and repossessed properties and $808,457 was attributable to deferred tax assets recorded in connection with the purchase accounting for the acquisition of First Commerce.

Loans at September 30, 2003 and December 31, 2002 were as follows:


	September 30,			December 31,
	2003			2002
Real estate - Construction	$	83,783,427		$	75,382,555
Real estate - Mortgage		353,979,511			245,496,076
Commercial, financial and agricultural		219,843,233			175,408,637
Consumer		36,972,957			37,045,878
All other loans		757,560			449,251

		695,336,688			533,782,397
Deferred origination fees, net		(872,176	)		(860,460	)

Total loans	$	694,464,512		$	532,921,937

Mortgage loans held for sale	$	37,866,479		$	32,452,162

The asset growth was funded by a combination of growth in deposits and other borrowings, acquired deposits and other borrowings, and earnings retained. Deposits increased $181,084,838, or 33.09%, from December 31, 2002 to September 30, 2003, including $133,032,423 acquired in the First Commerce merger. Excluding the acquired deposits, total deposits increased $48,052,415, or 8.78%. Over the same nine month period, noninterest-bearing demand deposits increased $30,945,863, or 30.86%, while interest-bearing demand deposits increased $59,146,973, or 33.99%. Noninterest-bearing and interest-bearing demand deposits acquired in the First Commerce merger were $30,376,231 and $21,453,573, respectively. Excluding the noninterest-bearing and interest-bearing demand deposits acquired from First Commerce, noninterest-bearing deposit growth was flat, while interest-bearing demand deposits increased $37,693,400, or 21.66%. The increase in interest-bearing demand deposits reflected a $8,215,576, or 9.22%, increase in NOW account deposits and a $50,931,397, or 60.01%, increase in money market deposits, of which $5,769,930 and $15,683,643, respectively, were acquired from First Commerce. Excluding the acquired money market deposits, such accounts increased $35,247,754 primarily because of continued growth in the Bank’s premium money market product. Savings deposits increased $1,231,497, or 4.77%, from December 31, 2002 to September 30, 2003. Excluding the $3,944,077 in savings deposits acquired from First Commerce, savings balances declined $2,712,580 during the nine month period. Time deposits increased $89,760,505, or 36.32%, from December 31, 2002 to September 30, 2003, of which $77,258,542 were acquired in the merger with First Commerce. Excluding time deposits acquired from First Commerce, time deposits grew $12,501,963, or 5.06%. Time deposits greater than $100,000 increased $46,710,522, or 40.73%, $39,856,717 of which were related to First Commerce, while other time deposits increased $43,049,983, or 32.50%, including $37,401,825 related to the merger. The Company’s loan to deposit ratio was 95.35% as of September 30, 2003 compared to 97.38% as of December 31, 2002, while the Bank’s loan to deposit ratio was 92.11% compared to 93.79% when comparing the same periods. As of the merger date, First Commerce had a loan to deposit ratio of 87.37%.

The Company has sources of funding, in addition to deposits, in the form of overnight and other short-term borrowings as well as other longer-term borrowings. Overnight borrowings are primarily in the form of federal funds purchased and commercial deposit products that sweep balances overnight into securities sold under agreements to repurchase or commercial paper issued by the Company. From December 31, 2002 to September 30, 2003, such overnight borrowings increased $1,336,506, or 7.99%, reflecting an increase of $1,236,035, or 8.23%, in commercial paper. Other borrowings increased $31,842,341, or 69.71%, which included borrowings of $27,000,000 from the First Commerce acquisition and an increase of $4,633,809, or 13.76%, in temporary borrowings by GLL primarily due to higher mortgage origination activity, particularly in the first seven months of the year.

Common stock outstanding increased 339,727 shares, or 2.55%, from December 31, 2002 to September 30, 2003, due to 543,217 shares issued in connection with the First Commerce acquisition and 16,682 shares issued in connection with the exercise of stock options, partially offset by 220,172 shares repurchased under the Company’s stock repurchase plan. Earnings retained were $7,419,769 for the first nine months of 2003, after paying cash dividends of $4,567,662. Accumulated other comprehensive income, net of deferred income taxes, decreased $265,524, or 26.67%, from December 31, 2002 to September 30, 2003, primarily because the value of securities available for sale and mortgages held for sale declined when longer term interest rates rose during the period.

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 September 30, 2003 such unfunded commitments to extend credit were $121,823,448, while commitments in the form of standby letters of credit totaled $6,440,629.

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 exchange 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 the its subsidiaries, principally the Bank. Because such dividend payments have the effect of reducing the 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.

In 2002, GLL changed the method in which it manages its mortgage loans in process. Prior to the change, as GLL committed to or locked in a mortgage rate with a customer, GLL would concurrently obtain a commitment from a institutional buyer to buy the mortgage upon its closing 30 to 45 days thereafter. Effective in late September 2002, GLL began waiting until the mortgage loan closes to arrange for the sale of the mortgage loan. This method allows GLL to bundle mortgage loans and obtain better pricing compared with the sale of individual mortgage loans. However, this method also introduces interest rate risk to GLL’s loans in process since rates may fluctuate subsequent to GLL’s rate commitment to the mortgage customer. In order to minimize the risk that interest rates may move against GLL subsequent to the rate commitment, GLL 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, GLL then buys the mortgage-backed security, thereby completing the hedge contract. GLL classifies all of its hedge contracts in accordance with SFAS No. 133 as a hedge of an exposure to changes in cash flows from a recorded asset or liability, referred to as a “cash flow” hedge. As of September 30, 2003, GLL held approximately $21,201,000 in open mortgage loan commitments with an estimated market value of approximately $21,557,000, an unrealized gain of approximately $356,000. Also as of September 30, 2003, GLL held approximately $21,931,000 in open mortgage-backed security commitments with an estimated market value of approximately $21,544,000, an unrealized loss of approximately $387,000. For the quarterly period ended September 30, 2003, there were realized losses on hedged mortgage loan commitments of $363,839 and realized gains of $487,439 on commitments to sell mortgage-backed securities.

Through its acquisition of First Commerce Corporation, 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 in an effort 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 and capital trust discussed above, 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 GLL both had contractual off-balance sheet obligations in the form of noncancelable operating leases with unrelated vendors, though such obligations and the related lease expenses were not material to the Company’s financial condition as of September 30, 2003 and December 31, 2002 or its 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. The Bank considers these to be a stable portion of the Bank’s liability mix and the result of on-going stable consumer and commercial banking relationships. At September 30, 2003, the Bank’s core deposits, defined as total deposits excluding time deposits of $100,000 or more, totaled $566,926,809, or 77.8%, of the Bank’s total deposits compared to $432,552,493, or 79.0%, of the Bank’s total deposits as of December 31, 2002.

The other principal methods of funding used by the Bank are large denomination certificates of deposit, federal funds purchased, repurchase agreements and other short and intermediate term borrowings. The Bank’s policy is to emphasize core deposit growth rather than growth through purchased or brokered time deposits because core deposits tend to be a more stable source of funding and purchased or brokered time deposits often have a higher cost of funds. During periods of weak demand for its deposit products, the Bank maintains several credit facilities under which it may borrow on a short-term basis. As of September 30, 2003, 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 September 30, 2003, the Bank had investment securities pledged to secure an overnight funding line of approximately $8,003,000 with the Federal Reserve Bank. The Bank also has significant capacity to pledge its loans secured by first liens on residential and commercial real estate as collateral for additional borrowings from the Federal Home Loan Bank during periods when loan demand exceeds deposit growth or when the interest rates on such borrowings compare favorably to interest rates on deposit products. As of September 30, 2003, the Bank had a line of credit in the amount of $37,917,000, which was collateralized by loans secured by first liens on residential real estate.

GLL temporarily funds its mortgages, from the time of origination until the time of sale, through the use of a warehouse line of credit from one of the Company’s correspondent financial institutions. GLL requests changes in the amount of the line of credit based on its estimated funding needs. As of September 30, 2003, the line was secured by $50,000,000 of the mortgage loans originated by GLL. The Company serves as guarantor under the terms of this line. As of September 30, 2003 and December 31, 2002, this line of credit was $50,000,000 and $30,000,000, respectively.

The majority of the Company’s deposits are rate-sensitive instruments with rates that 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 maximize net interest income while maintaining a stable deposit base. The Company’s deposit base is not generally subject to the level of volatility experienced in national financial markets in recent years; however, the Company does 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, 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.

Management uses interest sensitivity analysis to measure the sensitivity of projected earnings to changes in interest rates. The sensitivity analysis takes into account the current contractual agreements that the Company has on deposits, borrowings, loans, investments and any commitments to enter into those transactions. Management monitors interest sensitivity by means of computer models that incorporate the current volumes, average rates, scheduled maturities and payments and repricing opportunities of asset and liability portfolios. Using this information, the model estimates earnings based on projected portfolio balances under multiple interest rate scenarios. In an effort to estimate the effects of pure interest-rate risk, the Company assumes no growth in its balance sheet, because to do so could have the effect of distorting the balance sheet’s sensitivity to changing interest rates. The Company simulates the effects of interest rate changes on its earnings by assuming no change in interest rates as its base case scenario and either (1)

gradually increasing or decreasing interest rates by 3% over a twelve-month period or (2) immediately increasing or decreasing interest rates by 1%, 2%, 3% and 4%, as discussed below. Although these methods are subject to the accuracy of the assumptions that underlie the process and do not take into account the pricing strategies that management would undertake in response to sudden interest rate changes, the Company believes that these methods provide a better indication of the sensitivity of earnings to changes in interest rates than other analyses.

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

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

The Company has not experienced a change in the mix of its rate-sensitive assets and liabilities or in interest rates in the market that it believes would result in a material change in the Company’s analysis of its interest rate sensitivity as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Results of Operations

For the Three Month Period Ended September 30, 2003 Compared With
the Same Period in 2002 and for the Nine Month Period Ended
September 30, 2003 Compared With the Same Period in 2002

During the three month period ended September 30, 2003, the Company’s net income increased to $4,231,091, or 14.89%, from the $3,682,584 earned in the same period of 2002. The increase primarily resulted from higher mortgage and net interest income partially offset by higher overhead expenses. For essentially the same reasons, year-to-date net income was also higher. For the first nine months of 2003, net income was $11,987,431, up $1,070,973, or 9.81%, from the $10,916,458 earned in the same year-to-date period of 2002.

Net Interest Income for the Quarterly Periods

During the three month period ended September 30, 2003, the Company’s net interest income increased $1,875,073, or 21.72%, compared to the three months ended September 30, 2002, primarily due to higher volumes of interest-earning assets and interest-bearing liabilities resulting from the Company’s acquisition of First Commerce Bank. Although the volumes of interest-earning assets were significantly higher, the net interest margin on the assets acquired was lower than that of the Company prior to the merger. The Company’s net interest margin averaged 4.82% during the three month period compared to 5.44% during the same period in 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 “Liquidity, Interest Rate Sensitivity and Market Risks” above.

During the quarter ended September 30, 2003, interest income increased $2,380,443, or 21.06%, from the same period last year, primarily because of higher volumes of loan and investment assets from higher mortgage origination activity in GLL and assets acquired in the First Commerce acquisition, partially offset by reduced interest income due to lower rates on loans and investments in general. Interest and fees on loans increased $1,365,920, or 15.45%, primarily due to higher average volumes during the quarter resulting from greater mortgage origination activity and loans acquired from First Commerce. Yields on loans averaged 5.63% for the quarter, down from 6.62% for the same quarter last year. The prime lending rate during the three month period averaged 4.06% compared to 4.75% during the same period in 2002. Gross loans averaged $719,344,132 compared to $529,895,252 last year, an increase of $189,448,880, or 35.75%. Average loans of the Bank were $664,057,961 compared to $509,100,750 last year, an increase of $154,957,211, or 30.44%, while average loans of GLL were $55,286,171 compared to $20,794,502 last year, an increase of $34,491,669, or 165.87%. 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. The Bank acquired loans of approximately $114,341,000 in its First Commerce acquisition on July 15, 2003. Average securities and overnight investments were $176,516,502 compared to $130,733,212 last year, an increase of $45,783,290, or 35.02%, also due primarily to the acquisition.

Interest expense increased $505,370, or 18.94%, because of higher volumes of interest-bearing deposits and other borrowings, mostly resulting from the deposits and borrowings acquired in the First Commerce Bank acquisition, partially offset by lower rates on interest-bearing liabilities. Overall, rates on interest-bearing deposits averaged 1.74% for the quarter, down from 2.24% for the same quarter last year. Total interest-bearing deposits averaged $590,251,791 compared to $429,984,225 last year, an increase of $160,267,566, or 37.27%, which was significantly attributable, in all deposit categories, to the interest-bearing deposits of approximately $102,656,000 acquired in the First Commerce transaction. Savings, NOW and money market deposits averaged $253,466,107 compared to $162,282,688 last year, an increase of $91,183,419, or 56.19%. NOW account deposits averaged $97,732,619 compared to $82,355,536 last year, an increase of $15,377,083, or 18.67%. NOW account deposits of approximately $5,770,000 relate to the First Commerce acquisition. Money market deposits averaged $128,218,552 compared to $52,844,972 last year, an increase of $75,373,580, or 142.63%. Money market deposits of approximately $15,684,000 were acquired in the First Commerce acquisition. Time deposits averaged

$332,554,916 compared to $267,701,537 last year, an increase of $64,853,379, or 24.23%. Time deposits acquired in the First Commerce transaction were approximately $77,259,000. Overnight and other borrowings averaged $99,198,694 compared to $47,607,208 last year, an increase of $51,591,486, or 108.37%, due to an increase of $33,282,936, or 194.51%, in temporary borrowings of GLL primarily due to higher mortgage origination activity. and an increase of $16,331,006, or 99.96%, in average overnight and other borrowings of the Bank. Overnight borrowings averaged $18,006,303 compared to $30,495,983 last year, a decrease of $12,489,680, or 40.96%, reflecting a decrease of $14,467,224, or 88.55%, 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 $1,977,544, or 13.97%, in average overnight borrowings in the form of commercial paper related to the commercial deposit sweep arrangements of the Bank. Other borrowings averaged $81,192,391 compared to $17,111,225 last year, an increase of $64,081,166, or 374.50%, reflecting an increase of $30,798,230 in average borrowings of the Bank and an increase of $33,282,936, or 194.51%, in temporary borrowings of GLL primarily due to higher mortgage origination activity. Other borrowings were the principal source of funding for the mortgage origination activities of GLL. The increase in the other borrowings of the Bank is largely due to the other borrowings of approximately $27,000,000 that were acquired in the First Commerce transaction. The Company has not historically relied upon “out-of-market” or “brokered” deposits as a significant source of funding. The brokered deposits acquired in the First Commerce transaction were paid out during the third quarter.

Net Interest Income for the Year-to-Date Periods

For substantially the same reasons as during the third quarter, the Company’s net interest income increased $3,153,047, or 12.25%, during the nine month period ended September 30, 2003 compared to the same period in 2002. This increase was primarily because increases in net interest income from new volumes was only partially offset by lower net interest income resulting from lower interest rates. The Company’s net interest margin averaged 5.18% for the year-to-date period, down from 5.47% for the same period last year. 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 “Liquidity, Interest Rate Sensitivity and Market Risks” above.

As was the case for the third quarter, higher volumes led to higher interest income for the nine month period ended September 30, 2003. During the first nine months of 2003, interest income increased $3,118,424, or 9.17%, from the same period last year primarily because the growth in interest income from higher volumes of commercial and mortgage loans 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 $2,098,590, or 8.08%, due to higher average volumes and rates during the year-to-date period. Yields on loans averaged 5.97% for the year-to-date period, down from 6.70% for the same period last year. The prime rate during the nine month period averaged 4.17% compared to 4.76% during the same period in 2002. Gross loans averaged $628,368,352 compared to $518,470,314 last year, an increase of $109,898,038, or 21.20%. Average loans of the Bank were $583,533,227 compared to $498,751,722 last year, an increase of $84,781,505, or 17.00%, while average loans of GLL were $44,835,125 compared to $19,718,592 last year, an increase of $25,116,533, or 127.37%. 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 decreased $1,045,349, or 18.87%, due to lower average yields earned during the period. Average securities and overnight investments were $147,281,014 compared to $143,071,890 last year, an increase of $4,209,124, or 2.94%.

Interest expense decreased $34,623, or 0.42%, primarily because lower interest expense from lower rates on interest-bearing deposits and other borrowings was almost completely offset by higher interest expense from higher volumes of interest-bearing liabilities. Rates on interest-bearing deposits averaged 1.87% for the year-to-date period, down from 2.34% for the same period last year. Interest-bearing deposits averaged $506,587,157 compared to $426,459,027 last year, an increase of $80,128,130, or 18.79%. NOW deposits averaged $92,113,297 compared to $83,424,198 last year, an increase of $8,689,099, or 10.42%. Money market deposits averaged $107,855,848 compared to $45,976,740 last year, an increase of $61,879,108, or 134.59%. Time deposits averaged $280,321,348 compared to $270,776,271 last year, an increase of $9,545,077, or 3.53%. Overnight and other borrowings averaged $76,082,746 compared to $54,043,554 last year, an increase of $22,039,192, or 40.78%, due to an increase of $23,569,594, or 144.09%, in temporary borrowings of GLL primarily due to higher mortgage origination activity, partially offset by a decrease of $3,806,822, or 15.21%, in average overnight and other borrowings of the Bank. Overnight borrowings averaged $16,494,179 compared to $37,686,181 last year, a decrease of $21,192,002, or 56.23%, reflecting a decrease of $22,058,166, or 88.12%, in average overnight borrowings in the form of federal funds purchased and securities sold under agreements to repurchase of the Bank, which was partially offset by an increase of $866,164, or 6.84%, in average overnight borrowings in the form of commercial paper related to the commercial deposit sweep arrangements of the Bank. Other borrowings averaged $59,588,567 compared to $16,357,373 last year, an increase of $43,231,194, or 264.29%. reflecting an increase of $18,251,344 in average borrowings of the Bank and an increase of $23,569,594, or 144.09%, in temporary borrowings of GLL primarily due to higher mortgage origination activity. Other borrowings were the principal source of funding for the mortgage origination activities of GLL.

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

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. 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 review monthly 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.

As part of the continual grading process, individual commercial loans are assigned a credit risk grade based on their credit quality, which is subject to change as conditions warrant. Before making any changes in these risk grades, management considers assessments as determined by the third party risk assessment group, regulatory examiners and the Bank’s Credit Administration. Management considers certain commercial loans with weaker 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. A loan is considered impaired when, based on current information, it is probable that the Company will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, management measures impairment in accordance with SFAS 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.

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, expected future cash flows, 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. While 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 periods ended September 30, 2003 as compared to the twelve months ended December 31, 2002. Such revisions, estimates and assumptions are made in the 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 the recognition of 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 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 amounts of $1,139,250 and $3,423,631 for the three and nine month periods ended September 30, 2003, respectively, to provide for future losses related to uncollectible loans. The amounts compared to $896,782 and $2,695,066, respectively, for the comparable periods in 2002. At September 30, 2003, the loan loss reserve was 1.64% of net loans outstanding compared to 1.69% as of December 31, 2002 and 1.61% at September 30, 2002. The following discussion presents an analysis of changes in the allowance for loan losses for the quarter-to-date and year-to-date periods.

Also due to the continued weak local economy, 2003 charge-off’s were substantially higher than those in the same period of the previous year. In the third quarter of 2003, the Company charged off $734,742, an increase of $314,859 over the comparable period in 2002, of which $314,384 were related to commercial loans in default. Year-to date charge-offs were $3,213,757, an increase of $1,967,046 over the comparable period in 2002, of which $1,686,127 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 $10,958,016 at September 30, 2003 as compared with $6,554,602 and $7,604,843 at December 31, 2002 and September 30, 2002, respectively. 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 when the Catawba Valley economy will return to its former strength.

Nonperforming assets at September 30, 2003 and December 31, 2002 were as follows:


	September 30,			December 31,
	2003			2002
Nonperforming assets:
Nonaccrual loans	$	6,689,997		$	3,264,847
Loans past due 90 days or more and still accruing interest		4,060,705			1,152,998

Total nonperforming loans		10,750,702			4,417,845
Foreclosed properties		2,819,126			1,202,603

Total nonperforming assets	$	13,569,828		$	5,620,448

Nonperforming loans to total loans		1.55	%		0.83	%
Allowance coverage of nonperforming loans		104.53	%		186.13	%
Nonperforming assets to total assets		1.40	%		0.76	%

If interest from nonaccrual loans had been recognized in accordance with the original terms of the loans, net income for the quarter-to-date and year-to-date periods would not have been materially different from the amounts reported.

The Company’s investment in impaired loans at September 30, 2003 and December 31, 2002 was as follows:


	September 30,		December 31,
	2003		2002
Investment in impaired loans:
Impaired loans still accruing interest	$	4,835,711	$	1,889,846
Accrued interest on accruing impaired loans		125,960		55,988
Impaired loans not accruing interest		6,689,997		3,264,847
Accrued interest on nonaccruing impaired loans		115,520		127,417

Total investment in impaired loans	$	11,767,188	$	5,338,098

Loan loss allowance related to impaired loans	$	2,595,271	$	2,195,850

Loans are classified as non-accrual when the accrual of interest on such loans is discontinued because management believes that such interest will not be collected in a reasonable period of time. The recorded accrued interest receivable deemed uncollectible is reversed to the extent it was accrued in the current year or charged-off to the extent it was accrued in previous years. A loan classified as non-accrual is returned to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms, and the ultimate collection of principal and interest is no longer doubtful.

When comparing September 30, 2003 with September 30, 2002, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $11,767,188 ($6,805,517 of which was on a non-accrual basis) and $6,818,832 ($3,105,737 of which was on a non-accrual basis), respectively. The average recorded balance of impaired loans during the first nine months of 2003 and 2002 was not significantly different from the balances at September 30, 2003 and 2002, respectively. The related allowance for loan losses determined in accordance with SFAS No. 114 for these loans was $2,595,272 and $1,955,374 at September 30, 2003 and 2002, respectively. For the nine months ended September 30, 2003 and 2002, the Company recognized interest income on those impaired loans of approximately $241,480 and $170,509, respectively.

Noninterest Income and Expenses for the Quarterly Periods

For the quarter ended September 30, 2003, total noninterest income was $4,283,688, up $1,358,424, or 46.44%, from $2,925,264 earned in the same period of 2002, primarily because of higher fees from mortgage originations. As mortgage rates continued downward in 2003, mortgage origination activity rose dramatically. Mortgage origination fee income was $2,408,487 for the third quarter of 2003, up $1,444,758, or 149.91%, from $963,729 earned in the same period of 2002. Mortgage loans originated during the three months ended September 30, 2003 and 2002 were $125,450,857 and $74,058,758, 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. A recent rise in mortgage rates appears to be causing a slowdown in the level of mortgage originations, and future levels of mortgage lending activity will be affected significantly by trends in mortgage interest rates. There were no significant gains or losses on sales of securities in the third quarter of 2003 or 2002. Other noninterest income was $220,923 for the third quarter of 2003, down $61,911, or 21.89%, from $282,834 earned in the third quarter of 2002, primarily due to lower sales of small business loans which generated no gains in the third quarter of 2003 compared to $61,065 in the same quarter of 2002. Although management continued to emphasize fees from nontraditional banking services such as annuities, life insurance, and sales of mortgages and small business loans, management decided that in 2003 it would retain the small business loans in the Company’s loan portfolio rather than sell these loans at one-time gains. Fees from all nontraditional banking services such as annuities, life insurance, and sales of mortgages loans discussed above, produced $2,515,167 during the third quarter of 2003, up 118.03% from the third quarter of 2002.

Third quarter 2003 noninterest expenses, or overhead, totaled $7,170,306, up $2,152,513, or 42.90%, from $5,017,793 in the same quarter of 2002. The overhead costs of GLL increased $1,262,331, or 102.24%, due to the costs of meeting the higher demand for mortgage services, while the overhead costs of the Bank increased $876,863, or 23.51%, primarily due to the three branch offices acquired in the First Commerce transaction and the conversion of two loan production offices into full service offices. Personnel costs, the largest of the overhead expenses, were $4,578,103 during the quarter, up $1,433,672, or 45.59%, from $3,144,431 in 2002. Of the $1,433,672 increase in personnel costs, $978,272 were related to mortgage operations, while $455,400 were related to the personnel costs of the Bank.

Noninterest expenses other than for personnel increased $718,841, or 38.37%, to $2,592,203 during the quarter from $1,873,362 incurred in the same period of 2002. The increase reflected a $421,463 increase in the nonpersonnel costs of the Bank and a $284,059 increase in the nonpersonnel costs of GLL. Occupancy expenses for the quarter were $344,625, up $116,021, or 50.75%, from $228,604 in the same period of 2002, reflecting the additional expenses related to the three branch offices acquired in the First Commerce transaction and the two new full service offices. Third quarter other noninterest expenses were $1,870,113 in 2003, up $550,409, or 41.71%, from $1,319,704 in the same quarter a year ago. Of the $550,409 increase, a $277,136 increase was related to the other noninterest costs of the Bank and a $259,954 increase was related to the other noninterest costs of GLL. Income tax expense was $2,252,662 for the quarter, up $290,009, or 14.78%, from $1,962,653 for the 2002 third quarter. The effective tax rates were 34.74% and 34.77% for the third quarters of 2003 and 2002, respectively.

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

For the nine months ended September 30, 2003, total noninterest income was $11,434,148, up $3,390,827, or 42.16%, from $8,043,321 earned in the first nine months of 2002, primarily because of higher fees from mortgage originations. Fees on deposit accounts were $4,173,977 during the first nine months of 2003, up $225,372, or 5.71%, from $3,948,605 in the same period of 2002. Also for the year-to-date period, other service fees and commissions were $696,339, down $123,833, or 15.10%, from $820,172 in 2002, primarily due to lower fee income from sales of annuities, which decreased $172,649, or 44.69%. As was the case for the quarter, mortgage rates that continued to drop in 2003 increased mortgage origination activity. Mortgage origination fee income was $5,823,648 for the first three quarters of 2003, up $3,299,080, or 130.68%, from $2,524,568 earned in the same period of 2002. Mortgage loans originated during the nine months ended September 30, 2003 and 2002 were $349,226,855 and $176,732,281, 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. As noted above, a recent rise in mortgage rates appears to be causing a slowdown in the level of mortgage originations, and future levels of mortgage lending activity will be affected significantly by trends in mortgage interest rates. 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 such as annuities and life insurance, the year-to-date 2003 income from the sales of annuities and life insurance was disappointing, as reflected in the income from annuities data set forth above.

Total noninterest expenses were $18,676,953 during the first nine months of 2003, up $3,748,669, or 25.11%, from $14,928,284 in the same period of 2002. As was the case for the third quarter, the year-to-date 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 $12,200,105 during the first nine months of 2003, up $2,859,017, or 30.61%, from $9,341,088 in the same period of 2002. Of the $2,859,017 increase, $2,194,272 were related to mortgage operations, while $664,745 were related to banking operations.

Noninterest expenses other than for personnel increased 15.92% to $6,476,848, during the first nine months of 2003 from the $5,587,196 incurred in the same period of 2002. Of the $889,652 increase, GLL’s nonpersonnel costs increased $626,991, while the Bank’s nonpersonnel costs increased $266,306. Year-to-date occupancy expenses were $843,084, up $170,894, or 25.42%, from $672,190 in 2002, primarily reflecting the additional occupancy costs associated with the newly opened banking offices and the banking offices acquired in the First Commerce transaction. Other noninterest expenses were $4,657,078 for the nine months ended September 30, 2003, up $812,961, or 21.15%, from $3,844,117 in the same period of 2002. Of the $812,961 increase in other noninterest expenses, $559,233 were related to mortgage operations, and $257,373 were related to banking operations. Year-to-date income tax expense was $6,232,228 in 2003, up $995,667, or 19.01%, from $5,236,561 in 2002. The year-to-date effective tax rates were 34.21% and 32.42% 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report, and they have concluded that these controls and procedures are effective.

(b) Changes in Internal Controls

There was no change in internal controls over financial reporting during or subsequent to the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Disclosures About Forward Looking Statements

The discussions included in 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 the Company and its 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 the Company’s customers or vendors, fluctuations in interest rates, actions of government regulators, the availability of capital and personnel, and general economic conditions.

Part II - Other Information

Item 6 - Exhibits and Reports on Form 8-K

Exhibits, Financial Statement Schedules and Reports on Forms 8-K 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 written request.


(a)		Exhibits

3.1		Certificate of Incorporation

		Bank of Granite Corporation’s Restated Certificate of Incorporation, and Certificates of Amendment of Bank of Granite Corporation, filed as Exhibit 3.1 to the Company’s Registration Statement on Form S-4 (Registration Statement No. 333-104233) dated April 1, 2003, are incorporated herein by reference.

3.2		Bylaws of the Registrant

		Bank of Granite Corporation’s Bylaws, filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-4 (Registration Statement No. 333-104233) dated April 1, 2003, is incorporated herein by reference.

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

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

10.		Material Contracts

10.1		Employment Agreement between the Company and Wesley W. Sturges

10.2		Bank of Granite Corporation/First Commerce Corporation Omnibus Stock Incentive Plan

10.3		Bank of Granite Corporation/First Commerce Bank 1997 Incentive Stock Option Plan

10.4		Bank of Granite Corporation/First Commerce Bank 1997 Nonqualified Stock Option Plan for Directors

11.		Schedule of Computation of Net Income Per Share

		The information required by this item is set forth under Item 1 of Part I, Note 2


	31.1		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

	31.2		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

	32.1		Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	32.2		Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	(b)		Reports on Form 8-K

			On July 14, 2003, the Company filed a report on Form 8-K regarding its July 14, 2003 news release in which it announced its earnings for the quarter ended June 30, 2003. The full text of the Company’s news release dated July 14, 2003 was attached as Exhibit 99(a) to this Form 8-K filing.

			On July 16, 2003, the Company filed a report on Form 8-K regarding its July 16, 2003 news release in which it announced the completion of its merger with First Commerce Corporation of Charlotte, North Carolina effective at 11:59 p.m. on July 15, 2003. The full text of the Company’ s news release dated July 16, 2003 was attached as Exhibit 99(a) to this Form 8-K filing.

			On July 23, 2003, the Company filed a report on Form 8-K regarding financial statements and other information concerning the Company’s acquisition by merger of First Commerce Corporation of Charlotte, North Carolina, which became effective July 15, 2003.

Signatures

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


		Bank of Granite Corporation
		(Registrant)

Date: November 13, 2003		/s/ Kirby A. Tyndall

		Kirby A. Tyndall
		Senior Vice President and
		Chief Financial Officer and
		Principal Accounting Officer

Exhibit Index


		Begins
		on Page

3.1	Certificate of Incorporation, as amended	*

3.2	Bylaws of the Registrant	*

4.1	Form of stock certificate for Bank of Granite Corporation’s common stock	*

4.2	Articles 5, 6, 7, 10 and 13 of the Restated Certificate of Incorporation of Bank of Granite Corporation	*

10.1	Employment Agreement between the Company and Wesley W. Sturges	36

10.2	Bank of Granite Corporation/First Commerce Corporation Omnibus Stock Incentive Plan	51

10.3	Bank of Granite Corporation/First Commerce Bank 1997 Incentive Stock Option Plan	95

10.4	Bank of Granite Corporation/First Commerce Bank 1997 Nonqualified Stock Option Plan for Directors	111

11	Schedule of Computation of Net Income Per Share	*

31.1	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	125

31.2	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	126

32.1	Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	127

32.2	Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	128

Incorporated herein by reference.