The Company conducts its business through three reportable business segments: Community Banking, Mortgage Banking and Other. The Community Banking segment offers a variety of loan and deposit products and other financial services. The Mortgage Banking segment originates, retains and sells mortgage loans. The Other segment includes activities at the holding company level such as corporate and stockholder relations and funding from the issuance of commercial paper and trust preferred securities. For financial information on the Company’s three business segments, see Note 21, “Operating Segments,” of the “Notes to Consolidated Financial Statements.” The Company conducts its community banking business operations from 22 full-service offices located in Burke, Caldwell, Catawba, Forsyth, Iredell, Mecklenburg, Watauga, and Wilkes counties in North Carolina. According to the Federal Deposit Insurance Corporation (the “FDIC”), as of September 30, 2006, the Bank ranked 12th in assets and 12th in deposits among North Carolina banking institutions. The Company conducts its mortgage banking business operations from 14 offices in Cumberland, Guilford and Rowan counties in North Carolina, in addition to the counties where the Bank has community banking offices.
GENERAL BUSINESS
The Bank is an independent community bank. The Bank’s principal community banking activities include the taking of demand and time deposits and the making of loans, secured and unsecured, to individuals, associations, partnerships and corporations. The majority of the Bank’s customers are individuals and ses. No material part of its business is dependent upon a single customer or a few customers whose loss would have a material adverse effect on the business of the Bank. No material portion of the business of the Bank is seasonal.
Granite Mortgage’s principal mortgage banking activities include the origination and underwriting of mortgage loans to individuals. Granite Mortgage also sells mortgage servicing rights and appraisal services. Granite Mortgage specializes in government guaranteed mortgage products. The majority of its customers are individuals. Granite Mortgage’s business is not dependent on a single customer or a few customers whose loss would have a material adverse effect on the business. The mortgage business is sensitive to changes in interest rates in the market. When rates decline, Granite Mortgage generally experiences an increase in its mortgage business. When rates rise, Granite Mortgage’s business generally declines. No material portion of the business of Granite Mortgage is seasonal.
GENERAL DESCRIPTION OF ECONOMIC AREAS
Prior to 2003, the Company conducted its community banking operations primarily in Caldwell, Catawba and Burke counties of North Carolina. This area was historically known as a center for the manufacture of fiber optic and coaxial cable, furniture, and apparel. When the economy began to weaken in 2001, there were massive layoffs in these industries, and these counties were significantly impacted with a sudden and sustained rise in their unemployment rates. Since 2003, these counties have experienced gradual improvements in the high unemployment rates that occurred in 2001.
Since 2003, the Company has expanded its business by entering three new markets where the local economies are more diversified and growing. In 2003, the Bank opened new offices in Watauga County (Boone), Wilkes County (Wilkesboro), and Mecklenburg County (Matthews), and acquired First Commerce Bank and its three banking offices in Mecklenburg County (Charlotte and Cornelius). In 2004, the Bank opened a banking office in Forsyth County (Winston-Salem). The Bank opened a new loan production office in Iredell County (Statesville) in August 2006 and converted it to a full-service banking office in October 2006. The relative unemployment rates and the population growth in Mecklenburg, Forsyth and Iredell Counties, each as shown in the tables below, formed the primary basis for the Company’s decision to expand into those new markets.
| Month of December | 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||||||
Unemployment Rates* |
||||||||||||||||||||
Caldwell County |
8.4 | % | 7.5 | % | 7.2 | % | 7.5 | % | 7.6 | % | ||||||||||
Catawba County |
5.4 | % | 5.3 | % | 6.1 | % | 7.0 | % | 8.2 | % | ||||||||||
Burke County |
5.8 | % | 5.8 | % | 6.0 | % | 6.9 | % | 7.7 | % | ||||||||||
Watauga County |
3.1 | % | 3.2 | % | 3.4 | % | 3.5 | % | 4.2 | % | ||||||||||
Wilkes County |
5.7 | % | 4.9 | % | 6.0 | % | 6.4 | % | 7.5 | % | ||||||||||
Mecklenburg County |
4.3 | % | 4.2 | % | 4.8 | % | 5.0 | % | 5.6 | % | ||||||||||
Forsyth County |
4.2 | % | 4.2 | % | 4.5 | % | 5.0 | % | 5.4 | % | ||||||||||
Iredell County |
4.4 | % | 4.4 | % | 5.1 | % | 5.7 | % | 6.3 | % | ||||||||||
North Carolina |
4.9 | % | 5.1 | % | 5.3 | % | 6.1 | % | 6.5 | % | ||||||||||
United States |
4.5 | % | 4.9 | % | 5.4 | % | 5.7 | % | 6.0 | % | ||||||||||
* Source: Employment Security Commission of North Carolina
The population projections and estimates for the counties in the Company’s primary market areas are as follows:
| July 2009 | July 2005 | April 2000 | ||||||||||
| Projections | Estimates | Census | ||||||||||
Population Projections and Estimates* |
||||||||||||
Caldwell County |
79,820 | 78,492 | 77,386 | |||||||||
Catawba County |
156,587 | 149,032 | 141,686 | |||||||||
Burke County |
90,169 | 88,293 | 89,145 | |||||||||
Watauga County |
43,794 | 42,934 | 42,693 | |||||||||
Wilkes County |
68,288 | 66,897 | 65,632 | |||||||||
Mecklenburg County |
884,211 | 796,232 | 695,370 | |||||||||
Forsyth County |
344,139 | 326,340 | 306,067 | |||||||||
Iredell County |
153,092 | 139,727 | 122,660 | |||||||||
North Carolina |
9,243,581 | 8,682,066 | 8,046,485 | |||||||||
* Source of projection, estimate and census data: North Carolina Office of State Budget and Management
TERRITORY SERVED AND COMPETITION
The Bank operates 22 full-service community banking offices in the North Carolina cities and communities of Granite Falls, Lenoir, Hudson, Newton, Morganton, Hickory, Boone, Wilkesboro, Charlotte, Cornelius, Conover, Matthews, Winston-Salem, and Statesville.
The Federal Deposit Insurance Corporation (the “FDIC”) collects deposit data from insured depository institutions as of June 30 of each year as presented below ( deposit dollars in millions ).
| June 30, 2006 | June 30, 2005 | |||||||||||||||||||||||||||||||
| Bank of Granite | Market | Bank of Granite | Market | |||||||||||||||||||||||||||||
| County | Deposits | Market Share | Deposits | No. of Banks | Deposits | Market Share | Deposits | No. of Banks | ||||||||||||||||||||||||
Caldwell |
$ | 320.4 | 39.2 | % | $ | 817.1 | 9 | $ | 303.6 | 39.6 | % | $ | 767.5 | 9 | ||||||||||||||||||
Catawba |
386.0 | 15.7 | % | 2,457.9 | 13 | 331.2 | 14.4 | % | 2,293.7 | 13 | ||||||||||||||||||||||
Burke |
51.7 | 7.3 | % | 706.1 | 9 | 47.5 | 7.1 | % | 670.5 | 9 | ||||||||||||||||||||||
Watauga |
22.6 | 2.8 | % | 805.8 | 12 | 15.3 | 2.2 | % | 683.2 | 12 | ||||||||||||||||||||||
Wilkes |
14.3 | 1.9 | % | 749.7 | 11 | 8.1 | 1.2 | % | 690.8 | 11 | ||||||||||||||||||||||
Mecklenburg |
170.9 | 0.2 | % | 86,748.9 | 22 | 148.7 | 0.2 | % | 83,121.7 | 21 | ||||||||||||||||||||||
Forsyth |
15.9 | 0.1 | % | 13,168.2 | 16 | 8.7 | 0.1 | % | 12,953.4 | 16 | ||||||||||||||||||||||
Iredell* |
none | 0.0 | % | 1,916.7 | 17 | none | 0.0 | % | 1,744.1 | 16 | ||||||||||||||||||||||
* Deposit data for Bank of Granite in Iredell County will not be available until June 30, 2007.
The Bank’s community banking markets are highly competitive. The table above reflects the continuing competition in the Bank’s markets. In addition to competing with other large and small banks, which tend to be numerous, especially in the higher growth markets, the Bank also competes for both loan and deposit business with thrifts or savings institutions, credit unions, brokerage and insurance firms, and other nonbank businesses, such as manufacturers and retailers.
The mortgage banking business is also highly competitive, with both bank and nonbank mortgage originators competing in the market. Granite Mortgage conducts its mortgage banking business from 14 offices in the North Carolina cities and communities of Winston-Salem, Hickory, High Point, Lenoir, Morganton, Newton, Salisbury, Boone, Charlotte, Conover, Fayetteville, Wilkesboro, and Matthews.
The Company’s community banking and mortgage banking operations are both required to compete based on price in order to conduct business in each of the Company’s markets, as demonstrated in the Bank’s recent increases in interest rates on deposit accounts. However, the Company believes that its focus on and commitment to providing superior customer service is what distinguishes it from its competitors.
EMPLOYEES
As of December 31, 2006, the Bank had 278 and Granite Mortgage had 59 full-time equivalent employees. Each of the Bank and Granite Mortgage considers its relationship with its employees to be excellent.
SUPERVISION AND REGULATION
The following summaries of statutes and regulations affecting bank holding companies, banks and mortgage banks do not purport to be complete. Such summaries are qualified in their entirety by reference to such statutes and regulations.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is required to register as such with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”). Because of its number of stockholders, the Company is also regulated by the Securities and Exchange Commission (the “SEC”).
A bank holding company is required to file with the FRB annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to acquiring, directly or indirectly, more than 5% of the voting stock of a bank, unless it already owns a majority of the voting stock of the bank. Furthermore, with limited exceptions, a bank holding company must engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares of a company the activities of which the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
The FRB has cease-and-desist powers over bank holding companies and nonbank subsidiaries where their action would constitute a serious threat to the safety, soundness or stability of a subsidiary bank.
Although the Company is not presently subject to any regulatory restrictions on dividends, the Company’s ability to pay dividends depends to a large extent on the amount of dividends paid by the Bank and Granite Mortgage. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to Section 53-87 of the North Carolina General Statutes. As of December 31, 2006, the Bank had undivided profits of approximately $101.6 million. Additionally, current federal regulations require that the Bank maintain a ratio of total capital to assets, as defined by regulatory authorities, in excess of 6%. As of December 31, 2006, this ratio was 11.77% for the Bank, leaving approximately $68.5 million of the Bank’s undivided profits available for the payment of dividends.
In an effort to achieve a measurement of capital adequacy that is more sensitive to the individual risk profiles of financial institutions, the various financial institution regulators mandate minimum capital regulations and guidelines that categorize various components of capital and types of assets and measure capital adequacy in relation to a particular institution’s relative levels of those capital components and the level of risk associated with various types of assets of that financial institution. The FDIC and the FRB statements of policy on “risk-based capital” require the Company to maintain a level of capital commensurate with the risk profile assigned to its assets in accordance with the policy statements. The capital standards require minimum ratios of 4% for tier 1 capital, 8% for total risk-adjusted capital and 4% for leverage. At December 31, 2006, the Company’s tier 1 ratio, total capital ratio to risk-adjusted assets, and leverage ratio were 13.8%, 11.6% and 15.0%, respectively. The Company is in compliance with all regulatory capital requirements.
The Bank is subject to supervision and regulation, of which regular bank examinations are a part, by the FDIC and the North Carolina State Banking Commission (the “Banking Commission”). The Bank is a member of the FDIC, which currently insures the deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a semi-annual statutory assessment and is subject to the rules and regulations of the FDIC.
Federal banking laws applicable to all depository financial institutions, among other things, (i) afford federal bank regulatory agencies with powers to prevent unsafe and unsound banking practices; (ii) restrict preferential loans by banks to “insiders” of banks; (iii) require banks to keep information on loans to major stockholders and executive officers, and (iv) bar certain director and officer interlocks between financial institutions. The prohibitions against certain director and officer interlocks may inhibit the ability of the Bank and the Company to obtain experienced and capable officers and directors, to replace current officers and directors, or to add to their number.
The Company is an “affiliate” of the Bank within the meaning of the Federal Reserve Act, which imposes restrictions on loans by the Bank to the Company and on investments by the Bank in the stock or securities of the Company, which serve as security for loans by the Bank to any borrower. The Company is also subject to certain restrictions with respect to engaging in the business of issuing, underwriting and distributing securities.
Stockholders of banks (including bank holding companies that own stock in banks) may be compelled by bank regulatory authorities to invest additional capital in the event their banks experience either significant loan losses or rapid growth of loans or deposits. In addition, the Company may also be required to provide additional capital to any banks that it acquires as a condition to obtaining the approvals and consents of regulatory authorities in connection with such acquisitions.
Granite Mortgage, as a mortgage bank, is regulated by the Banking Commission. Because Granite Mortgage is a nonbank subsidiary of a bank holding company, it is also regulated by the FRB. In addition, because Granite Mortgage underwrites mortgages guaranteed by the government, it is subject to other audits and examinations as required by the government agencies or the investors who purchase the mortgages.
The Company cannot predict what other legislation might be enacted or what other regulation might be adopted or, if enacted or adopted, the effect thereof.
EFFECTS OF GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONTROLS
The Company is directly affected by governmental monetary policy and by regulatory measures affecting the banking industry in general. Of primary importance is the FRB, whose actions directly affect the money supply and, in general, affect banks’ lending abilities by increasing or decreasing the cost and availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in the United States government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against bank deposits.
Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks have eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates have increased banks’ costs of funds and made them more sensitive to fluctuations in money market rates.
In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, predictions as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Company are difficult and have very limited reliability.
INVESTMENT POLICIES
For a discussion of the Company’s investment policies, see “Investment Securities” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report.
LOAN PORTFOLIO
For a discussion of the Company’s loan portfolio, see “Loans” and “Provisions and Allowances for Loan Losses” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report.
AVAILABLE INFORMATION
Additional information about the Company and its business is available at the Company’s website, at www.bankofgranite.com. The Company’s filings with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934, are available, free of charge, on the Company’s website at www.bankofgranite.com under the heading “Investor Relations — SEC Filings.” These reports are available as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. In addition, copies of these filings are available at the Securities and Exchange Commission’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission’s website, www.sec.gov, is another source of this information. Information included on the Company’s website is not incorporated by reference into this annual report.
ITEM 1A — RISK FACTORS
Decreases in interest rates could cause our earnings to decline.
Our balance sheet remains asset sensitive because of its significant level of variable rate loans. Asset sensitive means that when market interest rates change, interest rates on our variable rate assets, primarily loans, change more rapidly than the interest rates on our deposits. Therefore, when interest rates fall, our interest income on variable rate loans declines at a faster pace than the interest we pay on time deposits and other fixed rate funding.
Strong competition within our market areas may limit our growth and profitability. Larger banks and numerous other financial institutions with greater resources may be able to compete more effectively than smaller community banks and mortgage banks.
We face numerous competitors in both our community banking and mortgage banking operations in all of our market areas. In addition to competing with larger and smaller banks, which tend to be numerous, especially in the higher growth markets, we also compete for both loan and deposit business with thrifts or savings institutions, credit unions, brokerage and insurance firms and other nonbank businesses, such as manufacturers and retailers that engage in consumer financing activities. Price competition for loans and deposits might result in earning less on our loans and paying more on our deposits, which would reduce our net interest income. Competition also makes it more challenging to grow loans and deposits and to hire and retain experienced employees. Some of the institutions with which we compete have substantially greater resources and lending limits than we do and may offer services that we do not provide. We expect competition to continue to increase in the future as a result of legislative, regulatory, and technological changes and the continuing trend of consolidation in the financial services industry.
The mortgage banking business is also highly competitive, with both large and small bank and nonbank mortgage originators competing in our mortgage banking markets.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in increases to our allowance. Material additions to our allowance would materially decrease our net income.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs required by regulatory authorities could have a material adverse effect on our financial condition and results of operations.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
Our holding company, community banking, and mortgage banking businesses are highly regulated. Our holding company is regulated by the Federal Reserve Board, the Banking Commission, and the Securities and Exchange Commission. Our community banking subsidiary is regulated by the Federal Deposit Insurance Corporation and the Banking Commission. Our mortgage banking subsidiary is regulated by the Federal Reserve Board and the Banking Commission. Such regulation and supervision govern the activities in which we may engage and are intended primarily for the protection of the deposit insurance fund and depositors. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations or legislation, may have a material impact on our operations. In addition to the risks of noncompliance, we are required to dedicate considerable time and monetary resources in our efforts to comply with the numerous laws and regulations that govern the ways in which we conduct our community banking and mortgage banking activities.
Economic declines in our markets could impair the ability of our customers, both individuals and businesses, to repay their loans.
We have significantly expanded our lending during the past five years as we have entered new markets in the high country of the Blue Ridge Mountains and the Winston-Salem and Charlotte metro areas of North Carolina. Our loan portfolios may not be as seasoned as the loan portfolios of our competitors in some of these new markets. Should local real estate markets or economies weaken, we may begin to experience higher default rates. Increased levels of non-performing loans would likely result in higher loan losses and lower profits.
We may have additional tax liabilities.
Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be different from our historical income tax provisions and accruals. Based on the results of an audit or litigation, a material effect on our income tax provision, net income or cash flows in the period or periods for which that determination is made could result.
If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings.
Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicated the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could have a negative impact on our results of operations.
Changes in accounting may affect our reported earnings and operating income.
Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations for many aspects of our business, such as accounting for investments, and treatment of goodwill or amortizable intangible assets, are highly complex and involve subjective judgments. Changes in these rules or their interpretation could significantly change our reported earnings. See Note 1, “Summary of Significant Accounting Policies,” of the “Notes to Consolidated Financial Statements.”
ITEM 1B — UNRESOLVED STAFF COMMENTS
Not applicable.
