CommunityOne Bancorp 10-Q 2009 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

___________________

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the quarterly period ended June 30, 2009 Commission File Number 0-13823

FNB UNITED CORP.

(Exact name of Registrant as specified in its Charter)

North Carolina	56-1456589
(State of Incorporation)	(I.R.S. Employer Identification No.)
150 South Fayetteville Street
Asheboro, North Carolina	27203
(Address of principal executive offices)	(Zip Code)

(336) 626-8300

(Registrant's telephone number, including area code)

___________________

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 T No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer £	Accelerated filer T	Non-accelerated filer £	Smaller reporting company £
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes £ No T

As of August 4, 2009 (the most recent practicable date), the Registrant had outstanding 11,429,203 shares of Common Stock.

FNB United Corp. and Subsidiary

Report on Form 10-Q

June 30, 2009

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1	Consolidated Financial Statements (Unaudited)
		Consolidated Balance Sheets June 30, 2009 and December 31, 2008	2
		Consolidated Statements of Income Three and Six Months Ended June 30, 2009 and 2008	3
		Consolidated Statements of Shareholders' Equity and Comprehensive Income Six Months Ended June 30, 2009 and 2008	4
		Consolidated Statements of Cash Flows Six Months Ended June 30, 2009 and 2008	5
	Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
	Item 3	Quantitative and Qualitative Disclosures about Market Risk	33
	Item 4	Controls and Procedures	34
PART II. OTHER INFORMATION
	Item 1	Legal Proceedings	35
	Item 1A	Risk Factors	35
	Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	35
	Item 3	Defaults Upon Senior Securities	35
	Item 4	Submission of Matters to a Vote of Security Holders	35
	Item 5	Other Information	35
	Item 6	Exhibits	35
		Signatures	36

FORWARD LOOKING STATEMENTS

Some of our statements contained in this quarterly report on Form 10-Q, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” that are based upon our current expectations and projections about future events that are not historical facts and our future financial performance. Forward-looking statements are not guarantees of performance or results. They often contain words like “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” and similar expressions. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following: the effects of future economic conditions, including inflation or a decrease in residential housing values; governmental monetary and fiscal policies, as well as legislative and regulatory changes; our ability to maintain required capital levels and adequate sources of funding and liquidity; the risks of changes in interest rates on the level and composition of deposits, loan demand and the values of loan collateral, securities and interest sensitive assets and liabilities; credit risks; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating regionally, nationally and internationally, together with competitors offering banking products and services by mail, telephone and the Internet; our ability to receive dividends from our subsidiary; the effects of critical accounting policies and judgments; fluctuations in our stock price; the effect of any mergers, acquisitions or other transactions to which we or our subsidiary may from time to time be a party; and the failure of assumptions underlying the establishment of our allowance for loan losses. All forward-looking statements speak only as of the date on which such statements are made and FNB United Corp. undertakes no obligation to update any statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FNB United Corp. and Subsidiary

Consolidated Balance Sheets (unaudited)

(dollars in thousands, except share and per share data)	June 30,			December 31,
	2009			2008
Assets
Cash and due from banks	$	26,675		$	28,743
Interest-bearing bank balances		56			404
Federal funds sold		42			206
Investment securities:
Available-for-sale, at estimated fair value (amortized cost of $254,250 in 2009 and $206,072 in 2008)		254,826			205,426
Held-to-maturity (estimated fair value of $99,544 in 2009 and $27,580 in 2008)		100,475			27,794
Loans held for sale		64,850			36,138
Loans held for investment		1,591,686			1,585,195
Less:  Allowance for loan losses		(36,844	)		(34,720	)
Net loans held for investment		1,554,842			1,550,475
Premises and equipment, net		49,430			50,947
Goodwill		52,395			52,395
Core deposit premiums		5,365			5,762
Other assets		90,650			86,144
Total Assets	$	2,199,606		$	2,044,434
Liabilities
Deposits:
Noninterest-bearing demand deposits	$	155,223		$	150,273
Interest-bearing deposits:
Demand, savings and money market deposits		549,630			479,223
Time deposits of $100,000 or more		295,490			407,539
Other time deposits		639,412			477,712
Total deposits		1,639,755			1,514,747
Retail repurchase agreements		17,460			18,145
Federal Home Loan Bank advances		184,445			238,910
Federal funds purchased		80,000			37,000
Subordinated debt		15,000			15,000
Junior subordinated debentures		56,702			56,702
Other liabilities		13,517			16,013
Total Liabilities		2,006,879			1,896,517
Shareholders' Equity
Preferred stock, $10.00 par value; authorized 200,000 shares, 51,500 shares issued and outstanding at $1,000 stated value		47,864			-
Common stock warrant		3,891			-
Common stock, $2.50 par value; authorized 50,000,000 shares, issued 11,429,203 shares in 2009 and 11,428,003 shares in 2008		28,573			28,570
Surplus		115,043			114,772
Retained earnings		920			8,904
Accumulated other comprehensive loss		(3,564	)		(4,329	)
Total Shareholders' Equity		192,727			147,917
Total Liabilities and Shareholders' Equity	$	2,199,606		$	2,044,434

See accompanying notes to consolidated financial statements.

2

FNB United Corp. and Subsidiary

Consolidated Statements of Income (unaudited)

(dollars in thousands, except share and per share data)	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2008		2009			2008
Interest Income
Interest and fees on loans	$	21,264		$	25,548	$	42,863		$	52,799
Interest and dividends on investment securities:
Taxable income		4,375			1,699		7,442			3,591
Non-taxable income		327			503		927			1,030
Other interest income		87			265		167			519
Total interest income		26,053			28,015		51,399			57,939
Interest Expense
Deposits		8,605			10,622		17,479			22,428
Retail repurchase agreements		35			163		68			412
Federal Home Loan Bank advances		1,479			1,829		3,077			3,521
Federal funds purchased		43			174		85			298
Other borrowed funds		645			588		1,312			1,496
Total interest expense		10,807			13,376		22,021			28,155
Net Interest Income before Provision for Loan Losses		15,246			14,639		29,378			29,784
Provision for loan losses		5,525			1,383		19,584			2,897
Net Interest Income after Provision for Loan Losses		9,721			13,256		9,794			26,887
Noninterest Income
Service charges on deposit accounts		2,232			2,174		4,306			4,291
Mortgage loan income		2,608			1,312		4,528			2,813
Cardholder and merchant services income		582			603		1,204			1,066
Trust and investment services		440			468		781			931
Bank owned life insurance		242			236		470			486
Other service charges, commissions and fees		296			155		581			387
Securities (losses)/gains, net		4			6		(2	)		6
Total other-than-temporary impairment loss		(4,367	)		-		(4,367	)		-
Portion of loss recognized in other comprehensive income		3,367			-		3,367			-
Net impairment loss recognized in earnings		(1,000	)		-		(1,000	)		-
Other income		86			99		265			296
Total noninterest income		5,490			5,053		11,133			10,276
Noninterest Expense
Personnel expense		8,100			9,044		16,267			17,898
Net occupancy expense		1,286			1,353		2,808			2,659
Furniture, equipment, and data processing expense		1,690			1,681		3,481			3,392
Professional fees		542			329		1,233			752
Stationery, printing and supplies		164			163		177			328
Advertising and marketing		469			348		1,056			773
Goodwill impairment		-			1,800		-			1,800
FDIC insurance		1,560			278		1,863			319
Other expense		2,545			2,324		5,078			4,846
Total noninterest expense		16,356			17,320		31,963			32,767
(Loss)/income before income taxes		(1,145	)		989		(11,036	)		4,396
Income taxes (benefit)/expense		(742	)		849		(4,866	)		1,933
Net (Loss)/Income		(403	)		140		(6,170	)		2,463
Preferred stock dividends		(809	)		-		(1,240	)		-
Net (Loss)/Income to Common Shareholders	$	(1,212	)	$	140	$	(7,410	)	$	2,463
Net (loss)/income per common share:
Basic	$	(0.11	)	$	0.01	$	(0.65	)	$	0.22
Diluted	$	(0.11	)	$	0.01	$	(0.65	)	$	0.22
Weighted average number of common shares outstanding:
Basic		11,413,735			11,414,330		11,411,909			11,409,630
Diluted		11,413,735			11,416,269		11,411,909			11,411,569

See accompanying notes to consolidated financial statements.

3

FNB United Corp. and Subsidiary

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (unaudited)

For the Three Months Ended June 30, 2009 and 2008

(in thousands, except share and per share data)												Common Stock Warrant		Surplus			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total
	Preferred Stock				Common Stock
	Shares		Amount		Shares			Amount
Balance, December 31, 2007		-	$	-		11,426,902		$	28,567			$	-	$	114,119		$	74,199		$	(629	)	$	216,256
Cumulative effect of a change in accounting principle - adoption of EITF 06-4		-		-		-			-				-		-			(357	)		-			(357	)
Comprehensive income:
Net income		-		-		-			-				-		-			2,463			-			2,463
Other comprehensive income, net of taxes:
Unrealized holding gains (losses) arising during the period on securities available-for-sale,net of tax		-		-		-			-				-		-			-			(1,318	)		(1,318	)
Reclassification adjustment for losses (gains)on securities available-for-sale included in net income, net of tax		-		-		-			-				-		-			-			-			-
Change in unrealized gains (losses) on securities, net of tax		-		-		-			-				-		-			-			(1,318	)		(1,318	)
Interest rate swap, net of tax		-		-		-			-				-		-			-			311			311
Pension and post-retirement liability, net of tax		-		-		-			-				-		-			-			28			28
Total comprehensive income																								1,484
Cash dividends declared on common stock,$.25 per share		-		-		-			-				-		-			(2,856	)		-			(2,856	)
Merger acquisition of subsidiary companies:
Common stock issued		-		-		-			-				-		-			-			-			-
Fair value of stock options assumed		-		-		-			-				-		-			-			-			-
Stock options:
Proceeds from options exercised		-		-		150			1				-		1			-			-			2
Compensation expense recognized		-		-		-			-				-		219			-			-			219
Net tax benefit related to option exercises		-		-		-			-				-		-			-			-			-
Restricted stock:
Shares issued/terminated, subject to restriction		-		-		(2,000	)		(5	)			-		5			-			-			-
Compensation expense recognized		-		-		-			-				-		134			-			-			134
Other compensatory stock issued		-		-		-			-						-			-			-			-
Adjustment to initially apply SFAS No. 158		-		-		-			-						-			-			-			-
Balance, June 30, 2008		-	$	-		11,425,052		$	28,563			$	-	$	114,478		$	73,449		$	(1,608	)	$	214,882
Balance, December 31, 2008		-	$	-		11,428,003		$	28,570			$	-	$	114,772		$	8,904		$	(4,329	)	$	147,917
Cumulative effect of a change in accounting principle - adoption of EITF 06-4		-		-		-			-				-		-			-			-			-
Comprehensive income (loss):
Net loss		-		-		-			-				-		-			(6,170	)		-			(6,170	)
Other comprehensive income, net of taxes:
Unrealized holding gain (losses) arising during the period on securities available-for-sale,		-		-		-			-				-		-			-			137			137
Reclassification adjustment for (gains)on securities available-for-sale included in net income		-		-		-			-				-		-			-			1			1
Unrealized gain (losses) on securities for which credit-related portion was recognized in net realized investment gains (losses)		-		-		-			-				-		-			-			605			605
Change in unrealized (losses) on securities, net of tax		-		-		-			-				-		-			-			743			743
Interest rate swap, net of tax		-		-		-			-				-		-			-			22			22
Pension and post-retirement liability, net of tax		-		-		-			-				-		-			-			-			-
Total comprehensive loss																								(5,405	)
Issuance of preferred stock		51,500		47,609		-			-				3,891		-			-			-			51,500
Accretion of discount on preferred stock		-		255		-			-				-		-			(255	)		-			-
Cash dividends declared on common stock, $0.05 per share		-		-		-			-				-		-			(572	)		-			(572	)
Cash dividends declared on Series A preferred stock, $12.50 per share		-		-		-			-				-		-			(987	)		-			(987	)
Stock options:
Proceeds from options exercised		-		-		-			-		��		-		-			-			-			-
Compensation expense recognized		-		-		-			-				-		115			-			-			115
Restricted stock:
Shares issued, subject to restriction		-		-		1,200			3				-		(2	)		-			-			1
Compensation expense recognized		-		-		-			-				-		158			-			-			158
Balance, June 30, 2009		51,500	$	47,864		11,429,203		$	28,573			$	3,891	$	115,043		$	920		$	(3,564	)	$	192,727

See accompanying notes to consolidated financial statements.

4

FNB United Corp. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

(dollars in thousands)	Six Months Ended June 30,
	2009			2008
Operating Activities
Net (loss)/income	$	(6,170	)	$	2,463
Adjustments to reconcile net income/(loss) to cash provided by operatings activities:
Depreciation and amortization of premises and equipment		1,813			1,714
Provision for loan losses		19,584			2,897
Deferred income taxes		456			319
Deferred loan fees and costs, net		(1,021	)		599
Premium amortization and discount accretion of investment securities, net		(653	)		(170	)
Loss/(gain) on sale of investment securities		2			-
Other-than-temporary impairment charge		1,000			-
Amortization of core deposit premiums		397			403
Stock compensation expense		273			353
Income from bank owned life insurance		(470	)		(486	)
Mortgage loans held for sale:
Origination of mortgage loans held for sale		(410,847	)		(151,196	)
Proceeds from sale of mortgage loans held for sale		384,435			150,667
Gain on mortgage loan sales		(2,608	)		(2,227	)
Mortgage servicing rights capitalized		(1,027	)		(731	)
Mortgage servicing rights amortization and impairment		1,222			379
Goodwill impairment		-			1,800
Changes in assets and liabilities:
(Increase)/decrease in interest receivable		(698	)		1,341
Decrease/(increase) in other assets		396			(1,219	)
(Decrease)/increase in accrued interest and other liabilities		(3,030	)		2,773
Net cash (used in) provided by operating activities		(16,946	)		9,679
Investing Activities
Available-for-sale securities:
Proceeds from sales		4,812			-
Proceeds from maturities and calls		40,656			43,934
Purchases		(94,873	)		(70,299	)
Held-to-maturity securities:
Proceeds from maturities and calls		8,575			10,250
Purchases		(80,373	)		-
Net increase in loans held for investment		(26,622	)		(134,992	)
Purchases of premises and equipment		(457	)		(5,079	)
Purchases of SBIC investments		(100	)		-
Net cash used in investing activities		(148,382	)		(156,186	)
Financing Activities
Net increase in deposits		125,008			45,092
(Decrease)/increase in retail repurchase agreements		(685	)		3,164
(Decrease)/increase in Federal Home Lo an Bank advances		(54,516	)		70,486
Increase in federal funds purchased		43,000			14,500
Increase (decrease) in other borrowings		-			15,000
Proceeds from exercise of stock options		-			2
Proceeds from issuance of Series A preferred stock and common stock warrant		51,500			-
Cash dividends paid on common stock		(572	)		(3,428	)
Cash dividends paid on Series A preferred stock		(987	)		-
Net cash provided by financing activities		162,748			144,816
Net Decrease in Cash and Cash Equivalents		(2,580	)		(1,691	)
Cash and Cash Equivalents at Beginning of Period		29,353			39,117
Cash and Cash Equivalents at End of Period	$	26,773		$	37,426
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest	$	22,613		$	28,487
Income taxes, net of refunds		-			1,159
Noncash transactions:
Foreclosed loans transferred to other real estate		4,605			5,047
Unrealized securities (losses) gains, net of income taxes (benefit)/expense		743			(1,318	)
Application of SFAS No. 158 to employee benefit plan costs, net of income taxes		-			28
Interest rate swap		22			311
Adoption of EITF Issue 06-4		1			(358	)

 See accompanying notes to consolidated financial statements.

5

FNB United Corp. and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

Nature of Operations

FNB United Corp. (“FNB United”), formerly known as FNB Corp., is a bank holding company incorporated under the laws of the State of North Carolina in 1984. On July 2, 1985, through an exchange of stock, FNB United acquired a wholly owned subsidiary, CommunityONE Bank, National Association (the “Bank”), a national banking association founded in 1907 and formerly known as First National Bank and Trust Company. The Bank has two operating subsidiaries, Dover Mortgage Company (“Dover”) and First National Investor Services, Inc. It also has an inactive subsidiary, Premier Investment Services, Inc., acquired through its merger with Alamance Bank. Through the Bank, FNB United offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers. The Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina. Dover has a retail origination network based in Charlotte with wholesale operations in North Carolina, South Carolina, Georgia, Maine, Maryland, Mississippi, Tennessee, and Virginia.

General

The accompanying consolidated financial statements, prepared without audit, include the accounts of FNB United and its subsidiary (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated.  The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Operating results for the three and six month periods ending June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation of the consolidated financial statements have been included. Certain reclassifications have been made to the prior period consolidated financial statements to place them on a comparable basis with the current period consolidated financial statements. These reclassifications have no effect on net income or shareholders’ equity as previously reported.  Descriptions of the organization and business of FNB United, accounting policies followed by the Company and other relevant information are contained in the Company’s 2008 Annual Report on Form 10-K, including in the notes to the Consolidated Financial Statements filed as part of that report. This quarterly report should be read in conjunction with that Annual Report.

2. Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include the balance sheet captions:  cash and due from banks, interest-bearing bank balances and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

3. Comprehensive Income

Comprehensive income is defined as the change in equity of an enterprise during a period from transactions and other events and circumstances from nonowner sources and, accordingly, includes both net income and amounts referred to as other comprehensive income. The items of other comprehensive income are included in the Consolidated Statements of Shareholders’ Equity and Comprehensive Income.  The accumulated balance of other comprehensive income is included in the shareholders’ equity section of the consolidated balance sheet. The Company’s components of accumulated other comprehensive income at June 30, 2009 include unrealized gains/(losses) on investment securities classified as available-for-sale and the changes in the value of the interest rate swap on one issue of trust preferred securities.

6

For the six months ended June 30, 2009 and 2008, total other comprehensive (loss)/income was $0.8 million and $(1.0) million, respectively. The deferred income tax benefit/(liability) related to the components of other comprehensive income amounted to $0.5 million and $(0.7) million respectively.  Unrealized holding gains/losses arising during the period is net of $2.5 million (after tax) of unrealized holding losses associates with one security where other than temporary impairment was recognized during the period.

The accumulated balances related to each component of other comprehensive income (loss) are as follows:

(dollars in thousands)	June 30, 2009						December 31, 2008
	Pretax			After-tax			Pretax			After-tax
Net unrealized securities losses	$	3,943		$	2,426		$	(608	)	$	(371	)
Other-than-temporary impairment losses on debt securities		(3,367	)		(2,054	)		-			-
Net unrealized gains on cash flow derivatives		(428	)		(278	)		(491	)		(300	)
Pension, other postretirement and postemployment benefit plan adjustments		(5,997	)		(3,658	)		(5,997	)		(3,658	)
Accumulated other comprehensive income	$	(5,849	)	$	(3,564	)	$	(7,096	)	$	(4,329	)

4. Earnings Per Share

Basic net income per share, or basic earnings per share (“EPS”), is computed by dividing net income/ (loss) to common shareholders by the weighted average number of common shares outstanding for the period. In 2009, the Company accrued dividends of approximately $987,100 on Series A preferred stock, which combined with the $254,500 accretion of the discount on the preferred stock, increased the net loss to common shareholders by $1.2 million. Diluted EPS reflects the potential dilution that could occur if the Company’s potential common stock, which consists of dilutive stock options and a common stock warrant, were exercised. As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation is provided in a footnote.

(dollars in thousands, except per share data)	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2008		2009			2008
Net (loss) income to common shareholders	$	(1,212	)	$	140	$	(7,410	)	$	2,463
Denominator:
Weighted average common shares outstanding		11,413,735			11,414,330		11,411,909			11,409,630
Equivalent shares from potential common stock issuance		-			1,939		-			1,939
Diluted weighted average common shares outstanding		11,413,735			11,416,269		11,411,909			11,411,569
Net (loss) income per share:							��
Basic	$	(0.11	)	$	0.01	$	(0.65	)	$	0.22
Diluted	$	(0.11	)	$	0.01	$	(0.65	)	$	0.22

Due to a net loss for the three and six months ended June 30, 2009, all stock options and the common stock warrant were considered anti-dilutive and thus are not included in this calculation. Additionally, for the three and six months ended June 30, 2009 there were 2,821,271 and 2,299,729 shares, respectively, and 647,004 and 656,520 for the same period in 2008, related to stock options and the common stock warrant that were anti-dilutive because the exercise price exceeded the average market price for the period and were omitted from the calculation of diluted earnings per share for their respective periods.

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5. Investment Securities

Summaries of the amortized cost and estimated fair value of investment securities and the related gross unrealized gains and losses are presented below:

(dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Available for Sale
June 30, 2009
U.S. Government agencies and corporations	$	78,810	$	1,750	$	686	$	79,874
Mortgage-backed securities		104,390		2,247		38		106,599
State, county and municipal		47,509		1,667		554		48,622
Other debt securities		20,874		266		3,367		17,773
Equity securities		2,667		-		709		1,958
Total	$	254,250	$	5,930	$	5,354	$	254,826
December 31, 2008
U.S. Government agencies and corporations	$	92,076	$	2,616	$	229	$	94,463
Mortgage-backed securities		66,583		1,546		11		68,118
State, county and municipal		38,336		921		343		38,914
Other debt securities		6,410		2		4,310		2,102
Equity securities		2,667		-		838		1,829
Total	$	206,072	$	5,085	$	5,731	$	205,426
Held to Maturity
June 30, 2009
U.S. Government agencies and corporations	$	2,001	$	9	$	-	$	2,010
Mortgage-backed securities		83,558		505		1,530		82,533
State, county and municipal		13,916		312		77		14,151
Other debt securities		1,000		-		150		850
Total	$	100,475	$	826	$	1,757	$	99,544
December 31, 2008
U.S. Government agencies and corporations	$	2,008	$	39	$	-	$	2,047
Mortgage-backed securities		8,420		117		1		8,536
State, county and municipal		16,366		171		252		16,285
Other debt securities		1,000		-		288		712
Total	$	27,794	$	327	$	541	$	27,580

The Bank, as a member of the Federal Home Loan Bank (the “FHLB”) of Atlanta, is required to own capital stock in the FHLB of Atlanta based generally upon the balances of total assets and FHLB advances.  FHLB capital stock is pledged to secure FHLB advances.  This investment is carried at cost since no ready market exists for FHLB stock and there is no quoted market value.  However, redemption of this stock has historically been at par value.  At June 30, 2009 and December 31, 2008, the Bank owned a total of $12.5 million and $14.2 million, respectively, of FHLB stock.  Due to the redemption provisions of FHLB stock, the Company estimated that fair value was equal to cost and that this investment was not impaired at June 30, 2009.  FHLB stock is included in other assets at its original cost basis.

The Bank, as a member bank of the Federal Reserve Bank (the “FRB”) of Richmond, is required to own capital stock of the FRB of Richmond based upon a percentage of the Bank’s common stock and surplus.  This investment is carried at cost since no ready market exists for FRB stock and there is no quoted market value.  At June 30, 2009 and December 31, 2008, the Bank owned a total of $5.3 million and $5.3 million, respectively of FRB stock.  Due to the nature of this investment in an entity of the U.S. Government, the Company estimated that fair value was equal

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to cost and that this investment was not impaired at June 30, 2009.  FRB stock is included in other assets at its original cost basis.

The following tables show investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2009 and December 31, 2008. Except as explicitly identified below, all unrealized losses on investment securities are considered by management to be temporarily impaired given the credit ratings on these investment securities and the short duration of the unrealized loss.

(dollars in thousands)	Less than 12 Months				12 Months or More				Total
	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
June 30, 2009
Available-for-Sale - Temporary Impairment
U.S. Government agencies and corporations	$	17,060	$	636	$	5,827	$	50	$	22,887	$	686
Mortgage-backed securities		1,122		38		-		-		1,122		38
State, county and municipal		7,634		426		1,214		128		8,848		554
Other debt securities		-		-		-		-		-		-
Equity securities		-		-		2,667		709		2,667		709
Total	$	25,816	$	1,100	$	9,708	$	887	$	35,524	$	1,987
Available-for-Sale - Other Than Temporary Impairment
Other debt securities	$	-	$	-	$	597	$	3,367	$	597	$	3,367
Total	$	-	$	-	$	597	$	3,367	$	597	$	3,367
Held-to-Maturity - Temporary Impairment
U.S. Government agencies and corporations	$	-	$	-	$	-	$	-	$	-	$	-
Mortgage-backed securities		44,983		1,529		-		-		44,983		1,529
State, county and municipal		2,658		78		-		-		2,658		78
Other debt securities		-		-		850		150		850		150
Total	$	47,641	$	1,607	$	850	$	150	$	48,491	$	1,757
December 31, 2008
Available-for-Sale - Temporary Impairment
U.S. Government agencies and corporations	$	19,941	$	221	$	1,289	$	8	$	21,230	$	229
Mortgage-backed securities		4,475		11		-		-		4,475		11
State, county and municipal		6,348		343		-		-		6,348		343
Other debt securities		-		-		644		4,310		644		4,310
Equity securities		52		11		2,615		827		2,667		838
Total	$	30,816	$	586	$	4,548	$	5,145	$	35,364	$	5,731
Held-to-Maturity - Temporary Impairment
U.S. Government agencies and corporations	$	-	$	-	$	-	$	-	$	-	$	-
Mortgage-backed securities		4,488		1		227		1		4,715		2
State, county and municipal		1,916		56		4,126		195		6,042		251
Other debt securities		-		-		712		288		712		288
Total	$	6,404	$	57	$	5,065	$	484	$	11,469	$	541

At June 30, 2009, the Company had 8 available-for-sale securities and 1 held-to-maturity security that were in an unrealized loss position for longer than 12 months.  At December 31, 2008, the Company had 3 available-for-sale securities and 12 held-to maturity securities that were in an unrealized loss position for longer than 12 months.  All of these securities’ impairments are deemed to be temporary as the declines in fair value noted above were

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attributable to increases in interest rates and not attributable to credit quality.  The Company has the intent to hold these securities until maturity or a market price recovery.

The aggregate amortized cost and fair value of debt securities at June 30, 2009, by remaining contractual maturity, are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

	Available-for-Sale				Held-to-Maturity
(dollars in thousands)	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Due in one year or less	$	24,348	$	24,576	$	3,557	$	3,588
Due after one one year through five years		55,541		56,983		5,679		5,643
Due after five years through 10 years		51,941		52,078		5,905		6,002
Due after 10 years		15,363		12,636		1,777		1,780
Total		147,193		146,273		16,918		17,013
Mortgage-backed securities		104,390		106,595		83,557		82,531
Equity securities		2,667		1,958		-		-
Total	$	254,250	$	254,826	$	100,475	$	99,544

Impairment of securities rated below investment grade or not rated was evaluated to determine if we expect not to recover the entire amortized cost basis of the security.  This evaluation was based on projections of estimated cash flows based on individual loans or issuers underlying each security using anticipated default rates and severities at foreclosure or default.

As of June 30, 2009, the Bank identified one security where expected cash flows were less than contractual cash flows.  This security is backed by a pool of issuers of trust preferred securities.  As of this date, issuers within the pool were either deferring or had defaulted on approximately 20.5% of the outstanding pool balance.  The security owned by the Bank is in a subordinated position to other securities backed by the trust preferred pool and was not paying dividends this quarter and we do not expect to receive any further dividend payments until sufficient reserves are established for the more senior securities.

The evaluation to determine impairment assumed that all issuers currently deferring would default and that additional defaults of 6% during the first year, 5% the second year, 4% the third year, 3% the fourth year, 2% the fifth year and 1% in year 6 and beyond would occur with a recovery rate of 40%.  Though the Bank does not know what the ultimate default and severity rates will be, management determined that this evaluation represented the best estimate of expected loss under a severe stress scenario.

Based on the evaluation, other-than-temporary impairment at June 30, 2009 was $4.4 million.  In accordance with FSP FAS 115-2, a $1.0 million other-than-temporary impairment charge due to the credit-related factors was recognized in earnings during the quarter, $3.4 million was determined to relate to other non-credit-related factors in the market place.  The difference between total unrealized losses and estimated credit losses on this security was charged against equity, net of deferred taxes, as a component of Other Comprehensive Income.

The following table, as of June 30, 2009, shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

(dollars in thousands)	June 30, 2009
Balance of credit losses on debt securities at the beginning of the current period	$	-
Additional increase related to the credit loss for which an other-than-impairment was recognized		1,000
Balance of credit losses on debt securities at the end of the current period	$	1,000

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6. Loans

The following summary sets forth the major categories of loans.

(dollars in thousands)	At June 30, 2009				At December 31, 2008
Loans held for sale	$	64,850			$	36,138
Loans held for investment:
Commercial and agricultural	$	202,385	12.7	%	$	184,909	11.7	%
Real estate-construction		442,796	27.8			453,668	28.6
Real estate-mortgage:
1-4 family residential		369,432	23.2			369,948	23.3
Commercial		536,069	33.7			540,192	34.1
Consumer		41,004	2.6			36,478	2.3
Total	$	1,591,686	100.0	%	$	1,585,195	100.0	%

The following is a summary of nonperforming assets for the periods ended as presented:

(dollars in thousands)	June 30, 2009		December 31, 2008
Loans on nonaccrual status	$	132,313	$	95,173
Loans more than 90 days delinquent, still on accrual		2,705		853
Real estate owned  / Repossessed assets		10,374		6,898
Total	$	145,392	$	102,924

7. Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

(dollars in thousands)	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
Balance, beginning of period	$	38,573		$	18,215		$	34,720		$	17,381
Provision charged to operations		5,525			1,383			19,584			2,897
Net charge-offs:
Charge-offs		(7,626	)		(1,106	)		(18,438	)		(2,152	)
Recoveries		372			353			978			719
Net charge-offs		(7,254	)		(753	)		(17,460	)		(1,433	)
Balance, end of period	$	36,844		$	18,845		$	36,844		$	18,845
Annualized net charge-offs during the period to average loans		1.83	%		0.19	%		2.20	%		0.19	%
Annualized net charge-offs during the period to allowance for loan losses		78.75	%		15.98	%		94.78	%		15.21	%
Allowance for loan losses to loans held for investment		2.31	%		1.20	%		2.31	%		1.20	%

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8.         Postretirement Employee Benefit Plans

The accompanying table details the components of the net periodic costs of the Company’s postretirement benefit plans as recognized in the Company’s Consolidated Statements of Income:

(dollars in thousands)	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2009			2008			2009			2008
Pension Plan
Service cost	$	50		$	66		$	103		$	132
Interest cost		153			165			325			330
Expected return on plan assets		(138	)		(235	)		(274	)		(470	)
Amortization of prior service cost		1			1			2			2
Amortization of net actuarial loss		77			2			160			4
Net periodic pension cost (income)	$	143		$	(1	)	$	316		$	(2	)
Supplemental Executive Retirement Plan
Service cost	$	35		$	34		$	98		$	68
Interest cost		33			36			75			72
Expected return on plan assets		-			-			-			-
Amortization of prior service cost		12			17			24			34
Amortization of net actuarial loss		(2	)		2			(2	)		4
Net periodic SERP cost	$	78		$	89		$	195		$	178
Other Postretirement Defined Benefit Plans
Service cost	$	5		$	4		$	10		$	8
Interest cost		25			18			47			36
Expected return on plan assets		-			-			-			-
Amortization of prior service cost (credit)		(1	)		(1	)		(2	)		(2	)
Amortization of net actuarial loss (gain)		5			-			10			-
Net periodic postretirement benefit cost	$	34		$	21		$	65		$	42

The Company expects to contribute $0.6 million to its pension plan in 2009. The other postretirement benefit plans are unfunded plans; and consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.

9. Recent Accounting Pronouncements

SFAS No. 141(R), “Business Combinations.”  This statement requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. In addition, this statement expands the scope of acquisition accounting to all transactions and circumstances under which control of a business is obtained. This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Earlier adoption is prohibited. The effective date of this statement is the same as that of the related SFAS No. 160.

SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.”  This statement improves the relevance, comparability and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way - as equity in the Consolidated Financial Statements. Moreover, SFAS No. 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The adoption of the provisions of SFAS No. 160 had no effect on financial position or results of operations.

SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133.”  SFAS No. 161 requires that an entity provide enhanced disclosures related to derivative and hedging activities. SFAS No. 161 is effective January 1, 2009 and has been adopted by the Company.  See Note 10 for additional disclosures.

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FSP FAS 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP FAS 115-2 and 124-2 creates a new model for evaluating other-than-temporary impairment on debt securities. If an entity intends to sell a debt security, or cannot assert it is more likely than not that it will not have to sell the security before recovery, OTTI must be taken. If the entity does not intend to sell the debt security before recovery, but the entity does not expect to recover the entire amortized cost basis, then OTTI must be taken, but the amount of impairment is to be bifurcated between impairment due to credit (which is recorded through earnings) and noncredit impairment (which becomes a component of other comprehensive income (“OCI”) for both available-for-sale (“AFS”) and held-to-maturity securities (“HTM”)). For HTM securities, the amount in OCI will be amortized prospectively over the security’s remaining life. Upon adoption, a cumulative effect adjustment must be made to opening retained earnings in the period adopted that reclassifies the noncredit portion of previously taken OTTI from retained earnings to accumulated OCI. This FSP also requires that annual disclosures required by SFAS 115 be presented in interim financial statements, and new disclosures are also required.  The adoption of FSP FAS 115-2 and FAS 124-2 required new disclosures that were included in the June 30, 2009 Form 10Q.  See Note 5 for additional disclosures.

FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS 107-1 and APB 28-1 requires companies to disclose the fair value of financial instruments within interim financial statements, adding to the current requirement to provide those disclosures annually.  The adoption of FSP FAS 107-1 and APB 28-1 did not have a material effect on the Company’s consolidated financial position or results of operations, although new disclosures as required by FSP FAS 107-1 and APB 28-1 were included in the June 30, 2009 Form 10Q.  See Note 11 for additional disclosures.

SFAS No. 165, “Subsequent Events.”  This statement sets forth the circumstances under which an entity should recognize events occurring after the balance sheet date and the disclosures that should be made.  Also, this statement requires disclosure of the date through which the entity has evaluated subsequent events.  The adoption of SFAS No. 165 did not have a material effect on the Company’s consolidated financial position or results of operations, although a new disclosure as required by SFAS No. 165 was included in the June 30, 2009 Form 10-Q.  See Note 14 for the disclosure.

SFAS No. 166, “Accounting for Transfers of Financial Assets.”  This statement, which is a revision to SFAS No. 140, eliminates the concept of a qualifying special purpose entity (QSPE), changes the requirements for derecognizing financial assets, and requires additional disclosures, including information about continuing exposure to risks related to transferred financial assets.  SFAS 166 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009.  The disclosure requirements must be applied to transfers that occurred before and after the effective date.  Early adoption is prohibited.  The Company has not yet completed its assessment of the impact of SFAS No. 166.

SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).”  This statement, which is a revision to FIN 46(R), contains new criteria for determining the primary beneficiary, eliminates the exception to consolidating QSPEs, requires continual reconsideration of conclusions reached in determining the primary beneficiary, and requires additional disclosures.  SFAS 167 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments (e.g., for newly-consolidated VIEs).  Early adoption is prohibited.  The Company has determined that the provisions of SFAS No. 167 will have no effect on financial position or results of operations..

SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles.”  The Codification will become the source of authoritative US GAAP recognized by the FASB to be applied by nongovernmental entities and will supersede all non-SEC accounting and reporting standards.  This statement is effective for financial statements issued for interim and annual financial statements ending after September 15, 2009.  Since the underlying GAAP guidance for nongovernmental entities will not change as a result of the issuance of SFAS No. 168, the Company’s adoption of the SFAS is not expected to have an impact on its financial condition or results of operations.  References to codification guidance will be updated in the Annual Report on Form 10-K for the fiscal year ending December 31, 2009.

FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”  This FSP requires companies to consider factors to determine whether there has been a significant decrease in the volume and level of activity compared to normal market activity and to consider whether an observed transaction was not orderly based on the

13

weight of available evidence.  Additionally, this FSP includes all assets and liabilities subject to fair value measurements and requires enhanced disclosures, including disclosure of investment securities by major security type.  The adoption of FSP FAS 157-4 required new disclosures that were included in the June 30, 2009 Form 10Q.  See Note 5 for additional disclosures.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

10. Derivative Financial Instruments

The Company is exposed to interest rate risk relating to its ongoing business operations. In connection with its asset/ liability management objectives, the Company has entered into interest rate swaps.

The Company adopted SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133,” at the beginning of the first quarter of 2009, and has included here the expanded disclosures required by that statement.

On March 14, 2008, FNB United entered into an interest rate swap to convert the floating rate cash flows on a $20 million trust preferred security to a fixed rate cash flow. As structured, the pay-fixed, receive-floating swap is evaluated, using the long-haul method, as being a cash flow hedge in which the ineffectiveness would be determined by any difference in valuation.  Consequently, the difference in cash flows in each period between the fixed rate interest payments that the Company makes and the variable interest payments received as well as any ineffectiveness in the cash flow hedge is currently reported in earnings, while gains and losses on the value of the swap instrument are recorded in shareholders’ equity.

Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts (“forward contracts”) and rate lock loan commitments. The fair value of the Company’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.

The table below provides data about the carrying values of derivative instruments:

	June 30, 2009								December 31, 2008
(dollars in thousands)	Assets		(Liabilities)						Assets		(Liabilities)
	Carrying Value		Carrying Value			Derivative Net Carrying Value			Carrying Value		Carrying Value			Derivative Net Carrying Value
Derivatives designated as hedging instruments:
Interest rate contracts (1)	$	-	$	(428	)	$	(428	)	$	-	$	(457	)	$	(457	)
Derivatives not designated as hedging instruments:
Mortgage loan forward sales and MBS (1)	$	101	$	-		$	101		$	-	$	-		$	-
Mortgage loan rate lock commitments (2)		-		(1	)		(1	)		-		-			-

(1) Included in "Other assets" on the Company's consolidated balance sheets.

(2) Included in "Other liabilities" on the Company's consolidated balance sheets.

The table below provides data about the amount of gains and losses related to derivative instruments designated as hedges included in the “Accumulated other comprehensive income (loss)” section of “Shareholders’ Equity” on the Company’s Consolidated Balance Sheets, and in “Other income” in the Company’s Consolidated Statements of Income:

(dollars in thousands)	Gain or (Loss), Net of Tax Recognized in Accumulated Other Comprehensive Loss (Effective Portion)						Gain or (Loss) in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	As of June 30, 2009			As of December 31, 2008			Three months ended June 30, 2009		Three months ended December 31, 2008
Derivatives designated as hedging instruments:
Interest rate contracts	$	(278	)	$	(301	)	$	-	$	-

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On April 7, 2009, Dover adopted FAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.  The adoption of FAS 159 allowed Dover to enter into a hedging arrangement for the purpose of limiting risk inherent in the mortgage loan pipeline and loans held for sale portfolio.  These loans have interest rate locks but have not yet settled.  The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:

	Gain or (Loss) During
(dollars in thousands)	Six Months Ended
	June 30, 2009			December 31, 2008
Derivatives not designated as hedging instruments:
Mortgage loan forward sales and MBS (1)	$	101		$	-
Mortgage loan rate lock commitments (2)		(1	)		-
Total	$	100		$	-

(1) Recognized in "Other expense" in the Company's consolidated statements of income.

(2) Recognized in "Mortgage loan sales" in the Company's consolidated statements of income.

11. Fair Values of Assets and Liabilities

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, derivative assets, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time-to-time, the Company may be required to record at fair value other assets and liabilities on a non-recurring basis, such as loans held for sale, loans held for investment and certain other assets and liabilities. These non-recurring fair value adjustments typically involve application of lower or cost or market accounting or write-downs of individual assets or liabilities.

Fair Value Hierarchy

Under SFAS 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:

Level 1:  Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2:  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3:  Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investments Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.

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Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value.  The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics.  With the adoption of FAS 159 by Dover, all loans held for sale originating from Dover are booked at fair value and are included in the recurring table.  The Bank has not adopted FAS 159 so all loans held for sale originated at the Bank are carried at the lower of cost of market and are considered nonrecurring fair value adjustments.  Dover loans held for sale and Bank loans held for sale are all recorded at Level 2.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans. At June 30, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loans as nonrecurring Level 3.

Other Real Estate Owned

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the OREO as nonrecurring Level 3.

Derivative Assets and Liabilities

Substantially all derivative instruments held or issued by the Company for risk management or customer-initiated activities are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivatives instruments held or issued for risk management or customer-initiated activities as Level 2.

Mortgage Servicing Rights

Mortgage servicing rights are recorded at fair value on a recurring basis, with changes in fair value recorded as a component of mortgage loan sales.  A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate, is used to determine fair value. Loan servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Company classifies mortgage servicing rights as Level 3.

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Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The following tables present the recorded amount of assets and liabilities measured at fair value on a recurring basis:

June 30, 2009

(dollars in thousands)	Total			Level 1		Level 2			Level 3
Investment securities available-for-sale	$	254,826		$	1,958	$	252,271		$	597
Derivative assets		101			-		101			-
Loans held for sale		59,079			-		59,079			-
Mortgage servicing rights		3,848			-		-			3,848
Total assets at fair value	$	317,854		$	1,958	$	311,451		$	4,445
Derivative liabilities	$	(428	)	$	-	$	(428	)	$	-
Total liabilities at fair value	$	(428	)	$	-	$	(428	)	$	-

December 31, 2008

(dollars in thousands)	Total			Level 1		Level 2			Level 3
Investment securities available-for-sale	$	205,426		$	1,829	$	203,597		$	-
Mortgage servicing rights		4,043			-		-			4,043
Total assets at fair value	$	209,469		$	1,829	$	203,597		$	4,043
Derivative liabilities	$	(456	)	$	-	$	(456	)	$	-
Total liabilities at fair value	$	(456	)	$	-	$	(456	)	$	-

The following are reconciliations of the beginning and ending balances for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the periods ended June 30, 2009 and 2008:

June 30, 2009

	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
(dollars in thousands)	Investment Securities Available- for-Sale		Mortgage Servicing Rights			Total
Beginning balance at December 31, 2008	$	-	$	4,043		$	4,043
Total gains or losses (realized/unrealized):
Included in earnings		-		(1,222	)		(1,222	)
Included in other comprehensive income		-		-			-
Purchases, issuances and settlements		-		1,027			1,027
Transfers in/out of Level 3		597		-			597
Ending balance at June 30, 2009	$	597	$	3,848		$	4,445

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June 30, 2008

	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
(dollars in thousands)	Investment Securities Available- for-Sale		Mortgage Servicing Rights		Total
Beginning balance at December 31, 2007	$	-	$	-	$	-
Total gains or losses (realized/unrealized):
Included in earnings		-		-		-
Included in other comprehensive income		-		-		-
Purchases, issuances and settlements		-		-		-
Transfers in/out of Level 3		3,351		-		3,351
Ending balance at June 30, 2008	$	3,351	$	-	$	3,351

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  Assets measured at fair value on a nonrecurring basis are included in the following tables.

June 30, 2009

(dollars in thousands)	Total		Level 1		Level 2		Level 3
Impaired loans	$	47,035	$	-	$	-	$	47,035
Other real estate owned		10,264		-		-		10,264
Total assets at fair value	$	57,299	$	-	$	-	$	57,299

December 31, 2008

(dollars in thousands)	Total		Level 1		Level 2		Level 3
Impaired loans	$	94,782	$	-	$	-	$	94,782
Total assets at fair value	$	94,782	$	-	$	-	$	94,782

Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value for each class of the Company’s financial instruments.

Cash and cash equivalents.    The carrying amounts for cash and due from banks approximate fair value because of the short maturities of those instruments.

Investment securities.   The fair value of investment securities is based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.  The fair value of equity investments in the restricted stock of the Federal Reserve Bank and Federal Home Loan Bank equals the carrying value.

Loans.  The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value.  The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value.

Investment in bank-owned life insurance.   The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

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Deposits.    The fair value of noninterest-bearing demand deposits and NOW, savings, and money market deposits are the amounts payable on demand at the reporting date.  The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowed funds.   The carrying value of retail repurchase agreements and federal funds purchased is considered to be a reasonable estimate of fair value.  The fair value of Federal Home Loan Bank advances and other borrowed funds is estimated using the rates currently offered for advances of similar remaining maturities.

Accrued interest.    The carrying amounts of accrued interest approximate fair value.

Financial instruments with off-balance sheet risk.  The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity.  For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value.

The estimated fair values of financial instruments are as follows:

	June 30, 2009				December 31, 2008
(dollars in thousands)	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets
Cash and cash equivalents	$	26,773	$	26,773	$	29,353	$	29,353
Investment securities:
Available-for-sale		254,826		254,826		205,426		205,426
Held-to-maturity		100,475		99,544		27,794		27,580
Loans held for sale		64,850		64,850		36,138		36,138
Net loans		1,554,842		1,553,592		1,585,195		1,480,270
Accrued interest receivable		7,588		7,588		7,196		7,196
Bank-owned life insurance		30,423		30,423		29,901		29,901
Other earning assets		17,920		17,920		19,825		19,825
Financial Liabilities
Deposits	$	1,639,755	$	1,628,880	$	1,514,747	$	1,526,719
Retail repurchase agreements		17,460		17,460		18,145		18,145
Federal Home Loan Bank advances		184,445		190,090		238,910		248,283
Federal funds purchased		80,000		80,000		37,000		37,000
Subordinated debt		15,000		15,000		15,000		14,173
Junior subordinated debentures		56,702		42,798		56,702		35,603
Accrued interest payable		3,431		3,431		4,078		4,078

12. Goodwill

Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires goodwill to be tested for impairment on an annual basis, or more frequently if circumstances indicate that an asset might be impaired, by comparing the fair value of such goodwill to its recorded or carrying amount. If the carrying amount of goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess. The Company typically tests goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment.

During 2008, FNB United performed goodwill impairment evaluations resulting in impairment charges of $57.8 million. As a result of continued market devaluation during the six months ended June 30, 2009, the Company continued its goodwill impairment evaluations.  As of the date of the filing of this report on Form 10-Q, the Company determined that it did not meet the first step goodwill test.  The Company is currently undertaking a second step analysis to determine the amount, if any, of goodwill impairment  that exists.

Due to the ongoing uncertainty in market conditions, which may continue to negatively impact the performance of the Company as well as the stock market valuations of financial institutions, including FNB United Corp.,

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management will continue to analyze goodwill each quarter for possible impairment. Future impairment may or may not occur, and the range of potential goodwill write-off, including through completion of the second step analysis currently being undertaken, could extend up to the full amount of remaining goodwill of $52.4 million.

13. Dividends Declared

On March 19, 2009, the Company declared a quarterly cash dividend of $0.025 per share on outstanding shares. The dividend was paid on April 24, 2009 to shareholders of record as of March 26, 2009.

On June 25, 2009, the Company declared a quarterly cash dividend of $0.025 per share on outstanding shares. The dividend was paid on July 24, 2009 to shareholders of record as of July 2, 2009.

14. Subsequent Events

The Company evaluated subsequent events up and through August 7, 2009, which is the date the financial statements were available to be issued.  As a result of that evaluation no subsequent events were identified that required recognition or disclosure in the financial statements.

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

The following presents management’s discussion and analysis of the financial condition, changes in financial condition and results of operations of FNB United Corp. (“FNB United”) and its wholly owned subsidiary, CommunityONE Bank, National Association (the “Bank”).  FNB United and its subsidiary are collectively referred to as the “Company.”  This discussion should be read in conjunction with the financial statements and related notes included elsewhere in the quarterly report.  This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors.  The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.

Executive Overview

Description of Operations

FNB United is a bank holding company with a full-service subsidiary bank, CommunityONE Bank, National Association, which offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers.  The Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina.

Additionally, the Bank has a mortgage banking subsidiary, Dover Mortgage Company, which originates, underwrites and closes loans for sale into the secondary market.  Dover has a retail origination network based in Charlotte and conducts wholesale operations in North Carolina, South Carolina, Georgia, Maine, Maryland, Mississippi, Tennessee, and Virginia.

Executive Summary

The Company’s total assets at June 30, 2009, were $2.2 billion, an increase of 8%, or $155.2 million from year-end 2008.  Investments grew $122.1 million, or 52%, reflecting the Company’s leveraging strategy to offset the earnings dilution resulting from participation in the Capital Purchase Program. Loans held for sale increased $28.9 million, or 80%, due to refinancing of residential mortgages. Gross loans held for investment totaled $1.6 billion at June 30, 2009, essentially flat from the prior year end.

Total deposits grew $125.0 million, to $1.6 billion in 2009, representing an 8% increase due primarily to increased consumer use of deposit account products in the current economic environment and an increase in the general consumer rate of savings.  Borrowings decreased $12.2 million or 3%, during the first six months of 2009, compared to the period ended December 31, 2008.  Total shareholders’ equity increased $44.8 million compared to December 31, 2008 primarily as a result of $51.5 million of capital invested by the U.S. Treasury in the first quarter of 2009 partially offset by the $7.4 million net loss for the first six months.

The Company experienced a net loss of $7.4 million in the first six months of 2009 compared to net income of $2.5 million for the same period in 2008 and is primarily the result of a $16.7 million increase in the provision for loan losses.  These losses were partially offset by $6.8 million in lower income taxes.

Noninterest income increased 8% to $11.1 million for the first six months in 2009, compared to $10.3 million for the same period in 2008.  Cardholder and merchant services income increased $0.1 million due to increased interchange fees and surcharge fees, and income from mortgage loan income increased by $1.7 million attributable to sizable increases in 2009 production driven by refinancing activity.

Noninterest expense year-to-date decreased 2% to $32.0 million in 2009 from $32.8 million in 2008.  The Company undertook a major noninterest expense improvement project during the second half of 2008, which included consolidation of operational functions, strong vendor management and tighter staffing models.  This effort resulted in a 9%, or $1.6 million decrease in personnel expense when comparing the first six months of 2009 to the same period in 2008.  This reduction was offset by increases in other expenses, primarily auditing fees and FDIC insurance costs, which were $0.3 million and $1.5 million, respectively, of which $1.0 million represented a one-time special FDIC assessment.  The Company also incurred noninterest expense of $0.3 million in the first quarter of 2009 related to its write-off of an investment in a failed banker’s bank.

Financial highlights are presented in the accompanying table.

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Selected Financial Data

(dollars in thousands, except per share data)	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2009			2008			2009			2008
Income Statement Data
Net interest income	$	15,246		$	14,639		$	29,378		$	29,784
Provision for loan losses		5,525			1,383			19,584			2,897
Noninterest income		5,490			5,053			11,133			10,276
Noninterest expense		16,356			17,320			31,963			32,767
Net (loss)/income		(403	)		140			(6,170	)		2,463
Preferred stock dividends		(809	)		-			(1,240	)		-
Net (loss)/income to common shareholders		(1,212	)		140			(7,410	)		2,463
Period End Balances
Assets	$	2,199,606		$	2,053,708		$	2,199,606		$	2,053,708
Loans held for sale		64,850			19,736			64,850			19,736
Loans held for investment (1)		1,591,686			1,575,044			1,591,686			1,575,044
Allowance for loan losses		36,844			18,845			36,844			18,845
Goodwill		52,395			108,395			52,395			108,395
Deposits		1,639,755			1,485,111			1,639,755			1,485,111
Borrowings		353,607			334,417			353,607			334,417
Shareholders' equity		192,727			214,882			192,727			214,882
Average Balances
Assets	$	2,169,526		$	2,044,790		$	2,140,613		$	2,002,031
Loans held for sale		53,955			20,686			53,309			18,983
Loans held for investment (1)		1,585,440			1,557,033			1,585,353			1,523,477
Allowance for loan losses		38,549			18,305			36,872			18,062
Goodwill		52,395			110,138			52,395			110,162
Deposits		1,624,788			1,486,154			1,587,787			1,468,676
Borrowings		339,948			322,753			355,005			297,037
Shareholders' equity		192,981			217,436			184,170			217,576
Per Common Share Data
Net (loss)/income per common share:
Basic	$	(0.11	)	$	0.01		$	(0.65	)	$	0.22
Diluted (2)		(0.11	)		0.01			(0.65	)		0.22
Cash dividends declared		0.025			0.10			0.05			0.25
Book value		12.33			18.81			12.33			18.81
Tangible book value		7.28			8.78			7.28			8.78
Performance Ratios
Return on average assets		(0.07	) %		0.03	%		(1.16	) %		0.49	%
Return on average tangible assets		(0.08	)		0.03			(1.19	)		0.53
Return on average equity (3)		(0.84	)		0.26			(13.44	)		4.55
Return on average tangible equity		(1.20	)		0.56			(19.61	)		9.80
Net interest margin (tax equivalent)		3.10			3.40			3.07			3.54
Dividend payout on common shares (4)		N/A			816.43			N/A			115.96
Asset Quality Ratios
Allowance for loan losses to period end loans held for investment		2.31	%		1.20	%		2.31	%		1.20	%
Nonperforming loans to period end allowance for loan losses		3.66			0.68			3.66			0.68
Net chargeoffs (annualized) to average loans held for investment		1.83			0.19			2.20			0.19
Nonperforming assets to period end loans held for investment and foreclosed property (5)		9.06			1.18			9.06			1.18
Capital and Liquidity Ratios
Average equity to average assets		8.90	%		10.63	%		8.60	%		10.87	%
Leverage capital		8.60			6.99			8.60			6.99
Tier 1 risk based capital		9.75			7.46			9.75			7.46
Total risk based capital		12.18			10.54			12.18			10.54
Average loans to average deposits		100.90			106.16			103.20			105.02
Average loans to average deposits and borrowings		83.44			87.22			84.35			87.36

(1) Loans held for investment, net of unearned income, before allowance for loan losses.

(2) Assumes the exercise of outstanding dilutive options to acquire common stock. See Note 15 to FNB United's consolidated financial statements included in the annual report on Form 10-K.

(3) Net (loss) income to common shareholders, which excludes preferred stock dividends, divided by average realized common equity which excludes accumulated other comprehensive income (loss).

(4) Not applicable to 2009 due to net loss.

(5) Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest.

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Application of Critical Accounting Policies

FNB United's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry and are fundamental to understanding management's discussion and analysis of results of operations and financial condition. FNB United's significant accounting policies are discussed in detail in Note 1 of the Consolidated Financial Statements contained in the Annual Report on Form 10-K for the year ended December 31, 2008.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and goodwill impairment. Actual results could differ from those estimates.

Allowance for Loan Losses

The allowance for loan losses, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management’s best estimate of probable loan losses incurred as of the balance sheet date.  FNB United’s allowance for loan losses is also analyzed quarterly by management.  This analysis includes a methodology that separates the total loan portfolio into comparable loan classifications for purposes of evaluating risk.  The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a comparable group.  Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines.  Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly.  While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used.  See additional discussion under “Asset Quality.”

Goodwill

FNB United has procedures to test goodwill for impairment on an annual basis or more frequently if necessary.  The testing procedures evaluate possible impairment based on the following:

The test assigns tangible assets and liabilities, identified intangible assets and goodwill to a reporting unit and compares the fair value of this reporting unit to its carrying value including goodwill.  The value is determined assuming a freely negotiated transaction between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Accordingly, to derive the fair value of the reporting unit, the following common approaches to valuing business combination transactions involving financial institutions are utilized by FNB United:  (1) the comparable transactions approach – specifically based on earnings, book, assets and deposit premium multiples received in recent sales of comparable bank franchises; and (2) the discounted cash flow approach.  The application of these valuation techniques takes into account the reporting unit’s operating history, the current market environment and future prospects. As of the most recent quarter, the Bank was carrying goodwill.

If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and no second step is required. If not, a second test is required to measure the amount of goodwill impairment. The second test of the overall goodwill impairment compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill. The impairment loss is equal to the excess of carrying value of goodwill over its implied fair value.

During 2008, FNB United performed goodwill impairment evaluations resulting in impairment charges of $57.8 million. As a result of continued market devaluation during the six months ended June 30, 2009, the Company continued its goodwill impairment evaluations.  As of the date of the filing of this report on Form 10-Q, the Company determined that it did not meet the first step goodwill test at the end of the second quarter.  The Company is currently undertaking a second step analysis to determine the amount, if any, of goodwill impairment that exists.

Due to the ongoing uncertainty in market conditions, which may continue to negatively impact the performance of the Company as well as the stock market valuations of financial institutions, including FNB United, management will continue to analyze goodwill each quarter for possible impairment. Future impairment may or may not occur, and the range of potential goodwill write-off, including through completion of the second step analysis currently being undertaken, could extend up to the full amount of remaining goodwill of $52.4 million.

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Summary

Management believes the accounting estimates related to the allowance for loan losses and the goodwill impairment test are “critical accounting estimates” because: (1) the estimates are highly susceptible to change from period to period as they require management to make assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on FNB United’s assets reported on the balance sheet as well as its net earnings.

Results of Operations

Net Interest Income

Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits.  Changes in net interest income result from changes in interest rates and in the volume, or average dollar level, and mix of earning assets and interest-bearing liabilities.  An analysis is presented in the Company’s average balances and net interest income analysis for the periods ended June 30, 2009 and 2008.

For the three months ended June 30, 2009, net interest income before the provision for loan losses was $15.2 million, an increase of $0.6 million, or 4%, from $14.6 million for the same quarter in 2008.  The increase was primarily due to a 110 basis point decrease in the yield on average earning assets, which increased $192.4 million, partially offset by an 88 basis point decrease in the cost of average interest-bearing liabilities, which increased $165.4 million.

The net interest margin (taxable-equivalent net interest income divided by average earning assets) compressed 30 basis points to 3.10% for the three months ended June 30, 2009, compared to 3.40% in the same period in 2008.  The decline in the net interest margin is due in part to a decline in the Federal funds target rate from 2.00% at June 30, 2008 to approximately 25 basis points at June 30, 2009.  Also negatively impacting our net interest margin is the increase in nonperforming assets during the three and six months ended June, 30, 2009 when compared to the same periods in 2008.  Nonperforming assets at period end were $145.4 million for the six months ended June 30, 2009 compared to $18.5 million for the six months ended June 30, 2008.Another variable impacting net interest margin is interest-earning assets repricing down faster than interest-bearing liabilities.  While the Company experienced a 110 basis point decrease in the yield on earning assets, the cost of interest-bearing liabilities only decreased 88 basis points. The $192.4 million growth in average earning assets was funded by higher cost deposits and wholesale borrowings.

For the six months ended June 30, 2009, net interest income before the provision for loan losses was $29.4 million, a decrease of $0.4 million, or 1%, from $29.8 million for the same period in 2008.  The decrease was primarily due to a $206.5 million increase in average earning asset balances and a $187.3 million increase in interest-bearing liabilities, offset by the 142 basis point decrease in yield on earning assets, combined with a 105 basis point decrease in interest-bearing liabilities.

The net interest margin (taxable-equivalent net interest income divided by average earning assets) compressed 47 basis points to 3.07% for the six months ended June 30, 2009, compared to 3.54% in the same period in 2008.

The 2009 and 2008 changes in net interest income on a taxable equivalent basis, as measured by volume and rate variances, are analyzed in the table below.  Volume refers to the average dollar level of earning assets and interest-bearing liabilities.

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Average Balances and Net Interest Income Analysis

	Three Months Ended June 30,
	2009							2008
(dollars in thousands)	Average Balance (3)		Income / Expense		Average Yield / Rate			Average Balance (3)		Income / Expense		Average Yield / Rate
Interest earning assets:
Loans (1)(2)	$	1,639,395	$	21,302		5.21	%	$	1,577,719	$	25,908		6.60	%
Taxable investment securities		288,442		4,375		6.08			156,392		1,699		4.37
Tax-exempt investment securities (1)		52,938		503		3.81			53,433		774		5.82
Other earning assets		18,903		87		1.85			19,768		265		5.39
Total earning assets		1,999,678		26,267		5.27			1,807,312		28,646		6.37
Non-earning assets:
Cash and due from banks		31,311							29,743
Goodwill and core deposit premium		57,889							116,395
Other assets, net		80,648							91,340
Total assets	$	2,169,526						$	2,044,790
Interest-bearing liabilities:
Interest-bearing demand deposits	$	196,380	$	542		1.11	%	$	170,040	$	227		0.54	%
Savings deposits		40,690		26		0.26			42,002		26		0.25
Money market deposits		304,668		1,124		1.48			286,604		1,843		2.59
Time deposits		928,723		6,913		2.99			823,572		8,526		4.16
Retail repurchase agreements		21,015		35		0.67			33,963		163		1.93
Federal Home Loan Bank advances		178,436		1,479		3.32			201,639		1,829		3.65
Federal funds purchased		68,795		43		0.25			30,293		174		2.31
Other borrowed funds		71,702		645		3.61			56,858		588		4.16
Total interest-bearing liabilities		1,810,409		10,807		2.39			1,644,971		13,376		3.27
Noninterest-bearing liabilities and shareholders' equity:
Noninterest-bearing demand deposits		154,327							163,936
Other liabilities		11,809							18,447
Shareholders' equity		192,981							217,436
Total liabilities and equity	$	2,169,526						$	2,044,790
Net interest income and net yield on earning assets (4)			$	15,460		3.10	%			$	15,270		3.40	%
Interest rate spread (5)						2.87	%						3.10	%

(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.

(2) The average loan balances include nonaccruing loans.

(3) The average balances for all years include market adjustments to fair value for securities and loans available/held for sale.

(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.

(5) Earning asset yield minus interest bearing liabilities rate.

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Average Balances and Net Interest Income Analysis

	Six Months Ended June 30,
	2009							2008
(dollars in thousands)	Average Balance (3)		Income / Expense		Average Yield / Rate			Average Balance (3)		Income / Expense		Average Yield / Rate
Interest earning assets:
Loans (1)(2)	$	1,638,662	$	42,954		5.29	%	$	1,542,460	$	53,497		6.97	%
Taxable investment securities		257,579		7,442		5.83			149,277		3,591		4.84
Tax-exempt investment securities (1)		54,265		1,426		5.30			54,868		1,585		5.81
Other earning assets		21,098		167		1.60			18,503		519		5.64
Total earning assets		1,971,604		51,989		5.32			1,765,108		59,192		6.74
Non-earning assets:
Cash and due from banks		29,449							30,192
Goodwill and core deposit premium		57,988							116,521
Other assets, net		81,572							90,210
Total assets	$	2,140,613						$	2,002,031
Interest-bearing liabilities:
Interest-bearing demand deposits	$	188,077	$	968		1.04	%	$	165,975	$	567		0.69	%
Savings deposits		39,774		51		0.26			41,659		52		0.25
Money market deposits		293,736		2,270		1.56			273,750		3,856		2.83
Time deposits		916,184		14,190		3.12			827,018		17,953		4.37
Retail repurchase agreements		20,658		68		0.66			32,073		412		2.58
Federal Home Loan Bank advances		201,277		3,077		3.08			185,519		3,521		3.82
Federal funds purchased		61,368		85		0.28			22,667		298		2.64
Other borrowed funds		71,702		1,312		3.69			56,778		1,496		5.30
Total interest-bearing liabilities		1,792,776		22,021		2.48			1,605,439		28,155		3.53
Noninterest-bearing liabilities and shareholders' equity:
Noninterest-bearing demand deposits		150,016							160,274
Other liabilities		13,651							18,742
Shareholders' equity		184,170							217,576
Total liabilities and equity	$	2,140,613						$	2,002,031
Net interest income and net yield on earning assets (4)			$	29,968		3.07	%			$	31,037		3.54	%
Interest rate spread (5)						2.84	%						3.22	%

(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.

(2) The average loan balances include nonaccruing loans.

(3) The average balances for all years include market adjustments to fair value for securities and loans available/held for sale.

(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.

(5) Earning asset yield minus interest bearing liabilities rate.

Provision for Loan Losses

This provision is the charge against earnings to provide an allowance for probable losses inherent in the loan portfolio.  The amount of each year’s charge is affected by several considerations including management’s evaluation of various risk factors in determining the adequacy of the allowance (see “Asset Quality”), actual loan loss experience and loan portfolio growth.

During the six-month period ended June 30, 2009, the provision for loan losses was $19.6 million, compared to $2.9 million in the same period of 2008.  The level of the provision was driven by deteriorating loan quality.  Net charge-offs for the six months ended June 30, 2009 totaled $17.5 million, or 2.20% of annualized average loans, compared to $1.4 million, or .19% of annualized average loans for the same period in 2008.  Approximately 49.01% of the 2009 six month charge-offs were comprised of land development loans.

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Noninterest Income

For the three months ended June 30, 2009, total noninterest income was $5.5 million, an increase of $0.4 million, or 8.6%, compared to the same period in 2008.  The primary factor impacting this increase was an increase in mortgage loan income of $1.3 million.  The increase in mortgage loan income was partially offset by an other than temporary impairment charge in the second quarter of $1.0 million related to the credit downgrading of an investment security owned by the Bank.

For the six months ended June 30, 2009, total noninterest income was $11.1 million, an increase of $0.9 million, or 8.3%, compared to the same period in 2008.  The primary reason for this increase was an increase in mortgage loan income of $1.7 million.  The increase in mortgage loan income was partially offset by an other than temporary impairment charge in the second quarter of $1.0 million related to our determination, through projected cash flow analysis, that it is unlikely the Bank will collect all payments due on an investment security owned by the Bank.

NONINTEREST INCOME	For the Six Months Ended June 30,
(dollars in thousands)	2009			2008
Service charges on deposit accounts	$	4,306		$	4,291
Mortgage loan income		4,528			2,813
Cardholder and merchant services income		1,204			1,066
Trust and investment services		781			931
Bank owned life insurance		470			486
Other service charges, commissions and fees		581			387
Security gains (losses)		(2	)		6
Total other than temporary impairment loss		(4,367	)		-
Portion of loss recognized in other comprehensive income		3,367			-
Net impairment loss recognized in earnings		(1,000	)		-
Other income		265			296
Total noninterest income	$	11,133		$	10,276

Mortgage loan sales production continued to be strong during the second quarter of 2009 due primarily to the recent increase in home mortgage refinancing and the benefit of hedging interest rate locks on sold mortgages as the interest rates on mortgage loans have changed in recent months beginning at the end of March, 2009.  The adoption of FAS 159 allowed Dover to enter into a hedging arrangement for the purpose of limiting risk inherent in the mortgage loan pipeline and loans held for sale portfolio.  In addition, the Bank has made a change in the way mortgage loan sales are reported on the income statement.  The result of this change reclassified approximately $0.2 million from interest income for the first three months of 2009.

The Bank incurred an other than temporary impairment charge in the second quarter of 2009 in the amount of $1.0 million.  The impairment analysis and subsequent charge was necessary after our cash flow analysis indicated that it is unlikely that the Bank will collect all future payments on a security owned by the Bank.  The Bank will continue to monitor this security in future periods to determine if further impairment charges are necessary.

Noninterest Expense

Noninterest expense for the second quarter of 2009 was approximately $16.4 million, a $0.9 million, or 5.6% decrease compared to the second quarter a year ago.  The second quarter of 2009 includes a $1.0 million special FDIC assessment while the second quarter of 2008 included a $1.8 million goodwill impairment charge for Dover Mortgage.  Also, contributing to the decrease is a reduction of 9.0% in personnel expense.

For the first six months of 2009, noninterest expense was $32.0 million, a $0.8 million, or 2.5% decrease, compared to the same period in 2008.  An FDIC special assessment of $1.0 million was taken in the second quarter of 2009 while a goodwill impairment charge of $1.8 million was taken in the second quarter 2008.  Personnel expense decreased $1.6 million with the noninterest expense improvement project undertaken in the second quarter of 2008.

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NONINTEREST EXPENSE	For the Six Months Ended June 30,
(dollars in thousands)	2009		2008
Personnel expense	$	16,267	$	17,898
Net occupancy expense		2,808		2,659
Furniture, equipment, and data processing expense		3,481		3,392
Professional fees		1,233		752
Stationery, printing and supplies		177		328
Advertising and marketing		1,056		773
Goodwill impairment		-		1,800
FDIC insurance		1,863		319
Other expense		5,078		4,846
Total noninterest expense	$	31,963	$	32,767

Personnel expense for the second quarter 2009 was $0.9 million lower than the same period a year ago due in part to the decrease in the number of full-time employees. The Company has frozen wages for all employees during 2009 and reduced the company contribution toward retirement plans. Full-time equivalent employees averaged 525 employees for the second quarter 2009 versus 545 employees for the second quarter of 2008.  Personnel expenses for the first six months of 2009 was 9% lower when compared to the same period in 2008.  This decrease equates to just over $1.6 million and can be attributed to a noninterest expense improvement project initiated in mid 2008.

Professional fees for the three and six months ended of June 30, 2009, were $0.5 million and $1.2 million, respectively, compared to $0.3 million and $0.8 million for the same periods in 2008.  The increase was principally attributable to increased audit fees in 2009.

The FDIC mandated a special assessment for all financial institutions in the second quarter of 2009 equivalent to 5 basis points on total assets minus tier one capital.  For the Bank the special assessment amounted to $1.0 million.  The expense is included in the second quarter noninterest expense as part of Other Expense.  The FDIC has not determined if additional special assessments will be required of all banks in a future period.

Provision for Income Taxes

The Company experienced an income tax benefit totaling $0.7 million for the second quarter of 2009 compared to a tax expense of $0.8 million for the same period in 2008.  The decrease in the provision for 2009, compared to the prior year, results primarily from the decrease in taxable income.  The Company’s provision for income taxes, as a percentage of (loss)/income before income taxes, was 64.8% for the three months ended June 30, 2009, compared to 30.4% for the three months ended June 30, 2008, exclusive of the impact of the nontax deductable $1.8 million write-down of goodwill associated with the acquisition of Dover Mortgage and reflective of different levels of tax-exempt earnings.

The Company experienced an income tax benefit totaling $4.9 million for the six months of 2009 compared to a tax expense of $1.9 million for the same period in 2008.  The decrease in the provision for 2009, compared to the prior year, results primarily from the decrease in taxable income.  Our provision for income taxes, as a percentage of (loss)/income before income taxes, was 44.1% for the six months ended June 30, 2009, compared to 31.2% for the first six months ended June 30, 2008, exclusive of the impact of the nontax deductable $1.8 million write-down of goodwill associated with the acquisition of Dover Mortgage and reflective of different levels of tax-exempt earnings.

Financial Condition

Since December 31, 2008, the Company’s assets have increased $155.2 million, to $2.2 billion at June 30, 2009.  The principal factors causing this overall increase during the first six months of 2009 were a $122.1 million increase in net investment securities, combined with a $28.9 million increase in loans held for sale.  Loans held for investment totaled $1.6 billion both at June 30, 2009 and at December 31, 2008.  Investment securities of $355.3 million at June 30, 2009 were 52% higher than the $233.2 million balance at December 31, 2008.

Deposits totaled $1.6 billion at June 30, 2009, compared to $1.5 billion at December 31, 2008.  At the end of the second quarter 2009, noninterest-bearing deposits were $155.2 million, or 9.5%, of total deposits, up 3% since the end of 2008.  Borrowings at the Federal Home Loan Bank (“FHLB”) totaled $184.4 million at June 30, 2009,

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compared to $238.9 million at December 31, 2008.  The decrease in the FHLB borrowings was partially offset by an increase in Federal funds purchased of $43.0 million.  The Company accessed the Federal Reserve’s Term Auction Liquidity Facility for the first time in January, 2009. Unlike FHLB funding, Federal Reserve funding allows construction and development loans as collateral.

Shareholders’ equity is strong, with all of our regulatory capital ratios at levels that classify the Company as “well capitalized” under bank regulatory capital guidelines.  Shareholders’ equity was $192.7 million at the end of the second quarter 2009, up 30% from $147.9 million at December 31, 2008. The increase reflects the issuance of Series A senior preferred stock and related warrant to the U.S. Department of the Treasury pursuant to the terms of the Capital Purchase Program. The Company declared common dividends of $.025 per share during the second quarter ended June 30, 2009.

Investment Securities

The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, to determine if an other-than-temporary impairment (“OTTI”) exists pursuant to guidelines established in FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.  In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than book value, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.  If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss.  Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income/(loss) in shareholders’ equity) and not recognized in income until the security is ultimately sold.

In April 2009, the FASB issued FASB Staff Position No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” (“FSP FAS 115-2 and 124-2”). FSP FAS 115-2 and 124-2 creates a new model for evaluating other-than-temporary impairment on debt securities. If an entity intends to sell a debt security, or cannot assert it is more likely than not that it will not have to sell the security before recovery, OTTI must be taken. If the entity does not intend to sell the debt security before recovery, but the entity does not expect to recover the entire amortized cost basis, then OTTI must be taken, but the amount of impairment is to be bifurcated between impairment due to credit (which is recorded through earnings) and noncredit impairment (which becomes a component of other comprehensive income (“OCI”) for both available-for-sale (“AFS”) and held-to-maturity securities (“HTM”)). For HTM securities, the amount in OCI will be amortized prospectively over the security’s remaining life.

The Company owns one trust preferred collateralized debt obligation with a book value as of June 30, 2009 of $4.9 million.  With very limited marketability of the security, a down-graded credit rating and rates well above the stated rate of this security, the current trading activity is $4.4 million below par for this security.  After extensive review, management determined that an OTTI charge due to credit losses of $1.0 million was necessary in the second quarter of 2009.  Management will continue to monitor this security for future OTTI.

At June 30, 2009, the remainder of the Company’s securities available-for-sale with an unrealized loss position were, in management’s belief, primarily due to differences in market interest rates as compared to those of the underlying securities.  Management does not believe any of these securities are other-than-temporarily impaired.  At June 30, 2009, the Company has both the intent and ability to hold these impaired securities for a period of time necessary to recover the unrealized losses; however, the Company may from time to time dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds could be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

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Asset Quality

Management considers the asset quality of the Bank to be of primary importance.  A formal loan review function, independent of loan origination, is used to identify and monitor problem loans.  As part of the loan review function, a third-party assessment group has been employed to review the underwriting documentation and risk grading analysis.  Beginning in 2010, the formal loan review function will be brought in-house in order to provide more timely response.  This function will be managed by credit administration.

Nonperforming assets

Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more, repossessed assets and other real estate owned (“OREO”).  Loans are placed in nonaccrual status when, in management’s opinion, the collection of all or a portion of interest becomes doubtful.  Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time.  OREO represents real estate acquired through foreclosure or deed in lieu of foreclosure and is generally carried at fair value, less estimated costs to sell.

Nonperforming loans at June 30, 2009 were $135.0 million, or 8.5% of loans held for investment, compared to $96.0 million, or 6.1% of loans held for investment at December 31, 2008.  OREO was $10.3 million at June 30, 2009, compared to $6.8 million at December 31, 2008.

Allowance for Loan Losses

In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process.  Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market area.  For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses.  Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations.  Loans are charged off when, in the opinion of management, they are deemed to be uncollectible.  Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.

The adequacy of the allowance for loan losses is measured on a quarterly basis against an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses.  Homogeneous pools of loans are segregated, and classifications of individual loans within certain of these pools are identified using risk grades derived from regulatory risk guidelines and additional internal parameters.  Utilizing the trailing four-year historical loss experience of the Bank (prior to the merger with Integrity) combined with recent loss experience with the acquired Integrity loan portfolio and the assessment of portfolio quality and diversification trends and economic factors, a range of appropriate reserves is calculated for each classification and pool of loans.  Allocated to each pool is a reserve amount within the calculated range, as supported by the historical loss ratios.  Additional reserves are estimated and assigned to the most adversely classified loans based upon an individual analysis of present-value repayment and/or liquidation projections of each loan.  A portion of the total reserve may be unallocated to any specific segment of the loan portfolio, but will not exceed the upper limit of the total calculated reserve range when aggregated with allocated portions.  The determination within the allowance model of allocated and unallocated components is not necessarily indicative of future losses or allocations.  The entire balance of the allowance for loan losses is available to absorb losses in any segment of the loan portfolio.

The allowance for loan losses, as a percentage of loans held for investment, amounted to 2.31% at June 30, 2009, 2.19% at December 31, 2008 and 1.20% at June 30, 2008.  Adequate provisions and allowances for loan losses are based upon numerous factors including growth of the loan portfolio, delinquencies, net charge offs, nonperforming loans, and collateral values.  Changes in the allowance for loan losses are presented in Note 7 to the Consolidated Financial Statements.

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Management believes the allowance for loan losses of $36.8 million at June 30, 2009 is adequate to cover probable losses inherent in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment.  Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid.  Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required.  No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company.

Liquidity Management

Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Company’s customers.  Deposit withdrawals, loan funding and general corporate activity create a need for liquidity for the Company.  Liquidity is derived from sources such as deposit growth; maturity, calls, or sales of investment securities; principal and interest payments on loans; access to borrowed funds or lines of credit; and profits.

Consistent with the general approach to liquidity, loans and other assets of the Bank are based primarily on a core of local deposits and the Bank’s capital position.  To date, the steady increase in deposits, retail repurchase agreements and capital, supplemented by Federal Home Loan Bank advances, term Federal funds and a modest amount of brokered deposits, has been adequate to fund loan demand in the Bank’s market area, while maintaining the desired level of immediate liquidity and a substantial investment securities portfolio available for both immediate and secondary liquidity purposes.

Commitments, Contingencies and Off-Balance Sheet Risk

In the normal course of business, various commitments are outstanding that are not reflected in the Consolidated Financial Statements.  Significant commitments at June 30, 2009 are discussed below.

Commitments by the Bank to extend credit and undisbursed advances on customer lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  At June 30, 2009, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $311.1 million.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many commitments expire without being fully drawn, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on the credit evaluation of the borrower.

The Bank issues standby letters of credit whereby it guarantees the performance of a customer to a third party if a specified triggering event or condition occurs.  The guarantees generally expire within one year and may be automatically renewed depending on the terms of the guarantee.  All standby letters of credit provide for recourse against the customer on whose behalf the letter of credit was issued, and this recourse may be further secured by a pledge of assets.  The maximum potential amount of undiscounted future payments related to standby letters of credit was $15.9 million at June 30, 2009, $16.1 million at December 31, 2008 and $19.4 million at June 30, 2008.

Dover Mortgage Company originates fixed rate residential mortgage loans with the intention of selling these loans.  Between the time that Dover enters into an interest rate lock or a commitment to originate a fixed rate residential mortgage loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments.  The Company believes that it is prudent to limit the variability of expected proceeds from the future sales of these loans by entering into forward sales commitments and commitments to deliver loans into a mortgage-backed security.  The commitments to originate fixed rate residential mortgage loans and the forward sales commitments are freestanding derivative instruments.  They do not qualify for hedge accounting treatment so their fair value adjustments are recorded through the income statement in income from mortgage loan sales.  The commitments to originate fixed rate residential mortgage loans totaled $72.2 million at June 30, 2009, and the related forward sales commitments totaled $72.2 million.  Loans held for sale by Dover totaled $61.7 million at June 30, 2009, and the related forward sales commitments totaled $61.7 million.

The Bank had loans held for sale of $5.8 million at June 30, 2009.  Commitments of the Bank for the origination of mortgage loans intended to be held for sale at June 30, 2009 were $37.0 million.

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The Company does not have any special purpose entities or other similar forms of off-balance sheet financing.

Asset/Liability Management and Interest Rate Sensitivity

One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates.  One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps; however, this method addresses only the magnitude of timing differences and does not address earnings or market value.  Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios in order to more accurately measure interest rate risk.

The Company’s balance sheet was asset-sensitive at June 30, 2009.  An asset-sensitive position means that, for cumulative gap measurement periods of one year or less, there are more assets than liabilities subject to immediate repricing as market rates change.  Because immediately rate sensitive assets exceed rate sensitive interest-bearing liabilities, the earnings position could improve in a rising rate environment and could deteriorate in a declining rate environment, depending on the correlation of rate changes in these two categories.  Included in interest-bearing liabilities subject to rate changes within 90 days is a portion of the interest-bearing demand, savings and money market deposits.  These types of deposits historically have not repriced coincidentally with or in the same proportion as general market indicators.

During the first six months of 2009 the Company initiated and completed a leveraging strategy through the investment portfolio to offset the cost of dividends payable to the preferred stock obligation through the Capital Purchase Program.  Cash flows from investment maturities and repayments of mortgage-backed securities are anticipated to be used to provide funding for future lending opportunities.  Funding for the securities purchased came through proceeds from preferred stock as well as customer deposits and short-term borrowings.  The leveraging strategy resulted in a sizable increase in the investment portfolio and in a slight reduction in the Company’s overall asset sensitivity from December 31, 2008.

Capital Adequacy and Resources

Under guidelines established by the Board of Governors of the Federal Reserve System, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio.  The risk-based capital ratios are determined by expressing allowable capital amounts, defined in terms of Tier 1 and Tier 2, as a percentage of risk-weighted assets, which are computed by measuring the relative credit risk of both the asset categories on the balance sheet and various off-balance sheet exposures.  Tier 1 capital consists primarily of common shareholders' equity and qualifying perpetual preferred stock and qualifying trust preferred securities, net of goodwill and other disallowed intangible assets.  Tier 2 capital, which is limited to the total of Tier 1 capital, includes allowable amounts of subordinated debt, mandatory convertible debt, preferred stock, trust preferred securities and the allowance for loan losses. Total capital, for risk-based purposes, consists of the sum of Tier 1 and Tier 2 capital.  Under current requirements, the minimum total capital ratio is 8.00% and the minimum Tier 1 capital ratio is 4.00%.  At June 30, 2009, FNB United and the Bank had total risk-based capital ratios of 12.18% and 11.48%, respectively, and Tier 1 capital ratios of 9.75% and 9.42%, respectively.

As shown in the accompanying table, FNB United and its wholly owned banking subsidiary have capital levels exceeding the minimum levels for “well capitalized” bank holding companies and banks as of June 30, 2009.

	Regulatory Guidelines
	Well Capitalized			Adequately Capitalized			FNB United			CommunityONE
Total Capital		10.00	%		8.00	%		12.18	%		11.48	%
Tier 1 Capital		6.00			4.00			9.75			9.42
Leverage Capital		5.00			4.00			8.60			8.30

On February 13, 2009, the Company entered into a Letter Agreement and Securities Purchase Agreement (the “Purchase Agreement”) with the U.S. Treasury Department (“Treasury”) under the TARP Capital Purchase Program (the “CPP”) discussed below, pursuant to which the Company sold (i) 51,500 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) for $51,500,000 and (ii) a warrant (the “Warrant”) to purchase 2,207,143 shares of the Company’s common stock for an exercise price of $3.50 per share, or $7.7 million in the aggregate, in cash.

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The warrant is immediately exercisable and expires 10 years from the date of issuance.  Proceeds from this sale of the preferred stock are expected to be used for general corporate purposes, including supporting the continued, anticipated growth of the Company.  The CPP preferred stock is generally non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years and 9% thereafter.  The preferred shares are redeemable at the option of the Company, subject to the approval of its primary federal regulator.

Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on its common stock is subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($.10) declared on the common stock prior to October 14, 2008, as adjusted for subsequent stock dividends and other similar actions.  In addition, as long as Series A Preferred Stock is outstanding, dividend payments are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.

The proceeds from the offering of the Series A Preferred Stock and related Warrant were allocated between the Series A Preferred Stock and Warrant based on their relative fair values.  The Warrant was assigned a fair value of $1.76 per share, or $3.9 million in the aggregate.  As a result, $3.9 million was recorded as the discount on the preferred stock obtained and will be accreted as a reduction in net income available for common shareholders over the next five years at approximately $0.6 million to $1.0 million per year.  For purposes of these calculations, the fair value of the shares subject to the Warrant was estimated using the Black-Scholes option pricing model.

Non-GAAP Measures

This Quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with generally accepted accounting principles (“GAAP”).  FNB United’s management uses these non-GAAP measures in their analysis of FNB United’s performance.  These non-GAAP measures exclude average goodwill and core deposit premiums from the calculations of return on average assets and return on average equity.  Management believes presentations of financial measures excluding the impact of goodwill and core deposit premiums provide useful supplemental information that is essential to a proper understanding of the operating results of FNB United’s core businesses. In addition, certain designated net interest income amounts are presented on a taxable equivalent basis.  Management believes that the presentation of net interest income on a taxable equivalent basis aids in the comparability of net interest income arising from taxable and tax-exempt sources.  These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the possible chance of loss from unfavorable changes in market prices and rates.  These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets, over interest expense on interest-bearing liabilities.

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities.  The structure of the Company’s loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income.  The Company does not maintain a trading account nor is FNB United subject to currency exchange risk or commodity price risk.  Interest rate risk is monitored as part of the Company’s asset/liability management function, which is discussed in “Asset/Liability Management and Interest Rate Sensitivity” above.  Interest rate risk is monitored as part of the Company’s asset/liability management function, which is discussed above in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Asset/Liability Management and Interest Rate Sensitivity.”

Management considers interest rate risk the Bank’s most significant market risk, which could potentially have the greatest impact on operating earnings.  The Company is asset sensitive, which means that falling interest rates could result in a reduced amount of net interest income.  The monitoring of interest rate risk is part of the Company’s overall asset/liability management process.  The primary oversight of asset/liability management rests with the

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Company’s Asset and Liability Committee.  The Committee meets on a regular basis to review asset/liability activities and to monitor compliance with established policies.

Management does not believe there has been any significant change in the overall performance of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2008.

Item 4. Controls and Procedures

As of June 30, 2009, the end of the period covered by this report, FNB United carried out an evaluation under the supervision and with the participation of the Company’s management, including FNB United’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of FNB United’s disclosure controls and procedures.  In designing and evaluating the Company’s disclosure controls and procedures, FNB United and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and FNB United’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures.  Based upon the evaluation, and for the reason described in the next paragraph, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were ineffective to provide reasonable assurance that information required to be disclosed by FNB United in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

As of December 31, 2008, FNB United concluded that it did not have adequate segregation of duties and staffing within its accounting department, adversely affecting its disclosure controls and procedures and internal control over financial reporting.  FNB United has since that date restructured various duties and responsibilities within the accounting department to ensure appropriate segregation of duties and has hired a controller to assist the Company in its financial reporting.  FNB United reviews its disclosure controls and procedures, which may include its internal controls over financial reporting, on an ongoing basis and may from time to time make changes aimed at enhancing their effectiveness.  No control enhancements during the quarter ended June 30, 2009, other than those described above, have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A Risk Factors

There have been no material changes from the risk factors as previously disclosed in Item 1A to Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable.

Item 3. Defaults Upon Senior Securities

Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders

(a) The annual meeting of the shareholders of FNB United Corp. was held on Tuesday, May 12, 2009.

(b) No response is required.

(c) At the annual meeting, the shareholders voted upon the election of directors and an advisory proposal to approve the compensation of FNB United’s named executive officers as determined by the Compensation Committee of the Board of Directors.

The shareholders voted in favor of electing the following persons as directors of FNB United Corp.:

For Terms Ending in 2012	Votes For	Votes Withheld/ Abstentions
Larry E. Brooks	7,820,977	939,290
Eugene B. McLaurin, II	7,878,130	882,138
R. Reynolds Neely, Jr.	7,841,767	918,500
Suzanne B. Rudy	7,742,875	1,017,392
Carl G. Yale	7,770,153	990,115

6,860,248 shares voted to approve the compensation of FNB United’s named executive officer, 1,633,045 shares voted against and 255,509 shares abstained

Item 5. Other Information

None

Item 6. Exhibits

Exhibits to this report are listed in the index to exhibits on pages 37-39 of this report.

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SIGNATURES

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

	FNB United Corp.
	(Registrant)
Date: August 7, 2009	By:	/s/ Mark A. Severson
		Mark A. Severson
		Executive Vice President and Chief
		Financial Officer
		(Duly Authorized Officer and Principal
		Financial Officer)

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INDEX TO EXHIBITS

Exhibit No.		Description of Exhibit
	3.10	Articles of Incorporation of the Registrant, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form S-14 Registration Statement (No. 2-96498) filed March 16, 1985.
	3.11	Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 10, 1988, incorporated herein by reference to Exhibit 19.10 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1988.
	3.12	Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 12, 1998, incorporated herein by reference to Exhibit 3.12 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1998.
	3.13	Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 23, 2003, incorporated herein by reference to Exhibit 3.13 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2003.
	3.14	Articles of Amendment to Articles of Incorporation of the Registrant, adopted March 15, 2006, incorporated herein by reference to Exhibit 3.14 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended March 31, 2006.
	3.15	Articles of Merger, setting forth amendment to Articles of Incorporation of the Registrant, effective April 28, 2006, incorporated herein by reference to Exhibit 3.15 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended March 31, 2006.
	3.16	Articles of Amendment to Articles of Incorporation, adopted January 23, 2009, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form 8-K Current Report filed January 23, 2009.
	3.17	Articles of Amendment to Articles of Incorporation, adopted February 11, 2009, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009.
	3.20	Amended and Restated Bylaws of the Registrant, adopted February 11, 2009, incorporated herein by reference to Exhibit 3.2 to the Registrant’s Form 8-K Current Report filed February 13, 2009.
	4.10	Specimen of Registrant’s Common Stock Certificate, incorporated herein by reference to Exhibit 4 to Amendment No. 1 to the Registrant’s Form S-14 Registration Statement (No. 2-96498) filed April 19, 1985.
	4.11	Specimen of Registrant’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, Stock Certificate, incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009.
	4.20	Indenture dated as of November 4, 2005, between FNB Corp. and U.S. Bank, National Association, as trustee, incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K Current Report filed November 8, 2005.
	4.21	Amended and Restated Declaration of Trust of FNB United Statutory Trust I dated as of November 4, 2005, among FNB Corp., as sponsor, U.S. Bank, National Association, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report dated November 4, 2005.
	4.30	Amended and Restated Declaration of Trust of FNB United Statutory Trust I dated as of November 4, 2005, among FNB Corp., as sponsor, U.S. Bank, National Association, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report filed November 8, 2005.

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4.31	Amended and Restated Trust Agreement of FNB United Statutory Trust II dated as of April 27, 2006, among FNB Corp., as sponsor, Wilmington Trust Company, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report dated April 27, 2006 and filed April 28, 2006.
4.40	Warrant to purchase up to 2,207,143 shares of Common Stock used to the United States Department of the Treasury, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report filed February 13, 2009.
10.10*	Form of Split Dollar Insurance Agreement dated as of November 1, 1987 between First National Bank and Trust Company and certain of its key employees and directors, incorporated herein by reference to Exhibit 19.20 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1988.
10.11*	Form of Amendment to Split Dollar Insurance Agreement dated as of November 1, 1994 between First National Bank and Trust Company and certain of its key employees and directors, incorporated herein by reference to Exhibit 10.11 to the Registrant’s Form 10-KSB Annual Report for the fiscal year ended December 31, 1994.
10.20*	Stock Compensation Plan as amended effective May 12, 1998, incorporated herein by reference to Exhibit 10.30 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1998.
10.21*	Form of Incentive Stock Option Agreement between FNB Corp. and certain of its key employees, pursuant to the Registrant’s Stock Compensation Plan, incorporated herein by reference to Exhibit 10.31 to the Registrant’s Form 10-KSB Annual Report for the fiscal year ended December 31, 1994.
10.22*	Form of Nonqualified Stock Option Agreement between FNB Corp. and certain of its directors, pursuant to the Registrant’s Stock Compensation Plan, incorporated herein by reference to Exhibit 10.32 to the Registrant’s Form 10-KSB Annual Report for the fiscal year ended December 31, 1994.
10.23*	FNB United Corp. 2003 Stock Incentive Plan, as amended and restated as of December 31, 2008, incorporated herein by reference to Exhibit 10.23 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.24*	Form of Incentive Stock Option Agreement between FNB Corp. and certain of its key employees, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.24 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended  September 30, 2003.
10.25*	Form of Nonqualified Stock Option Agreement between FNB Corp. and certain of its directors, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.25 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2003.
10.26*	Form of Restricted Stock Agreement between FNB United Corp. and certain of its key employees and non-employee directors, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.26 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2006.
10.30*	Amended and Restated Employment Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association and Michael C. Miller, incorporated herein by reference to Exhibit 10.30 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.31*	Carolina Fincorp, Inc. Stock Option Plan (assumed by the Registrant on April 10, 2000), incorporated herein by reference to Exhibit 99.1 to the Registrant’s Registration Statement on Form S-8 (File No. 333-54702).
10.32*	Amended and Restated Employment Agreement dated as of December 31, 2008 between CommunityONE Bank, National Association and R. Larry Campbell, incorporated herein by

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	reference to Exhibit 10.32 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.33*	Nonqualified Supplemental Retirement Plan with R. Larry Campbell, incorporated herein by reference to Exhibit 10(c) to the Annual Report on Form 10-KSB of Carolina Fincorp, Inc. for the fiscal year ended June 30, 1997.
10.34*	Amendment to Executive Income Deferred Compensation Agreement dated as of December 31, 2008 between CommunityONE Bank, National Association and R. Larry Campbell, incorporated herein by reference to Exhibit 10.34 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.35*	Amended and Restated Change of Control Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association, and R. Mark Hensley, incorporated herein by reference to Exhibit 10.35 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.36*	Amended and Restated Change of Control Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association, and Mark A. Severson, incorporated herein by reference to Exhibit 10.36 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.37*	Form of Change of Control Agreement among FNB United Corp., CommunityONE Bank, National Association and certain key officers and employees, incorporated herein by reference to Exhibit 10.37 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008.
10.38*	Form of Letter Agreement between FNB United Corp. and senior executive officers incorporated herein by reference to the Registrant’s Form 8-K Current Report filed February 13, 2009.
10.40	Guarantee Agreement dated as of November 4, 2005, by FNB Corp. for the benefit of the holders of trust preferred securities, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated November 4, 2005 and filed November 5, 2005.
10.41	Guarantee Agreement dated as of April 27, 2006 between FNB Corp. and Wilmington Trust Company, as guarantee trustee, for the benefit of the holders of trust preferred securities, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated April 27, 2006 and filed April 28, 2006.
10.42	Subordinated Debt Loan Agreement dated as of June 30, 2008, between CommunityONE Bank, National Association and SunTrust Bank, incorporated herein by reference to Exhibit 10.43 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2008.
10.5	Letter Agreement between the Registrant and the United States Department of the Treasury, dated February 13, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009.
31.10	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.11	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

________________

* Management contract, or compensatory plan or arrangement.

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