CommunityOne Bancorp 10-Q 2007 Q1 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 March 31, 2007

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)

(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  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

The registrant had 11,358,605 shares of $2.50 par value common stock outstanding at May 9, 2007.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FNB United Corp. and Subsidiaries

CONSOLIDATED BALANCE SHEETS (unaudited)

	March 31,						December 31,
	2007			2006			2006
	(in thousands, except share and per share data)
ASSETS
Cash and due from banks	$	38,905		$	20,751		$	35,225
Interest-bearing bank balances		10,757			1,207			42,929
Federal funds sold		50,130			17,829			30,186
Investment securities:
Available for sale, at estimated fair value (amortized cost of $182,127, $115,2373 and $128,367)		182,552			114,689			128,945
Held to maturity (estimated fair value of $41,464, $42,106 and $41,865)		42,318			43,593			42,870
Loans:
Loans held for sale		26,497			20,822			20,862
Loans held for investment		1,313,168			799,888			1,301,840
Less allowance for loan losses		(15,757	)		(9,713	)		(15,943	)
Net loans		1,323,908			810,997			1,306,759
Premises and equipment, net		45,780			25,422			45,691
Goodwill		110,961			31,389			110,956
Core deposit premiums		7,173			1,285			7,378
Other assets		61,920			39,353			64,643
Total Assets	$	1,874,404		$	1,106,515		$	1,815,582
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits	$	161,908		$	105,824		$	158,938
Interest-bearing deposits:
Demand, savings and money market deposits		480,003			239,648			463,355
Time deposits of $100,000 or more		375,265			234,194			365,770
Other time deposits		448,535			270,895			432,950
Total deposits		1,465,711			850,561			1,421,013
Retail repurchase agreements		27,225			15,642			23,161
Federal Home Loan Bank advances		65,866			84,676			65,825
Other borrowed funds		83,439			39,559			78,032
Other liabilities		21,739			12,141			19,883
Total Liabilities		1,663,980			1,002,579			1,607,914
Shareholders' equity:
Preferred stock - $10.00 par value; authorized 200,000 shares, none issued		—			—			—
Common stock - $2.50 par value; authorized 50,000,000 shares, issued shares - 11,348,201, 6,387,146 and 11,293,992		28,371			15,968			28,235
Surplus		112,873			23,870			112,213
Retained earnings		70,716			64,430			68,662
Accumulated other comprehensive loss		(1,536	)		(332	)		(1,442	)
Total Shareholders' Equity		210,424			103,936			207,668
Total Liabilities and Shareholders' Equity	$	1,874,404		$	1,106,515		$	1,815,582

See accompanying notes to consolidated financial statements.

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FNB United Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

	Three Months Ended March 31,
	2007		2006
	(in thousands, except share and per share data)
Interest Income
Interest and fees on loans	$	27,870	$	15,206
Interest and dividends on investment securities:
Taxable income		1,656		1,296
Non-taxable income		553		460
Other interest income		818		164
Total interest income		30,897		17,126
Interest Expense
Deposits		12,798		5,503
Retail repurchase agreements		305		164
Federal Home Loan Bank advances		681		859
Federal funds purchased		0		8
Other borrowed funds		1,288		511
Total interest expense		15,072		7,045
Net Interest Income		15,825		10,081
Provision for loan losses		524		77
Net Interest Income After Provision for Loan Losses		15,301		10,004
Noninterest Income
Service charges on deposit accounts		2,050		1,417
Mortgage loan sales		1,138		963
Trust and investment services		371		293
Cardholder and merchant services income		507		369
Other service charges, commissions and fees		336		250
Bank owned life insurance		236		159
Other income		304		59
Total noninterest income		4,942		3,510
Noninterest Expense
Personnel expense		8,420		5,271
Net occupancy expense		1,178		601
Furniture and equipment expense		1,113		645
Data processing services		532		593
Other expense		3,338		2,305
Total noninterest expense		14,581		9,415
Income Before Income Taxes		5,662		4,099
Income taxes		1,910		1,422
Net Income	$	3,752	$	2,677
Net income per common share:
Basic	$	0.33	$	0.42
Diluted	$	0.33	$	0.42
Weighted average number of shares outstanding:
Basic		11,263,325		6,380,077
Diluted		11,295,221		6,445,107

See accompanying notes to consolidated financial statements.

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FNB United Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME

Three Months Ended March 31, 2007 and March 31, 2006 (unaudited)

	Common Stock					Retained			Accumulated Other Comprehensive
	Shares	Amount		Surplus		Earnings			Income (Loss)			Total
	(in thousands, except share and per share data)
Balance, December 31, 2005	6,370,486	$	15,926	$	23,542	$	62,711		$	136		$	102,315
Comprehensive income:
Net income	—		—		—		2,677			—			2,677
Other comprehensive income:
Unrealized securities losses, net of income tax benefit of $306	—		—		—		—			(468	)		(468	)
Total comprehensive income	—		—		—		—			—			2,209
Cash dividends declared, $.15 per share	—		—		—		(958	)		—			(958	)
Stock options:
Proceeds from options exercised	16,660		42		179		—			—			221
Compensation expense recognized	—		—		119		—			—			119
Net tax benefit related to option exercises	—		—		30		—			—			30
Balance, March 31, 2006	6,387,146	$	15,968	$	23,870	$	64,430		$	(332	)	$	103,936
Balance, December 31, 2006	11,293,992	$	28,235	$	112,213	$	68,662		$	(1,442	)	$	207,668
Comprehensive income:
Net income	—		—		—		3,752			—			3,752
Other comprehensive income:
Unrealized securities losses, net of income tax benefit of $46	—		—		—		—			(94	)		(94	)
Total comprehensive income	—		—		—		—			—			3,658
Cash dividends declared, $.15 per share	—		—		—		(1,698	)		—			(1,698	)
Stock options:	—						—			—			—
Proceeds from options exercised	53,777		135		329		—			—			464
Compensation expense recognized	—		—		134		—			—			134
Net tax benefit related to option exercises	—		—		108		—			—			108
Restricted stock:							—			—
Compensation expense recognized	—		—		82		—			—			82
Other compensatory stock issued	432		1		7		—			—			8
Balance, March 31, 2007	11,348,201	$	28,371	$	112,873	$	70,716		$	(1,536	)	$	210,424

See accompanying notes to consolidated financial statements.

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FNB United Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

	Three months ended, March 31, 2007
	2007			2006
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,752		$	2,677
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization of premises and equipment		905			523
Provision for loan losses		524			77
Deferred income taxes (benefit)		256			153
Deferred loan fees and costs, net		(231	)		(51	)
Premium amortization and discount accretion of investment securities, net		20			74
Amortization of core deposit premiums		205			41
Stock compensation expense		224			119
Income from bank owned life insurance		(236	)		(159	)
Mortgage loans held for sale:
Originated loans		(96,317	)		(60,294	)
Proceeds from the sale of loans		91,820			58,051
Gain on mortgage loans sales		(1,138	)		(963	)
Changes in assets and liabilities:
(Increase) decrease in interest receivable		(827	)		—
(Increase) decrease in other assets		1,315			168
Increase (decrease) in accrued interest and other liabilities		2,078			(548	)
NET CASH PROVIDED BY (USED IN ) OPERATING ACTIVITIES		2,350			(132	)
CASH FLOWS FROM INVESTING ACTIVITIES
Available for Sale Securities
Proceeds from maturities and calls		18,554			1,098
Purchases		(69,794	)		(5,657	)
Held-to-Maturity securities
Proceeds from maturities and calls		512			5,661
Purchases		—			(425	)
Net increase in loans held for investment		(12,038	)		(5,032	)
Purchases of premises and equipment		(994	)		(1,275	)
Purchase of SBIC investments		—			(750	)
Net change in other investments		—			(83	)
NET CASH USED IN INVESTING ACTIVITIES		(63,760	)		(6,463	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		44,698			8,973
Net increase (decrease) in retail repurchase agreements		4,064			(5,696	)
Net increase (decrease) in Federal Home Loan Bank advances		41			(1,500	)
Net increase (decrease) in other borrowings		5,407			555
Proceeds from the exercise of stock options		464			221
Tax benefit from the exercise of stock options		108			30
Payment of cash dividends		(1,920	)		(1,080	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		52,862			1,503
NET DECREASE IN CASH AND CASH EQUIVALENTS		(8,548	)		(5,092	)
CASH AND CASH EQUIVALENTS, BEGINNING		108,340			44,879
CASH AND CASH EQUIVALENTS, ENDING	$	99,792		$	39,787

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FNB United Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS - (unaudited)

	Three months ended, March 31, 2007
	2007			2006
	(in thousands)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest	$	15,018		$	6,987
Income taxes, net of refunds		—			285
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Foreclosed loans transferred to other real estate		—			42
Unrealized gains (losses) on securities available for sale, net of deferred taxes		(94	)		(468	)

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FNB United Corp. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

FNB United Corp. (“FNB United”), formerly known as FNB Corp., is a bank holding company whose wholly owned subsidiaries are First National Bank and Trust Company (“First National Bank”) and Dover Mortgage Company (“Dover”). First National Bank has two wholly owned subsidiaries, First National Investor Services, Inc. and Premier Investment Services, Inc. Through its subsidiaries, 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. First National Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina. Dover Mortgage Company operates mortgage production offices in North Carolina at Charlotte, Carolina Beach, Goldsboro, Greenville, Lake Norman, Leland, Raleigh, Waxhaw, Wilmington and Wrightsville Beach.

The accompanying consolidated financial statements, prepared without audit, include the accounts of FNB United and its subsidiaries (collectively the “Corporation”). 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 month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007.

Certain amounts in the 2006 consolidated financial statements have been reclassified to conform to the 2007 presentation. The reclassifications had no effect on net income or shareholders’ equity as previously reported.

The organization and business of FNB United, accounting policies followed by the Corporation and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Corporation's 2006 annual report on Form 10-K. 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 on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

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3. Merger Information

Integrity Financial Corporation

On April 28, 2006, the Corporation completed a merger for the acquisition of Integrity Financial Corporation (“Integrity”), headquartered in Hickory, North Carolina and the holding company for First Gaston Bank of North Carolina, including its divisions Catawba Valley Bank and Northwestern Bank. At the date of the merger, First Gaston Bank operated seventeen offices and, based on estimated fair values, had approximately $728.7 million in total assets, $475.3 million in net loans and $563.3 million in deposits. On August 1, 2006, First Gaston Bank was merged into First National Bank. The primary reasons for the merger were as follows:

• To create a banking organization, approximately two-thirds larger in total assets than FNB United prior to the merger, that could offer an expanded array of services including the ability to provide larger loans and professional wealth management services in a community banking setting;

• To expand the footprint of the Corporation from ten central-North Carolina counties to 17 counties with 42 community offices, stretching from the Central and Southern Piedmont to the Foothills and Mountains of Western North Carolina, including areas of the state which possessed faster income and population growth characteristics than many existing FNB United franchise areas; and

• To create shareholder value based upon the opportunities set out above.

Pursuant to the terms of the merger, each share of Integrity common stock was converted into 0.8743 shares of FNB United common stock and $5.20 in cash. The aggregate purchase price was $127.2 million, consisting of $27.7 million in cash payments to Integrity shareholders, 4,654,504 shares of FNB United common stock valued at $94.8 million, outstanding Integrity stock options valued at $3.3 million and transaction costs of $1.4 million.

The merger transaction has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of Integrity were recorded based on estimated fair values as of April 28, 2006, with the estimate of goodwill being subject to possible adjustment during the one-year period from that date. The consolidated financial statements include the results of operations of Integrity since April 28, 2006.

4. Earnings Per Share (EPS)

Basic net income per share, or basic EPS, is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if the Corporation’s potential common stock and contingently issuable shares, which consist of dilutive stock options and restricted stock, were exercised. The numerator of the basic EPS computation is the same as the numerator of the diluted EPS computation for all periods presented. A reconciliation of the denominators of the basic and diluted EPS computations is as follows:

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	Three Months Ended March 31,
	2007	2006
Basic EPS denominator - Weighted average number of common shares outstanding	11,263,325	6,380,077
Dilutive share effect arising from potential common stock issuances	31,896	65,030
Diluted EPS denominator	11,295,221	6,445,107

For the three months ended March 31, 2007 and 2006 there were 329,141 and 152,718 stock options, respectively, that were antidilutive since the exercise price exceeded the average market price. These common stock equivalents were omitted from the calculations of diluted EPS for their respective periods.

5. Loans

Following is a summary of loans at each of the balance sheet dates presented:

	At March 31, 2007					At December 31, 2006
	Amount			% of		Amount			% of
	(dollars in thousands)
Real estate – mortgage loans	$	401,067		29.9	%	$	374,092		28.3	%
Real estate – commercial		325,172		24.3	%		304,546		23.0	%
Commercial and industrial loans		290,479		21.7	%		293,630		22.2	%
Real estate – construction loans		248,459		18.5	%		278,124		21.0	%
Consumer loans		38,746		2.9	%		38,725		2.9	%
Other loans		35,742		2.7	%		33,585		2.5	%
Gross loans		1,339,665		100.0	%		1,322,702		100.0	%
Allowance for loan losses		(15,757	)				(15,943	)
Net Loans	$	1,323,908				$	1,306,759

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6. Allowance for Loan Loss

Changes in the allowance for loan losses were as follows:

	Three Months Ended March 31,
	2007			2006
	(dollars in thousands)
Balance at beginning of period	$	15,943		$	9,698
Provision for loan losses		524			77
Net charge-offs
Charge-offs		(1,198	)		(549	)
Recoveries		488			487
Net charge-offs		(710	)		(62	)
Balance, end of period	$	15,757		$	9,713
Annualized net charge-offs during the period to average loans		0.21	%		0.03	%
Annualized net charge-offs during the period to allowance for loan losses		18.02	%		2.55	%
Allowance for loan loss to loans held for investment		1.20	%		1.21	%

7. Supplementary Income Statement Information

Significant components of other expense were as follows:

	Three Months Ended March 31,
	2007		2006
Stationary, printing and office supplies	$	263	$	279
Professional Fees		286		206
Communications		352		185
Advertising and marketing		263		180
Other		2,174		1,455
	$	3,338	$	2,305

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8. Postretirement Employee Benefit Plans

Information concerning the net periodic cost of the Corporation’s postretirement benefit plans is as follows:

	Three Months Ended March 31, 2007
	Pension Plan			Supplemental Executive Retirement Plan		Other Postretirement Defined Benefit Plans
	(in thousands)
Service cost	$	60		$	26	$	4
Interest cost		161			33		18
Expected return on plan assets		(235	)		—		—
Amortization of prior service cost		1			18		—
Amortization of transition obligation		—			—		4
Amortization of net (gain)/loss		16			7		(1	)
Net periodic postretirement benefit cost	$	3		$	84	$	25

	Three Months Ended March 31, 2006
	Pension Plan			Supplemental Executive Retirement Plan		Other Postretirement Defined Benefit Plans
	(in thousands)
Service cost	$	201		$	25	$	22
Interest cost		163			23		22
Expected return on plan assets		(224	)		—		—
Amortization of prior service cost		7			12		—
Amortization of transition obligation		—			—		5
Amortization of net (gain)/loss		48			8		3
Net periodic postretirement benefit cost	$	195		$	68	$	52

The Corporation does not expect to contribute any funds to its pension plan in 2007. 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.

As a result of the merger with Integrity, the Bank assumed the obligations of a non-qualified deferred compensation plan for the former president of Integrity. Under the plan provisions, benefit payments

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began in 2006 and are payable for 10 years. During the three months ended March 31, 2007, provisions of $10,804 were expensed for future benefits to be provided under this plan. The total liability under this plan was $514,922 at March 31, 2007 and is included in other liabilities in the accompanying balance sheets. Payments amounting to $17,612 were made under the provision of the plan.

9. Derivatives and Financial Instruments

Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended, establishes accounting and reporting standards for derivative and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

In connection with its asset/liability management objectives, the Corporation in 2004 entered into an interest rate swap on a $7.0 million Federal Home Loan Bank (FHLB) advance that converts the fixed rate cash flow exposure on the FHLB advance to a variable rate cash flow. As structured, the pay-variable, receive-fixed swap is evaluated as being a fair value hedge with no ineffectiveness; and, consequently, the difference in cash flows in each period between the variable rate interest payments that the Corporation makes and the fixed rate interest payments received is currently reported in earnings.

For the three months ended March 31, 2007 and 2006, the interest rate swap resulted in net increases of 37,000 and $21,000, respectively, in the interest expense that would otherwise have been reported for the FHLB advance. The fair value of the swap at March 31, 2007 was recorded on the consolidated balance sheet as a liability in the amount of $0.2 million, offset by a valuation adjustment in the same amount to the FHLB advance.

The Corporation has also identified the following derivative instruments which were recorded on the consolidated balance sheet at March 31, 2007: commitments to originate fixed rated residential mortgage loans and forward sales commitments

Dover Mortgage Company originates certain 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 Corporation is subject to variability in market prices related to these commitments. The Corporation 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 $32.7 million at March 31, 2007, and the related forward sales commitments totaled $32.7 million. Loans held for sale by Dover Mortgage Company totaled $21.7 million at March 31, 2007 and the related forward sales commitments totaled $21.7 million.

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First National Bank had loans held for sale of $4.8 million at March 31, 2007. Binding commitments of First National Bank for the origination of mortgage loans intended to be held for sale at March 31, were not material.

10. New Accounting Pronouncements

In July 2006, the FASB issued Financial Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”, which is a change in accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Corporation adopted FIN 48 effective January 1, 2007. The adoption of FIN 48 did not have a material effect on its consolidated financial position or results of operations.

The Corporation adopted the provisions of SFAS No. 155,Accounting for Certain Hybrid Financial Instruments, effective January 1, 2007. The adoption of the provisions of SFAS No. 155 had no material effect on financial position or results of operations.

The provisions of SFAS No. 156,Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140, were effective beginning January 1, 2007. The adoption of the provisions of SFAS No. 156 had no effect on financial position or results of operations.

SFAS No. 157,Fair Value Measurements, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is in the process of evaluating the impact of the adoption of SFAS No. 157 on the consolidated financial statements.

SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities,permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option permits companies to choose to measure eligible items at fair value at specified election dates. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption. SFAS No. 159 requires additional disclosures related to the fair value measurements included in the companies financial statements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted; however, the Corporation will adopt SFAS No. 159 effective January 1, 2008. The Corporation is evaluating the impact of SFAS No. 159 on the consolidated financial statements.

From time to time, the FASB issues exposure drafts of 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 financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

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11. Business Segment Information

The Corporation is considered to have two principal business segments: the full-service subsidiary bank, First National Bank, and the mortgage banking subsidiary, Dover Mortgage Company. Dover originates, underwrites and closes loans for sale into the secondary market. Financial performance for each segment is detailed in the following tables. Included in the “Other” column are amounts for other corporate activities, including the interest expense recognized on trust preferred securities, and eliminations of intersegment transactions.

	Three Months Ended March 31, 2007
	First National Bank		Dover Mortgage Company			Other			Total
	(in thousands)
Interest income	$	30,691	$	206		$	—		$	30,897
Interest expense		13,784		196			1,092			15,072
Net interest income		16,907		10			(1,092	)		15,825
Provision for loan losses		524		—			—			524
Net interest income after provision for loan losses		16,383		10			(1,092	)		15,301
Noninterest income		4,007		903			32			4,942
Noninterest expense		13,558		962			61			14,581
Income (loss) before income taxes		6,832		(49	)		(1,121	)		5,662
Income taxes (benefit)		2,337		(13	)		(414	)		1,910
Net income (loss)	$	4,495	$	(36	)	$	(707	)	$	3,752
Total assets	$	1,843,876	$	26,704		$	3,824		$	1,874,404
Net loans		1,302,201		21,707			—			1,323,908
Goodwill		108,802		2,159			—			110,961
Equity		263,034		4,329			(56,939	)		210,424

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	Three Months Ended March 31, 2006
	First National Bank		Dover Mortgage Company			Other			Total
	(in thousands)
Interest income	$	16,935	$	191		$	—		$	17,126
Interest expense		6,570		169			306			7,045
Net interest income		10,365		22			(306	)		10,081
Provision for loan losses		77		—			—			77
Net interest income after provision for loan losses		10,288		22			(306	)		10,004
Noninterest income		2,621		831			58			3,510
Noninterest expense		8,501		846			68			9,415
Income (loss) before income taxes		4,408		7			(316	)		4,099
Income taxes (benefit)		1,523		9			(110	)		1,422
Net income (loss)	$	2,885	$	(2	)	$	(206	)	$	2,677
Total assets	$	1,081,019	$	25,008		$	241		$	1,106,268
Net loans		791,178		19,572			—			810,750
Goodwill		27,605		3,784			—			31,389
Equity		116,982		5,765			(18,811	)		103,936

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

The purpose of this discussion and analysis is to assist in the understanding and evaluation of the financial condition, changes in financial condition and results of operations of FNB United Corp. (“FNB United” or the “Parent Company”), formerly known as FNB Corp. prior to April 28, 2006, and its wholly owned subsidiaries, First National Bank and Trust Company (“First National Bank”) and Dover Mortgage Company (“Dover”), collectively referred to as the “Corporation”. This discussion should be read in conjunction with the financial information appearing elsewhere in this report.

Overview

Description of Operations

FNB United is a bank holding company with a full-service subsidiary bank, First National Bank, that 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. First National Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina.

Additionally, FNB United has a mortgage banking subsidiary, Dover Mortgage Company, that originates, underwrites and closes loans for sale into the secondary market. Dover operates mortgage production offices in North Carolina at Charlotte, Carolina Beach, Goldsboro, Greenville, Lake Norman, Leland, Raleigh, Wilmington and Wrightsville Beach.

For business segment information related to the financial performance of First National Bank and Dover Mortgage Company, see Note 11 to the Consolidated Financial Statements.

Merger Acquisition of Integrity Financial Corporation in 2006

On April 28, 2006, the Corporation completed a merger for the acquisition of Integrity Financial Corporation (“Integrity”), headquartered in Hickory, North Carolina and the holding company for First Gaston Bank of North Carolina, including its divisions Catawba Valley Bank and Northwestern Bank. At the date of the merger, First Gaston Bank operated seventeen offices and, based on estimated fair values, had approximately $728.7 million in total assets, $475.3 million in net loans and $563.3 million in deposits. On August 1, 2006, First Gaston Bank was merged into First National Bank. The primary reasons for the merger were as follows:

• To create a banking organization, approximately two-thirds larger in total assets than FNB United prior to the merger, that could offer an expanded array of services including the ability to provide larger loans and professional wealth management services in a community banking setting;

• To expand the footprint of the company from ten central-North Carolina counties to 17 counties with 42 community offices, stretching from the Central and Southern Piedmont to the Foothills and Mountains of Western North Carolina, including areas of the state which possessed faster income and population growth characteristics than many existing FNB United franchise areas; and

• To create shareholder value based upon the opportunities set out above.

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Pursuant to the terms of the merger, each share of Integrity common stock was converted into 0.8743 shares of FNB United common stock and $5.20 in cash. The aggregate purchase price was $127.2 million, consisting of $27.7 million in cash payments to Integrity shareholders, 4,654,504 shares of FNB United common stock valued at $94.8 million, outstanding Integrity stock options valued at $3.3 million and transaction costs of $1.4 million. The merger transaction has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of Integrity were recorded based on estimated fair values as of April 28, 2006, with the estimate of goodwill being subject to possible adjustment during the one-year period from that date. The consolidated financial statements include the results of operations of Integrity since April 28, 2006.

Financial Summary

The Corporation earned $3.75 million in the first quarter of 2007, a 40% increase from earnings of $2.68 million in the same period of 2006. The increase in net income resulted from improved levels of net interest income and noninterest income, partially offset by higher provision for loan losses and higher noninterest expense. Basic earnings per share decreased from $.41 to $.33 and diluted earnings per share decreased from $.40 to $.33. As noted above, Integrity Financial Corporation. was acquired through merger effective April 28, 2006 impacting both net income and the calculation of earnings per share since the acquisition date and the comparability of operating results for the first quarter of 2007 and 2006.

Total assets were $1.87 billion at March 31, 2007, up 3% from December 31, 2006. Gross loans increased $17.0 million, or 1%, to $1.34 billion at March 31, 2007 compared to $1.32 billion at December 31, 2006. Total deposits increased $44.8 million, or 3%, to $1.47 billion at March 31, 2007, compared to $1.42 billion at December 31, 2006.

Financial highlights are presented in the table below.

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Table 1

Selected Financial Data

	2007			2006
	First Quarter			Fourth Quarter			First Quarter
	(dollars in thousands, except per share data)
Selected components income statement data
Interest income	$	30,897		$	30,490		$	17,126
Interest expense		15,072			14,614			7,045
Net interest income		15,825			15,876			10,081
Provision for loan losses		524			220			77
Net interest income after provision for loan losses		15,301			15,656			10,004
Noninterest income		4,942			5,682			3,510
Noninterest expense		14,581			16,225			9,415
Income before income taxes		5,662			5,113			4,099
Income taxes		1,910			2,115			1,422
Net income	$	3,752		$	2,998		$	2,677
Common share data
Basic earnings per share	$	0.33		$	0.27		$	0.42
Diluted earnings per share		0.33			0.27			0.42
Dividends		0.15			0.17			0.15
Book value per share		18.54			18.39			16.27
Weighted average shares outstanding-basic		11,263,325			11,196,885			6,380,077
Weighted average shares outstanding-diluted		11,295,221			11,287,752			6,445,107
Financial condition data
Total Assets	$	1,874,404		$	1,817,574		$	1,106,515
Securities		224,870			171,815			158,282
Net Loans		1,323,908			1,306,776			810,997
Deposits		1,465,711			1,420,931			850,561
Goodwill		110,961			110,961			31,389
Borrowings		149,305			88,986			124,235
Shareholders' Equity		210,424			207,668			103,936
Average Balances
Total Assets	$	1,827,595		$	1,797,323		$	1,091,873
Securities		190,569			160,301			161,922
Loans		1,330,199			1,311,120			809,513
Interest-earning assets		1,582,818			1,552,870			986,403
Deposits		1,426,640			1,404,144			836,424
Total interest-bearning liabilities		1,441,278			1,412,441			877,463
Shareholders' Equity		209,579			211,073			104,383
Performance Ratios
Return on average assets		0.83	%		0.66	%		0.99	%
Return on tangible assets		0.89	%		0.71	%		1.02	%
Return on average equity		7.26	%		5.64	%		10.40	%
Return on tangible equity		16.64	%		12.83	%		15.14	%
Net interest margin		4.15	%		4.17	%		4.28	%
Non-interest income to average assets		1.10	%		1.25	%		1.30	%
Non-interest expense to average assets		3.24	%		3.58	%		3.50	%
Efficiency Ratio		70.21	%		75.26	%		69.27	%

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Critical Accounting Policies

The Corporation’s significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K Annual Report for the fiscal year ended December 31, 2006. Of these significant accounting policies, the Corporation considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Corporation’s assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Corporation’s allowance for loan losses and related matters, see “Asset Quality”.

Earnings Performance

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 of the Corporation’s net interest income on a taxable-equivalent basis and average balance sheet for the three months ended March 31, 2007 and 2006 is presented in Table 2.

For the three months ended March 31, 2007, net interest income was $15.8 million, an increase of $5.7 million or 57.0% from $10.1 million for the same quarter in 2006. The increase was primarily due to a $520 million increase in average loan balances associated with the Integrity acquisition.

The net interest margin (taxable-equivalent net interest income divided by average earning assets) compressed 13 basis points to 4.15% for the three months ended March 31, 2007, compared to 4.28% in the same period in 2006. The decline in the net interest margin was attributable to pressures associated with an inverted yield curve whereby short-term rates are higher than long-term rates. While the Corporation experienced an 83 basis point increase in the yield or earning assets, the cost of interest-bearing liabilities increased 98 basis points. Higher cost deposit growth outpaced loan growth (highest yielding costs). The excess funds were deployed in lower yielding assets (overnight investments and available for sale securities) and the spread was minimal because of the flat yield curve.

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Table 2

Average Balances and Net Interest Income Analysis

	Three Months Ended March 31,
	2007						2006
	Average Balance		Interest Income/ Expense		Average Rate		Average Balance		Interest Income/ Expense		Average Rate
	(taxable equivalent basis, dollars in thousands)
Interest-earning assets:
Loans	$	1,330,199	$	27,927	8.51	%	$	809,513	$	15,234	7.63	%
Investment securities:
Taxable income		133,842		1,656	5.02	%		112,754		1,348	4.85	%
Non-taxable income		56,727		851	6.08	%		49,168		713	5.88	%
Federal funds sold		43,979		708	6.53	%		12,924		146	4.58	%
Interest bearing bank deposits		18,071		110	2.47	%		2,044		18	3.57	%
Total interest-earning assets		1,582,818		31,252	8.01	%		986,403		17,459	7.18	%
Other assets		244,777						105,470
Total assets	$	1,827,595					$	1,091,873
Interest-bearing liabilities:
Interest-bearing deposits:
Demand deposits	$	168,858		716	1.72	%	$	112,195		353	1.27	%
Savings deposits		50,225		114	0.92	%		49,705		40	0.33	%
Money market deposits		40,614		2,436	4.11	%		82,246		462	2.28	%
Certificates and other time deposits		810,952		9,532	4.77	%		492,839		4,648	3.83	%
Retail repurchase agreements		26,499		305	4.67	%		17,183		164	3.87	%
Federal funds purchased		—		—				540		8	6.01	%
Federal Home Loan Bank advances		65,834		681	4.20	%		85,263		859	4.09	%
Other borrowed funds		78,296		1,288	6.67	%		37,492		511	5.53	%
Total interest-bearing liabilities		1,441,278		15,072	4.24	%		877,463		7,045	3.26	%
Non-interest bearing demand deposits		155,991						99,439
Other liabilities		21,148						10,588
Stockholders' equity		209,178						104,383
Total liabilities and stockholders' equity	$	1,827,595					$	1,091,873
Net interest income and interest rate spread			$	16,180	3.77	%			$	10,414	3.92	%
Net yield on average interest-earning assets					4.15	%					4.28	%
Ratio of average interest-earning assets to average interest-bearing liabilities					109.82	%					112.42	%

1. Yields on nontaxable securities and loans are stated on a taxable-equivalent basis assuming a Federal tax rate of 35%.

2. Nonaccrual loans are included in the average loan balance. Average loan balances are shown net of unearned income. Loan fees and the incremental direct cost associated with making loans are deferred and subsequently recognized over the life of the as an adjustment of interest income.

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Provision for Loan Losses

The provision for loan losses is a charge against earnings to provide an allowance or reserve for probable losses inherent in the loan portfolio. The amount of each period’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 three month period ended March 31, 2007, management determined a charge to operations of $524,000 would bring the allowance for loan loss reserve to a balance considered to be adequate to reflect the growth in loans and to absorb estimated potential losses in the portfolio. This amount compared to $77,000 for the first quarter of 2006. The increase in the provision was primarily attributable to the level of net charge-offs. Net charge-offs for the three months ended March 31, 2007 totaled $710,000, or ..21% annualized of average loans, compared to $62,000, or .03% annualized of average loans for the same 2006 period.

Noninterest Income

For the three months ended March 31, 2007, total noninterest income was $4.9 million, an increase of $1.4 million or 41% compared to the same period in 2006, due primarily to the effects of the acquisition of Integrity. Service charge income on deposit accounts, the largest component of noninterest income, was $2.1 million, an increase of $633,000 or 44.7%. An increase in mortgages sold to the secondary market generated an additional $175,000 of income in the 2007 first quarter over the same period last year.

Noninterest Expense

Noninterest expense for the 2007 first quarter was $14.6 million, a $5.2 million increase compared to the first quarter of 2006, due largely to the acquisition of Integrity on April 28, 2006. Personnel expense, which comprises over fifty percent of non-interest expense increased $3.1 million. Increases in other non-interest expense occurred due to increases in expenses associated with couriers, postage, telephone and amortization of the core deposit intangible resulting from the Integrity merger.

Income Taxes

The effective income tax rate decreased from 34.7% in the first three months of 2006 to 33.7% in the same period of 2007 due principally to lower levels of taxable income.

Balance Sheet Analysis

Investment Securities

At March 31, 2007 and December 31, 2006, the investment securities portfolio totaled $224.9 million and $171.8 million, respectively. Total investment securities have increased 31% since December 31, 2006. During the first quarter of 2007, growth in deposits exceeded loan demand, resulting in excess liquidity that was invested in the investment securities portfolio. The investment securities portfolio represents 13.8% and 11.6% of earning assets at March 31, 2007 and December 31, 2006, respectively.

Investment securities held to maturity totaled $42.3 million at March 31, 2007, compared to $42.8 million at December 31, 2006. This component of the investment securities portfolio continues to decline as securities mature and all new investment securities purchases are classified as available for sale.

At March 31, 2007, securities available for sale were $182.6 million compared to $142.6 million at December 31, 2006. Purchases in the available for sale portfolio were comprised of bullet and one time callable agency securities with final maturities inside three years. Available-for-sale securities are accounted at fair value, with unrealized gains and losses recorded net of tax as a component of other comprehensive income in shareholders’ equity unless the unrealized losses are considered other-than-temporary.

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Loans

The Corporation’s primary source of revenue and largest component of earning assets is the loan portfolio. Gross loans increased $17.0 million or 5.0% annualized, to $1.34 billion at March 31, 2007 compared to $1.32 at December 31, 2006. Loan production was strong for the 2007 quarter; however, a portion of new originations was offset by the payout of a large commercial credit. The growth was driven primarily by commercial real estate and one-to-four family real estate loans, which increased $19.7 million and $27.6 million. A portion of this increase was offset by a decline in construction loans of $30.8 million.

Asset Quality

Management considers the asset quality of First National 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 is employed to review the underwriting documentation and risk grading analysis.

Nonperforming assets

Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more 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 collectibility 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 thereof and is generally carried at fair value, less estimated costs to sell.

Nonperforming loans at March 31, 2007 were $12.7 million or .97% of loans held for investment compared to $11.1 million or .86% of loans held for investment at December 31, 2006. Other real estate owned declined to $3.1 million at March 31, 2007 from $3.4 million at December 31, 2006.

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 First National 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 First National Bank’s allowance for loan losses. Such agencies may require First National 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

22

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 First National Bank 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.

Changes in the allowance for loan losses follow:

Table 3

Allowance for Loan Losses

	Three Months Ended March 31,
	2007			2006
	(dollars in thousands)
Balance at beginning of period	$	15,943		$	9,698
Provision for loan losses		524			77
Net charge-offs
Charge-offs		(1,198	)		(549	)
Recoveries		488			487
Net charge-offs		(710	)		(62	)
Balance, end of period	$	15,757		$	9,713
Annualized net charge-offs during the period to average loans		0.21	%		0.03	%
Annualized net charge-offs during the period to allowance for loan losses		18.02	%		2.55	%
Allowance for loan loss to loans held for investment		1.20	%		1.21	%

The allowance for loan losses, as a percentage of loans held for investment, amounted to 1.20% at March 31, 2007, 1.22% at December 31, 2006 and 1.21% at March 31, 2006. The allowance percentage has remained within a 1.20% to 1.22% based on the results from application of the allowance model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses.

Management believes the allowance for loan losses of $15.8 million at March 31, 2007 is adequate to cover probable losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment.

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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 Corporation.

Deposits

The level and mix of deposits is affected by various factors, including general economic conditions, the particular circumstances of local markets and the specific deposit strategies employed. In general, broad interest rate declines tend to encourage customers to consider alternative investments such as mutual funds and tax-deferred annuity products, while interest rate increases tend to have the opposite effect.

Total deposits increased $44.8 million, or 13% annualized, to $1.47 billion at March 31, 2007 compared to $1.42 billion at December 31, 2006. During the first three months of 2007, the increases by deposit category were as follows: $3.1 million for noninterest-bearing demand deposits, $20.1 million for money market and savings deposits and $25.1 million for time deposits. Interest-bearing demand deposits declined $3.4 million. Average deposits increased $22.5 million with the majority of the increase occurring in time deposits.

Other Borrowed Funds

Other borrowed funds consist of subordinated debentures related to trust preferred securities and a line of credit for Dover Mortgage Company. At March 31, 2007 other borrowed funds totaled $83.4 million, an increase of $5.4 million from December 31, 2005. The increase is associated with draws on the line of credit by Dover Mortgage to fund increases in mortgage originations.

Liquidity

Liquidity for First National Bank refers to its continuing ability to meet deposit withdrawals, fund loan commitments and capital expenditures, maintain reserve requirements, pay operating expenses and provide funds to the Parent Company for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks, (b) the outstanding balance of federal funds sold, (c) lines for the purchase of federal funds from other banks, (d) the line of credit established at the Federal Home Loan Bank, less charges against that line for existing advances and letters of credit used to secure public funds on deposit, and (e) the investment securities portfolio. All debt securities are of investment grade quality and, if the need arises, can be liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with the general approach to liquidity, loans and other assets of First National Bank are based primarily on a core of local deposits and First National Bank’s capital position. To date, the steady increase in deposits, retail repurchase agreements and capital, supplemented by Federal Home Loan Bank advances and a modest amount of brokered deposits, has been adequate to fund loan demand in First National 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.

Liquidity for Dover Mortgage Company refers to its continuing ability to fund mortgage loan commitments, pay operating expenses and provide funds to the Parent Company for payment of dividends, debt service and other operational requirements. Liquidity is principally available from a line of credit with another financial institution.

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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 March 31, 2007 are discussed below.

Commitments by First National 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 March 31, 2007, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $314.7 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 Corporation 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.

First National 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 $6.8 million at March 31, 2007 and $6.6 million at December 31, 2006. Due to insignificance, the Corporation has recorded no liability at March 31, 2007 for the current carrying amount of the obligation to perform as a guarantor.

Dover Mortgage Company originates certain 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 Corporation is subject to variability in market prices related to these commitments. The Corporation 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 $32.7 million at March 31, 2007, and the related forward sales commitments totaled $32.7 million. Loans held for sale by Dover Mortgage Company totaled $21.7 million at March 31, 2007, and the related forward sales commitments totaled $21.7 million.

First National Bank had loans held for sale of $4.8 million at March 31, 2007. Binding commitments of First National Bank for the origination of mortgage loans intended to be held for sale at March 31, 2007 were not material.

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

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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 Corporation’s balance sheet was asset-sensitive at March 31, 2007. 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.

Capital Adequacy

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, Tier 2 and Tier 3, 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 amounts of perpetual preferred stock and 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. Tier 3 capital, applicable only to financial institutions subject to certain market risk capital guidelines, is capital allocated to support the market risk related to a financial institution’s ongoing trading activities. At March 31, 2007, FNB United and First National Bank were not subject to the market risk capital guidelines and, accordingly, had no Tier 3 capital allocation. Total capital, for risk-based purposes, consists of the sum of Tier 1, Tier 2 and Tier 3 capital. Under current requirements, the minimum total capital ratio is 8.00% and the minimum Tier 1 capital ratio is 4.00%. At March 31, 2007, FNB United and First National Bank had total capital ratios of 11,08% and 10.89%, respectively, and Tier 1 capital ratios of 8.16% and 9.80%.

The leverage capital ratio, which serves as a minimum capital standard, considers Tier 1 capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date. As currently required, the minimum leverage capital ratio is 4.00%. At March 31, 2007, FNB United and First National Bank had leverage capital ratios of 7.30% and 8.79%, respectively.

First National Bank is also required to comply with prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. To be categorized as well-capitalized, a bank must have a minimum ratio for total capital of 10.00%, for Tier 1 capital of 6.00% and for leverage capital of 5.00%. As noted above, First National Bank met all of those ratio requirements at March 31, 2007 and, accordingly, is well-capitalized under the regulatory framework for prompt corrective action.

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Accounting Pronouncement Matters

In July 2006, the FASB issued Financial Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”, which is a change in accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Corporation adopted "FIN 48", effective January 1, 2007. The adoption of FIN 48 did not have a material effect on its consolidated financial position or results of operations.

The Corporation adopted the provisions of SFAS No. 155,Accounting for Certain Hybrid Financial Instruments, effective January 1, 2007. The adoption of the provisions of SFAS No. 155 had no material effect on financial position or results of operations.

The provisions of SFAS No. 156,Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140, were effective beginning January 1, 2007. The adoption of the provisions of SFAS No. 156 had no effect on financial position or results of operations.

SFAS No. 157,Fair Value Measurements, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is in the process of evaluating the impact of the adoption of SFAS No. 157 on the consolidated financial statements.

SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities,permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option permits companies to choose to measure eligible items at fair value at specified election dates. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption. SFAS No. 159 requires additional disclosures related to the fair value measurements included in the companies financial statements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted; however, the Corporation will adopt SFAS No. 159 effective January 1, 2008. The Corporation is evaluating the impact of SFAS No. 159 on the consolidated financial statements.

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 Corporation and monitors the status of changes to and proposed effective dates of exposure drafts.

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”). The Corporation’s management uses these non-GAAP measures in their analysis of the Corporation’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

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goodwill and core deposit premiums provide useful supplemental information that is essential to a proper understanding of the operating results of the Corporation’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.

Cautionary Statement for Purpose of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995

The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995), which can be identified by the use of forward-looking terminology such as “believes”, “expects”, “plans”, “projects”, “goals”, “estimates”, “may”, “could”, “should”, or “anticipates” or the negative thereof or other variations thereon of comparable terminology, or by discussions of strategy that involve risks and uncertainties. In addition, from time to time, the Corporation or its representatives have made or may make forward-looking statements, orally or in writing. Such forward-looking statements may be included in, but are not limited to, various filings made by the Corporation with the Securities and Exchange Commission, or press releases or oral statements made by or with the approval of an authorized executive officer of the Corporation. Forward-looking statements are based on management’s current views and assumptions and involve risks and uncertainties that could significantly affect expected results. The Corporation wishes to caution the reader that factors, such as those listed below, in some cases have affected and could affect the Corporation’s actual results, causing actual results to differ materially from those in any forward-looking statement. These factors include, without limitation: (i) expected cost savings from the mergers described in the Overview may not materialize or may not fully materialize within the expected time frame, (ii) revenues following the mergers may not meet expectations, (iii) costs or difficulties related to the integration of the businesses of FNB United and Integrity may be greater than anticipated, (iv) competitive pressure in the banking industry or in the Corporation’s markets may increase significantly, (v) changes in the interest rate environment may reduce margins, (vi) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, credit quality deterioration, (vii) changes may occur in banking legislation and regulation, (viii) changes may occur in general business conditions, (ix) changes may occur in the securities markets and (x) any new capital accords adopted by the Basel Committee on Banking Supervision and implemented by U.S. federal bank regulatory agencies will affect the Corporation’s future capital requirements. Readers should also consider information on risks and uncertainties contained in the discussions of competition, supervision and regulation, and effect of governmental policies contained in the Corporation’s most recent Annual Report on Form 10-K.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

The Corporation’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of the Corporation’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 Corporation does not maintain a trading account nor is the Corporation subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the Corporation’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 does not believe there has been any significant change in the overall analysis 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, 2006.

Item 4. Controls and Procedures

As of March 31, 2007, the end of the period covered by this report, FNB United carried out an evaluation under the supervision and with the participation of the Corporation’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 Corporation’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, the Chief Executive Officer and Chief Financial Officer concluded that, subject to the matter discussed in the following paragraph, the Corporation’s disclosure controls and procedures are effective 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.

During the fourth quarter of 2006, the Corporation’s management learned that FNB United did not maintain effective internal control over financial reporting as it did not have controls designed and in place for nonroutine transactions, such as the restructuring of the Corporation’s investment portfolio that occurred in the third quarter of 2006. 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.

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PART II. OTHER INFORMATION

Item 6. Exhibits

Exhibits to this report are listed in the index to exhibits on pages 32, 33, 34 and 35 of this report.

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SIGNATURES

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

			FNB United Corp.
			(Registrant)
Date:	May 9, 2007	By:	/s/ Jerry A. Little
			Jerry A. Little
			Treasurer and Secretary
			(Principal Financial and Accounting 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.
3.20	Amended and Restated Bylaws of the Registrant, adopted March 18, 2004, incorporated herein by reference to Exhibit 3.20 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended March 31, 2004.
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.
4.20	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 dated November 4, 2005.

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Exhibit No.	Description of Exhibit
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	Junior Subordinated Indenture dated as of April 27, 2006, between FNB Corp. and Wilmington Trust Company, as trustee, incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K Current Report dated April 27, 2006 and filed April 28, 2006.
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.
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.

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Exhibit No.	Description of Exhibit
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*	Employment Agreement dated as of January 1, 2006 among FNB Corp., First National Bank and Trust Company and Michael C. Miller, incorporated herein by reference to Exhibit 10 to the Registrant’s Current Report on Form 8-K filed on January 6, 2006.
10.31*	Carolina Fincorp, Inc. Stock Option Plan (assumed by the Registrant on April10, 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*	Employment Agreement dated as of April 10, 2000 between First National Bank and Trust Company and R. Larry Campbell, incorporated herein by reference to Exhibit 10.32 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2000.
10.33*	First Amendment to Employment Agreement dated as of June 30, 2006 between First National Bank and Trust Company and R. Larry Campbell, incorporated herein by reference to Exhibit 10 to the Registrant’s Form 8-K Current Report dated June 30, 2006 and filed July 7, 2006.
10.34*	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.
10.35*	Form of Change of Control Agreement between FNB United Corp. and certain of its key employees and officers, incorporated herein by reference to Exhibit 10.35 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2006.

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Exhibit No.	Description of Exhibit
10.40	Guarantee Agreement dated as of November 4, 2006, 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 8, 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.
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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