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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934



For the fiscal year ended December 31, 2006



Commission File Number 0-13823



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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)



Securities pursuant to Section 12(g) of the Act:



Common Stock, par value $2.50 per share

(Title of Class)



Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.     Yes ̈No x



Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No x



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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈



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 aggregate market value of common stock held by nonaffiliates of the Registrant, assuming, without admission, that all directors and officers of the
Registrant may be deemed affiliates, was $202,249,000 as of June 30, 2006, the last business day of the Registrants most recently completed second fiscal quarter.



As of March 1, 2007, the Registrant had 11,319,662 shares of $2.50 par value common stock outstanding.



Portions of the Proxy Statement of the Registrant for the Annual Meeting of
Shareholders to be held on May 8, 2007 are incorporated by reference in Part III of this report.



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CROSS REFERENCE INDEX



|         |  |         |  |                                                                                                                                                 |  |       
|-------- |  | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------
|         |  |         |  |                                                                                                                                                 |  | Page  
|Part I   |  | Item 1  |  | Business                                                                                                                                        |  | 1-11  
|         |  | Item 1A |  | Risk Factors                                                                                                                                    |  | 9-11  
|         |  | Item 1B |  | Unresolved Staff Comments                                                                                                                       |  |       
|         |  |         |  | Not applicable                                                                                                                                  |  |       
|         |  | Item 2  |  | Properties                                                                                                                                      |  | 8-9   
|         |  | Item 3  |  | Legal Proceedings                                                                                                                               |  |       
|         |  |         |  | Not applicable.                                                                                                                                 |  |       
|         |  | Item 4  |  | Submission of Matters to a Vote of Security Holders                                                                                             |  |       
|         |  |         |  | Not applicable.                                                                                                                                 |  |       
|Part II  |  | Item 5  |  | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities                                |  | 11, 37
|         |  | Item 6  |  | Selected Financial Data                                                                                                                         |  | 12    
|         |  | Item 7  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                           |  | 13-37 
|         |  | Item 7A |  | Quantitative and Qualitative Disclosures about Market Risk                                                                                      |  | 23-24 
|         |  | Item 8  |  | Financial Statements and Supplementary Data                                                                                                     |  |       
|         |  |         |  | Report of Independent Registered Public Accounting Firm                                                                                         |  | 38    
|         |  |         |  | Consolidated Balance Sheets at December 31, 2006 and 2005                                                                                       |  | 39    
|         |  |         |  | Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2006                                        |  | 40    
|         |  |         |  | Consolidated Statements of Shareholders Equity and Comprehensive Income for each of the years in the three-year period ended December 31, 2006 |  | 41    
|         |  |         |  | Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2006                                    |  | 42    
|         |  |         |  | Notes to Consolidated Financial Statements                                                                                                      |  | 43-83 
|         |  |         |  | Quarterly Financial Data for 2006 and 2005                                                                                                      |  | 37    
|         |  | Item 9  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                                                            |  |       
|         |  |         |  | Not applicable.                                                                                                                                 |  |       
|         |  | Item 9A |  | Controls and Procedures                                                                                                                         |  | 84-87 
|         |  |         |  | Managements Annual Report on Internal Control Over Financial Reporting                                                                         |  | 85    
|         |  |         |  | Report of Independent Registered Public Accounting Firm                                                                                         |  | 86-87 
|         |  | Item 9B |  | Other Information                                                                                                                               |  |       
|         |  |         |  | Not applicable                                                                                                                                  |  |       
|Part III |  | Item 10 |  | Directors and Executive Officers of the Registrant                                                                                              |  | *     
|         |  | Item 11 |  | Executive Compensation                                                                                                                          |  | *     
|         |  | Item 12 |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                                                  |  | *     
|         |  | Item 13 |  | Certain Relationships and Related Transactions                                                                                                  |  | *     
|         |  | Item 14 |  | Principal Accountant Fees and Services                                                                                                          |  | *     
|Part IV  |  | Item 15 |  | Exhibits and Financial Statement Schedules                                                                                                      |  |       
|         |  |         |  | (a) Financial Statements (See Item 8 for reference).                                                                                            |  |       
|         |  |         |  | (b) Financial Statement Schedules normally required on Form 10-K are omitted since     they are not applicable.                                 |  |       
|         |  |         |  | (c) Exhibits have been filed separately with the Commission and are available upon     written request.                                         |  |       

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|* |  | Information called for by Part III is incorporated herein by reference to portions of the Registrants Proxy Statement for the 2007 Annual Meeting of Shareholders, as follows:
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 10See information that appears
under the headings Election of Directors, Executive Officers and Report of the Audit Committee.

Item 11See information that appears under the headings Compensation Discussion and Analysis and Executive Compensation.

Item 12See information that appears under the headings Voting Securities Outstanding and Principal Shareholders and Security Ownership of Management.

Item 13See information that appears under the heading Business Relationships and Related Person Transactions

Item 14  See information that appears under the heading Independent Auditors.



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BUSINESS



General



FNB United Corp. (FNB United), formerly known as FNB Corp. prior to April 28, 2006, 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 bank subsidiary, First National Bank and Trust Company (First National Bank), a national banking association
founded in 1907. First National Bank has an operating subsidiary, First National Investor Services, Inc., and an inactive subsidiary, Premier Investment Services, Inc., acquired through its merger with Alamance Bank. On November 4, 2005, FNB
United acquired, through its merger with United Financial, Inc. (United), another wholly owned bank subsidiary, Alamance Bank, a North Carolina-chartered bank organized in 1998 as a national bank. Alamance Bank was merged into First
National Bank effective February 1, 2006. On April 28, 2006, FNB United acquired through its merger with Integrity Financial Corporation (Integrity), an additional bank subsidiary, First Gaston Bank of North Carolina, including
its divisions Catawba Valley Bank and Northwestern Bank. On August 1, 2006, First Gaston Bank was merged into First National Bank. FNB United also owns a mortgage banking subsidiary, Dover Mortgage Company (Dover), and is parent to
FNB United Statutory Trust I, FNB United Statutory Trust II, Catawba Valley Capital Trust I and Catawba Valley Capital Trust II, the latter two trusts formerly being Integrity subsidiaries. FNB United and its subsidiaries are collectively referred
to as the Corporation.



First National Bank, which
is a full-service bank, currently conducts all of its operations in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North
Carolina. First National Bank has three offices, including the headquarters office, in the City of Asheboro and forty additional community offices. Some of the major banking services offered include regular checking accounts, interest checking
accounts (including package account versions that offer a variety of products and services), money market accounts, savings accounts, certificates of deposit, individual retirement accounts, debit cards, credit cards and loans, both secured and
unsecured, for business, agricultural and personal use. Other services offered include internet banking, cash management, investment management and trust services. First National Bank also has automated teller machines and is a member of Plus, a
national automated teller machine network, and Star, a regional network.



First National Investor Services, Inc., which does business as Marketplace Finance, is engaged in servicing loans purchased by First National Bank from automobile dealers.



As noted above, on November 4, 2005, the Corporation completed a merger
for the acquisition of United Financial, Inc, holding company for Alamance Bank, headquartered in Graham, North Carolina. The merger transaction has been accounted for using the purchase method of accounting for business combinations, and
accordingly, the assets and liabilities of United were recorded based on estimated fair values as of November 4, 2005, with the estimate of goodwill subject to possible adjustment during the one-year period from that date. The net of all such
adjustments during that one year period amounted to a $264,000 reduction in goodwill. The consolidated financial statements include the results of operations of United since November 4, 2005.



As additionally noted above, on April 28, 2006, the Corporation
completed a merger for the acquisition of Integrity Financial Corporation, 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.
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 net of all such adjustments that have occurred from April 28, 2006 through December 31, 2006 have amounted to an $81,000 reduction
in goodwill. The consolidated financial statements include the results of operations of Integrity since April 28, 2006. 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
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| | 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 10 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 that 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.
| | - |  | -----------------------------------------------------------------------



In August 2003, First National Bank received regulatory approval for relocation of its existing branch office in Randleman,
North Carolina. The new office, which opened for business in August 2005, represents a move from an owned facility that is expected to be sold.



In January 2004, First National Bank received regulatory approval for establishment of its first branch office in Greensboro, North Carolina, resulting in
the opening of a loan production office in February 2004. A full-service banking office in a leased facility replaced the loan production office in May 2005.



In November 2004, First National Bank received regulatory approval for the establishment of a second branch office in Greensboro, North Carolina. The new
office opened for business in January 2006.



In June 2005,
First National Bank received regulatory approval for the establishment of a second branch office in Salisbury, North Carolina. The new office, which is a leased facility and also houses regional operations, opened for business in September 2006.



In May 2006, Dover Mortgage Company opened a new mortgage
production office in Wrightsville Beach, North Carolina.



In
the 2006 fourth quarter, First National Bank significantly expanded its headquarters facilities in Asheboro, North Carolina, adding a separate facility for certain of its executive and administrative functions and an operating center for its loan
and deposit operations and certain of its finance operations.



In November 2005 and April 2006, FNB United formed FNB United Statutory Trust I and FNB United Statutory Trust II, respectively, to facilitate the issuance of trust preferred securities. Each trust, other than FNB United Statutory Trust I,
is a statutory business trust formed under the laws of the State of Delaware. FNB United Statutory Trust I is a statutory business trust formed under the laws of the State of Connecticut. All common securities of the trusts are owned by FNB United.
Similar trust arrangements, Catawba Valley Capital Trust I and Catawba Valley Capital Trust II, were acquired by FNB United on April 28, 2006 through its merger with Integrity.



FNB United makes its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and
amendments to those reports available on its website at www.MyYesBank.com without charge as soon as reasonably practicable after filing or furnishing them to the Securities and Exchange Commission. In addition, FNB United will provide without charge
a copy of its annual report on Form 10-K to any shareholder by mail. Requests should be sent to FNB United Corp., Attention: Secretary, 150 South Fayetteville Street (27203), P.O. Box 1328, Asheboro, North Carolina 27204.



Competition



The banking industry within First National Banks marketing area is extremely competitive. First National Bank faces
direct competition in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties from approximately 90 different financial institutions,
including commercial banks, savings institutions and credit



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unions. Although no one of these entities is dominant, First National Bank considers itself to be one of the significant financial institutions in the area
in terms of total assets and deposits. Further competition is provided by banks located in adjoining counties, as well as other types of financial institutions such as insurance companies, finance companies, pension funds and brokerage houses and
other money funds. The principal methods of competing in the commercial banking industry are improving customer service through the quality and range of services provided, improving cost efficiencies and pricing services competitively.



Dover faces competition within its market area from other mortgage banking
companies and from all types of financial institutions engaged in the mortgage loan business. The principal methods of competing in the mortgage banking business are offering competitively priced mortgage loan products and providing prompt and
efficient customer service.



Regulation and Supervision



The following discussion sets forth material elements of the regulatory
framework applicable to bank holding companies and their subsidiaries. It also provides certain specific information relevant to FNB United. This regulatory framework is intended primarily for the protection of customers and depositors and the
deposit insurance funds that insure deposits of banks and savings institutions, and not for the protection of security holders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its
entirety by reference to those provisions. A change in the statutes, regulations or regulatory policies applicable to FNB United or its subsidiaries may have a material effect on the business of the Corporation. Additional information related to
regulatory matters is contained in Managements Discussion and Analysis of Financial Condition and Results of Operations below.



General



As a bank holding company, FNB United is subject to regulation under the Bank Holding Company Act of 1956, as amended, and to inspection, examination and
supervision by the Federal Reserve Board. Under the Bank Holding Company Act, bank holding companies, such as FNB United, that have not elected to become financial holding companies under the Gramm-Leach-Bliley Act generally may not acquire
ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve Boards prior approval. With limited exceptions, bank holding companies may engage only in
the business of banking or managing or controlling banks or furnishing services to or performing services for their subsidiary banks. A significant exception is that a bank holding company may own shares in a company whose activities the Federal
Reserve Board has determined to be closely related to banking or managing or controlling banks.



As a national banking association, First National Bank is subject to regulation and examination primarily by the Office of the Comptroller of the Currency
(OCC). It is also regulated by the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board. First National Banks deposits are insured by the FDIC through the Bank Insurance Fund and the Savings Association Insurance Fund.
The OCC and the FDIC impose various requirements and restrictions on First National Bank, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be
charged on loans, limitations on the types of investments that may be made and the types of services that may be offered, and requirements governing capital adequacy, liquidity, earnings, dividends, management practices and branching. As a member of
the Federal Reserve System, First National Bank is subject to the applicable provisions of the Federal Reserve Act, which imposes restrictions on loans by subsidiary banks to a holding company and its other subsidiaries and on the use of stock or
securities as collateral security for loans.



FNB United
acquired Alamance Bank, a North Carolina-chartered bank, on November 4, 2005 through its merger with United Financial, Inc. Alamance Bank merged with and into First National Bank on February 1, 2006. Prior to the bank merger, Alamance Bank
was regulated by the North Carolina Commissioner of Banks.



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FNB Uniteds subsidiary, Dover Mortgage Company, is regulated by the North Carolina Commissioner of
Banks. Because Dover is a nonbank subsidiary of a bank holding company, it is also regulated by the Federal Reserve Board. Because Dover underwrites mortgages guaranteed by the government, it is subject to other audits and examinations as required
by the government agencies or the investors who purchase the mortgages.



Various consumer laws and regulations also affect the operations of the Corporation. In addition to the impact of regulation, financial institutions may be significantly affected by legislation, which can change the statutes affecting them
in substantial and unpredictable ways, and by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability to influence the economy. The instruments of monetary policy used by the Federal Reserve Board
include its open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements on member bank deposits. The actions of the Federal Reserve Board influence the growth of
bank loans, investments and deposits and also affect interest rates charged on loans or paid on deposits.



In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no
prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Corporation.



Liability for Bank Subsidiaries



Under current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to its subsidiary
banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, the cross-guaranty provisions of the Federal Deposit
Insurance Act provide that if the FDIC suffers or anticipates a loss as a result of a default by a banking subsidiary or by providing assistance to a subsidiary in danger of default, then any other bank subsidiaries may be assessed for the
FDICs loss. Federal law authorizes the OCC to order an assessment of FNB United if the capital of First National Bank were to become impaired. If the assessment were not paid within three months, the OCC could order the sale of FNB
Uniteds stock in First National Bank to cover the deficiency.



Any capital loans by a bank holding company to any of its bank subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of such bank subsidiaries. In the event of a bank holding companys
bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.



Transactions with Affiliates



There are certain restrictions on the ability of FNB United and certain of
its nonbank affiliates to borrow from, and engage in other transactions with, its bank subsidiary and on the ability of its bank subsidiary to pay dividends to FNB United. In general, these restrictions require that any extensions of credit must be
secured by designated amounts of specified collateral and are limited, as to any one of FNB United or a nonbank affiliate, to 10% of the lending banks capital stock and surplus, and, as to FNB United and all such nonbank affiliates in the
aggregate, to 20% of such lending banks capital stock and surplus. These restrictions, other than the 10% of capital limit on covered transactions with any one affiliate, are also applied to transactions between national banks and their
financial subsidiaries. In addition, certain transactions with affiliates must be on terms and conditions, including credit standards, that are substantially the same, or at least as favorable to the institution, as those prevailing at the time for
comparable transactions involving other nonaffiliated companies or, in the absence of comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to, or would apply to, nonaffiliated companies.



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Unsafe and Unsound Practices



The OCC has authority under the Financial Institutions Advisory Act to prohibit national banks from engaging in any activity
that, in the OCCs opinion, constitutes an unsafe or unsound practice in conducting their businesses. The Federal Reserve Board has similar authority with respect to FNB United and its nonbank subsidiaries.



Capital Requirements



FNB United and First National Bank are required to comply with federal
regulations on capital adequacy. There are two measures of capital adequacy: a risk-based measure and a leverage measure. All capital standards must be satisfied for an institution to be considered in compliance. The risk-based capital standards are
designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and
off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. For additional information, see
Capital Adequacy in Managements Discussion and Analysis of Financial Condition and Results of Operations below.



Dividend Restrictions



FNB United is a legal entity separate and distinct from its bank and other subsidiaries. Because the principal source of FNB Uniteds revenues is
dividends from the subsidiary bank, the ability of FNB United to pay dividends to its shareholders and to pay service on its own debt depends largely upon the amount of dividends its subsidiaries may pay to FNB United. There are statutory and
regulatory limitations on the payment of dividends by First National Bank to FNB United, as well as by FNB United to its shareholders.



First National Bank must obtain the prior approval of the OCC to pay dividends if the total of all dividends declared by the bank in any calendar year
will exceed the sum of its net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits First National Bank from paying dividends that in the
aggregate would be greater than its undivided profits after deducting statutory bad debts in excess of its loan loss allowance.



FNB United and First National Bank are also subject to various general regulatory policies and requirements relating to the payment of dividends,
including requirements to maintain adequate capital above regulatory minimums. If, in the opinion of the appropriate federal regulatory authority, a bank under its jurisdiction is engaged in or is about to be engaged in an unsafe or unsound
practice, the authority may require that the bank cease and desist from such practice. The Federal Reserve Board, the OCC and the FDIC have indicated that paying dividends that deplete a banks capital base to an inadequate level would be an
unsafe and unsound banking practice. Under the FDICIA, an insured bank may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Further, the Federal Reserve Board, OCC and FDIC have each
indicated that banking institutions should generally pay dividends only out of current operating earnings.



FDIC Insurance Assessments



The deposits of First National Bank are insured by the Deposit Insurance Fund (DIF) of the FDIC up to the limits set forth under applicable law and are
subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the Reform Act). Under this
system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk
categories determined by



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reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further
determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. Beginning January 1, 2007, assessments for the DIF can range from 5 to 43 basis points per $100 of assessable deposits,
depending on the insured institutions risk category as described above. This assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed
quarterly. The Reform Act also provides for a one-time premium assessment credit for eligible insured depository institutions, including those institutions in existence and paying deposit insurance premiums on December 31, 1996, or certain
successors to any such institution. The assessment credit is determined based on the eligible institutions deposits at December 31, 1996 and is applied automatically to reduce the institutions quarterly premium assessments to the
maximum extent allowed, until the credit is exhausted. In addition, insured depository institutions have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (FICO) to fund the closing
and disposal of failed thrift institutions by the Resolution Trust Corporation.



Under the Federal Deposit Insurance Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a banks federal regulatory agency.



Community Reinvestment Act



First National Bank is subject to the provisions of the Community Reinvestment Act of 1977, as amended (CRA). Under the CRA, all financial institutions
have a continuing and affirmative obligation consistent with their safe and sound operation to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions, nor does it limit an institutions discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.



The CRA requires the appropriate federal bank regulatory agency, in
connection with its examination of the bank, to assess the banks record in meeting the credit needs of the community served by the bank, including low- and moderate-income neighborhoods. The regulatory agencys assessment of the
banks record is made available to the public. Should the Corporation fail to serve the community adequately, potential penalties are regulatory denials to expand branches, relocate, add subsidiaries and affiliates, expand into new financial
activities and merge with or purchase other financial institutions.



Interstate Banking and Branching



The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Banking Act) permits interstate acquisitions of banks by bank holding companies. FNB United and any other bank holding company located in North Carolina may
acquire a bank located in any other state, and any bank holding company located outside North Carolina may lawfully acquire any North Carolina-based bank, regardless of state law to the contrary, in either case subject to certain deposit-percentage
limitations, aging requirements and other restrictions. The Interstate Banking Act also generally provides that national and state-chartered banks may branch interstate through acquisitions of banks in other states. It allowed, however, any state to
elect prior to June 1, 1997 either to opt in and accelerate the date after which interstate branching was permissible or to opt out and prohibit interstate branching altogether. North Carolina enacted opt in
legislation permitting interstate branching. The Interstate Banking Act may have the effect of increasing competition within the markets in which FNB United operates.



Depositor Preference Statute



Under federal law, depositors and certain claims for administrative expenses and employee compensation against an insured
depository institution would be afforded a priority over other general unsecured claims against



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such an institution, including federal funds and letters of credit, in the liquidation or other resolution of such an institution by any
receiver.



Gramm-Leach-Bliley Act



The Gramm-Leach-Bliley Act allows bank holding companies to engage in a
wider range of nonbanking activities, including greater authority to engage in the securities and insurance businesses. Under the Gramm-Leach-Bliley Act, a bank holding company that elects to become a financial holding company may engage in any
activity that is financial in nature, is incidental to financial activity or complements financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Activities
cited by the law as being financial in nature include securities underwriting, dealing in securities and market making, insurance underwriting and agency, providing financial, investment or economic advisory services, and activities that
the Federal Reserve Board has determined to be closely related to banking. FNB United has not elected to become a financial holding company.



Subject to certain limitations on investment, a national bank or its financial subsidiary may also engage in activities that are financial in nature,
other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, so long as the bank is well-capitalized, well-managed and has at least a satisfactory Community Reinvestment Act rating.
Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well-capitalized and well-managed to continue to engage in activities that are financial in nature. In addition, a financial holding
company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has at least a satisfactory Community Reinvestment Act rating.



Privacy



The Gramm-Leach-Bliley Act also modified other financial laws, including
laws related to financial privacy. Under the act, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules
require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The Fair Credit Reporting Act restricts information sharing among
affiliates and was amended in December 2003 to restrict further affiliate sharing of information for marketing purposes.



International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001



The President signed the USA Patriot Act of 2001 into law in October 2001. This act contains the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the IMLAFA). The IMLAFA substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposes new compliance
and due diligence obligations, creates new crimes and penalties, compels the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United
States, and clarifies the safe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as our
bank subsidiary. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their
customers.



Pursuant to the IMLAFA, the Corporation established
anti-money laundering compliance and due diligence programs.



7



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Sarbanes-Oxley Act of 2002



The President signed into law the Sarbanes-Oxley Act of 2002, which addresses, among other issues, corporate governance,
auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. The act is intended to allow shareholders to monitor more easily and efficiently the performance of public companies and their directors.



Future Legislation



Changes to the laws and regulations in the United States and North Carolina
can affect the Corporations operating environment in substantial and unpredictable ways. FNB United cannot predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon
the financial condition or results of operations of the Corporation.



Employees



As of December 31, 2006, FNB
United had five officers, all of whom were also officers of First National Bank. On that same date, First National Bank had 493 full-time employees and 36 part-time employees and Dover had 52 full-time employees and 3 part-time employees. Each
subsidiary considers its relationship with its employees to be excellent. The Corporation provides employee benefit programs, including a noncontributory defined benefit pension plan, matching retirement/savings (401(k)) plan, group
life, health and dental insurance, paid vacations, sick leave, and health care and life insurance benefits for retired employees.



In September 2006, the Board of Directors of FNB United approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees
are eligible to enter the plan. Participants who are at least age 40, have earned 10 years of vesting service as an employee of FNB United and remain an active employee as of December 31, 2006 will qualify for continued benefits under
grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. Additionally, the plans definition of final average compensation will be changed from
a 10-year averaging period to a 5-year averaging period as of January 1, 2007. All other eligible participants in the plan will have their retirement benefit frozen as of December 31, 2006. Effective January 1, 2007, the 401(k) plan
will be enhanced and will be the primary retirement benefit plan.



In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees are eligible to enter the plan. Participants who are at
least age 40, have earned 10 years of vesting service as an employee of the Corporation and remain an active employee as of December 31, 2006 will qualify under a grandfathering provision. Under the grandfathering provision, the participant
will continue to accrue benefits under the plan through December 31, 2011.



Properties



The principal executive and
administrative offices of FNB United and First National Bank are located in an office building at 150 South Fayetteville Street, Asheboro, North Carolina. First National Bank also has six other facilities in Asheboro containing three community
banking operations and various administrative and operational functions. First National Bank has other community banking offices in Archdale (two offices), Biscoe, Burlington, China Grove, Ellerbe, Graham, Greensboro (two offices), Hillsborough,
Kannapolis, Laurinburg, Pinehurst, Ramseur, Randleman, Rockingham (two offices), Salisbury (two offices), Seagrove, Siler City, Southern Pines and Trinity, North Carolina. First National Bank also operates other community banking offices in North
Carolina identified as part of the First Gaston Bank division in Belmont, Dallas, Gastonia, Mt. Holly and Stanley; the Catawba Valley Bank division in Hickory (three offices), Mooresville, Newton and Statesville; and the Northwestern Bank division
in Boone, Millers Creek, Taylorsville, West Jefferson and Wilkesboro (two



8



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##### Table of Contents

offices). Nine of the community banking offices are leased facilities, and two such offices are situated on land that is leased. Two of the facilities
housing operational functions in Asheboro are leased.



The main
offices of Dover are located in Charlotte, North Carolina. Dover also has loan production offices in Carolina Beach, Goldsboro, Greenville, Lake Norman, Leland, Raleigh, Wilmington and Wrightsville Beach, North Carolina. All of the Dover facilities
are leased.



Risk Factors



There Is a Limited Market for FNB Common Stock



Although FNB United common stock is traded on The NASDAQ Select Global
Market, the volume of trading has historically been low, averaging only a few thousand shares per week. Therefore, there can be no assurance that a holder of FNB United common stock who wishes to sell his or her shares would be able to do so
immediately or at an acceptable price.



Certain Provisions
of FNB Uniteds Articles of Incorporation and Bylaws May Discourage Takeovers



FNB Uniteds articles of incorporation and bylaws contain certain anti-takeover provisions that may discourage or may make more difficult or expensive a tender offer, change in control or takeover attempt that is
opposed by FNB Uniteds board of directors. In particular, FNB Uniteds articles of incorporation and bylaws:



| |  |  | classify its board of directors into three classes, so that shareholders elect only one-third of its board of directors each year.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | permits FNB Uniteds board of directors to issue, without shareholder approval unless otherwise required by law, nonvoting preferred stock with such terms as
the board may determine, and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | require the affirmative vote of the holders of at least 75% of FNB Uniteds voting shares to approve major corporate transactions unless the transaction is
approved by three-fourths of FNB Uniteds disinterested directors.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



These provisions of FNB Uniteds articles of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a
change in control, even though a majority of FNB Uniteds shareholders may consider such proposal desirable. Such provisions could also make it more difficult for third parties to remove and replace the members of FNB Uniteds board of
directors. They may also inhibit increases in the trading price of FNB Uniteds common stock that could result from takeover attempts.



Changes in Interest Rates May Have an Adverse Effect on FNB Uniteds Profitability



FNB Uniteds earnings and financial condition are dependent to a large
degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of the margin between interest rates earned on loans and investments and the
interest rates paid on deposits and borrowings could adversely affect FNB Uniteds earnings and financial condition. FNB United can neither predict with certainty nor control changes in interest rates. These changes can occur at any time and
are affected by many factors, including national, regional and local economic conditions and monetary policies of the Federal Reserve Board. FNB United has ongoing policies and procedures designed to manage the risks associated with changes in
market interest rates. Notwithstanding these policies and procedures, changes in interest rates may have an adverse effect on FNB Uniteds profitability. For example, high interest rates could adversely affect FNB Uniteds mortgage banking
business because higher interest rates could cause customers to apply for fewer mortgages or mortgage refinancings.



FNB United Faces Significant Operational Risk



FNB United processes large volumes of transactions on a daily basis, exposing the company to numerous types of operational risk. Operational risk includes
the risk of fraud or theft by employees or persons outside



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##### Table of Contents

FNB United, unauthorized transactions by employees or operational errors, including clerical or recordkeeping errors or those resulting from faulty or
disabled computer or telecommunications systems, and breaches of the internal control system and compliance requirements. Negative public opinion can result from FNB Uniteds actual or alleged conduct in a variety of areas, including lending
practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely FNB Uniteds ability to attract and retain
customers and can expose it to litigation and regulatory action. Operational risk also includes potential legal actions that could arise from an operational deficiency or a as a result of noncompliance with applicable regulatory standards.



Because the nature of the banking business involves a high
volume of transactions, certain errors may be repeated or compounded before they are found and corrected. FNB Uniteds necessary reliance upon automated systems to record and process its transactions may further increase the risk that technical
flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. FNB United may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its
control (e.g., computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability.



FNB United May Experience Significant Competition in its Market Area, Which May Adversely Affect its Business



The banking industry within FNB Uniteds marketing
area is extremely competitive. In addition, FNB United competes with other providers of financial services, such as savings and loan associations, credit unions, insurance companies, finance companies, pension funds and brokerage houses and other
money funds. Some of FNB Uniteds larger competitors include several large interstate financial holding companies that are among the largest in the nation and are headquartered in North Carolina. These companies have a significant presence in
FNB Uniteds market area, have greater resources than FNB United, may have higher lending limits and may offer products and services not offered by FNB United. These institutions may be able to offer the same products and services at more
competitive rates and prices.



FNB United Is Vulnerable to
the Economic Conditions within the Relatively Small Region in Which It Operates



FNB Uniteds overall success is dependent in part on the general economic conditions within its market area, which extends from the central and southern Piedmont and Sandhills to the foothills and mountains of
western North Carolina. An economic downturn in this fairly small geographic region that negatively affects FNB Uniteds customers could adversely affect FNB United.



FNB United May Not Be Able to Successfully Integrate Bank or Nonbank Mergers and Acquisitions



Difficulties may arise in the integration of the business and operations of
bank holding companies, banks and other non-bank entities FNB United acquires and, as a result, FNB United may not be able to achieve the cost savings and synergies that it expects will result from such transactions. Achieving cost savings is
dependent on consolidating certain operational and functional areas, eliminating duplicative positions and terminating certain agreements for outside services. Additional operational savings are dependent upon the integration of the acquired or
merged entitys businesses with FNB United or one of its subsidiaries, the conversion of core operating systems, data systems and products and the standardization of business practices. Complications or difficulties in the conversion of the
core operating systems, data systems and products may result in the loss of customers, damage to FNB Uniteds reputation within the financial services industry, operational problems, one-time costs currently not anticipated or reduced cost
savings resulting from such mergers or acquisitions. Annual cost savings in each such transaction may be materially less than anticipated if the holding company, bank merger or nonbank merger or acquisition is delayed unexpectedly, the integration
of operations is delayed beyond what is anticipated or the conversion to a single data system is not accomplished on a timely basis.



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##### Table of Contents

Difficulty in integrating an acquired company may cause FNB United not to realize expected revenue
increases, cost savings, increases in geographic or product presence and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of FNB
Uniteds businesses or the businesses of the acquired company, or otherwise adversely affect FNB Uniteds ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition.



Other Risks



There are risks and uncertainties relating to an investment in FNB United
common stock or to economic conditions and regulatory matters generally that should affect other financial institutions in similar ways. These aspects are discussed under Forward-Looking Statements and Regulation and
Supervision elsewhere in this Annual Report on Form 10-K.



Performance
Graph



The following graph and table are furnished with
this Annual Report on Form 10-K and compare the cumulative total shareholder return of FNB United Common Stock for the five-year period ended December 31, 2006 with the SNL Southeast Bank Index and the Russell 3000 Stock Index, assuming an
investment of $100 at the beginning of the period and the reinvestment of dividends.



LOGO



|                         |  |                    |        |      |   |        |  |      |        |      |   |        |  |   |        |  |   |       
|------------------------ |  | ------------------ | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------ |  | - | ------
|                         |  | As of December 31,
|                         |  | 2001               |        | 2002 |   | 2003   |  | 2004 |        | 2005 |   | 2006  
|FNB United Corp.         |  | $                  | 100.00 |      | $ | 132.06 |  | $    | 147.77 |      | $ | 137.74 |  | $ | 141.15 |  | $ | 140.82
|SNL Southeast Bank Index |  |                    | 100.00 |      |   | 110.46 |  |      | 138.72 |      |   | 164.50 |  |   | 168.39 |  |   | 197.45
|Russell 3000 Index       |  |                    | 100.00 |      |   | 78.46  |  |      | 102.83 |      |   | 115.11 |  |   | 122.16 |  |   | 141.35



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



FIVE YEAR FINANCIAL HISTORY



|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|----------------------------------------------------- |  | --------------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                      |  | 2006                                          |           |   | 2005 |   |           | 2004 |  |   | 2003    |   |  | 2002 |        
|                                                      |  | (dollars in thousands, except per share data) |          
|Summary of Operations                                 |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                       |  | $                                             | 103,369   |   |      | $ | 54,415    |      |  | $ | 40,436  |   |  | $    | 40,158  |   |  | $ | 39,452  |  
|Interest expense                                      |  |                                               | 47,155    |   |      |   | 20,050    |      |  |   | 12,402  |   |  |      | 13,144  |   |  |   | 14,114  |  
|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income                                   |  |                                               | 56,214    |   |      |   | 34,365    |      |  |   | 28,034  |   |  |      | 27,014  |   |  |   | 25,338  |  
|Provision for loan losses                             |  |                                               | 2,526     |   |      |   | 2,842     |      |  |   | 4,030   |   |  |      | 1,860   |   |  |   | 1,780   |  
|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income after provision for loan losses   |  |                                               | 53,688    |   |      |   | 31,523    |      |  |   | 24,004  |   |  |      | 25,154  |   |  |   | 23,558  |  
|Noninterest income                                    |  |                                               | 19,215    |   |      |   | 14,926    |      |  |   | 13,673  |   |  |      | 13,600  |   |  |   | 8,268   |  
|Noninterest expense                                   |  |                                               | 53,441    |   |      |   | 31,678    |      |  |   | 28,755  |   |  |      | 27,159  |   |  |   | 20,140  |  
|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income before income taxes                            |  |                                               | 19,462    |   |      |   | 14,771    |      |  |   | 8,922   |   |  |      | 11,595  |   |  |   | 11,686  |  
|Income taxes                                          |  |                                               | 7,275     |   |      |   | 4,834     |      |  |   | 2,324   |   |  |      | 3,195   |   |  |   | 3,486   |  
|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income                                            |  | $                                             | 12,187    |   |      | $ | 9,937     |      |  | $ | 6,598   |   |  | $    | 8,400   |   |  | $ | 8,200   |  
|                                                      |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Per Share Data                                        |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income:                                           |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Basic                                                 |  | $                                             | 1.27      |   |      | $ | 1.73      |      |  | $ | 1.17    |   |  | $    | 1.50    |   |  | $ | 1.63    |  
|Diluted                                               |  |                                               | 1.25      |   |      |   | 1.69      |      |  |   | 1.13    |   |  |      | 1.43    |   |  |   | 1.58    |  
|Cash dividends declared                               |  |                                               | .62       |   |      |   | .62       |      |  |   | .60     |   |  |      | .59     |   |  |   | .58     |  
|Book value                                            |  |                                               | 18.39     |   |      |   | 16.06     |      |  |   | 14.66   |   |  |      | 14.32   |   |  |   | 13.49   |  
|                                                      |  |                                               |           |   |     
|Balance Sheet Information                             |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total assets                                          |  | $                                             | 1,814,905 |   |      | $ | 1,102,085 |      |  | $ | 862,891 |   |  | $    | 773,245 |   |  | $ | 754,370 |  
|Investment securities                                 |  |                                               | 171,815   |   |      |   | 159,806   |      |  |   | 125,143 |   |  |      | 144,259 |   |  |   | 153,857 |  
|Loans                                                 |  |                                               | 1,322,702 |   |      |   | 812,666   |      |  |   | 664,754 |   |  |      | 551,913 |   |  |   | 502,342 |  
|Goodwill                                              |  |                                               | 110,956   |   |      |   | 31,381    |      |  |   | 16,335  |   |  |      | 16,325  |   |  |   | 12,601  |  
|Deposits                                              |  |                                               | 1,421,013 |   |      |   | 841,609   |      |  |   | 659,544 |   |  |      | 597,925 |   |  |   | 592,354 |  
|Borrowed funds                                        |  |                                               | 167,018   |   |      |   | 146,567   |      |  |   | 113,647 |   |  |      | 86,721  |   |  |   | 81,815  |  
|Shareholders equity                                  |  |                                               | 207,668   |   |      |   | 102,315   |      |  |   | 82,147  |   |  |      | 81,458  |   |  |   | 73,090  |  
|                                                      |  |                                               |           |   |     
|Ratios (Averages)                                     |  |                                               |           |   |      |   |           |      |  |   |         |   |  |      |         |   |  |   |         |  
|Return on assets                                      |  |                                               | 0.77      | % |      |   | 1.06      | %    |  |   | .80     | % |  |      | 1.07    | % |  |   | 1.25    | %
|Return on shareholders equity                        |  |                                               | 7.00      |   |      |   | 11.25     |      |  |   | 8.00    |   |  |      | 10.66   |   |  |   | 12.82   |  
|Shareholders equity to assets                        |  |                                               | 11.05     |   |      |   | 9.46      |      |  |   | 9.99    |   |  |      | 10.00   |   |  |   | 9.75    |  
|Dividend payout ratio                                 |  |                                               | 51.17     |   |      |   | 36.32     |      |  |   | 51.36   |   |  |      | 39.54   |   |  |   | 36.05   |  
|Loans to deposits                                     |  |                                               | 93.79     |   |      |   | 99.26     |      |  |   | 98.03   |   |  |      | 92.36   |   |  |   | 82.00   |  
|Net yield on earning assets, taxable equivalent basis |  |                                               | 4.20      |   |      |   | 4.16      |      |  |   | 3.89    |   |  |      | 3.94    |   |  |   | 4.40    |  



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##### Table of Contents

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 consolidated financial statements and supplemental 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 19 to the Consolidated Financial Statements.



Merger Acquisition of United Financial, Inc. in 2005



On November 4, 2005, the Corporation completed a merger for the acquisition of United Financial, Inc. (United), holding company for
Alamance Bank, headquartered in Graham, North Carolina. At the date of merger, Alamance Bank operated three offices and, based on estimated fair values, had $163.7 million in total assets, $95.2 million in net loans and $113.0 in deposits. On
February 1, 2006, Alamance Bank was merged into First National Bank. Pursuant to the terms of the merger, each share of United common stock was converted, at the election of the shareholder, into either: (1) $14.25 in cash, (2) 0.6828
shares of FNB Corp. common stock, or (3) $4.99 in cash and 0.4438 shares of FNB Corp. common stock, the overall conversion of stock being limited to 65% of United shares. The aggregate purchase price, as adjusted by a reduction of $0.2 million
during the one-year period following the date of merger, was $22.5 million, consisting of $8.2 million of cash payments and 728,625 shares of FNB Corp. common stock valued at $14.3 million. The merger transaction has been accounted for using the
purchase method of accounting for business combinations, and accordingly, the assets and liabilities of United were recorded based on estimated fair values as of November 4, 2005, with the estimate of goodwill being subject to possible
adjustment during the one-year period from that date. The adjustments recorded during that one-year period, including the purchase price adjustment noted above, resulted in a net $264,000 reduction in the amount initially recorded for goodwill. The
consolidated financial statements include the results of operations of United since November 4, 2005.



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##### Table of Contents

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 seventeen counties with forty-two 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.



Primary Financial
Data for 2006



The Corporation earned $12.2 million in
2006, a 22.6% increase in net income from 2005. Basic earnings per share decreased from $1.73 in 2005 to $1.27 in 2006 and diluted earnings per share decreased from $1.69 to $1.25, for percentage decreases of 26.6% and 26.0%, respectively. As noted
above, First Gaston Bank and Alamance Bank were acquired through mergers effective April 28, 2006 and November 4, 2005, impacting both net income and the calculation of earnings per share since the acquisition dates and the comparability
of operating results on a year-to-date basis between 2006 and 2005 (see Note 19 to the Consolidated Financial Statements for business segment information and also below in Significant Factors Affecting Earnings in 2006). The First Gaston
Bank acquisition added $728.7 million or approximately 66% to total assets at the time of acquisition, while the Alamance Bank acquisition earlier added $163.7 million or approximately 18% to total assets at the time of acquisition. Largely
reflecting the First Gaston Bank acquisition, total assets were $1.81 billion at December 31, 2006, up 65% from year-end 2005. Loans amounted to $1.32 billion at December 31, 2006, increasing 63% from the prior year. Total deposits
grew 69% to $1.42 billion in 2005.



Significant Factors
Affecting Earnings in 2006



The acquisitions of First
Gaston Bank and Alamance Bank have affected the comparability of operating results, as the consolidated financial statements include the results of operations of First Gaston Bank and Alamance Bank since April 28, 2006 and November 4,
2005, respectively, and prior period financial information has not been restated under the purchase method of accounting for business combinations. Consequently, the results of operations for 2006 include the results of the former First Gaston Bank
operations for only the last eight months of that period and the results of the Alamance Bank operations for all of that period, while the results of 2005 do not include First Gaston Bank and include Alamance Bank for only the last two months of
that



14



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##### Table of Contents

period. As noted above, the First Gaston Bank acquisition added approximately 66% to total assets at the time of acquisition and the Alamance Bank
acquisition added approximately 18%.



Net interest income has
continued to be impacted by the tightening measures utilized by the Federal Reserve for monetary policy purposes since mid-2004. These measures have resulted in prime rate increases that have tended to improve the yield on earning assets while
similarly increasing the cost of funds. Net interest income increased $21.8 million or 64% in 2006 compared to 2005, reflecting the effect of a 61% increase in the level of average earning assets coupled with an increase in the net interest margin,
stated on a taxable equivalent basis, from 4.16% in 2005 to 4.20% in 2006.



The provision for loan losses was $2,526,000 in 2006 compared to $2,842,000 in 2005, a decrease of $316,000, or 11.1%. The 2005 provision was $1,188,000 below the $4,030,000 provision in 2004 when the second quarter
provision was $2,780,000 and actual loan charge-offs in that quarter amounted to $2,754,000. Due partially to the continuing evaluation of the quality of the loan portfolio acquired as part of the acquisition of First Gaston Bank, the allowance for
loan losses has increased to 1.28% of loans held for investment at December 31, 2006 compared to 1.25% at December 31, 2005 and 1.12% at December 31, 2004.



The amounts reported for the provision for loan losses and also noninterest income have been impacted by the adoption in the
second quarter of 2005 of new regulatory guidance on the accounting for courtesy overdraft programs. The initial result from adoption of this guidance was a $324,000 increase in the provision for loan losses in the second quarter of 2005, the effect
of which was partially offset by a $156,000 increase in income from service charges on deposit accounts. In periods subsequent to the second quarter of 2005, the regulatory guidance on accounting for courtesy overdraft programs will have a
continuing effect on the results of operations by increasing the level of both the provision for loan losses and income from service charges on deposit accounts, although these effects should tend to be offsetting with only a minor impact on net
income. The total increase in the provision for loan losses in 2005 due to the new regulatory guidance was $712,000 and for 2006 was $670,000.



Noninterest income was significantly affected in 2006 by the restructuring of the investment portfolio in the third quarter to eliminate certain
underperforming investments and to improve the net interest margin in future periods. Approximately $120 million of available-for-sale securities, or approximately 52% of the total carrying value of the investment portfolio, was sold. Portions of
the liquidated investments were obtained in the acquisitions of First Gaston Bank and Alamance Bank. The pre-tax loss recognized on this transaction was $557,000.



Noninterest income was additionally impacted in 2006 by the recognition of $826,000 of income in connection with certain
SBIC investments that qualify as Community Reinvestment Act investments. A loss of $23,000 was recorded on SBIC investments in 2005. Noninterest income was further augmented in 2006 by the sale in the fourth quarter of $10.4 million of nonperforming
and higher risk loans, resulting in a gain of $118,000, and by a $336,000 death benefit from a bank owned life insurance policy insuring a former employee. Partially offsetting these gains was a mortgage servicing rights impairment charge of
$250,000.



Noninterest expense was significantly impacted in
2006 by a goodwill impairment charge of $1.6 million related to Dover Mortgage Company as discussed in Note 3 to the Consolidated Financial Statements.



Noninterest expense was generally affected in 2006 by the increased size of the organization following the acquisitions of Alamance Bank and First Gaston
Bank, as discussed above, and by the related restructuring/conversion expenses. The February 2006 Alamance Bank merger and the August 2006 First Gaston Bank merger into First National Bank have resulted in restructuring and system conversion
expenses, which are estimated to be approximately $1.4 million. These amounts include consulting services, data processing and other records conversion expense, the buyout of various contracts, and legal and accounting fees. The resulting bank,
until at least some point in 2007, is continuing to operate under the existing four trade names (First National Bank and



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Trust Company, First Gaston Bank, Catawba Valley Bank, and Northwestern Bank). The Corporation is in the process of conducting a branding study to determine
the advisability of adopting a new bank name in 2007. The YES YOU CAN(R) and YES WE CAN(R) trademarks owned by First National will continue to be utilized. Accordingly, the Corporation anticipates there will be additional merger related
expenditures, including replacement of signage, office supplies and some remaining systems conversions. While additional merger related charges may be recognized, synergies from the acquisition of First Gaston Bank are beginning to be realized.



Noninterest expense was also affected in 2006 by the
recognition of stock-based compensation. As discussed in Notes 1 and 16 to the Consolidated Financial Statements, effective January 1, 2006, the Corporation adopted Statement of Financial Accounting Standards No. 123R (SFAS
No. 123R), Share-Based Payment, which requires companies to recognize charges to the income statement for the grant-date fair value of stock options, restricted stock and other equity-based compensation issued to employees
over the period during which an employee is required to provide service in exchange for the award (presumptively the vesting period). Stock-based compensation for all types of compensation arrangements amounted to $673,000 in 2006 and the related
income tax benefit was $92,000. Stock-based compensation related only to stock options amounted to $510,000 in 2006 and the related income tax benefit was $27,000. Prior to the adoption of SFAS No. 123R, the Corporation used the intrinsic value
method as prescribed by APB No. 25 and thus recognized no compensation expense for stock options granted with exercise prices equal to the fair market value of the common stock on the date of grant.



Critical Accounting Policies



The Corporations significant accounting policies are set forth in Note
1 to the Consolidated Financial Statements. 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 impact of regulatory examinations, and the discovery of information with respect to borrowers which 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 Review



The Corporations net income increased $2.3 million in 2006, up 22.6% over 2005, largely reflecting the significant increase in net interest income.
Earnings were positively impacted in 2006 by increases of $21.8 million or 64% in net interest income and $4.3 million in noninterest income and by a $316,000 reduction in the provision for loan losses, which gains were largely offset by a $21.8
million increase in noninterest expense. Certain factors specifically affecting the elements of income and expense and the comparability of operating results on a year-to-date basis between 2006 and 2005 are discussed in the Overview -
Significant Factors Affecting Earnings in 2006.



The
Corporations net income increased $3.3 million in 2005, up 50.6% over 2004, largely reflecting the significant increase in net interest income. Earnings were positively impacted in 2005 by increases of $6.3 million or 22.6% in net interest
income and $1.3 million in noninterest income and by a $1.2 million reduction in the provision for loan losses, which gains were partially offset by a $2.9 million increase in noninterest expense. Certain factors specifically affecting the elements
of income and expense and the comparability of operating results on a year-to-date basis between 2005 and 2004 are discussed in the Overview - Significant Factors Affecting Earnings in 2006.



16



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Return on average assets increased from 0.80% in 2004 to 1.06% in 2005 and decreased to 0.77% in 2006.
Return on average shareholders equity increased from 8.00% in 2004 to 11.25% in 2005 and decreased to 7.00% in 2006. In 2006, return on tangible assets and equity (calculated by deducting average goodwill and core deposit premiums from average
assets and from average equity) amounted to 0.82% and 14.75%, respectively, compared to 1.09% and 14.36% in 2005 and 0.82% and 9.98% in 2004.



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.



Net interest income was $56.2 million in 2006 compared to $34.4 million in 2005. The increase of $21.8 million or 64%
resulted primarily from a 61% increase in the level of average earning assets coupled with an improvement in the net yield on earning assets, or net interest margin, from 4.16% in 2005 to 4.20% in 2006. In 2005, the increase of $6.3 million or 22.6%
resulted primarily from a 13.2% increase in the level of average earning assets coupled with an improvement in the net yield on earning assets, or net interest margin, from 3.89% in 2004 to 4.16% in 2005. On a taxable equivalent basis, the increases
in net interest income in 2006 and 2005 were $22.2 million and $6.2 million, respectively, reflecting changes in the relative mix of taxable and non-taxable earning assets in each year.



Table 1 sets forth for the periods indicated information with respect to the Corporations average balances of assets
and liabilities, as well as the total dollar amounts of interest income (taxable equivalent basis) from earning assets and interest expense on interest-bearing liabilities, resultant rates earned or paid, net interest income, net interest spread and
net yield on earning assets. Net interest spread refers to the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. Net yield on earning assets, or net interest margin, refers to net
interest income divided by average earning assets and is influenced by the level and relative mix of earning assets and interest-bearing liabilities.



17



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##### Table of Contents

Table 1

Average
Balances and Net Interest Income Analysis



|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|------------------------------------------ |  | ------------------------------------------------ | --------- | ------------------------- | ---- | -------------------------- |  | ---- | -------------- |  | ------------------------- | ------- | ----------------------- | - | ------ | -------------- | ---- | ------------------------- |  | ------------------------ | ------- |  | - | ------ |  | ---- | -
|                                           |  | 2006                                             |           |                           | 2005 |                            |  | 2004 |               
|                                           |  | AverageBalance                                   |           | InterestIncome  / Expense |      | AverageRatesEarned  / Paid |  |      | AverageBalance |  | InterestIncome  / Expense |         | AverageRatesEarned/Paid |   |        | AverageBalance |      | InterestIncome  / Expense |  | AverageRatesEarned/ Paid |        
|                                           |  | (taxable equivalent basis, dollars in thousands) |          
|EARNING ASSETS                             |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Loans (1) (2)                              |  | $                                                | 1,142,350 |                           | $    | 92,746                     |  | 8.12 | %              |  | $                         | 711,431 |                         | $ | 48,718 |                | 6.85 | %                         |  | $                        | 612,217 |  | $ | 35,308 |  | 5.77 | %
|Investment securities (1):                 |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Taxable income                             |  |                                                  | 138,225   |                           |      | 7,065                      |  | 5.11 |                |  |                           | 85,082  |                         |   | 3,860  |                | 4.54 |                           |  |                          | 81,253  |  |   | 3,556  |  | 4.38 |  
|Non-taxable income                         |  |                                                  | 54,831    |                           |      | 3,225                      |  | 5.88 |                |  |                           | 44,731  |                         |   | 2,595  |                | 5.80 |                           |  |                          | 47,630  |  |   | 2,725  |  | 5.72 |  
|Other earning assets                       |  |                                                  | 41,015    |                           |      | 1,932                      |  | 4.71 |                |  |                           | 13,129  |                         |   | 445    |                | 3.39 |                           |  |                          | 13,602  |  |   | 161    |  | 1.19 |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Total earning assets                       |  |                                                  | 1,376,421 |                           |      | 104,968                    |  | 7.63 |                |  |                           | 854,373 |                         |   | 55,618 |                | 6.51 |                           |  |                          | 754,702 |  |   | 41,750 |  | 5.53 |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Cash and due from banks                    |  |                                                  | 27,864    |                           |      |                            |  |      |                |  |                           | 18,642  |                         |   |        |                |      |                           |  |                          | 16,945  |  |   |        |  |      |  
|Goodwill and core deposit premiums         |  |                                                  | 91,495    |                           |      |                            |  |      |                |  |                           | 20,216  |                         |   |        |                |      |                           |  |                          | 16,462  |  |   |        |  |      |  
|Other assets, net                          |  |                                                  | 79,527    |                           |      |                            |  |      |                |  |                           | 42,676  |                         |   |        |                |      |                           |  |                          | 37,081  |  |   |        |  |      |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|TOTAL ASSETS                               |  | $                                                | 1,575,307 |                           |      |                            |  |      |                |  | $                         | 933,907 |                         |   |        |                |      |                           |  | $                        | 825,190 |  |   |        |  |      |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|INTEREST-BEARING LIABILITIES               |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Interest-bearing deposits:                 |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Demand deposits                            |  | $                                                | 156,837   |                           |      | 2,592                      |  | 1.65 |                |  | $                         | 97,623  |                         |   | 733    |                | .75  |                           |  | $                        | 89,827  |  |   | 362    |  | .40  |  
|Savings deposits                           |  |                                                  | 52,827    |                           |      | 182                        |  | .34  |                |  |                           | 51,483  |                         |   | 165    |                | .32  |                           |  |                          | 54,298  |  |   | 168    |  | .31  |  
|Money market deposits                      |  |                                                  | 180,513   |                           |      | 6,766                      |  | 3.75 |                |  |                           | 75,948  |                         |   | 1,504  |                | 1.98 |                           |  |                          | 75,824  |  |   | 798    |  | 1.05 |  
|Certificates and other time deposits       |  |                                                  | 685,270   |                           |      | 29,025                     |  | 4.24 |                |  |                           | 407,303 |                         |   | 12,917 |                | 3.17 |                           |  |                          | 329,812 |  |   | 7,646  |  | 2.32 |  
|Retail repurchase agreements               |  |                                                  | 21,134    |                           |      | 923                        |  | 4.37 |                |  |                           | 17,770  |                         |   | 503    |                | 2.83 |                           |  |                          | 15,890  |  |   | 158    |  | .99  |  
|Federal Home Loan Bank advances            |  |                                                  | 80,410    |                           |      | 3,387                      |  | 4.21 |                |  |                           | 71,152  |                         |   | 2,766  |                | 3.89 |                           |  |                          | 69,490  |  |   | 2,546  |  | 3.66 |  
|Federal funds purchased                    |  |                                                  | 696       |                           |      | 40                         |  | 5.71 |                |  |                           | 342     |                         |   | 9      |                | 2.53 |                           |  |                          | 4,181   |  |   | 71     |  | 1.70 |  
|Other borrowed funds                       |  |                                                  | 64,266    |                           |      | 4,240                      |  | 6.60 |                |  |                           | 31,044  |                         |   | 1,453  |                | 4.68 |                           |  |                          | 22,306  |  |   | 653    |  | 2.93 |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Total interest-bearing liabilities         |  |                                                  | 1,241,953 |                           |      | 47,155                     |  | 3.80 |                |  |                           | 752,665 |                         |   | 20,050 |                | 2.66 |                           |  |                          | 661,628 |  |   | 12,402 |  | 1.87 |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|Noninterest-bearing demand deposits        |  |                                                  | 142,624   |                           |      |                            |  |      |                |  |                           | 84,393  |                         |   |        |                |      |                           |  |                          | 74,741  |  |   |        |  |      |  
|Other liabilities                          |  |                                                  | 16,595    |                           |      |                            |  |      |                |  |                           | 8,481   |                         |   |        |                |      |                           |  |                          | 6,389   |  |   |        |  |      |  
|Shareholders equity                       |  |                                                  | 174,135   |                           |      |                            |  |      |                |  |                           | 88,368  |                         |   |        |                |      |                           |  |                          | 82,432  |  |   |        |  |      |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |  | $                                                | 1,575,307 |                           |      |                            |  |      |                |  | $                         | 933,907 |                         |   |        |                |      |                           |  | $                        | 825,190 |  |   |        |  |      |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|NET INTEREST INCOME AND SPREAD             |  |                                                  |           |                           | $    | 57,813                     |  | 3.83 | %              |  |                           |         |                         | $ | 35,568 |                | 3.85 | %                         |  |                          |         |  | $ | 29,348 |  | 3.66 | %
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  
|NET YIELD ON EARNING ASSETS                |  |                                                  |           |                           |      |                            |  | 4.20 | %              |  |                           |         |                         |   |        |                | 4.16 | %                         |  |                          |         |  |   |        |  | 3.89 | %
|                                           |  |                                                  |           |                           |      |                            |  |      |                |  |                           |         |                         |   |        |                |      |                           |  |                          |         |  |   |        |  |      |  

---

|(1) |  | Interest income and yields related to certain investment securities and loans exempt from both federal and state income tax or from state income tax alone are stated on a fully
taxable equivalent basis, assuming a federal tax rate of 35% in 2006 and 34% in 2005 and 2004 and applicable state tax rate, reduced by the nondeductible portion of interest expense.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Nonaccrual loans are included in the average loan balance. Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the
life of the loan as an adjustment of interest income.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Changes in the net interest margin and net interest spread tend to correlate with movements in the prime
rate of interest. There are variations, however, in the degree and timing of rate changes, compared to prime, for the different types of earning assets and interest-bearing liabilities.



Following a generally low-rate environment for interest rates both earned and paid by the Corporation, the Federal Reserve
took action to raise the level of interest rates by 25 basis points at the end of June 2004, due to concern about increasing inflationary pressures, causing the prime rate to increase to 4.25% in July 2004. Four additional rate increases of 25 basis
points each during the second six months of 2004, eight more such rate increases in 2005 and four more in 2006 have raised the prime rate to the 8.25% level at December 31, 2006. The prime rate averaged 4.33% in 2004, rising to 6.15% in 2005
and 7.94% in 2006.



In 2006, the net interest spread decreased
by 2 basis points from 3.85% in 2005 to 3.83% in 2006, reflecting the effect of an increase in the average total yield on earning assets that was more than offset by the increase in the average rate paid on interest-bearing liabilities, or cost of
funds. The yield on earning assets increased by 112 basis points from 6.51% in 2005 to 7.63% in 2006, while the cost of funds increased by 114 basis points from 2.66% to 3.80%. In 2005, the 18 basis points increase in net interest spread resulted
from a 98 basis points increase in the yield on earning assets as partially offset by a 79 basis points increase in the cost of funds.



The 2006 and 2005 changes in net interest income on a taxable equivalent basis, as measured by volume and rate variances, are analyzed in Table 2. Volume
refers to the average dollar level of earning assets and interest-bearing liabilities.



Table 2

Volume and Rate Variance Analysis



|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|------------------------------------------- |  | ---------------------------------------- | ------ | ------------------- | - | ---------- |  | ------ | ------ |  | ---- | ----- | ---------- |  | - | ----- |  | - | ------ | -
|                                            |  | 2006 Versus 2005                         |        | 2005 Versus 2004    |  
|                                            |  | Variance due to (1)                      |        | Variance due to (1) |  
|                                            |  | Volume                                   |        | Rate                |   | Net Change |  | Volume |        |  | Rate |       | Net Change | 
|                                            |  | (taxable equivalent basis, in thousands) |       
|Interest Income                             |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Loans (2)                                   |  | $                                        | 33,710 |                     | $ | 10,318     |  | $      | 44,028 |  | $    | 6,223 |            |  | $ | 7,187 |  | $ | 13,410 |  
|Investment securities (2):                  |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Taxable income                              |  |                                          | 2,669  |                     |   | 536        |  |        | 3,205  |  |      | 171   |            |  |   | 133   |  |   | 304    |  
|Non-taxable income                          |  |                                          | 594    |                     |   | 36         |  |        | 630    |  |      | (168  | )          |  |   | 38    |  |   | (130   | )
|Other earning assets                        |  |                                          | 1,257  |                     |   | 230        |  |        | 1,487  |  |      | (6    | )          |  |   | 290   |  |   | 284    |  
|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Total interest income                       |  |                                          | 38,230 |                     |   | 11,120     |  |        | 49,350 |  |      | 6,220 |            |  |   | 7,648 |  |   | 13,868 |  
|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Interest Expense                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Interest-bearing deposits:                  |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Demand deposits                             |  |                                          | 624    |                     |   | 1,235      |  |        | 1,859  |  |      | 33    |            |  |   | 338   |  |   | 371    |  
|Savings deposits                            |  |                                          | 5      |                     |   | 12         |  |        | 17     |  |      | (9    | )          |  |   | 6     |  |   | (3     | )
|Money market deposits                       |  |                                          | 3,190  |                     |   | 2,072      |  |        | 5,262  |  |      | 1     |            |  |   | 705   |  |   | 706    |  
|Certificates and other time deposits 10,778 |  |                                          | 5,330  |                     |   | 16,108     |  |        | 2,060  |  |      | 3,211 |            |  |   | 5,271 |  |   |        |  
|Retail repurchase agreements                |  |                                          | 108    |                     |   | 312        |  |        | 420    |  |      | 21    |            |  |   | 324   |  |   | 345    |  
|Federal Home Loan Bank advances             |  |                                          | 380    |                     |   | 241        |  |        | 621    |  |      | 61    |            |  |   | 159   |  |   | 220    |  
|Federal funds purchased                     |  |                                          | 14     |                     |   | 17         |  |        | 31     |  |      | (86   | )          |  |   | 24    |  |   | (62    | )
|Other borrowed funds                        |  |                                          | 2,015  |                     |   | 772        |  |        | 2,787  |  |      | 317   |            |  |   | 483   |  |   | 800    |  
|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Total interest expense                      |  |                                          | 17,114 |                     |   | 9,991      |  |        | 27,105 |  |      | 2,398 |            |  |   | 5,250 |  |   | 7,648  |  
|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  
|Net Interest Income                         |  | $                                        | 21,116 |                     | $ | 1,129      |  | $      | 22,245 |  | $    | 3,822 |            |  | $ | 2,398 |  | $ | 6,220  |  
|                                            |  |                                          |        |                     |   |            |  |        |        |  |      |       |            |  |   |       |  |   |        |  



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---

|(1) |  | The mix variance, not separately stated, has been proportionally allocated to the volume and rate variances based on their absolute dollar amount.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Interest income related to certain investment securities and loans exempt from both federal and state income tax or from state income tax alone is stated on a fully taxable
equivalent basis, assuming a federal tax rate of 35% in 2006 and 34% in 2005 and 2004 and applicable state tax rate, reduced by the nondeductible portion of interest expense.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Provision for Loan Losses



This provision is the charge against earnings to provide an allowance or
reserve 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. Earnings were positively impacted in 2006 and 2005 by reductions in the provision for loan losses of $316,000 and $1,188,000, respectively. For additional information
concerning the provision for loan losses, see the discussion in the Overview  Significant Factors Affecting Earnings in 2006.



The allowance for loan losses, as a percentage of loans held for investment, amounted to 1.28% at December 31, 2006, 1.25% at December 31, 2005
and 1.12% at December 31, 2004. The allowance percentage has increased 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 and also from the continuing evaluation of the quality of the loan portfolio acquired as part of the acquisition of First Gaston Bank, as discussed in the Overview.



Noninterest Income



Noninterest income increased $4.3 million or 29% in 2006, due primarily to the effects of the acquisition of First Gaston Bank on April 28, 2006 as
discussed in the Overview. This acquisition largely resulted in the $2.2 million or 36% increase in service charges on deposit accounts, although there was an additional impact from the adoption in the second quarter of 2005 of new
regulatory guidance on the accounting for courtesy overdraft programs. Additional information concerning factors which specifically affected noninterest income in 2006 is discussed in the OverviewSignificant Factors Affecting Earnings in
2006.



Noninterest income increased $1.3 million or 9.2%
in 2005, due primarily to increases of $610,000 in income from mortgage loan sales and $638,000 in service charges on deposit accounts.



Noninterest Expense



Noninterest expense was $21.8 million or 69% higher in 2006. This increase resulted primarily from the increased size of the organization following the
acquisitions of Alamance Bank and First Gaston Bank, from a $1.6 million goodwill impairment charge and from the initial recognition of stock-based compensation, all as discussed in the OverviewSignificant Factors Affecting Earnings in
2006.



Noninterest expense was $2.9 million or 10.2%
higher in 2005. This increase resulted primarily from a higher level of compensation expense, due in part to increased incentive compensation, the higher level of mortgage loan sales activity and the acquisition of Alamance Bank on November 4,
2005 as discussed in the Overview.



Income Taxes



The effective income tax rate increased from 32.7% in 2005 to 37.4% in
2006 due principally to a higher level of nondeductible expenses in 2006, including much of the stock-based compensation initially recognized in



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2006 and the $1.6 million goodwill impairment charge. Additionally, the Corporations federal income tax rate increased from 34% to 35% in 2006. The
effective income tax rate increased from 26.0% in 2004 to 32.7% in 2005 due principally to the significant increase in the ratio of taxable to tax-exempt income.



Liquidity



Liquidity for First National Bank refers to its continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, 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 promptly 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.



Contractual Obligations



Under existing contractual obligations, the Corporation will be required to make payments in future periods. Table 3 presents aggregated information about
the payments due under such contractual obligations at December 31, 2006. Transaction deposit accounts with indeterminate maturities have been classified as having payments due in one year or less. Benefit plan payments cover estimated amounts
due through 2016.



Table 3

Contractual Obligations



|                                           |  |                                             |           |                  |   |                   |  |                 |        |       |   |         |  |   |          
|------------------------------------------ |  | ------------------------------------------- | --------- | ---------------- | - | ----------------- |  | --------------- | ------ | ----- | - | ------- |  | - | ---------
|                                           |  | Payments Due by Period at December 31, 2006
|                                           |  | One Year or Less                            |           | One toThreeYears |   | Three toFiveYears |  | Over Five Years |        | Total
|                                           |  | (dollars in thousands)                     
|Deposits                                   |  | $                                           | 1,336,004 |                  | $ | 75,173            |  | $               | 9,035  |       | $ | 801     |  | $ | 1,421,013
|Retail repurchase agreements               |  |                                             | 23,161    |                  |   |                  |  |                 |       |       |   |        |  |   | 23,161   
|Federal Home Loan Bank advances            |  |                                             | 3,750     |                  |   | 15,000            |  |                 | 9,000  |       |   | 38,075  |  |   | 65,825   
|Other borrowed funds                       |  |                                             | 16,287    |                  |   |                  |  |                 |       |       |   | 61,745  |  |   | 78,032   
|Lease obligations                          |  |                                             | 1,225     |                  |   | 2,188             |  |                 | 1,824  |       |   | 9,613   |  |   | 14,850   
|Estimated benefit plan payments:           |  |                                             |           |                  |   |                   |  |                 |        |       |   |         |  |   |          
|Pension                                    |  |                                             | 399       |                  |   | 1,011             |  |                 | 1,167  |       |   | 3,670   |  |   | 6,247    
|Other                                      |  |                                             | 107       |                  |   | 286               |  |                 | 290    |       |   | 965     |  |   | 1,648    
|Pension plan contribution expected in 2007 |  |                                             |          |                  |   |                  |  |                 |       |       |   |        |  |   |         
|                                           |  |                                             |           |                  |   |                   |  |                 |        |       |   |         |  |   |          
|Total contractual cash obligations         |  | $                                           | 1,380,933 |                  | $ | 93,658            |  | $               | 21,316 |       | $ | 114,869 |  | $ | 1,610,776
|                                           |  |                                             |           |                  |   |                   |  |                 |        |       |   |         |  |   |          



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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 December 31, 2006 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 December 31, 2006, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $303.5 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 $6.6 million at December 31, 2006 and $7.8 million at December 31, 2005. Due to insignificance, the Corporation has recorded no liability at December 31, 2006 for the current carrying amount of the obligation to perform
as a guarantor.



Dover Mortgage Company originates certain
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 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 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 residential mortgage loans totaled $19.3 million at December 31, 2006, and the
related forward sales commitments totaled $19.3 million. Loans held for sale by Dover Mortgage Company totaled $16.3 million at December 31, 2006, and the related forward sales commitments totaled $16.3 million.



First National Bank had loans held for sale of $4.6 million at
December 31, 2006. Binding commitments of First National Bank for the origination of mortgage loans intended to be held for sale at December 31, 2006 were not material.



The Corporation 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 Corporations balance sheet was asset-sensitive at December 31, 2006. An asset-sensitive position means that, for cumulative gap measurement periods of one year or less, there are more assets than
liabilities



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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.



Table 4 presents information about the periods in which the
interest-sensitive assets and liabilities at December 31, 2006 will either mature or be subject to repricing in accordance with market rates, and the resulting interest-sensitivity gaps. This table shows the sensitivity of the balance sheet at
one point in time and is not necessarily indicative of what the sensitivity will be on other dates. As a simplifying assumption concerning repricing behavior, 50% of the interest-bearing demand, savings and money market deposits are assumed to
reprice immediately and 50% are assumed to reprice beyond one year.



Table 4

Interest Rate Sensitivity Analysis



|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|-------------------------------------------------------------------- |  | ---------------------- | ------- | - | -------------- | - | -------- | ------- |  | - | -------- | - |  | - | ------- | - |  | - | --------- | -
|                                                                     |  | December 31, 2006      |        
|                                                                     |  | Rate Maturity in Days  |         |   | BeyondOne Year |   |          | Total   | 
|                                                                     |  | 1-90                   |         |   | 91-180         |   |          | 181-365 |  |   |         
|                                                                     |  | (dollars in thousands) |        
|Earning Assets                                                       |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Loans                                                                |  | $                      | 836,576 |   |                | $ | 23,815   |         |  | $ | 56,241   |   |  | $ | 396,070 |   |  | $ | 1,322,702 |  
|Investment securities                                                |  |                        | 53,038  |   |                |   | 14,125   |         |  |   | 21,993   |   |  |   | 82,659  |   |  |   | 171,815   |  
|Interest-bearing bank balances                                       |  |                        | 42,929  |   |                |   |         |         |  |   |         |   |  |   |        |   |  |   | 42,929    |  
|Federal funds sold                                                   |  |                        | 30,186  |   |                |   |         |         |  |   |         |   |  |   |        |   |  |   | 30,186    |  
|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Total earning assets                                                 |  |                        | 962,729 |   |                |   | 37,940   |         |  |   | 78,234   |   |  |   | 488,729 |   |  |   | 1,567,632 |  
|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Interest-Bearing Liabilities                                         |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Interest-bearing deposits:                                           |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Demand deposits                                                      |  |                        | 88,749  |   |                |   |         |         |  |   |         |   |  |   | 88,749  |   |  |   | 177,498   |  
|Savings deposits                                                     |  |                        | 25,258  |   |                |   |         |         |  |   |         |   |  |   | 25,259  |   |  |   | 50,517    |  
|Money market deposits                                                |  |                        | 117,670 |   |                |   |         |         |  |   |         |   |  |   | 117,670 |   |  |   | 235,340   |  
|Time deposits of $100,000 or more                                    |  |                        | 148,882 |   |                |   | 108,239  |         |  |   | 81,266   |   |  |   | 27,383  |   |  |   | 365,770   |  
|Other time deposits                                                  |  |                        | 113,963 |   |                |   | 139,507  |         |  |   | 126,722  |   |  |   | 52,758  |   |  |   | 432,950   |  
|Retail repurchase agreements                                         |  |                        | 23,161  |   |                |   |         |         |  |   |         |   |  |   |        |   |  |   | 23,161    |  
|Federal Home Loan Bank advances                                      |  |                        | 8,538   |   |                |   | 1,250    |         |  |   | 2,500    |   |  |   | 53,537  |   |  |   | 65,825    |  
|Other borrowed funds                                                 |  |                        | 72,988  |   |                |   |         |         |  |   |         |   |  |   | 5,044   |   |  |   | 78,032    |  
|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Total interest-bearing liabilities                                   |  |                        | 599,209 |   |                |   | 248,996  |         |  |   | 210,488  |   |  |   | 370,400 |   |  |   | 1,429,093 |  
|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Interest Sensitivity Gap                                             |  | $                      | 363,520 |   |                | $ | (211,056 | )       |  | $ | (132,254 | ) |  | $ | 118,329 |   |  | $ | 138,539   |  
|                                                                     |  |                        |         |   |                |   |          |         |  |   |          |   |  |   |         |   |  |   |           |  
|Cumulative gap                                                       |  | $                      | 363,520 |   |                | $ | 152,464  |         |  | $ | 20,210   |   |  | $ | 138,539 |   |  | $ | 138,539   |  
|Ratio of interest-sensitive assets to interest-sensitive liabilities |  |                        | 161     | % |                |   | 15       | %       |  |   | 37       | % |  |   | 132     | % |  |   | 110       | %



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



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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 in Asset/Liability Management and Interest Rate
Sensitivity above. The use of an interest rate swap in conjunction with asset/liability management objectives is discussed in Note 1 to the Consolidated Financial statements.



Table 5 presents information about the contractual maturities, average interest rates and estimated fair values of financial
instruments considered market risk sensitive at December 31, 2006.



Table 5

Market Risk Analysis of Financial Instruments



|                                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|-------------------------------- |  | ------------------------------------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ---------------- |  | ----- | ------- | ----------------------- | - | ------------------- |  | - | --------- |  | ---- |  | - | ---------
|                                 |  | Contractual Maturities at December 31, 2006 |         |      |   |        
|                                 |  | 2007                                        |         | 2008 |   | 2009    |  | 2010 |         | 2011 |   | BeyondFive Years |  | Total |         | AverageInterestRate (1) |   | EstimatedFair Value
|                                 |  | (dollars in thousands)                     
|Financial Assets                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Debt Securities:                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Fixed rate                       |  | $                                           | 76,390  |      | $ | 17,503  |  | $    | 7,699   |      | $ | 14,198           |  | $     | 11,311  |                         | $ | 27,102              |  | $ | 154,203   |  | 5.21 |  | $ | 153,759  
|Variable rate                    |  |                                             |        |      |   |        |  |      |        |      |   |                 |  |       | 5,000   |                         |   |                    |  |   | 5,000     |  | 6.45 |  |   | 5,000    
|Equity securities                |  |                                             |        |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   | 12,034              |  |   | 12,034    |  |     |  |   | 12,051   
|Loans:                           |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Fixed rate                       |  |                                             | 130,247 |      |   | 91,750  |  |      | 80,811  |      |   | 59,546           |  |       | 58,853  |                         |   | 80,075              |  |   | 501,264   |  | 7.17 |  |   | 502,399  
|Variable rate                    |  |                                             | 390,269 |      |   | 147,005 |  |      | 96,506  |      |   | 42,116           |  |       | 36,949  |                         |   | 108,593             |  |   | 821,438   |  | 8.32 |  |   | 881,553  
|Interest-bearing bank balances   |  |                                             | 42,929  |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   |                    |  |   | 42,929    |  | 5.25 |  |   | 42,929   
|Federal funds sold               |  |                                             | 30,186  |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   | 30,186    |  | 5.25 |  |   | 30,186   
|                                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Total                            |  | $                                           | 670,021 |      | $ | 256,258 |  | $    | 185,016 |      | $ | 115,860          |  | $     | 112,113 |                         | $ | 227,804             |  | $ | 1,567,054 |  | 7.43 |  | $ | 1,627,877
|                                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Financial Liabilities            |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Interest-bearing demand deposits |  | $                                           |        |      | $ |        |  | $    |        |      | $ |                 |  | $     |        |                         | $ |                    |  | $ | 177,498   |  | 1.68 |  | $ | 177,498  
|Savings deposits                 |  |                                             |        |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   |                    |  |   | 50,517    |  | 0.29 |  |   | 50,517   
|Money market deposits            |  |                                             |        |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   |                    |  |   | 235,340   |  | 4.09 |  |   | 235,340  
|Time deposits:                   |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Fixed rate                       |  |                                             | 704,526 |      |   | 61,280  |  |      | 9,215   |      |   | 6,342            |  |       | 2,693   |                         |   | 801                 |  |   | 784,857   |  | 4.70 |  |   | 784,293  
|Variable rate                    |  |                                             | 9,183   |      |   | 4,086   |  |      | 592     |      |   |                  |  |       |         |                         |   |                     |  |   | 13,861    |  | 5.29 |  |   | 13,894   
|Retail repurchase agreements     |  |                                             |        |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   |                    |  |   | 23,161    |  | 4.50 |  |   | 23,155   
|Federal Home Loan                |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Bank advances:                   |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Fixed rate                       |  |                                             | 3,750   |      |   | 1,500   |  |      | 13,500  |      |   | 9,000            |  |       |        |                         |   | 38,075              |  |   | 65,825    |  | 3.87 |  |   | 62,805   
|Variable rate                    |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Other borrowed funds             |  |                                             | 16,287  |      |   |        |  |      |        |      |   |                 |  |       |        |                         |   | 61,745              |  |   | 78,032    |  | 6.88 |  |   | 78,032   
|                                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          
|Total                            |  | $                                           | 733,746 |      | $ | 66,866  |  | $    | 23,307  |      | $ | 15,342           |  | $     | 2,693   |                         | $ | 100,621             |  | $ | 1,429,091 |  | 4.15 |  | $ | 1,425,534
|                                 |  |                                             |         |      |   |         |  |      |         |      |   |                  |  |       |         |                         |   |                     |  |   |           |  |      |  |   |          



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---

|(1) |  | The average interest rate related to debt securities is stated on a fully taxable equivalent basis, assuming a 35% federal income tax rate.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Nonaccrual loans are included in the balance of loans. The allowance for loan losses is excluded.
|--- |  | -------------------------------------------------------------------------------------------------



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
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 December 31, 2006, FNB United Corp. 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 December 31, 2006, FNB United
Corp. and First National Bank had total capital ratios of 11.53% and 11.30%, respectively, and Tier 1 capital ratios of 8.36% and 10.14%.



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 December 31, 2006, FNB
United Corp. and First National Bank had leverage capital ratios of 7.16% and 8.72%, 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 December 31, 2006 and, accordingly, is well-capitalized under the regulatory framework for prompt corrective action.



Balance Sheet Review



As discussed in the Overview, the growth in total assets in 2006 largely reflected the acquisition of First Gaston Bank on April 28,
2006, while the growth in 2005 reflected the acquisition of Alamance Bank on November 4, 2005. Significant estimated fair values initially recorded for First Gaston Bank included total assets of $728.7 million, investment securities of $84.4
million, gross loans of $481.3 million, deposits of $563.3 million and Federal Home Loan Bank advances of $18.6 million. Significant estimated fair values initially recorded for Alamance Bank included total assets of $163.7 million, investment
securities of $34.7 million, gross loans of $96.6 million, deposits of $113.0 million and Federal Home Loan Bank advances of $21.9 million. Total assets increased $712.8 million or 65% in 2006 and $239.2 million or 28% in 2005. By similar
comparison, deposits increased $579.4 million or 69% and $182.1 million or 28%. The average asset growth rates were 69% in 2006 and 13% in 2005. The corresponding average deposit growth rates were 70% and 15%.



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Investment Securities



Investments are carried on the consolidated balance sheet at estimated fair value for available-for-sale securities and at amortized cost for
held-to-maturity securities. Table 6 presents information, on the basis of selected maturities, about the composition of the investment securities portfolio for each of the last three years.



Table 6

Investment Securities Portfolio Analysis



|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|------------------------------------------ |  | ---------------------- | ------- | ------------------ | ---- | --------------------------- | ---- | ----- | ------------- |  | ------------- | ------- |  | - | ------
|                                           |  | December 31           
|                                           |  | 2006                   |         |                    | 2005 |                             | 2004
|                                           |  | AmortizedCost          |         | EstimatedFairValue |      | TaxableEquivalent Yield (1) |      |       | CarryingValue |  | CarryingValue
|                                           |  | (dollars in thousands)
|Available for Sale                         |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|U.S. Government agencies and corporations: |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Within one year                            |  | $                      | 21,349  |                    | $    | 21,375                      |      | 4.77  | %             |  | $             | 3,430   |  | $ | 1,262 
|One to five years                          |  |                        | 47,356  |                    |      | 47,346                      |      | 5.17  |               |  |               | 16,895  |  |   | 13,078
|Five to ten years                          |  |                        | 5,637   |                    |      | 5,700                       |      | 5.48  |               |  |               | 22,421  |  |   | 15,583
|Over ten years                             |  |                        |        |                    |      |                            |      |      |               |  |               |        |  |   | 2,002 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 74,342  |                    |      | 74,421                      |      | 4.85  |               |  |               | 42,746  |  |   | 31,925
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Mortgage-backed securities                 |  |                        | 751     |                    |      | 759                         |      | 5.04  |               |  |               | 28,628  |  |   | 8,392 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|State, county and municipal:               |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Within one year                            |  |                        | 536     |                    |      | 539                         |      | 7.25  |               |  |               | 636     |  |   | 866   
|One to five years                          |  |                        | 11,988  |                    |      | 12,072                      |      | 6.79  |               |  |               | 4,114   |  |   | 4,038 
|Five to ten years                          |  |                        | 13,479  |                    |      | 13,820                      |      | 6.96  |               |  |               | 10,978  |  |   | 10,292
|Over ten years                             |  |                        | 10,237  |                    |      | 10,283                      |      | 6.34  |               |  |               | 11,159  |  |   | 6,793 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 36,240  |                    |      | 36,714                      |      | 6.73  |               |  |               | 26,887  |  |   | 21,989
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Other debt securities:                     |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|One to five years                          |  |                        |        |                    |      |                            |      | 2,489 |               |  |               | 3,138   |  |   |       
|Over ten years                             |  |                        | 5,000   |                    |      | 5,000                       |      | 6.45  |               |  |               | 3,215   |  |   | 2,657 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 5,000   |                    |      | 5,000                       |      | 6.45  |               |  |               | 5,704   |  |   | 5,795 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total debt securities                      |  |                        | 116,332 |                    |      | 116,894                     |      | 5.59  |               |  |               | 103,965 |  |   | 68,101
|Equity securities                          |  |                        | 12,034  |                    |      | 12,051                      |      | 6,953 |               |  |               | 5,662   |  |   |       
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total available-for-sale securities        |  | $                      | 128,367 |                    | $    | 128,945                     |      |       |               |  | $             | 110,918 |  | $ | 73,763
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Held to Maturity                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|U.S. Government agencies and corporations: |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Within one year                            |  | $                      | 4,490   |                    | $    | 4,439                       |      | 3.00  |               |  | $             | 4,011   |  | $ | 2,001 
|One to five years                          |  |                        | 12,119  |                    |      | 11,713                      |      | 3.63  |               |  |               | 16,726  |  |   | 13,912
|Five to ten years                          |  |                        |        |                    |      |                            |      |      |               |  |               |        |  |   | 7,000 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 16,610  |                    |      | 16,152                      |      | 3.46  |               |  |               | 20,737  |  |   | 22,913
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Mortgage-backed securities                 |  |                        | 4,517   |                    |      | 4,471                       |      | 5.46  |               |  |               | 3,190   |  |   | 1,270 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|State, county and municipal:               |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Within one year                            |  |                        | 2,115   |                    |      | 2,101                       |      | 2.75  |               |  |               | 2,059   |  |   | 2,151 
|One to five years                          |  |                        | 6,435   |                    |      | 6,203                       |      | 3.74  |               |  |               | 7,504   |  |   | 8,078 
|Five to ten years                          |  |                        | 7,419   |                    |      | 7,276                       |      | 5.37  |               |  |               | 7,244   |  |   | 7,307 
|Over ten years                             |  |                        | 4,774   |                    |      | 4,692                       |      | 6.02  |               |  |               | 6,154   |  |   | 7,661 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 20,743  |                    |      | 20,272                      |      | 4.74  |               |  |               | 22,961  |  |   | 25,197
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Other debt securities:                     |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Within one year                            |  |                        |        |                    |      |                            |      |      |               |  |               | 1,000   |  |   |      
|One to five years                          |  |                        | 1,000   |                    |      | 969                         |      | 4.70  |               |  |               |        |  |   | 1,000 
|Five to ten years                          |  |                        |        |                    |      |                            |      |      |               |  |               | 1,000   |  |   | 1,000 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total                                      |  |                        | 1,000   |                    |      | 969                         |      | 4.70  |               |  |               | 2,000   |  |   | 2,000 
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       
|Total held-to-maturity securities          |  | $                      | 42,870  |                    | $    | 41,865                      |      | 4.32  |               |  | $             | 48,888  |  | $ | 51,380
|                                           |  |                        |         |                    |      |                             |      |       |               |  |               |         |  |   |       



26



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##### Table of Contents

---

|(1) |  | Yields are stated on a fully taxable equivalent basis, assuming a 35% federal income tax rate.
|--- |  | ----------------------------------------------------------------------------------------------



Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are
not otherwise needed to satisfy loan demand. In 2006, the level of investment securities was significantly impacted by two factors: the net increase of $84.4 million from the First Gaston Bank acquisition on April 26, 2006, as discussed in the
Balance Sheet Review, and the sale in the third quarter of approximately $120 million of available-for-sale securities, or approximately 52% of the total carrying value of the investment portfolio, as discussed in the
OverviewSignificant Factors Affecting Earnings in 2006. Since only a portion of the proceeds from the sale was reinvested in securities in the 2006 fourth quarter, the net increase in the level of investment securities in 2006,
taking into account the addition to the portfolio from the First Gaston Bank acquisition, was only $12.0 million or 7.5%. In 2005, there was a net increase of $34.7 million, or 28% in the level of investment securities, due primarily to the addition
of $34.7 million in investment securities from the Alamance Bank acquisition on November 4, 2005.



Investable funds not otherwise utilized are temporarily invested on an overnight basis as federal funds sold or as interest-bearing balances at other
banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs. As noted above, only a portion of the proceeds from the sale of investment securities in the 2006 third quarter was reinvested in the fourth
quarter, resulting in a $73.1 million total balance of federal funds sold and interest-bearing bank balances at December 31, 2006 compared to a $22.5 million total balance at December 31, 2005. These liquid funds at year-end 2006 will be
used, as appropriate, to fund loan originations and investment securities purchases or to liquidate borrowed funds.



Loans



The Corporations primary source of revenue and largest component of earning assets is the loan portfolio. In 2006, loans increased $510.0 million or 63%, due primarily to the addition of $481.3 million in loans
from the First Gaston Bank acquisition on April 28, 2006, as discussed in the Balance Sheet Review. Similarly in 2005, loans increased $147.9 million or 22%, due largely to the addition of $96.6 million in loans from the Alamance
Bank acquisition on November 4, 2005. Excluding the amount of loans added by the merger acquisitions, loans increased $28.7 million or 3.5% in 2006 and $51.3 million or 7.7% in 2005. The level of loans was further impacted in 2006 by the sale
in the fourth quarter of $10.4 million of nonperforming and higher risk loans, as noted in the OverviewSignificant Factors Affecting Earnings in 2006. Average loans increased $430.9 million or 61% in 2006 and $99.2 million or 12%
in 2005. The ratio of average loans to average deposits decreased from 99.3% in 2005 to 93.8% in 2006. The ratio of loans to deposits at December 31, 2006 was 93.1%.



27



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##### Table of Contents

Table 7 sets forth the major categories of loans for each of the last five years. The maturity
distribution and interest rate sensitivity of selected loan categories at December 31, 2006 are presented in Table 8.



Table 7

Loan Portfolio Composition



|                            |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      
|--------------------------- |  | ---------------------- | --------- | ---- | ----- | ------ | - | ------- |  | ------ |  | - | ------- | ------ | ----- | - | - | ------- |  | ----- |  | - | ------- |  | -----
|                            |  | December 31           
|                            |  | 2006                   |           | 2005 |       | 2004   |   | 2003    |  | 2002  
|                            |  | Amount                 |           | %    |       | Amount |   | %       |  | Amount |  | % |         | Amount |       | % |   | Amount  |  | %    
|                            |  | (dollars in thousands)
|Commercial and agricultural |  | $                      | 315,184   |      | 24.2  |        | $ | 176,286 |  | 22.2   |  | $ | 196,846 |        | 30.1  |   | $ | 215,036 |  | 39.6  |  | $ | 198,085 |  | 39.6 
|Real estateconstruction    |  |                        | 278,124   |      | 21.4  |        |   | 142,096 |  | 17.9   |  |   | 83,433  |        | 12.8  |   |   | 36,357  |  | 6.7   |  |   | 29,553  |  | 5.9  
|Real estatemortgage:       |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      
|1-4 family residential      |  |                        | 319,182   |      | 24.5  |        |   | 231,071 |  | 29.1   |  |   | 197,855 |        | 30.3  |   |   | 184,881 |  | 34.0  |  |   | 188,764 |  | 37.8 
|Commercial and other        |  |                        | 350,261   |      | 26.9  |        |   | 221,457 |  | 27.8   |  |   | 154,024 |        | 23.6  |   |   | 86,734  |  | 15.9  |  |   | 59,760  |  | 12.0 
|Consumer                    |  |                        | 39,089    |      | 3.0   |        |   | 24,141  |  | 3.0    |  |   | 20,899  |        | 3.2   |   |   | 19,973  |  | 3.7   |  |   | 21,550  |  | 4.3  
|Leases                      |  |                        |          |      |      |        |   |        |  |       |  |   | 49      |        |      |   |   | 365     |  | .1    |  |   | 1,843   |  | .4   
|                            |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      
|Loans held for investment   |  |                        | 1,301,840 |      | 100.0 |        |   | 795,051 |  | 100.0  |  |   | 653,106 |        | 100.0 |   |   | 543,346 |  | 100.0 |  |   | 499,555 |  | 100.0
|                            |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      
|Loans held for sale         |  |                        | 20,862    |      |       |        |   | 17,615  |  |        |  |   | 11,648  |        |       |   |   | 8,567   |  |       |  |   | 2,787   |  |      
|                            |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      
|Gross loans                 |  | $                      | 1,322,702 |      |       |        | $ | 812,666 |  |        |  | $ | 664,754 |        |       |   | $ | 551,913 |  |       |  | $ | 502,342 |  |      
|                            |  |                        |           |      |       |        |   |         |  |        |  |   |         |        |       |   |   |         |  |       |  |   |         |  |      



Table 8

Selected Loan Maturities



|                             |  |                   |         |                  |   |                |  |       |        |  |   |        
|---------------------------- |  | ----------------- | ------- | ---------------- | - | -------------- |  | ----- | ------ |  | - | -------
|                             |  | December 31, 2006
|                             |  | One Yearor Less   |         | One toFive Years |   | Over FiveYears |  | Total
|                             |  | (in thousands)   
|Commercial and agricultural  |  | $                 | 131,746 |                  | $ | 145,928        |  | $     | 37,511 |  | $ | 315,184
|Real estateconstruction     |  |                   | 137,185 |                  |   | 124,980        |  |       | 15,959 |  |   | 278,124
|                             |  |                   |         |                  |   |                |  |       |        |  |   |        
|Total selected loans         |  | $                 | 268,931 |                  | $ | 270,908        |  | $     | 53,469 |  | $ | 593,308
|                             |  |                   |         |                  |   |                |  |       |        |  |   |        
|Sensitivity to rate changes: |  |                   |         |                  |   |                |  |       |        |  |   |        
|Fixed interest rates         |  | $                 | 23,556  |                  | $ | 101,376        |  | $     | 26,846 |  | $ | 151,778
|Variable interest rates      |  |                   | 245,375 |                  |   | 169,532        |  |       | 26,623 |  |   | 441,530
|                             |  |                   |         |                  |   |                |  |       |        |  |   |        
|Total                        |  | $                 | 268,931 |                  | $ | 270,908        |  | $     | 53,469 |  | $ | 593,308
|                             |  |                   |         |                  |   |                |  |       |        |  |   |        



In 2006, loan growth,
including the loans added by the First Gaston Bank acquisition, was significant in all types of loans, with the largest percentage increase being related to the portfolio of construction loans. In 2005, loan growth through internal generation
continued at a high level as in 2004 and 2003, following an extended period in which the level of the entire loan portfolio had been adversely impacted by the general slowdown of the economy. In particular, considering only growth through internal
generation in both 2005 and 2004, the portfolios related to construction loans and commercial and other real estate loans experienced significant gains in each year, while the commercial and agricultural loan portfolio declined. The balance of the
1-4 family residential mortgage loan portfolio considered held for investment also experienced growth in both 2005 and 2004, due primarily to home equity lines of credit in 2004. In 2005, there was a modest decline in the balance of home
equity lines of credit.



28



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##### Table of Contents

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.



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.



At
December 31, 2006, the Corporation had impaired loans which totaled $9.3 million. Of the $9.3 million, $1.6 million had an allowance for loan losses of $388,000 and $7.7 million had no allowance for loan losses. At December 31, 2005, the
Corporation had impaired loans which totaled $6.0 million, all of which had an allowance for loan losses which amounted to $1.1 million.



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 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.



The allowance for loan losses, as a percentage of loans held for investment, amounted to 1.28% at December 31, 2006, 1.25% at December 31, 2005
and 1.12% at December 31, 2004. The allowance percentage has increased 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 and also from the continuing evaluation of the quality of the loan portfolio acquired as part of the acquisition of First Gaston Bank, as discussed in the Overview.



Management believes the allowance for loan losses of $16.6 million at December 31, 2006 is adequate to cover probable
losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment.



29



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##### Table of Contents

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.



Table 9 presents an analysis of the changes
in the allowance for loan losses and of the level of nonperforming assets for each of the last five years. Information about managements allocation of the allowance for loan losses by loan category is presented in Table 10.



Table 9

Allowance for Loan Losses and Nonperforming Assets



|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|------------------------------------------------------ |  | ---------------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | - |  | ---- | ----- | - |  | - | ----- | -
|                                                       |  | 2006                   |        |   | 2005 |   |       | 2004 |  |   | 2003  |   |  | 2002 |      
|                                                       |  | (dollars in thousands) |       
|Allowance for Loan Losses                              |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Balance at beginning of year                           |  | $                      | 9,945  |   |      | $ | 7,293 |      |  | $ | 6,172 |   |  | $    | 6,109 |   |  | $ | 4,417 |  
|Charge-offs:                                           |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Commercial and agricultural                            |  |                        | 1,817  |   |      |   | 747   |      |  |   | 2,007 |   |  |      | 1,165 |   |  |   | 502   |  
|Real estateconstruction                               |  |                        | 499    |   |      |   |      |      |  |   |      |   |  |      | 133   |   |  |   |      |  
|Real estatemortgage                                   |  |                        | 210    |   |      |   | 449   |      |  |   | 943   |   |  |      | 244   |   |  |   | 101   |  
|Consumer (1)                                           |  |                        | 2,104  |   |      |   | 1,420 |      |  |   | 211   |   |  |      | 332   |   |  |   | 538   |  
|Leases                                                 |  |                        |       |   |      |   |      |      |  |   | 106   |   |  |      | 26    |   |  |   | 243   |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total charge-offs                                      |  |                        | 4,630  |   |      |   | 2,616 |      |  |   | 3,267 |   |  |      | 1,900 |   |  |   | 1,384 |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Recoveries:                                            |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Commercial and agricultural                            |  |                        | 1,123  |   |      |   | 427   |      |  |   | 158   |   |  |      | 14    |   |  |   | 116   |  
|Real estateconstruction                               |  |                        | 120    |   |      |   |      |      |  |   | 1     |   |  |      |      |   |  |   |      |  
|Real estatemortgage                                   |  |                        | 268    |   |      |   | 7     |      |  |   | 36    |   |  |      |      |   |  |   | 1     |  
|Consumer (1)                                           |  |                        | 1,231  |   |      |   | 522   |      |  |   | 94    |   |  |      | 85    |   |  |   | 76    |  
|Leases                                                 |  |                        | 3      |   |      |   | 65    |      |  |   | 114   |   |  |      | 4     |   |  |   | 64    |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total recoveries                                       |  |                        | 2,745  |   |      |   | 1,021 |      |  |   | 403   |   |  |      | 103   |   |  |   | 257   |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Net loan charge-offs                                   |  |                        | 1,885  |   |      |   | 1,595 |      |  |   | 2,864 |   |  |      | 1,797 |   |  |   | 1,127 |  
|Provision for loan losses (1)                          |  |                        | 2,526  |   |      |   | 2,842 |      |  |   | 4,030 |   |  |      | 1,860 |   |  |   | 1,780 |  
|Purchase accounting acquisition                        |  |                        | 6,038  |   |      |   | 1,405 |      |  |   |      |   |  |      |      |   |  |   | 1,039 |  
|Allowance adjustment for loans sold                    |  |                        | (4     | ) |      |   |      |      |  |   | (45   | ) |  |      |      |   |  |   |      |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Balance at end of year                                 |  | $                      | 16,620 |   |      | $ | 9,945 |      |  | $ | 7,293 |   |  | $    | 6,172 |   |  | $ | 6,109 |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Nonperforming Assets, at end of year                   |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Nonaccrual loans                                       |  | $                      | 8,282  |   |      | $ | 5,398 |      |  | $ | 3,952 |   |  | $    | 5,235 |   |  | $ | 4,944 |  
|Accruing loans past due 90 days or more                |  |                        | 2,852  |   |      |   | 648   |      |  |   | 1,275 |   |  |      | 758   |   |  |   | 1,268 |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming loans                              |  |                        | 11,134 |   |      |   | 6,046 |      |  |   | 5,227 |   |  |      | 5,993 |   |  |   | 6,212 |  
|Foreclosed assets                                      |  |                        | 196    |   |      |   | 108   |      |  |   | 77    |   |  |      | 65    |   |  |   | 61    |  
|Other real estate owned                                |  |                        | 3,361  |   |      |   | 929   |      |  |   | 543   |   |  |      | 1,008 |   |  |   | 414   |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming assets                             |  | $                      | 14,961 |   |      | $ | 7,083 |      |  | $ | 5,847 |   |  | $    | 7,066 |   |  | $ | 6,687 |  
|                                                       |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Ratios                                                 |  |                        |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Net loan charge-offs to average loans                  |  |                        | .16    | % |      |   | .22   | %    |  |   | .47   | % |  |      | .33   | % |  |   | .26   | %
|Net loan charge-offs to allowance for loan losses      |  |                        | 11.34  |   |      |   | 16.03 |      |  |   | 39.27 |   |  |      | 29.12 |   |  |   | 18.45 |  
|Allowance for loan losses to loans held for investment |  |                        | 1.28   |   |      |   | 1.25  |      |  |   | 1.12  |   |  |      | 1.14  |   |  |   | 1.22  |  
|Total nonperforming loans to loans held for investment |  |                        | .86    |   |      |   | .76   |      |  |   | .80   |   |  |      | 1.10  |   |  |   | 1.24  |  



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---

|(1) |  | Includes activity related to an overdraft protection program commencing in mid-2005. Charge-offs and recoveries related to the overdraft protection program were $1.6 million and
$784,000, respectively, in 2006 and $1.1 million and $461,000, respectively, in 2005. The provision for loan losses associated with this program was $670,000 in 2006 and $712,000 in 2005.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Table 10

Allocation of Allowance For Credit Losses



|                                |  |                |        |      |   |       |  |      |       |      |   |       |  |   |      
|------------------------------- |  | -------------- | ------ | ---- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                |  | December 31   
|                                |  | 2006           |        | 2005 |   | 2004  |  | 2003 |       | 2002
|                                |  | (in thousands)
|Commercial and agricultural     |  | $              | 5,151  |      | $ | 3,165 |  | $    | 2,953 |      | $ | 3,440 |  | $ | 2,939
|Real estateconstruction        |  |                | 3,829  |      |   | 1,939 |  |      | 1,015 |      |   | 118   |  |   | 128  
|Real estatemortgage            |  |                | 5,745  |      |   | 3,892 |  |      | 2,401 |      |   | 1,395 |  |   | 1,539
|Consumer                        |  |                | 1,895  |      |   | 707   |  |      | 592   |      |   | 756   |  |   | 911  
|Leases                          |  |                |       |      |   |      |  |      |      |      |   | 21    |  |   | 194  
|Unallocated                     |  |                |       |      |   | 242   |  |      | 332   |      |   | 442   |  |   | 398  
|                                |  |                |        |      |   |       |  |      |       |      |   |       |  |   |      
|Total allowance for loan losses |  | $              | 16,620 |      | $ | 9,945 |  | $    | 7,293 |      | $ | 6,172 |  | $ | 6,109
|                                |  |                |        |      |   |       |  |      |       |      |   |       |  |   |      



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.



In 2006, deposits increased $579.4 million or 69%, due primarily to the addition of $563.3 million in deposits from the First Gaston Bank acquisition on
April 28, 2006, as discussed in the Balance Sheet Review. Similarly in 2005, deposits increased $182.1 million or 28%, due largely to the addition of $113.0 million in deposits from the Alamance Bank acquisition on November 4,
2005.



The level and mix of the various deposit categories has
been significantly affected in 2006 and 2005 by the merger acquisitions. Information concerning the significant increases that occurred in almost all deposit categories, except for savings deposits, is contained in Table 11.



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Table 11 shows the year-end and average deposit balances for the years 2006, 2005 and 2004 and the
changes in 2006 and 2005.



Table 11

Analysis of Deposits



|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|------------------------------------ |  | ---------------------- | --------- | ---------------------- | ---- | ------- | ------- | ---- | --------------------- | ------ |  | ------- | ------- |  | - | ------- | - |  | ---- | - |  | - | -------
|                                     |  | 2006                   |           |                        | 2005 |         |         | 2004
|                                     |  | Balance                |           | Change from Prior Year |      |         | Balance |      | Change fromPrior Year |        |  | Balance
|                                     |  |                        | Amount    |                        |      | %       |         |      |                       | Amount |  |         | %       |  |  
|                                     |  | (dollars in thousands)
|Year-End Balances                    |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Interest-bearing deposits:           |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Demand deposits                      |  | $                      | 177,498   |                        | $    | 60,939  |         |      | 52.3                  |        |  | $       | 116,559 |  | $ | 23,180  |   |  | 24.8 |   |  | $ | 93,379 
|Savings deposits                     |  |                        | 50,517    |                        |      | (246    | )       |      | (0.5                  | )      |  |         | 50,763  |  |   | (2,403  | ) |  | (4.5 | ) |  |   | 53,166 
|Money market deposits                |  |                        | 235,340   |                        |      | 149,807 |         |      | 175.1                 |        |  |         | 85,533  |  |   | 12,110  |   |  | 16.5 |   |  |   | 73,423 
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total                                |  |                        | 463,355   |                        |      | 210,500 |         |      | 83.2                  |        |  |         | 252,855 |  |   | 32,887  |   |  | 15.0 |   |  |   | 219,968
|Certificates and other time deposits |  |                        | 798,720   |                        |      | 310,431 |         |      | 63.6                  |        |  |         | 488,289 |  |   | 124,123 |   |  | 34.1 |   |  |   | 364,166
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total interest-bearing deposits      |  |                        | 1,262,075 |                        |      | 520,931 |         |      | 70.3                  |        |  |         | 741,144 |  |   | 157,010 |   |  | 26.9 |   |  |   | 584,134
|Noninterest-bearing demand deposits  |  |                        | 158,938   |                        |      | 58,473  |         |      | 58.2                  |        |  |         | 100,465 |  |   | 25,055  |   |  | 33.2 |   |  |   | 75,410 
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total deposits                       |  | $                      | 1,421,013 |                        | $    | 579,404 |         |      | 68.8                  |        |  | $       | 841,609 |  | $ | 182,065 |   |  | 27.6 |   |  | $ | 659,544
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Average Balances                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Interest-bearing deposits:           |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Demand deposits                      |  | $                      | 156,837   |                        | $    | 59,214  |         |      | 60.7                  |        |  | $       | 97,623  |  | $ | 7,796   |   |  | 8.7  |   |  | $ | 89,827 
|Savings deposits                     |  |                        | 52,827    |                        |      | 1,344   |         |      | 2.6                   |        |  |         | 51,483  |  |   | (2,815  | ) |  | (5.2 | ) |  |   | 54,298 
|Money market deposits                |  |                        | 180,513   |                        |      | 104,565 |         |      | 137.7                 |        |  |         | 75,948  |  |   | 124     |   |  | .2   |   |  |   | 75,824 
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total                                |  |                        | 390,177   |                        |      | 165,123 |         |      | 73.4                  |        |  |         | 225,054 |  |   | 5,105   |   |  | 2.3  |   |  |   | 219,949
|Certificates and other time deposits |  |                        | 685,270   |                        |      | 277,967 |         |      | 68.2                  |        |  |         | 407,303 |  |   | 77,491  |   |  | 23.5 |   |  |   | 329,812
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total interest-bearing deposits      |  |                        | 1,075,447 |                        |      | 443,090 |         |      | 70.1                  |        |  |         | 632,357 |  |   | 82,596  |   |  | 15.0 |   |  |   | 549,761
|Noninterest-bearing demand deposits  |  |                        | 142,624   |                        |      | 58,231  |         |      | 69.0                  |        |  |         | 84,393  |  |   | 9,652   |   |  | 12.9 |   |  |   | 74,741 
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        
|Total deposits                       |  | $                      | 1,218,071 |                        | $    | 501,321 |         |      | 69.9                  |        |  | $       | 716,750 |  | $ | 92,248  |   |  | 14.8 |   |  | $ | 624,502
|                                     |  |                        |           |                        |      |         |         |      |                       |        |  |         |         |  |   |         |   |  |      |   |  |   |        



Business Development Matters



As discussed in the Overview and in Note 2 to
the Consolidated Financial Statements, on November 4, 2005, the Corporation completed a merger for the acquisition of United Financial, Inc., holding company for Alamance Bank, headquartered in Graham, North Carolina, in a transaction accounted
for using the purchase method of accounting for business combinations. On February 1, 2006, Alamance Bank was merged with and into First National Bank.



As discussed in the Overview and in Note 2 to the Consolidated Financial Statements, 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, in a transaction accounted for using the purchase method of accounting for
business combinations. On August 1, 2006, First Gaston Bank was merged with and into First National Bank.



In conjunction with the completion of the Integrity merger, FNB Uniteds wholly owned and newly formed subsidiary, FNB United Statutory Trust II,
issued $30,000,000 of trust preferred securities on April 27, 2006. The



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proceeds of the trust preferred securities, along with the proceeds of $928,000 received by the trust from the issuance of its common securities to FNB
United, were used to purchase $30,928,000 of FNB Uniteds junior subordinated debt securities. The proceeds of FNB Uniteds junior subordinated debt securities were primarily used to fund the cash portion of the merger consideration to the
former Integrity shareholders. The trust preferred securities bear interest at a variable rate based on the three-month LIBOR rate plus 1.32% and mature on June 30, 2036, but may be redeemed at the option of FNB United beginning on
June 30, 2011.



In August 2003, First National Bank
received regulatory approval for relocation of its existing branch office in Randleman, North Carolina. The new office, which opened for business in August 2005, represents a move from an owned facility that is expected to be sold.



In January 2004, First National Bank received regulatory approval for
establishment of its first branch office in Greensboro, North Carolina, resulting in the opening of a loan production office in February 2004. A full-service banking office in a leased facility replaced the loan production office in May 2005.



In November 2004, First National Bank received regulatory
approval for the establishment of a second branch office in Greensboro, North Carolina. The new office opened for business in January 2006.



In June 2005, First National Bank received regulatory approval for the establishment of a second branch office in Salisbury, North Carolina. The new
office, which is a leased facility, opened for business in September 2006.



In May 2006, Dover Mortgage Company opened a new mortgage production office in Wrightsville Beach, North Carolina.



In the 2006 fourth quarter, First National Bank significantly expanded its headquarters facilities in Asheboro, North Carolina, adding a separate facility
for certain of its executive and administrative functions and an operating center for its loan and deposit operations and certain of its finance operations.



Accounting Pronouncement Matters



In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155 (SFAS No. 155), Accounting for Certain Hybrid
Financial Instrumentsan amendment of FASB Statements No. 133 and 140, which is effective for all financial instruments acquired or issued after the beginning of fiscal years beginning after September 15, 2006. SFAS No. 155
was issued to clarify the application of SFAS No. 133 to beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments, regardless of the form of the instruments. SFAS
No. 155 provides relief from the requirement to separately determine the fair value of an embedded derivative that would otherwise be bifurcated from the host contract under SFAS No. 133 and allows an irrevocable election on an
instrument-by-instrument basis to measure such a hybrid financial instrument at fair value. The Corporation is currently evaluating SFAS No.155 to determine the potential impact, if any, on its consolidated financial statements.



In March 2006, the FASB issued Statement of Financial Accounting Standards
No. 156 (SFAS No. 156), Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140, which is effective for fiscal years beginning after September 15, 2006. SFAS No. 156
was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. SFAS No. 156 requires that all separately recognized servicing assets and liabilities be
initially measured at fair value and permits (but does not require) subsequent measurement of servicing assets and liabilities at fair value. The Corporation is currently evaluating SFAS No. 156 to determine the potential impact, if any, on its
consolidated financial statements.



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



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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 is currently evaluating the impact of FIN 48 on its consolidated financial statements.



In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS No. 157), Fair Value
Measurements, which is effective for fiscal years beginning after November 15, 2007. SFAS No. 157 enhances existing guidance for measuring assets and liabilities using fair value. Prior to the issuance of SFAS No. 157, guidance
for applying fair value was incorporated in several accounting pronouncements. SFAS No. 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value
to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active
markets. Under FAS No. 157, fair value measurements are disclosed by level within that hierarchy. While SFAS No. 157 does not add any new fair value measurements, it does change current practice. Changes to practice include: (1) a
requirement for an entity to include its own credit standing in the measurement of its liabilities; (2) a modification of the transaction price presumption; (3) a prohibition on the use of block discounts when valuing large blocks of
securities for broker-dealers and investment companies; and (4) a requirement to adjust the value of restricted stock for the effect of the restriction even if the restriction lapses within one year. The Corporation has not determined the
impact of adopting SFAS No. 157 on its consolidated financial statements.



In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS No. 158), Employers Accounting for Defined Benefit Pension and Other Postretirement
Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R). SFAS No. 158 requires an employer to: (a) recognize in its statement of financial position an asset for a plans overfunded status or a liability for a
plans underfunded status; (b) measure a plans assets and its obligations that determine its funded status as of the end of the employers fiscal year (with limited exceptions); and (c) recognize changes in the funded
status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income of a business entity and in changes in net assets of a not-for-profit organization. The requirement by
SFAS No. 158 to recognize the funded status of a benefit plan and the disclosure requirements of SFAS No. 158 are effective as of the end of the fiscal year ending after December 15, 2006 for entities with publicly traded equity
securities. The requirement to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Effective
December 31, 2006, the Corporation adopted the provisions of SFAS NO. 158 that require recognition of the funded status of a benefit plan and related disclosures. The Corporation is currently evaluating the remaining requirements of SFAS
No. 158 to determine the potential impact, if any, on its consolidated financial statements.



The Emerging Issues Task Force (EITF) reached a consensus at its September 2006 meeting regarding EITF 06-4, Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. The scope of EITF 06-4 is limited to the recognition of a liability and related compensation costs for endorsement split-dollar life
insurance policies that provide a benefit to an employee that extends to postretirement periods. Therefore, this EITF would not apply to a split-dollar life insurance arrangement that provides a specified benefit to an employee that is limited to
the employees active service period with an employer. This EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Corporation has not determined the impact of adopting EITF 06-4
on its consolidated financial statements.



The EITF reached a
consensus at its September 2006 meeting regarding EITF 06-5, Accounting for Purchases of Life Insurance Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-5. The scope of EITF 06-5 is
limited to the determination of net cash surrender value



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of a life insurance contract in accordance with Technical Bulletin 85-4. This EITF outlines when contractual limitations of the policy should be considered
when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted. The Corporation is currently evaluating the impact of EITF 06-5 on its
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.



Effects of Inflation



The operations of First National Bank and Dover Mortgage Company and, therefore, of the Corporation are subject to the
effects of inflation through interest rate fluctuations and changes in the general price level of noninterest operating expenses. Such costs as salaries, fringe benefits and utilities have tended to increase at a rate comparable to or even greater
than the general rate of inflation. Broadly speaking, all operating expenses have risen to higher levels as inflationary pressures have increased. Management has responded to this situation by evaluating and adjusting fees charged for specific
services and by emphasizing operating efficiencies.



The level
of interest rates is also considered to be influenced by inflation, rising whenever inflationary expectations and the actual level of inflation increase and declining whenever the inflationary outlook appears to be improving. Management constantly
monitors this situation, attempting to adjust both rates received on earning assets and rates paid on interest-bearing liabilities in order to maintain the desired net yield on earning assets.



Additionally, the level of activity in the origination of 1-4 family
residential mortgage loans which directly affects the amount of income from mortgage loan sales, the principal source of revenue for Dover and an important source for First National Bank, is significantly affected by the level of interest rates,
increasing as rates decline and decreasing as rates rise. In periods of rising rates, which do not generally benefit from the activity that results from the refinancing of residential mortgage loans, management attempts to increase the volume of
originations resulting from traditional purchase mortgage transactions.



Non-GAAP Measures



This Annual Report on Form
10-K 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 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 Annual Report on Form 10-K 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



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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, 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. All forward-looking statements speak only as of the date on which such statements are made, and the Corporation 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.



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Table 12

Quarterly Financial Data (Unaudited)



|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|--------------------------------------------------- |  | ------------------------------------- | ------ | ------ | - | ------ |  | ------ | ------ |  | - | ------
|                                                    |  | First                                 |        | Second |   | Third  |  | Fourth
|                                                    |  | (in thousands, except per share data)
|2006                                                |  |                                       |        |        |   |        |  |        |        |  |   |       
|Interest income                                     |  | $                                     | 17,126 |        | $ | 25,806 |  | $      | 29,947 |  | $ | 30,490
|Interest expense                                    |  |                                       | 7,045  |        |   | 11,429 |  |        | 14,067 |  |   | 14,614
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net interest income                                 |  |                                       | 10,081 |        |   | 14,377 |  |        | 15,880 |  |   | 15,876
|Provision for loan losses                           |  |                                       | 77     |        |   | 405    |  |        | 1,824  |  |   | 220   
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net interest income after provision for loan losses |  |                                       | 10,004 |        |   | 13,972 |  |        | 14,056 |  |   | 15,656
|Noninterest income                                  |  |                                       | 3,510  |        |   | 4,604  |  |        | 5,419  |  |   | 5,682 
|Noninterest expense                                 |  |                                       | 9,415  |        |   | 12,261 |  |        | 15,540 |  |   | 16,225
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Income before income taxes                          |  |                                       | 4,099  |        |   | 6,315  |  |        | 3,935  |  |   | 5,113 
|Income taxes                                        |  |                                       | 1,422  |        |   | 2,282  |  |        | 1,456  |  |   | 2,115 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net income                                          |  | $                                     | 2,677  |        | $ | 4,033  |  | $      | 2,479  |  | $ | 2,998 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Per share data:                                     |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net income:                                         |  |                                       |        |        |   |        |  |        |        |  |   |       
|Basic                                               |  | $                                     | .42    |        | $ | .42    |  | $      | .22    |  | $ | .27   
|Diluted                                             |  |                                       | .42    |        |   | .41    |  |        | .22    |  |   | .27   
|Cash dividends declared                             |  |                                       | .15    |        |   | .15    |  |        | .15    |  |   | .17   
|Common stock price (1):                             |  |                                       |        |        |   |        |  |        |        |  |   |       
|High                                                |  |                                       | 21.25  |        |   | 20.74  |  |        | 19.50  |  |   | 18.93 
|Low                                                 |  |                                       | 18.35  |        |   | 17.40  |  |        | 17.54  |  |   | 17.58 
|                                                    |  |                                       |        |       
|2005                                                |  |                                       |        |        |   |        |  |        |        |  |   |       
|Interest income                                     |  | $                                     | 11,814 |        | $ | 12,682 |  | $      | 13,713 |  | $ | 16,206
|Interest expense                                    |  |                                       | 3,995  |        |   | 4,497  |  |        | 5,093  |  |   | 6,465 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net interest income                                 |  |                                       | 7,819  |        |   | 8,185  |  |        | 8,620  |  |   | 9,741 
|Provision for loan losses                           |  |                                       | 370    |        |   | 864    |  |        | 446    |  |   | 1,162 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net interest income after provision for loan losses |  |                                       | 7,449  |        |   | 7,321  |  |        | 8,174  |  |   | 8,579 
|Noninterest income                                  |  |                                       | 3,162  |        |   | 3,960  |  |        | 3,966  |  |   | 3,838 
|Noninterest expense                                 |  |                                       | 7,222  |        |   | 7,937  |  |        | 8,319  |  |   | 8,200 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Income before income taxes                          |  |                                       | 3,389  |        |   | 3,344  |  |        | 3,821  |  |   | 4,217 
|Income taxes                                        |  |                                       | 1,083  |        |   | 1,072  |  |        | 1,262  |  |   | 1,417 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net income                                          |  | $                                     | 2,306  |        | $ | 2,272  |  | $      | 2,559  |  | $ | 2,800 
|                                                    |  |                                       |        |        |   |        |  |        |        |  |   |       
|Per share data:                                     |  |                                       |        |        |   |        |  |        |        |  |   |       
|Net income:                                         |  |                                       |        |        |   |        |  |        |        |  |   |       
|Basic                                               |  | $                                     | .41    |        | $ | .41    |  | $      | .46    |  | $ | .46   
|Diluted                                             |  |                                       | .40    |        |   | .40    |  |        | .44    |  |   | .45   
|Cash dividends declared                             |  |                                       | .15    |        |   | .15    |  |        | .15    |  |   | .17   
|Common stock price (1):                             |  |                                       |        |        |   |        |  |        |        |  |   |       
|High                                                |  |                                       | 21.39  |        |   | 21.85  |  |        | 21.50  |  |   | 19.32 
|Low                                                 |  |                                       | 17.80  |        |   | 18.20  |  |        | 18.50  |  |   | 17.35 

---

|(1) |  | FNB United Corp. common stock is traded on the Nasdaq Global Select Market under the symbol FNBN. At December 31, 2006, there were 3,925 shareholders of record.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



37



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##### Table of Contents

LOGO



REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM



To the
Stockholders and the Board of Directors

FNB United Corp.

Asheboro, North Carolina



We have audited the accompanying consolidated balance sheets of FNB United Corp. (formerly FNB Corp.) and Subsidiaries as of December 31, 2006 and
2005, and the related consolidated statements of income, shareholders equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the
responsibility of the Corporations management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for
our opinion.



In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the financial position of FNB United Corp. and Subsidiaries at December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006 FNB United Corp. adopted the provisions of Statement of
Financial Accounting Standards (SFAS) No. 123(R), Shared-based Payment, and, effective December 31, 2006, adopted the recognition and disclosure provisions of SFAS No. 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plans.



We have
also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FNB United Corp.s internal control over financial reporting as of December 31, 2006, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 26, 2007 expressed an unqualified opinion on managements
assessment of, and an adverse opinion on the effective operation of the Corporations internal control over financial reporting.



LOGO



Raleigh, North Carolina

March 26, 2007



38



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FNB UNITED CORP. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



|                                                                                                                           |  |                                                |           |   |      |   |           |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------- | --------- | - | ---- | - | --------- | -
|                                                                                                                           |  | December 31                                    |          
|                                                                                                                           |  | 2006                                           |           |   | 2005 |  
|                                                                                                                           |  | (in thousands, except shareand per share data) |          
|Assets                                                                                                                     |  |                                                |           |   |      |   |           |  
|Cash and due from banks                                                                                                    |  | $                                              | 35,225    |   |      | $ | 22,389    |  
|Interest-bearing bank balances                                                                                             |  |                                                | 42,929    |   |      |   | 2,310     |  
|Federal funds sold                                                                                                         |  |                                                | 30,186    |   |      |   | 20,180    |  
|Investment securities:                                                                                                     |  |                                                |           |   |      |   |           |  
|Available for sale, at estimated fair value (amortized cost of $128,367 in 2006 and $110,693 in 2005)                      |  |                                                | 128,945   |   |      |   | 110,918   |  
|Held to maturity (estimated fair value of $41,865 in 2006 and $47,508 in 2005)                                             |  |                                                | 42,870    |   |      |   | 48,888    |  
|Loans:                                                                                                                     |  |                                                |           |   |      |   |           |  
|Loans held for sale                                                                                                        |  |                                                | 20,862    |   |      |   | 17,615    |  
|Loans held for investment                                                                                                  |  |                                                | 1,301,840 |   |      |   | 795,051   |  
|Less allowance for loan losses                                                                                             |  |                                                | (16,620   | ) |      |   | (9,945    | )
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Net loans                                                                                                                  |  |                                                | 1,306,082 |   |      |   | 802,721   |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Premises and equipment, net                                                                                                |  |                                                | 45,691    |   |      |   | 24,670    |  
|Goodwill                                                                                                                   |  |                                                | 110,956   |   |      |   | 31,381    |  
|Core deposit premiums                                                                                                      |  |                                                | 7,378     |   |      |   | 1,326     |  
|Other assets                                                                                                               |  |                                                | 64,643    |   |      |   | 37,302    |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Total Assets                                                                                                               |  | $                                              | 1,814,905 |   |      | $ | 1,102,085 |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Liabilities and Shareholders Equity                                                                                       |  |                                                |           |   |      |   |           |  
|Deposits:                                                                                                                  |  |                                                |           |   |      |   |           |  
|Noninterest-bearing demand deposits                                                                                        |  | $                                              | 158,938   |   |      | $ | 100,465   |  
|Interest-bearing deposits:                                                                                                 |  |                                                |           |   |      |   |           |  
|Demand, savings and money market deposits                                                                                  |  |                                                | 463,355   |   |      |   | 252,855   |  
|Time deposits of $100,000 or more                                                                                          |  |                                                | 365,770   |   |      |   | 229,910   |  
|Other time deposits                                                                                                        |  |                                                | 432,950   |   |      |   | 258,379   |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Total deposits                                                                                                             |  |                                                | 1,421,013 |   |      |   | 841,609   |  
|Retail repurchase agreements                                                                                               |  |                                                | 23,161    |   |      |   | 21,338    |  
|Federal Home Loan Bank advances                                                                                            |  |                                                | 65,825    |   |      |   | 86,225    |  
|Other borrowed funds                                                                                                       |  |                                                | 78,032    |   |      |   | 39,004    |  
|Other liabilities                                                                                                          |  |                                                | 19,206    |   |      |   | 11,594    |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Total Liabilities                                                                                                          |  |                                                | 1,607,237 |   |      |   | 999,770   |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Shareholders equity:                                                                                                      |  |                                                |           |   |      |   |           |  
|Preferred stock, $10.00 par value; authorized 200,000 shares, non issued                                                   |  |                                                |          |   |      |   |          |  
|Common stock, $2.50 par value; authorized 50,000,000 shares, issued 11,293,992 shares in 2006 and 6,370,486 shares in 2005 |  |                                                | 28,235    |   |      |   | 15,926    |  
|Surplus                                                                                                                    |  |                                                | 112,213   |   |      |   | 23,542    |  
|Retained earnings                                                                                                          |  |                                                | 68,662    |   |      |   | 62,711    |  
|Accumulated other comprehensive income (loss)                                                                              |  |                                                | (1,442    | ) |      |   | 136       |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Total Shareholders Equity                                                                                                 |  |                                                | 207,668   |   |      |   | 102,315   |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  
|Total Liabilities and Shareholders Equity                                                                                 |  | $                                              | 1,814,905 |   |      | $ | 1,102,085 |  
|                                                                                                                           |  |                                                |           |   |      |   |           |  



Commitments (Note 17)



See accompanying notes to consolidated financial statements



39



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME



|                                                    |  |                                                |           |   |      |   |           |  |   |          
|--------------------------------------------------- |  | ---------------------------------------------- | --------- | - | ---- | - | --------- |  | - | ---------
|                                                    |  | Years Ended December 31                       
|                                                    |  | 2006                                           |           |   | 2005 |   | 2004     
|                                                    |  | (in thousands, except shareand per share data)
|Interest Income                                     |  |                                                |           |   |      |   |           |  |   |          
|Interest and fees on loans                          |  | $                                              | 92,565    |   |      | $ | 48,604    |  | $ | 35,184   
|Interest and dividends on investment securities:    |  |                                                |           |   |      |   |           |  |   |          
|Taxable income                                      |  |                                                | 6,791     |   |      |   | 3,689     |  |   | 3,369    
|Non-taxable income                                  |  |                                                | 2,081     |   |      |   | 1,677     |  |   | 1,727    
|Other interest Income                               |  |                                                | 1,932     |   |      |   | 445       |  |   | 156      
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Total interest Income                               |  |                                                | 103,369   |   |      |   | 54,415    |  |   | 40,436   
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Interest Expense                                    |  |                                                |           |   |      |   |           |  |   |          
|Deposits                                            |  |                                                | 38,565    |   |      |   | 15,319    |  |   | 8,974    
|Retail repurchase agreements                        |  |                                                | 923       |   |      |   | 503       |  |   | 158      
|Federal Home Loan Bank advances                     |  |                                                | 3,387     |   |      |   | 2,766     |  |   | 2,546    
|Federal funds purchased                             |  |                                                | 40        |   |      |   | 9         |  |   | 71       
|Other borrowed funds                                |  |                                                | 4,240     |   |      |   | 1,453     |  |   | 653      
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Total interest expense                              |  |                                                | 47,155    |   |      |   | 20,050    |  |   | 12,402   
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Net Interest Income                                 |  |                                                | 56,214    |   |      |   | 34,365    |  |   | 28,034   
|Provision for loan losses                           |  |                                                | 2,526     |   |      |   | 2,842     |  |   | 4,030    
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Net Interest Income After Provision for Loan Losses |  |                                                | 53,688    |   |      |   | 31,523    |  |   | 24,004   
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Noninterest Income                                  |  |                                                |           |   |      |   |           |  |   |          
|Service charges on deposit accounts                 |  |                                                | 8,214     |   |      |   | 6,057     |  |   | 5,419    
|Mortgage loan sales                                 |  |                                                | 4,841     |   |      |   | 4,642     |  |   | 4,032    
|Cardholder and merchant services income             |  |                                                | 1,908     |   |      |   | 1,347     |  |   | 1,078    
|Trust and investment services                       |  |                                                | 1,529     |   |      |   | 1,293     |  |   | 1,535    
|Bank owned life insurance                           |  |                                                | 1,226     |   |      |   | 597       |  |   | 617      
|Other service charges, commissions and fees         |  |                                                | 987       |   |      |   | 882       |  |   | 843      
|Gain (loss) on sale of securities, net              |  |                                                | (559      | ) |      |   |          |  |   |         
|Factoring operations                                |  |                                                | 334       |   |      |   |          |  |   |         
|Other income                                        |  |                                                | 735       |   |      |   | 108       |  |   | 149      
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Total noninterest income                            |  |                                                | 19,215    |   |      |   | 14,926    |  |   | 13,673   
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Noninterest Expense                                 |  |                                                |           |   |      |   |           |  |   |          
|Personnel expense                                   |  |                                                | 28,078    |   |      |   | 18,934    |  |   | 16,755   
|Occupancy expense                                   |  |                                                | 3,774     |   |      |   | 1,888     |  |   | 1,566    
|Furniture and equipment expense                     |  |                                                | 3,832     |   |      |   | 2,241     |  |   | 1,943    
|Data processing services                            |  |                                                | 2,432     |   |      |   | 1,473     |  |   | 1,331    
|Goodwill impairment                                 |  |                                                | 1,625     |   |      |   |          |  |   |         
|Other expense                                       |  |                                                | 13,700    |   |      |   | 7,142     |  |   | 7,160    
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Total noninterest expense                           |  |                                                | 53,441    |   |      |   | 31,678    |  |   | 28,755   
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Income Before Income Taxes                          |  |                                                | 19,462    |   |      |   | 14,771    |  |   | 8,922    
|Income taxes                                        |  |                                                | 7,275     |   |      |   | 4,834     |  |   | 2,324    
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Net Income                                          |  | $                                              | 12,187    |   |      | $ | 9,937     |  | $ | 6,598    
|                                                    |  |                                                |           |   |      |   |           |  |   |          
|Net income per common share:                        |  |                                                |           |   |      |   |           |  |   |          
|Basic                                               |  | $                                              | 1.27      |   |      | $ | 1.73      |  | $ | 1.17     
|Diluted                                             |  | $                                              | 1.25      |   |      | $ | 1.69      |  | $ | 1.13     
|Weighted average number of shares outstanding:      |  |                                                |           |   |      |   |           |  |   |          
|Basic                                               |  |                                                | 9,619,870 |   |      |   | 5,731,966 |  |   | 5,663,173
|Diluted                                             |  |                                                | 9,715,585 |   |      |   | 5,869,023 |  |   | 5,822,047



See accompanying notes
to consolidated financial statements.



40



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREOLDERS EQUITY AND COMPREHENSIVE INCOME



|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|--------------------------------------------------- |  | ----------------------------------------------- | - |  | ------- | ------ | - | ---------------- | - | ------- | ------------------------------------------- |  | - | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                    |  | Common Stock                                    |   |  | Surplus |        |   | RetainedEarnings |   |         | AccumulatedOther ComprehensiveIncome (Loss) |  |   | Total  |  
|                                                    |  | Shares                                          |   |  | Amount  |        |   |                  |   |        
|                                                    |  | (in thousands, except share and per share data) |  
|Balance, December 31, 2003                          |  | 5,686,899                                       |   |  | $       | 14,217 |   |                  | $ | 12,478  |                                             |  | $ | 53,174 |   |  | $ | 1,589  |   |  | $ | 81,458  |  
|Comprehensive income:                               |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                          |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | 6,598  |   |  |   |       |   |  |   | 6,598   |  
|Other comprehensive income, net of taxes:           |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Unrealized securities losses:                       |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net losses arising during period                    |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   |       |   |  |   | (481   | ) |  |   | (481    | )
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Total comprehensive income                          |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   | 6,117   |  
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Cash dividends declared, $.60 per share             |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | (3,389 | ) |  |   |       |   |  |   | (3,389  | )
|Stock options:                                      |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Proceeds from options exercised                     |  | 66,303                                          |   |  |         | 166    |   |                  |   | 566     |                                             |  |   |       |   |  |   |       |   |  |   | 732     |  
|Net tax benefit related to option exercises         |  |                                                |   |  |         |       |   |                  |   | 59      |                                             |  |   |       |   |  |   |       |   |  |   | 59      |  
|Common stock repurchased                            |  | (148,100                                        | ) |  |         | (370   | ) |                  |   | (2,460  | )                                           |  |   |       |   |  |   |       |   |  |   | (2,830  | )
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2004                          |  | 5,605,102                                       |   |  |         | 14,013 |   |                  |   | 10,643  |                                             |  |   | 56,383 |   |  |   | 1,108  |   |  |   | 82,147  |  
|Comprehensive income:                               |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                          |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | 9,937  |   |  |   |       |   |  |   | 9,937   |  
|Other comprehensive income, net of taxes:           |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Unrealized securities losses:                       |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net losses arising during period                    |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   |       |   |  |   | (972   | ) |  |   | (972    | )
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Total comprehensive income                          |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   | 8,965   |  
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Cash dividends declared, $.62 per share             |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | (3,609 | ) |  |   |       |   |  |   | (3,609  | )
|Merger acquisition of subsidiary company:           |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Common stock issued                                 |  | 728,625                                         |   |  |         | 1,822  |   |                  |   | 12,685  |                                             |  |   |       |   |  |   |       |   |  |   | 14,507  |  
|Stock options:                                      |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Proceeds from options exercised                     |  | 61,559                                          |   |  |         | 153    |   |                  |   | 555     |                                             |  |   |       |   |  |   |       |   |  |   | 708     |  
|Net tax benefit related to option exercises         |  |                                                |   |  |         |       |   |                  |   | 96      |                                             |  |   |       |   |  |   |       |   |  |   | 96      |  
|Common stock repurchased                            |  | (24,800                                         | ) |  |         | (62    | ) |                  |   | (437    | )                                           |  |   |       |   |  |   |       |   |  |   | (499    | )
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2005                          |  | 6,370,486                                       |   |  |         | 15,926 |   |                  |   | 23,542  |                                             |  |   | 62,711 |   |  |   | 136    |   |  |   | 102,315 |  
|Comprehensive income:                               |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net Income                                          |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | 12,187 |   |  |   |       |   |  |   | 12,187  |  
|Other comprehensive income, net of taxes:           |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Unrealized securities gains (losses):               |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Net gains arising during period                     |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   |       |   |  |   | (123   | ) |  |   | (123    | )
|Reclassification adjustment for net realized losses |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   |       |   |  |   | 338    |   |  |   | 338     |  
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Total comprehensive income                          |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   | 12,402  |  
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Cash dividends declared, $.62 per share             |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   | (6,236 | ) |  |   |       |   |  |   | (6,236  | )
|Merger acquisition of subsidiary companies:         |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Common stock issued                                 |  | 4,654,504                                       |   |  |         | 11,636 |   |                  |   | 82,964  |                                             |  |   |       |   |  |   |       |   |  |   | 94,600  |  
|Fair value of stock options assumed                 |  |                                                |   |  |         |       |   |                  |   | 3,311   |                                             |  |   |       |   |  |   |       |   |  |   | 3,311   |  
|Stock options:                                      |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Proceeds from options exercised                     |  | 214,502                                         |   |  |         | 536    |   |                  |   | 1,581   |                                             |  |   |       |   |  |   |       |   |  |   | 2,117   |  
|Compensation expense recognized                     |  |                                                |   |  |         |       |   |                  |   | 510     |                                             |  |   |       |   |  |   |       |   |  |   | 510     |  
|Net tax benefit related to option exercises         |  |                                                |   |  |         |       |   |                  |   | 279     |                                             |  |   |       |   |  |   |       |   |  |   | 279     |  
|Restricted stock:                                   |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Shares issued, subject to restriction               |  | 53,875                                          |   |  |         | 135    |   |                  |   | (135    | )                                           |  |   |       |   |  |   |       |   |  |   |        |  
|Compensation expense recognized                     |  |                                                |   |  |         |       |   |                  |   | 151     |                                             |  |   |       |   |  |   |       |   |  |   | 151     |  
|Other compensatory stock issued                     |  | 625                                             |   |  |         | 2      |   |                  |   | 10      |                                             |  |   |       |   |  |   |       |   |  |   | 12      |  
|Adjustment to initially apply SFAS No. 158          |  |                                                |   |  |         |       |   |                  |   |        |                                             |  |   |       |   |  |   | (1,793 | ) |  |   | (1,793  | )
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2006                          |  | 11,293,992                                      |   |  | $       | 28,235 |   |                  | $ | 112,213 |                                             |  | $ | 68,662 |   |  | $ | (1,442 | ) |  | $ | 207,668 |  
|                                                    |  |                                                 |   |  |         |        |   |                  |   |         |                                             |  |   |        |   |  |   |        |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



41



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|--------------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                  |  | Years Ended December 31 |         
|                                                                                  |  | 2006                    |          |   | 2005 |   |          | 2004 | 
|                                                                                  |  | (in thousands)          |         
|Operating Activities                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net Income                                                                        |  | $                       | 12,187   |   |      | $ | 9,937    |      |  | $ | 6,598    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                         |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization of premises and equipment                           |  |                         | 2,855    |   |      |   | 1,755    |      |  |   | 1,619    |  
|Provision for loan losses                                                         |  |                         | 2,526    |   |      |   | 2,842    |      |  |   | 4,030    |  
|Deferred income taxes (benefit)                                                   |  |                         | 1,735    |   |      |   | (502     | )    |  |   | (12      | )
|Deferred loan fees and costs, net                                                 |  |                         | 694      |   |      |   | (119     | )    |  |   | 229      |  
|Premium amortization and discount accretion of investment securities, net         |  |                         | 339      |   |      |   | 453      |      |  |   | 591      |  
|Loss on sale of investment securities                                             |  |                         | 559      |   |      |   |         |      |  |   |         |  
|Amortization of core deposit premiums                                             |  |                         | 604      |   |      |   | 66       |      |  |   | 55       |  
|Stock compensation expense                                                        |  |                         | 673      |   |      |   |         |      |  |   |         |  
|Income from bank owned life insurance                                             |  |                         | (1,226   | ) |      |   | (597     | )    |  |   | (617     | )
|Origination of mortgage loans held for sale                                       |  |                         | (368,632 | ) |      |   | (334,883 | )    |  |   | (270,484 | )
|Proceeds from sale of mortgage loans held for sale                                |  |                         | 370,226  |   |      |   | 333,558  |      |  |   | 271,435  |  
|Gain on mortgage loan sales                                                       |  |                         | (4,841   | ) |      |   | (4,642   | )    |  |   | (4,032   | )
|Gain on other loan sales                                                          |  |                         | (118     | ) |      |   |         |      |  |   |         |  
|Mortgage servicing rights capitalized                                             |  |                         | (701     | ) |      |   | (754     | )    |  |   | (681     | )
|Mortgage servicing rights amortization and impairment                             |  |                         | 637      |   |      |   | 351      |      |  |   | 303      |  
|Goodwill impairment                                                               |  |                         | 1,625    |   |      |   |         |      |  |   |         |  
|Decrease (increase) in other assets                                               |  |                         | 2,103    |   |      |   | (925     | )    |  |   | 3,146    |  
|Increase (decrease) in other liabilities                                          |  |                         | (2,779   | ) |      |   | (27      | )    |  |   | 324      |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Net Cash provided by Operating Activities                                         |  |                         | 18,466   |   |      |   | 6,513    |      |  |   | 12,504   |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Investing Activities                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Available-for-sale securities:                                                    |  |                         |          |   |      |   |          |      |  |   |          |  
|Proceeds from sales                                                               |  |                         | 119,490  |   |      |   |         |      |  |   |         |  
|Proceeds from maturities and calls                                                |  |                         | 37,712   |   |      |   | 6,266    |      |  |   | 35,659   |  
|Purchases                                                                         |  |                         | (90,746  | ) |      |   | (10,464  | )    |  |   | (29,858  | )
|Held-to-maturity securities:                                                      |  |                         |          |   |      |   |          |      |  |   |          |  
|Proceeds from maturities and calls                                                |  |                         | 7,562    |   |      |   | 4,407    |      |  |   | 12,812   |  
|Purchases                                                                         |  |                         | (1,730   | ) |      |   | (2,192   | )    |  |   | (871     | )
|Net increase in loans held for investment                                         |  |                         | (41,520  | ) |      |   | (48,411  | )    |  |   | (128,634 | )
|Proceeds from sales of loans                                                      |  |                         | 10,443   |   |      |   |         |      |  |   | 12,534   |  
|Purchases of premises and equipment                                               |  |                         | (6,293   | ) |      |   | (5,614   | )    |  |   | (3,799   | )
|Net cash received (paid) in merger transactions                                   |  |                         | 10,256   |   |      |   | (447     | )    |  |   |         |  
|Purchases of SBIC investments                                                     |  |                         | (1,050   | ) |      |   | (250     | )    |  |   | (150     | )
|Net change in other investments                                                   |  |                         | 396      |   |      |   | 399      |      |  |   | (18      | )
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Net Cash Provided by (Used in) Investing Activities                               |  |                         | 44,520   |   |      |   | (56,306  | )    |  |   | (102,325 | )
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Financing Activities                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net increase in deposits                                                          |  |                         | 16,435   |   |      |   | 69,118   |      |  |   | 61,619   |  
|Increase (decrease) in retail repurchase agreements                               |  |                         | (1,735   | ) |      |   | 7,466    |      |  |   | (998     | )
|Increase (decrease) in Federal Home Loan Bank advances                            |  |                         | (39,018  | ) |      |   | (4,500   | )    |  |   | 16,000   |  
|Increase (decrease) in federal funds purchased                                    |  |                         |         |   |      |   | (8,175   | )    |  |   | 7,550    |  
|Increase in other borrowed funds                                                  |  |                         | 27,789   |   |      |   | 13,319   |      |  |   | 4,589    |  
|Proceeds from exercise of stock options                                           |  |                         | 2,117    |   |      |   | 804      |      |  |   | 791      |  
|Tax benefit exercise of stock options                                             |  |                         | 279      |   |      |   |         |      |  |   |         |  
|Common stock repurchased                                                          |  |                         |         |   |      |   | (499     | )    |  |   | (2,830   | )
|Cash dividends paid                                                               |  |                         | (5,392   | ) |      |   | (3,370   | )    |  |   | (3,515   | )
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Net Cash Provided by Financing Activities                                         |  |                         | 475      |   |      |   | 74,163   |      |  |   | 83,206   |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Net Increase (Decrease) in Cash and Cash Equivalents                              |  |                         | 63,461   |   |      |   | 24,370   |      |  |   | (6,615   | )
|Cash and Cash Equivalents at Beginning of Year                                    |  |                         | 44,879   |   |      |   | 20,509   |      |  |   | 27,124   |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash and Cash Equivalents at End of Year                                          |  | $                       | 108,340  |   |      | $ | 44,879   |      |  | $ | 20,509   |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Supplemental disclosure of cash flow information:                                 |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash paid during the year for:                                                    |  |                         |          |   |      |   |          |      |  |   |          |  
|Interest                                                                          |  | $                       | 44,844   |   |      | $ | 18,871   |      |  | $ | 12,344   |  
|Income taxes                                                                      |  |                         | 5,836    |   |      |   | 5,334    |      |  |   | 1,172    |  
|Noncash transactions:                                                             |  |                         |          |   |      |   |          |      |  |   |          |  
|Foreclosed loans transferred to other real estate                                 |  |                         | 3,393    |   |      |   | 1,004    |      |  |   | 1,872    |  
|Unrealized securities gains (losses), net of income taxes (benefit)               |  |                         | 215      |   |      |   | (972     | )    |  |   | (481     | )
|Initial application of SFAS No. 158, net of income tax benefit                    |  |                         | (1,793   | ) |      |   |         |      |  |   |         |  
|Merger acquisition of subsidiary company:                                         |  |                         |          |   |      |   |          |      |  |   |          |  
|Fair value of assets acquired                                                     |  |                         | 728,722  |   |      |   | 163,668  |      |  |   |         |  
|Fair value of common stock issued                                                 |  |                         | 98,123   |   |      |   | 14,507   |      |  |   |         |  
|Cash paid                                                                         |  |                         | 27,717   |   |      |   | 8,201    |      |  |   |         |  
|                                                                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Liabilities assumed                                                               |  |                         | 602,882  |   |      |   | 140,960  |      |  |   |         |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES



Nature of
Operations/Consolidation



FNB United Corp. (FNB
United), formerly known as FNB Corp., is a bank holding company whose wholly owned subsidiaries are the 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, Wilmington and
Wrightsville Beach.



The consolidated financial statements
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 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.



Certain amounts for prior years have been reclassified to conform to the financial statement presentation for 2006. These reclassifications had no effect
on net income or shareholders equity as previously reported.



Business Segments



The Corporation reports
business segments in accordance with Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS No. 131). Business segments are components of an
enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. SFAS No. 131 requires that a public enterprise
report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the way that the business segments were determined and other items. The Corporation has two reportable business segments, the
full-service subsidiary bank, First National Bank, and the mortgage banking subsidiary, Dover Mortgage Company. Business segment information is disclosed in Note 19.



Recently Adopted Accounting Pronouncements



In November 2003, the Emerging Issues Task Force (EITF) issued EITF Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-01). EITF 03-01 provided guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect
to these investments. In September 2004, the Financial Accounting Standards Board (FASB) issued a FASB Staff Position (FSP EITF 03-1-b) to delay the requirement to record impairment losses under EITF 03-1. The guidance also
included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requirements for disclosures about unrealized losses that have ot been recognized as other-than-temporary impairments. In November 2005, the
FASB issued FSP FAS 115-1 and



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



FAS 124-1, which addresses the determination as to when an investment is considered impaired. This FSP nullifies certain requirements of EITF 03-01 and
supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. This FSP is to be applied to reporting periods beginning after December 15. 2005. The
Corporation adopted the provisions of FSP FAS 115-1 on January 1, 2006 with no effect on its consolidated financial statements.



In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (SFAS No. 123R), Share-Based
Payment, which is a revision of FASB Statement No. 123 Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees. SFAS No. 123R requires companies
to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees over the period during which an employee is required to provide service in exchange for the award (presumptively
the vesting period). SFAS No. 123R sets accounting requirements for share-based compensation to employees, including employee-stock purchase plans (ESPPs). Awards to most nonemployee directors will be accounted for as
employee awards. This Statement was to be effective for public companies that do not file as small business issuers as of the beginning of interim or annual reporting periods beginning after June 15, 2005. In April 2005, the Securities and
Exchange Commission (SEC) issued Release No. 2005-57, which defers the effective date of SFAS No. 123R for many registrants. Registrants that do not file as small business issuers must adopt SFAS No. 123R as of the
beginning of their first annual period beginning after June 15, 2005. The Corporation adopted the provisions of SFAS No. 123R on January 1, 2006 as discussed below in Notes 1 and 16.



In March 2005, the SEC issued Staff Accounting Bulletin No. 107
(SAB 107), which contains guidance on applying the requirements in SFAS No. 123R. SAB 107 provides guidance on valuation techniques, development of assumptions used in valuing employee share options and related MD&A disclosures.
SAB 107 is effective for the period in which SFAS No. 123R is adopted. In conjunction with the adoption of SFAS No. 123R on January 1, 2006, the Corporation adopted the provisions of SAB 107.



In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 (SFAS No. 154), Accounting Changes and Error Corrections, which replaces APB Opinion No. 20 Accounting Changes and FASB Statement No. 3 Reporting Accounting Changes in Interim
Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in an accounting principle. SFAS No. 154 requires retrospective application for voluntary changes in an accounting
principle unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Corporation adopted the provisions of SFAS No. 154 on January 1, 2006
with no effect on its consolidated financial statements.



In
September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS No. 158), Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB
Statements No. 87, 88, 106, and 132R). SFAS No. 158 requires an employer to: (a) recognize in its statement of financial position an asset for a plans overfunded status or a liability for a plans underfunded status;
(b) measure a plans assets and its obligations that determine its funded status as of the end of the employers fiscal year (with limited exceptions); and (c) recognize changes in the funded status of a defined benefit
postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income of a business entity and in changes in net assets of a not-for-profit organization. The requirement by SFAS No. 158 to recognize
the funded status of a benefit plan and the disclosure requirements of SFAS No. 158 are effective as of the end of the fiscal year ending after December 15, 2006 for entities with publicly traded equity securities. The requirement to
measure plan assets and benefit obligations as of the date of



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Effective
December 31, 2006, the Corporation adopted the provisions of SFAS NO. 158 that require recognition of the funded status of a benefit plan and related disclosures. The Corporation is currently evaluating the remaining requirements of SFAS
No. 158 to determine the potential impact, if any, on its consolidated financial statements.



In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB No. 108), Considering the Effects of
Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements. SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial statements.
SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements and is effective for annual periods ending after November 15, 2006. The Corporation adopted the
provisions of SAB No. 108 effective December 31, 2006 with no effect on its consolidated financial statements.



Business Combinations



For all business combination transactions initiated after June 30, 2001, the purchase method of accounting has been used, and accordingly, the assets
and liabilities of the acquired company have been recorded at their estimated fair values as of the merger date. The fair values are subject to adjustment as information relative to the fair values as of the acquisition date becomes available. The
Corporation uses an allocation period, not to exceed one year, to identify and quantify the fair value of the assets acquired and liabilities assumed in business combinations accounted for as purchases. The consolidated financial statements include
the results of operations of any acquired company since the acquisition date.



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.



Investment Securities



Investment securities are categorized and accounted for as follows:



| |  |  | Held-to-maturity securitiesDebt securities that the Corporation has the positive intent and ability to hold to maturity are reported at amortized cost.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Trading securitiesDebt and equity securities bought and held principally for the purpose of being sold in the near future are reported at fair value, with
unrealized gains and losses included in earnings.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Available-for-sale securitiesDebt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value,
with unrealized gains and losses, net of related tax effect, included as an item of accumulated other comprehensive income and reported as a separate component of shareholders equity.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Corporation intends to hold its securities classified as
available-for-sale securities for an indefinite period of time but may sell them prior to maturity. All other securities, which the Corporation has the positive intent and ability to hold to maturity, are classified as held-to-maturity securities.



45



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



A decline, which is deemed to be other than temporary, in the market value of any available-for-sale or held-to-maturity security to a level below cost results in a reduction in carrying amount to fair value. The
impairment is charged to earnings and a new cost basis for the security is established.



Interest income on debt securities is adjusted using the level yield method for the amortization of premiums and accretion of discounts. The adjusted cost of the specific security is used to compute gains or losses on
the disposition of securities.



Loans



Interest income on loans is generally calculated by using the constant yield
method based on the daily outstanding balance. The recognition of interest income is discontinued 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. The past due status of loans is based on the contractual payment terms.



A loan is considered impaired when, based on current information or events,
it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. 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. When the ultimate collectibility of the impaired loans principal is doubtful, all cash receipts are applied to principal. Once the recorded
principal balance has been reduced to zero, future cash receipts are first recorded as recoveries of any amounts previously charged-off and are then applied to interest income, to the extent that any interest has been foregone.



Loan fees and the incremental direct costs associated with making loans are
deferred and subsequently recognized over the life of the loan as an adjustment of interest income. The premium or discount on purchased loans is amortized over the expected life of the loans and is included in interest and fees on loans.



Residential mortgage loans held for sale are valued at the
lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis.



The Corporation accounts for loans acquired in a transfer that are subject to the scope of American Institute of Certified Public Accountants (AICPA)
Statement of Position 03-3, Accounting for Certain Loans and Debt Securities Acquired in a Transfer (SOP 03-3) at fair value, which is the net present value of all cash flows expected to be collected over the life of the
loan. These cash flows are determined on the date of transfer. At December 31, 2006, the principal balance of and net investment in these loans was immaterial. At December 31, 2005, there were no loans subject to SOP 03-3.



Allowance for Loan Losses



The allowance for loan losses represents an amount considered
adequate to absorb probable loan losses inherent in the portfolio. Managements evaluation of the adequacy of the allowance is based on 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. Losses are charged and recoveries are credited to the allowance for loan losses. 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 adjustments to the allowance based on their judgments about information available to them at the time of their examinations.





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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



Other Real Estate



Other real estate, which is included in other assets on the consolidated balance sheet, represents properties acquired through foreclosure or deed in lieu thereof. In accordance with Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the property is classified as held for sale when the sale is probable and expected to occur within one year. The property is initially carried at fair value based on recent
appraisals, less estimated costs to sell. Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income.



Premises and Equipment



Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over
the estimated useful lives of the assets as follows: buildings and improvements, 10 to 50 years and furniture and equipment, 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated life of the
improvement or the term of the lease.



Intangible Assets



Intangible assets include goodwill and other identifiable
assets, such as core deposit premiums, resulting from acquisitions. Core deposit premiums are amortized primarily on a straight-line basis over a ten-year life based upon historical studies of core deposits. Goodwill is not amortized but is tested
annually for impairment or at any time an event occurs or circumstances change that may trigger a decline in the value of the reporting unit. Examples of such events or circumstances include adverse changes in legal factors, business climate,
unanticipated competition, change in regulatory environment or loss of key personnel.



The Corporation tests for impairment in accordance with SFAS No. 142. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. The fair value of a reporting
unit is computed using one or a combination of the following three methods: income, market value or cost method. The income method uses a discounted cash flow analysis to determine fair value by considering a reporting units capital structure
and applying a risk-adjusted discount rate to forecast earnings based on a capital asset pricing model. The market value method uses recent transaction analysis or publicly traded comparable analysis for similar assets and liabilities to determine
fair value. The cost method assumes the net assets of a recent business combination accounted for under the purchase method of accounting will be recorded at fair value if no event or circumstance has occurred triggering a decline in the value. To
the extent a reporting units carrying amount exceeds its fair value, an indication exists that the reporting units goodwill may be impaired, and a second step of impairment test will be performed. In the second step, the implied fair
value of the reporting units goodwill, determined by allocating the reporting units fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the
date of the impairment test. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value. The loss recognized is limited to the carrying amount of
goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.



47



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



Mortgage Servicing Rights (MSRs)



The rights to service mortgage loans for others are included in other assets on the consolidated balance sheet. MSRs are capitalized based on the allocated cost which is determined when the underlying loans are sold.
MSRs are amortized using the interest method over the expected life of the underlying loan as an adjustment of servicing income. Impairment reviews of MSRs are performed on a quarterly basis.



Income Taxes



Income tax expense includes both a current provision based on the amounts
computed for income tax return purposes and a deferred provision that results from application of the asset and liability method of accounting for deferred taxes. Under the asset and liability method, deferred tax assets and liabilities are
established for the temporary differences between the financial reporting basis and the tax basis of the Corporations assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.



Earnings Per Share (EPS)



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 is provided in a footnote of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.



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 statement 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 Corporations components of accumulated other comprehensive income at December 31,
2006 include unrealized gains (losses) on investment securities classified as available-for-sale and the adjustment to initially apply SFAS No. 158.



Information concerning the income tax effects applicable to the components of other comprehensive income included in the consolidated statements of
shareholders equity and comprehensive income and the components of accumulated other comprehensive income included in the shareholders equity section of the consolidated balance sheets is as follows:



|                                                                              |  |                |        |   |      |   |      |      |  |   |       |  
|----------------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ---- | ---- |  | - | ----- | -
|                                                                              |  | 2006           |        |   | 2005 |   |      | 2004 | 
|                                                                              |  | (in thousands) |       
|Income tax expense (benefit) related to unrealized securities gains (losses): |  |                |        |   |      |   |      |      |  |   |       |  
|Arising during the period                                                     |  | $              | (81    | ) |      | $ | (607 | )    |  | $ | (302  | )
|Reclassification adjustment for net realized losses                           |  |                | 220    |   |      |   |     |      |  |   |      |  
|                                                                              |  |                |        |   |      |   |      |      |  |   |       |  
|Total                                                                         |  | $              | 139    |   |      | $ | (607 | )    |  | $ | (302  | )
|                                                                              |  |                |        |   |      |   |      |      |  |   |       |  
|Accumulated other comprehensive income (loss):                                |  |                |        |   |      |   |      |      |  |   |       |  
|Unrealized securities gains                                                   |  | $              | 351    |   |      | $ | 136  |      |  | $ | 1,108 |  
|Application of SFAS No. 158                                                   |  |                | (1,793 | ) |      |   |     |      |  |   |      |  
|                                                                              |  |                |        |   |      |   |      |      |  |   |       |  
|Total                                                                         |  | $              | (1,442 | ) |      | $ | 136  |      |  | $ | 1,108 |  
|                                                                              |  |                |        |   |      |   |      |      |  |   |       |  



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



Employee Benefit Plans



The Corporation has a defined benefit pension plan covering substantially all full-time employees. Pension costs, which are actuarially determined using the projected unit credit method, are charged to current operations. Annual
funding contributions are made up to the maximum amounts allowable for Federal income tax purposes.



In September 2006, the Board of Directors of FNB United approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees
are eligible to enter the plan. Participants who are at least age 40, have earned 10 years of vesting service as an employee of FNB United and remain an active employee as of December 31, 2006 will qualify for a grandfathering provision. Under
the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. Additionally, the plans definition of final average compensation will be improved from a 10-year averaging period to
a 5-year averaging period as of January 1, 2007. All other eligible participants in the plan will have their retirement benefit frozen as of December 31, 2006. Effective January 1, 2007, the 401K plan will be enhanced and will be the
primary retirement benefit plan.



The Corporation has a
noncontributory, nonqualified supplemental executive retirement plan (the SERP) covering certain executive employees. Annual benefits payable under the SERP are based on factors similar to those for the pension plan, with offsets related
to amounts payable under the pension plan and social security benefits. SERP costs, which are actuarially determined using the projected unit credit method and recorded on an unfunded basis, are charged to current operations and credited to a
liability account on the consolidated balance sheet.



Medical
and life insurance benefits are provided by the Corporation on a postretirement basis under defined benefit plans covering substantially all full-time employees. Postretirement benefit costs, which are actuarially determined using the attribution
method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet.



In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective
December 31, 2006, no new employees are eligible to enter the plan. Participants who are at least age 40, have earned 10 years of vesting service as an employee of the Corporation and remain an active employee as of December 31, 2006 will
qualify for a grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011.



Stock-Based Compensation



Effective January 1, 2006, the Corporation adopted Statement of Financial Accounting Standards No. 123R (revised 2004), Share-Based
Payment, (SFAS 123R) which was issued by the FASB in December 2004. SFAS No. 123R revises FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in
the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in
exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as financing cash inflows, rather than as a
reduction of taxes paid, which is included within operating cash flows.



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



The Corporation adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application,
compensation expense is required to be recorded for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.



Prior to the adoption of SFAS No. 123R, the Corporation used the
intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the common stock on the date of grant.



The effect (increase/(decrease)) of the adoption of SFAS No. 123R for
the year ended December 31, 2006 is as follows (in thousands, except per share data):



|                                           |  |   |      |  
|------------------------------------------ |  | - | ---- | -
|Income before income taxes                 |  | $ | (510 | )
|Net income                                 |  |   | (483 | )
|Cash flow from operating activities        |  |   | (279 | )
|Cash flow provided by financing activities |  |   | 279  |  
|                                           | 
|Net income per share:                      |  |   |      |  
|Basic                                      |  |   | (.05 | )
|Diluted                                    |  |   | (.05 | )



The
following illustrates the effect on net income available to common stockholders if the Corporation had applied the fair value recognition provisions of SFAS No. 123 to the results for the years ended December 31, 2005 and 2004:



|                                                                                                                   |  |                                       |       |      |   |      
|------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------- | ----- | ---- | - | -----
|                                                                                                                   |  | 2005                                  |       | 2004
|                                                                                                                   |  | (in thousands, except per share data)
|Net income, as reported                                                                                            |  | $                                     | 9,937 |      | $ | 6,598
|Add: Stock-based employee compensation expense included in reported net income, net of related income tax effects  |  |                                       |      |      |   |     
|Less: Stock-based compensation determined under fair value based method of all awards, net of related income taxes |  |                                       | 387   |      |   | 340  
|                                                                                                                   |  |                                       |       |      |   |      
|Net income, pro forma                                                                                              |  | $                                     | 9,550 |      | $ | 6,258
|                                                                                                                   |  |                                       |       |      |   |      
|Net income per share:                                                                                              |  |                                       |       |      |   |      
|Basic:                                                                                                             |  |                                       |       |      |   |      
|As reported                                                                                                        |  | $                                     | 1.73  |      | $ | 1.17 
|Pro forma                                                                                                          |  |                                       | 1.67  |      |   | 1.11 
|Diluted:                                                                                                           |  |                                       |       |      |   |      
|As reported                                                                                                        |  |                                       | 1.69  |      |   | 1.13 
|Pro forma                                                                                                          |  |                                       | 1.63  |      |   | 1.07 



Derivatives and
Financial Instruments



Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), as amended by SFAS Nos. 137, 138, 149 and 155, 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.



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 1SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(Continued)



In connection with its asset/liability management objectives, the Corporation in 2004 entered into an interest rate swap on a $7,000,000 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 twelve months ended December 31, 2006 and 2005, the interest rate swap resulted in a net increase of $125,000 and a net reduction of $1,000,
respectively, in the interest expense that would otherwise have been reported for the FHLB advance. The fair value of the swap at December 31, 2006 was recorded on the consolidated balance sheet as a liability in the amount of $244,000, 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 December 31, 2006: commitments to originate residential mortgage loans and forward sales commitments.



Dover Mortgage Company originates certain 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 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 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.



See Note 17 for additional information related to derivatives and financial instruments.



NOTE 2MERGER INFORMATION



United Financial, Inc.



On November 4, 2005, the Corporation completed a merger for the
acquisition of United Financial, Inc. (United), holding company for Alamance Bank, headquartered in Graham, North Carolina. At the date of merger, Alamance Bank operated three offices and, based on estimated fair values, had $163.7
million in total assets, $95.2 million in net loans and $113.0 million in deposits. On February 1, 2006, Alamance Bank was merged into First National Bank.



Pursuant to the terms of the merger, each share of United common stock was converted, at the election of the shareholder, into either: (1) $14.25
in cash, (2) 0.6828 shares of FNB Corp. common stock, or (3) $4.99 in cash and 0.4438 shares of FNB Corp. common stock, the overall conversion of stock being limited to 65% of United shares. The aggregate purchase price, as adjusted by a
reduction of $0.2 million during the one-year period following the date of merger, was $22.5 million, consisting of $8.2 million of cash payments and 728,625 shares of FNB Corp. common stock valued at $14.3 million.



The merger transaction has been accounted for using the purchase method of
accounting for business combinations, and accordingly, the assets and liabilities of United were recorded based on estimated fair values



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2MERGER
INFORMATION(Continued)



as of November 4, 2005, with the estimate of goodwill being subject to possible adjustment during the one-year period from that date. The adjustments
recorded during that one-year period, including the purchase price adjustment noted above, resulted in a net $264,000 reduction in the amount initially recorded for goodwill. The consolidated financial statements include the results of operations of
United since November 4, 2005.



The estimated fair values
of the assets acquired and liabilities assumed at the date of merger on November 4, 2005, and the subsequent adjustments during the one year period from that date, are as follows:



|                                          |  |                |          |   |                       |   |      |                 |  |   |          |  
|----------------------------------------- |  | -------------- | -------- | - | --------------------- | - | ---- | --------------- |  | - | -------- | -
|                                          |  | InitialAmounts |          |   | SubsequentAdjustments |   |      | AdjustedAmounts | 
|                                          |  | (in thousands) |         
|Assets                                    |  |                |          |   |                       |   |      |                 |  |   |          |  
|Cash and cash equivalents                 |  | $              | 7,754    |   |                       | $ |     |                 |  | $ | 7,754    |  
|Investment securities, available for sale |  |                | 34,712   |   |                       |   |     |                 |  |   | 34,712   |  
|Loans, net                                |  |                | 95,219   |   |                       |   |     |                 |  |   | 95,219   |  
|Premises and equipment                    |  |                | 4,139    |   |                       |   |     |                 |  |   | 4,139    |  
|Goodwill                                  |  |                | 15,022   |   |                       |   | (264 | )               |  |   | 14,758   |  
|Core deposit intangible                   |  |                | 1,290    |   |                       |   |     |                 |  |   | 1,290    |  
|Other assets                              |  |                | 5,532    |   |                       |   | 60   |                 |  |   | 5,592    |  
|Deposits                                  |  |                | (112,961 | ) |                       |   |     |                 |  |   | (112,961 | )
|Borrowings                                |  |                | (24,420  | ) |                       |   |     |                 |  |   | (24,420  | )
|Other liabilities                         |  |                | (4,083   | ) |                       |   | (8   | )               |  |   | (4,091   | )
|                                          |  |                |          |   |                       |   |      |                 |  |   |          |  
|Net assets acquired                       |  |                | 22,204   |   |                       |   | (212 | )               |  |   | 21,992   |  
|Transaction costs                         |  |                | 504      |   |                       |   |     |                 |  |   | 504      |  
|                                          |  |                |          |   |                       |   |      |                 |  |   |          |  
|Total purchase price                      |  | $              | 22,708   |   |                       | $ | (212 | )               |  | $ | 22,496   |  
|                                          |  |                |          |   |                       |   |      |                 |  |   |          |  



The core deposit
intangible will be amortized on the straight-line basis over a ten-year life. The amortization method and valuation of the core deposit intangible are based upon a historical study of the deposits acquired. Goodwill will not be amortized but will be
tested for impairment in accordance with SFAS No. 142. None of the goodwill is expected to be deductible for income tax purposes. Premiums and discounts that resulted from recording the United assets and liabilities at their respective fair
values are being amortized using methods that approximate an effective yield over the life of the assets and liabilities. The net amortization of premiums and discounts related to this merger increased income before income taxes by $499,000 in 2006
and $88,000 in 2005.



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 company from ten central-North Carolina counties to seventeen counties with forty-two community offices, stretching from the Central
and Southern Piedmont to the Foothills
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2MERGER
INFORMATION(Continued)



| | 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.



The estimated fair values of the assets acquired and liabilities assumed at
the date of merger on April 28, 2006, and the subsequent adjustments from that date through December 31, 2006, are as follows:



|                                          |  |                |          |   |                       |   |     |                 |  |   |          |  
|----------------------------------------- |  | -------------- | -------- | - | --------------------- | - | --- | --------------- |  | - | -------- | -
|                                          |  | InitialAmounts |          |   | SubsequentAdjustments |   |     | AdjustedAmounts | 
|                                          |  | (in thousands) |         
|Assets                                    |  |                |          |   |                       |   |     |                 |  |   |          |  
|Cash and cash equivalents                 |  | $              | 37,973   |   |                       | $ |    |                 |  | $ | 37,973   |  
|Investment securities, available for sale |  |                | 84,373   |   |                       |   |    |                 |  |   | 84,373   |  
|Loans, net                                |  |                | 475,281  |   |                       |   |    |                 |  |   | 475,281  |  
|Premises and equipment                    |  |                | 17,786   |   |                       |   | 193 |                 |  |   | 17,979   |  
|Goodwill                                  |  |                | 81,537   |   |                       |   | (81 | )               |  |   | 81,456   |  
|Core deposit intangible                   |  |                | 6,656    |   |                       |   |    |                 |  |   | 6,656    |  
|Other assets                              |  |                | 25,050   |   |                       |   | (46 | )               |  |   | 25,004   |  
|Deposits                                  |  |                | (563,311 | ) |                       |   |    |                 |  |   | (563,311 | )
|Borrowings                                |  |                | (32,237  | ) |                       |   |    |                 |  |   | (32,237  | )
|Other liabilities                         |  |                | (7,268   | ) |                       |   | (66 | )               |  |   | (7,334   | )
|                                          |  |                |          |   |                       |   |     |                 |  |   |          |  
|Net assets acquired                       |  |                | 125,840  |   |                       |   |    |                 |  |   | 125,840  |  
|Transaction costs                         |  |                | 1,344    |   |                       |   |    |                 |  |   | 1,344    |  
|                                          |  |                |          |   |                       |   |     |                 |  |   |          |  
|Total purchase price                      |  | $              | 127,184  |   |                       | $ |    |                 |  | $ | 127,184  |  
|                                          |  |                |          |   |                       |   |     |                 |  |   |          |  



The core deposit
intangible will be amortized on the straight-line basis over a ten-year life. The amortization method and valuation of the core deposit intangible are based upon a historical study of the deposits acquired. Goodwill will not be amortized but will be
tested for impairment in accordance with SFAS No. 142. None of the goodwill is expected to be deductible for income tax purposes. Premiums and discounts that resulted from recording the Integrity assets and liabilities at their respective fair
values are being amortized using methods that approximate an effective yield over the life of the assets and liabilities. The net amortization of premiums and discounts related to this merger increased income before income taxes by $1,522,000 in
2006.



The following pro forma financial information presents
the combined results of operations of FNB United and Integrity as if the merger had occurred as of the beginning of the year for the years ended December 31, 2006 and 2005, after giving effect to certain adjustments, including amortization of
the core deposit intangible and



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2MERGER
INFORMATION(Continued)



related income tax effects. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had FNB
United and Integrity constituted a single entity during these years.



|                             |  |                                       |        |      |   |       
|---------------------------- |  | ------------------------------------- | ------ | ---- | - | ------
|                             |  | 2006                                  |        | 2005
|                             |  | (in thousands, except per share data)
|Net interest income          |  | $                                     | 64,788 |      | $ | 58,400
|Noninterest income           |  |                                       | 20,780 |      |   | 19,748
|Net income                   |  |                                       | 13,655 |      |   | 15,730
|                             |  |                                      
|Net income per common share: |  |                                       |        |      |   |       
|Basic                        |  |                                       | 1.23   |      |   | 1.51  
|Diluted                      |  |                                       | 1.21   |      |   | 1.47  



NOTE 3INTANGIBLE ASSETS



Business Combinations



For intangible assets related to business combinations, the following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets and the carrying amount of unamortized intangible assets:



|                                                         |  |                |         |      |   |       
|-------------------------------------------------------- |  | -------------- | ------- | ---- | - | ------
|                                                         |  | December 31,  
|                                                         |  | 2006           |         | 2005
|                                                         |  | (in thousands)
|Amortized intangible assets:                             |  |                |         |      |   |       
|Core deposit premium related to whole bank acquisitions: |  |                |         |      |   |       
|Carrying amount                                          |  | $              | 8,202   |      | $ | 1,546 
|Accumulated amortization                                 |  |                | 824     |      |   | 220   
|                                                         |  |                |         |      |   |       
|Net core deposit premium                                 |  | $              | 7,378   |      | $ | 1,326 
|                                                         |  |                |         |      |   |       
|Unamortized intangible assets:                           |  |                |         |      |   |       
|Goodwill                                                 |  | $              | 110,956 |      | $ | 31,381
|                                                         |  |                |         |      |   |       



Amortization of
intangibles totaled $604,000 for core deposit premiums in 2006, $66,000 in 2005 and $55,000 in 2006. The estimated amortization expense for core deposit premiums for each year ending December 31 from 2006 through 2011 is as follows: $814,000 in
2007, $802,000 in 2008, $795,000 in 2009, $795,000 in 2010 and $795,000 in 2011.



The changes in the carrying amount of goodwill in 2006 were as follows:



|                                                                                                                                    |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | - | ------- | -
|Balance, December 31, 2005                                                                                                          |  | $ | 31,381  |  
|Acquisition of Integrity Financial Corporation in 2006                                                                              |  |   | 81,456  |  
|Adjustment of estimated fair values of assets and liabilities of United Financial, Inc., acquired in 2005                           |  |   | (264    | )
|Payment of additional cash consideration to shareholders of Dover Mortgage Company, acquired in 2003, per terms of merger
agreement |  |   | 8       |  
|Recognition of goodwill impairment charge for Dover Mortgage Company                                                                |  |   | (1,625  | )
|                                                                                                                                    |  |   |         |  
|Balance December 31, 2006                                                                                                           |  | $ | 110,956 |  
|                                                                                                                                    |  |   |         |  



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 3INTANGIBLE
ASSETS(Continued)



The 2006 review for
potential impairment of goodwill indicated on a preliminary basis that the goodwill related to the separate FNB United subsidiary of Dover Mortgage Company might be impaired. Further testing of Dover goodwill by an outside consulting company
resulted in the determination that there was an impairment loss of approximately $1.6 million.



Mortgage Servicing Rights



Mortgage loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of mortgage loans serviced for others amounted to $231.7 million, $202.3 million and $180.2 million at December 31,
2006, 2005 and 2004, respectively.



The following is an
analysis of mortgage servicing rights included in other assets on the consolidated balance sheet:



|                              |  |                         |       |   |      |   |       |      |  |   |       |  
|----------------------------- |  | ----------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                              |  | Years Ended December 31 |      
|                              |  | 2006                    |       |   | 2005 |   |       | 2004 | 
|                              |  | (in thousands)          |      
|Balance at beginning of year  |  | $                       | 2,409 |   |      | $ | 2,006 |      |  | $ | 1,628 |  
|Servicing rights capitalized  |  |                         | 701   |   |      |   | 754   |      |  |   | 681   |  
|Amortization expense          |  |                         | (387  | ) |      |   | (351  | )    |  |   | (303  | )
|Change in valuation allowance |  |                         | (250  | ) |      |   |      |      |  |   |      |  
|                              |  |                         |       |   |      |   |       |      |  |   |       |  
|Balance at end of year        |  | $                       | 2,473 |   |      | $ | 2,409 |      |  | $ | 2,006 |  
|                              |  |                         |       |   |      |   |       |      |  |   |       |  



The estimated
amortization expense for mortgage servicing rights for the years ending December 31 is as follows: $420,000 in 2007, $420,000 in 2008, $420,000 in 2009, $420,000 in 2010, $420,000 in 2011, and $373,000 in 2012. The estimated amortization
expense is based on current information regarding loan payments and prepayments. Amortization expense could change in future periods based on changes in the volume of prepayments and economic factors.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4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:



|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|----------------------------------------- |  | -------------- | ------- | -------------------- | - | --------------------- |  | ------------------- | ----- |  | - | -------
|                                          |  | AmortizedCost  |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFair Value
|                                          |  | (in thousands)
|Available For Sale                        |  |                |         |                      |   |                       |  |                     |       |  |   |        
|December 31, 2006                         |  |                |         |                      |   |                       |  |                     |       |  |   |        
|U.S. Government agencies and corporations |  | $              | 74,342  |                      | $ | 112                   |  | $                   | 33    |  | $ | 74,421 
|Mortgage-backed securities                |  |                | 751     |                      |   | 8                     |  |                     |      |  |   | 759    
|State, county and municipal               |  |                | 36,240  |                      |   | 541                   |  |                     | 67    |  |   | 36,714 
|Other debt securities                     |  |                | 5,000   |                      |   |                      |  |                     |      |  |   | 5,000  
|Equity securities                         |  |                | 12,034  |                      |   | 17                    |  |                     |      |  |   | 12,051 
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|Total                                     |  | $              | 128,367 |                      | $ | 678                   |  | $                   | 100   |  | $ | 128,945
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|December 31, 2005                         |  |                |         |                      |   |                       |  |                     |       |  |   |        
|U.S. Government agencies and corporations |  | $              | 43,340  |                      | $ | 33                    |  | $                   | 627   |  | $ | 42,746 
|Mortgage-backed securities                |  |                | 28,903  |                      |   | 38                    |  |                     | 313   |  |   | 28,628 
|State, county and municipal               |  |                | 26,384  |                      |   | 550                   |  |                     | 47    |  |   | 26,887 
|Other debt securities                     |  |                | 5,126   |                      |   | 606                   |  |                     | 28    |  |   | 5,704  
|Equity securities                         |  |                | 6,940   |                      |   | 13                    |  |                     |      |  |   | 6,953  
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|Total                                     |  | $              | 110,693 |                      | $ | 1,240                 |  | $                   | 1,015 |  | $ | 110,918
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|Held to Maturity                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|December 31, 2006                         |  |                |         |                      |   |                       |  |                     |       |  |   |        
|U.S. Government agencies and corporations |  | $              | 16,610  |                      | $ |                      |  | $                   | 458   |  | $ | 16,152 
|Mortgage-backed securities                |  |                | 4,517   |                      |   | 22                    |  |                     | 67    |  |   | 4,472  
|State, county and municipal               |  |                | 20,743  |                      |   | 74                    |  |                     | 545   |  |   | 20,272 
|Other debt securities                     |  |                | 1,000   |                      |   |                      |  |                     | 31    |  |   | 969    
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|Total                                     |  | $              | 42,870  |                      | $ | 96                    |  | $                   | 1,101 |  | $ | 41,865 
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|December 31, 2005                         |  |                |         |                      |   |                       |  |                     |       |  |   |        
|U.S. Government agencies and corporations |  | $              | 20,737  |                      | $ |                      |  | $                   | 618   |  | $ | 20,119 
|Mortgage-backed securities                |  |                | 3,190   |                      |   |                      |  |                     | 74    |  |   | 3,116  
|State, county and municipal               |  |                | 22,961  |                      |   | 32                    |  |                     | 691   |  |   | 22,302 
|Other debt securities                     |  |                | 2,000   |                      |   |                      |  |                     | 29    |  |   | 1,971  
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        
|Total                                     |  | $              | 48,888  |                      | $ | 32                    |  | $                   | 1,412 |  | $ | 47,508 
|                                          |  |                |         |                      |   |                       |  |                     |       |  |   |        



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4INVESTMENT
SECURITIES(Continued)



The amortized cost
and estimated fair value of investment securities at December 31, 2006, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to prepay obligations with or without
prepayment penalties.



|                                       |  |                    |         |                     |   |               |  |                     |        |  |   |       
|-------------------------------------- |  | ------------------ | ------- | ------------------- | - | ------------- |  | ------------------- | ------ |  | - | ------
|                                       |  | Available For Sale |         | Held To Maturity   
|                                       |  | AmortizedCost      |         | EstimatedFair Value |   | AmortizedCost |  | Estimated FairValue
|                                       |  | (in thousands)    
|Due in one year or less                |  | $                  | 21,884  |                     | $ | 21,912        |  | $                   | 6,606  |  | $ | 6,540 
|Due after one year through five years  |  |                    | 62,973  |                     |   | 63,102        |  |                     | 18,554 |  |   | 17,916
|Due after five years through ten years |  |                    | 15,487  |                     |   | 15,836        |  |                     | 8,419  |  |   | 8,246 
|Due after ten years                    |  |                    | 15,238  |                     |   | 15,285        |  |                     | 4,774  |  |   | 4,691 
|                                       |  |                    |         |                     |   |               |  |                     |        |  |   |       
|Total                                  |  |                    | 115,582 |                     |   | 116,135       |  |                     | 38,353 |  |   | 37,393
|Mortgage-backed securities             |  |                    | 751     |                     |   | 759           |  |                     | 4,517  |  |   | 4,472 
|Equity securities                      |  |                    | 12,034  |                     |   | 12,051        |  |                     |       |  |   |      
|                                       |  |                    |         |                     |   |               |  |                     |        |  |   |       
|Total investment securities            |  | $                  | 128,367 |                     | $ | 128,945       |  | $                   | 42,870 |  | $ | 41,865
|                                       |  |                    |         |                     |   |               |  |                     |        |  |   |       



Debt securities with
an estimated fair value of $59.4 million at December 31, 2006 and $67.2 million at December 31, 2005 were pledged to secure public funds and trust funds on deposit. Debt securities with an estimated fair value of $31.0 million at
December 31, 2006 and $29.1 million at December 31, 2005 were pledged to secure retail repurchase agreements. There were no debt securities pledged to secure advances from the Federal Home Loan Bank at December 31, 2006 and debt
securities pledged with an estimated fair value of $24.6 million at December 31, 2005. Debt securities with an estimated fair value of and $3.8 million at December 31, 2006 and $8.1 million at December 31, 2005 were pledged for other
purposes.



Gross gains and losses recognized on the sale of
securities are summarized as follows:



|                                                            |  |                          |        |   |      |   |      |  |   |  
|----------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ---- |  | - | -
|                                                            |  | Years ended December 31,
|                                                            |  | 2006                     |        |   | 2005 |   | 2004
|                                                            |  | (in thousands)          
|Gains on sales of investment securities available for sale  |  | $                        | 839    |   |      | $ |     |  | $ | 
|Losses on sales of investment securities available for sale |  |                          | (1,398 | ) |      |   |     |  |   | 
|                                                            |  |                          |        |   |      |   |      |  |   |  
|Total securities gains (losses)                             |  | $                        | (559   | ) |      | $ |     |  | $ | 
|                                                            |  |                          |        |   |      |   |      |  |   |  



First National 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 December 31, 2006 and 2005, First National
Bank owned a total of $6.6 million and $6.0 million, respectively, of FHLB stock. Due to the redemption provisions of FHLB stock, the Corporation estimated that fair value was equal to cost and that this investment was not impaired at
December 31, 2006.



First National 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 First National 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



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4INVESTMENT
SECURITIES(Continued)



market value. At December 31, 2006 and 2005, First National Bank owned a total of $5.2 million and $1.0 million, respectively of FRB stock. Due to the
nature of this investment in an entity of the U. S. Government, the Corporation estimated that fair value was equal to cost and that this investment was not impaired at December 31, 2006.



Gross unrealized losses on investment securities and the estimated fair value
of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:



|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|----------------------------------------- |  | ------------------- | ------ | --------------------- | - | ------------------ |  | --------------------- | ------ | ------------------ | - | --------------------- |  | - | ------ |  | - | -----
|                                          |  | Less than 12 Months |        | 12 Months or More     |   | Total             
|                                          |  | EstimatedFairValue  |        | GrossUnrealizedLosses |   | EstimatedFairValue |  | GrossUnrealizedLosses |        | EstimatedFairValue |   | GrossUnrealizedLosses
|December 31, 2006                         |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Available For Sale                        |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|U.S. Government agencies and corporations |  | $                   | 27,459 |                       | $ | 28                 |  | $                     | 1,273  |                    | $ | 5                     |  | $ | 28,732 |  | $ | 33   
|State, county and municipal               |  |                     | 1,550  |                       |   | 10                 |  |                       | 5,525  |                    |   | 57                    |  |   | 7,075  |  |   | 67   
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Total                                     |  | $                   | 29,009 |                       | $ | 38                 |  | $                     | 6,798  |                    | $ | 62                    |  | $ | 35,807 |  | $ | 100  
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Held to Maturity                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|U.S. Government agencies and corporations |  | $                   |       |                       | $ |                   |  | $                     | 16,152 |                    | $ | 458                   |  | $ | 16,152 |  | $ | 458  
|Mortgage-backed securities                |  |                     |       |                       |   |                   |  |                       | 2,884  |                    |   | 67                    |  |   | 2,884  |  |   | 67   
|State, county and municipal               |  |                     |       |                       |   |                   |  |                       | 14,215 |                    |   | 545                   |  |   | 14,215 |  |   | 545  
|Other debt securities                     |  |                     |       |                       |   |                   |  |                       | 969    |                    |   | 31                    |  |   | 969    |  |   | 31   
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Total                                     |  | $                   |       |                       | $ |                   |  | $                     | 34,220 |                    | $ | 1,101                 |  | $ | 34,220 |  | $ | 1,101
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|December 31, 2005                         |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Available For Sale                        |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|U.S. Government agencies and corporations |  | $                   | 16,237 |                       | $ | 226                |  | $                     | 17,820 |                    | $ | 412                   |  | $ | 34,057 |  | $ | 638  
|Mortgage-backed securities                |  |                     | 20,841 |                       |   | 260                |  |                       | 1,225  |                    |   | 42                    |  |   | 22,066 |  |   | 302  
|State, county and municipal               |  |                     | 5,419  |                       |   | 47                 |  |                       |       |                    |   |                      |  |   | 5,419  |  |   | 47   
|Other debt securities                     |  |                     |       |                       |   |                   |  |                       | 972    |                    |   | 28                    |  |   | 972    |  |   | 28   
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Total                                     |  | $                   | 42,497 |                       | $ | 533                |  | $                     | 20,017 |                    | $ | 482                   |  | $ | 62,514 |  | $ | 1,015
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Held to Maturity                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|U.S. Government agencies and corporations |  | $                   | 459    |                       | $ | 8                  |  | $                     | 19,660 |                    | $ | 610                   |  | $ | 20,119 |  | $ | 618  
|Mortgage-backed securities                |  |                     | 2,686  |                       |   | 57                 |  |                       | 430    |                    |   | 17                    |  |   | 3,116  |  |   | 74   
|State, county and municipal               |  |                     | 6,349  |                       |   | 81                 |  |                       | 12,706 |                    |   | 610                   |  |   | 19,055 |  |   | 691  
|Other debt securities                     |  |                     | 976    |                       |   | 24                 |  |                       | 995    |                    |   | 5                     |  |   | 1,971  |  |   | 29   
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      
|Total                                     |  | $                   | 10,470 |                       | $ | 170                |  | $                     | 33,791 |                    | $ | 1,242                 |  | $ | 44,261 |  | $ | 1,412
|                                          |  |                     |        |                       |   |                    |  |                       |        |                    |   |                       |  |   |        |  |   |      



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4INVESTMENT
SECURITIES(Continued)



Information
concerning the status of investment securities with unrealized losses at December 31, 2006 is as follows:



Debt securities other than mortgage-backed securities.    97 debt securities other than mortgage-backed securities had
unrealized losses with aggregate depreciation of 1.7% from the amortized cost basis. The unrealized losses were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a
price less than the par value of the investment, adjusted for call premiums if appropriate. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Corporation has the ability and intent
to hold these investments until maturity or a market price recovery, these investments are not considered other-than-temporarily impaired.



Mortgage-backed securities.20 mortgage-backed securities had unrealized losses with aggregate depreciation of 2.3% from the amortized cost basis. The unrealized
losses were caused by interest rate increases. These securities were issued by reputable organizations and, for certain of these securities, the contractual cash flows are guaranteed by U.S Government agencies and corporations. It is expected that
the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Corporation has the ability and
intent to hold these investments until maturity or a market price recovery, these investments are not considered other-than-temporarily impaired.



NOTE 5LOANS



Major classifications of loans are as follows:



|                            |  |                |           |      |   |        
|--------------------------- |  | -------------- | --------- | ---- | - | -------
|                            |  | December 31   
|                            |  | 2006           |           | 2005
|                            |  | (in thousands)
|Commercial and agricultural |  | $              | 315,184   |      | $ | 176,286
|Real estateconstruction    |  |                | 278,124   |      |   | 142,096
|Real estatemortgage:       |  |                |           |      |   |        
|1-4 family residential      |  |                | 319,182   |      |   | 231,071
|Commercial and other        |  |                | 350,261   |      |   | 221,457
|Consumer                    |  |                | 39,089    |      |   | 24,141 
|                            |  |                |           |      |   |        
|Loans held for investment   |  |                | 1,301,840 |      |   | 795,051
|Loans held for sale         |  |                | 20,862    |      |   | 17,615 
|                            |  |                |           |      |   |        
|Gross loans                 |  | $              | 1,322,702 |      | $ | 812,666
|                            |  |                |           |      |   |        



Loans as presented are
reduced by net deferred loan fees of $1.8 million and $0.9 million at December 31, 2006 and 2005, respectively. Accruing loans past due 90 days or more amounted to $2.9 million at December 31, 2006 and $648,000 at December 31, 2005.
Nonaccrual loans amounted to $8.3 million at December 31, 2006 and $5.4 million at December 31, 2005. Interest income that would have been recorded on nonaccrual loans for the years ended December 31, 2006, 2005 and 2004, had they
performed in accordance with their original terms, amounted to approximately $1,174,000, $588,000 and $355,000, respectively. Interest income on all such loans included in the results of operations amounted to approximately $618,000 in 2006,
$307,000 in 2005 and $216,000 in 2004.



At December 31,
2006, the Corporation had impaired loans which totaled $9.3 million. Of the $9.3 million, $1.6 million had an allowance for loan losses of $388,000 and $7.7 million had no allowance for loan losses. At



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 5LOANS(Continued)



December 31, 2005, the Corporation had impaired loans which totaled $6.0 million, all of which had an allowance for loan losses which amounted to $1.1
million. The average carrying value of impaired loans was $7.7 million in 2006 and $5.6 million in 2005. Interest income recognized on impaired loans amounted to approximately $650,000 in 2006, $397,000 in 2005 and $334,000 in 2004.



Loans with outstanding balances of $3.4 million in 2006 and $1.0 million in
2005 were transferred from loans to other real estate acquired through foreclosure. Other real estate acquired through loan foreclosures amounted to $3.4 million at December 31, 2006 and $0.9 million at December 31, 2005 and is included in
other assets on the consolidated balance sheet.



Loans held for
investment are primarily made in the region of North Carolina that includes Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties. The real
estate loan portfolio can be affected by the condition of the local real estate markets.



Loans have been made by First National Bank to directors and executive officers of the Corporation and to the associates of such persons, as defined by the Securities and Exchange Commission. Such loans were made in
the ordinary course of business on substantially the same terms, including rate and collateral, as those prevailing at the time in comparable transactions with other borrowers and do not involve more than normal risk of collectibility. A summary of
the activity with respect to related party loans, based upon the related parties as determined in each year, is as follows:



|                             |  |                |         |   |      |   |         |  
|---------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                             |  | 2006           |         |   | 2005 |  
|                             |  | (in thousands) |        
|Balance at beginning of year |  | $              | 8,933   |   |      | $ | 2,137   |  
|New loans                    |  |                | 45,205  |   |      |   | 29,231  |  
|Repayments                   |  |                | (32,795 | ) |      |   | (22,435 | )
|                             |  |                |         |   |      |   |         |  
|Balance at end of year       |  | $              | 21,343  |   |      | $ | 8,933   |  
|                             |  |                |         |   |      |   |         |  



NOTE 6ALLOWANCE FOR LOAN LOSSES



Changes in the allowance for loan losses were as follows:



|                                           |  |                         |        |   |      |   |        |      |  |   |        |  
|------------------------------------------ |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                           |  | Years Ended December 31 |       
|                                           |  | 2006                    |        |   | 2005 |   |        | 2004 | 
|                                           |  | (in thousands)          |       
|Balance at beginning of year               |  | $                       | 9,945  |   |      | $ | 7,293  |      |  | $ | 6,172  |  
|Provision for losses charged to operations |  |                         | 2,526  |   |      |   | 2,842  |      |  |   | 4,030  |  
|Loans charged off                          |  |                         | (4,630 | ) |      |   | (2,616 | )    |  |   | (3,267 | )
|Recoveries on loans previously charged off |  |                         | 2,745  |   |      |   | 1,021  |      |  |   | 403    |  
|Acquired in purchase transactions          |  |                         | 6,038  |   |      |   | 1,405  |      |  |   |       |  
|Allowance adjustment for loans sold        |  |                         | (4     | ) |      |   |       |      |  |   | (45    | )
|                                           |  |                         |        |   |      |   |        |      |  |   |        |  
|Balance at end of year                     |  | $                       | 16,620 |   |      | $ | 9,945  |      |  | $ | 7,293  |  
|                                           |  |                         |        |   |      |   |        |      |  |   |        |  



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 7PREMISES AND EQUIPMENT



Premises and equipment are summarized as follows:



|                                               |  |                |        |      |   |       
|---------------------------------------------- |  | -------------- | ------ | ---- | - | ------
|                                               |  | December 31   
|                                               |  | 2006           |        | 2005
|                                               |  | (in thousands)
|Land                                           |  | $              | 12,240 |      | $ | 5,864 
|Buildings and improvements                     |  |                | 29,306 |      |   | 17,822
|Furniture and equipment                        |  |                | 21,338 |      |   | 16,654
|Leasehold improvements                         |  |                | 1,612  |      |   | 969   
|                                               |  |                |        |      |   |       
|Total                                          |  |                | 64,496 |      |   | 41,309
|Less accumulated depreciation and amortization |  |                | 18,805 |      |   | 16,639
|                                               |  |                |        |      |   |       
|Premises and equipment, net                    |  | $              | 45,691 |      | $ | 24,670
|                                               |  |                |        |      |   |       



NOTE 8INCOME TAXES



Income taxes as reported in the consolidated income statement included the following expense (benefit) components:



|                   |  |                |       |      |   |       |      |  |   |       |  
|------------------ |  | -------------- | ----- | ---- | - | ----- | ---- |  | - | ----- | -
|                   |  | 2006           |       | 2005 |   |       | 2004 | 
|                   |  | (in thousands) |      
|Current:           |  |                |       |      |   |       |      |  |   |       |  
|Federal            |  | $              | 4,618 |      | $ | 4,510 |      |  | $ | 2,046 |  
|State              |  |                | 922   |      |   | 826   |      |  |   | 290   |  
|                   |  |                |       |      |   |       |      |  |   |       |  
|Total              |  |                | 5,540 |      |   | 5,336 |      |  |   | 2,336 |  
|                   |  |                |       |      |   |       |      |  |   |       |  
|Deferred:          |  |                |       |      |   |       |      |  |   |       |  
|Federal            |  |                | 1,430 |      |   | (429  | )    |  |   | 2     |  
|State              |  |                | 305   |      |   | (73   | )    |  |   | (14   | )
|                   |  |                |       |      |   |       |      |  |   |       |  
|Total              |  |                | 1,735 |      |   | (502  | )    |  |   | (12   | )
|                   |  |                |       |      |   |       |      |  |   |       |  
|Total income taxes |  | $              | 7,275 |      | $ | 4,834 |      |  | $ | 2,324 |  
|                   |  |                |       |      |   |       |      |  |   |       |  



A reconciliation of
income tax expense computed at the statutory Federal income tax rate to actual income tax expense is presented below:



|                                                                                                |  |                |        |   |      |   |       |      |  |   |       |  
|----------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                |  | 2006           |        |   | 2005 |   |       | 2004 | 
|                                                                                                |  | (in thousands) |       
|Amount of tax computed using Federal statutory tax rate of 35% in 2006 and 2005 and 34% in 2004 |  | $              | 6,812  |   |      | $ | 5,170 |      |  | $ | 3,033 |  
|Increases (decreases) resulting from effects of:                                                |  |                |        |   |      |   |       |      |  |   |       |  
|Non-taxable income                                                                              |  |                | (1,099 | ) |      |   | (783  | )    |  |   | (811  | )
|State income taxes, net of federal benefit                                                      |  |                | 798    |   |      |   | 489   |      |  |   | 183   |  
|Other                                                                                           |  |                | 764    |   |      |   | (42   | )    |  |   | (81   | )
|                                                                                                |  |                |        |   |      |   |       |      |  |   |       |  
|Total                                                                                           |  | $              | 7,275  |   |      | $ | 4,834 |      |  | $ | 2,324 |  
|                                                                                                |  |                |        |   |      |   |       |      |  |   |       |  



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 8INCOME
TAXES(Continued)



The components of
deferred tax assets and liabilities and the tax effect of each are as follows:



|                                            |  |                |        |      |   |      
|------------------------------------------- |  | -------------- | ------ | ---- | - | -----
|                                            |  | December 31   
|                                            |  | 2006           |        | 2005
|                                            |  | (in thousands)
|Deferred tax assets:                        |  |                |        |      |   |      
|Allowance for loan losses                   |  | $              | 6,394  |      | $ | 3,712
|Compensation and benefit plans              |  |                | 2,460  |      |   | 2,114
|Fair value basis of loans                   |  |                | 2,469  |      |   | 517  
|Contract termination costs                  |  |                | 464    |      |   |     
|Pension and other post retirement benefits  |  |                | 603    |      |   |     
|Other                                       |  |                | 257    |      |   | 88   
|                                            |  |                |        |      |   |      
|Gross deferred tax assets                   |  |                | 12,647 |      |   | 6,431
|                                            |  |                |        |      |   |      
|Deferred tax liabilities:                   |  |                |        |      |   |      
|Core deposit intangible                     |  |                | 2,904  |      |   |     
|Mortgage servicing rights                   |  |                | 977    |      |   | 951  
|Prepaid pension cost                        |  |                |       |      |   | 925  
|Depreciable basis of premises and equipment |  |                | 1,232  |      |   | 724  
|Net deferred loan fees and costs            |  |                | 427    |      |   | 231  
|Net unrealized securities gains             |  |                | 227    |      |   | 89   
|Other                                       |  |                | 481    |      |   | 303  
|                                            |  |                |        |      |   |      
|Gross deferred tax liabilities              |  |                | 6,248  |      |   | 3,223
|                                            |  |                |        |      |   |      
|Net deferred tax asset                      |  | $              | 6,399  |      | $ | 3,208
|                                            |  |                |        |      |   |      



Changes in net
deferred tax asset were as follows:



|                                                                                            |  |                |        |   |      |   |      
|------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | -----
|                                                                                            |  | 2006           |        |   | 2005
|                                                                                            |  | (in thousands)
|Balance at beginning of year                                                                |  | $              | 3,208  |   |      | $ | 563  
|Purchase accounting acquisition:                                                            |  |                |        |   |      |   |      
|Integrity Financial Corporation                                                             |  |                | 3,896  |   |      |   | 1,536
|Income tax effect from change in unrealized losses (gains) on available-for-sale securities |  |                | (139   | ) |      |   | 607  
|Adoption of SFAS No. 158                                                                    |  |                | 1,169  |   |      |   |     
|Deferred income tax benefit (expense) on continuing operations                              |  |                | (1,735 | ) |      |   | 502  
|                                                                                            |  |                |        |   |      |   |      
|Balance at end of year                                                                      |  | $              | 6,399  |   |      | $ | 3,208
|                                                                                            |  |                |        |   |      |   |      



Under accounting
principles generally accepted in the United States of America, the Corporation is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve through 1987, the base year. Retained earnings at
December 31, 2006 includes approximately $2.7 million for which no provision for federal income tax has been made. These amounts represent allocations of income to bad debt deductions for tax purposes only. Reductions of such amounts for
purposes other than bad debt losses could create income for tax purposes in certain remote instances, which would then be subject to the then current corporate income tax rate.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 9TIME DEPOSITS



The scheduled maturities of time deposits at December 31, 2006 are as follows (in thousands):



|                         |  |   |        
|------------------------ |  | - | -------
|Years ending December 31 |  |  
|2007                     |  | $ | 713,711
|2008                     |  |   | 65,366 
|2009                     |  |   | 9,807  
|2010                     |  |   | 6,342  
|2011                     |  |   | 2,693  
|2012 and later years     |  |   | 801    
|                         |  |   |        
|Total time deposits      |  | $ | 798,720
|                         |  |   |        



Interest
expense on time deposits of $100,000 or more amounted to $14.1 million in 2006, $6.1 million in 2005 and $3.0 million in 2004.



NOTE 10BORROWED FUNDS



Retail Repurchase Agreements and Federal Funds Purchased



Funds are borrowed on an overnight basis through retail repurchase
agreements with bank customers and federal funds purchased from other financial institutions. Retail repurchase agreement borrowings are collateralized by securities of the U.S. Treasury and U.S. Government agencies and corporations.



Information concerning retail repurchase agreements and federal funds
purchased is as follows:



|                                |  |                            |        |   |                       |   |        |                            |  |   |                       |   |  |                            |       |   |                       |   |        |   |  |   |        |  
|------------------------------- |  | -------------------------- | ------ | - | --------------------- | - | ------ | -------------------------- |  | - | --------------------- | - |  | -------------------------- | ----- | - | --------------------- | - | ------ | - |  | - | ------ | -
|                                |  | 2006                       |        |   | 2005                  |   |        | 2004                       | 
|                                |  | RetailRepurchaseAgreements |        |   | FederalFundsPurchased |   |        | RetailRepurchaseAgreements |  |   | FederalFundsPurchased |   |  | RetailRepurchaseAgreements |       |   | FederalFundsPurchased |  
|                                |  | (dollars in thousands)     |       
|Balance at December 31          |  | $                          | 23,161 |   |                       | $ |       |                            |  | $ | 21,338                |   |  | $                          |      |   |                       | $ | 13,818 |   |  | $ | 8,175  |  
|Average balance during the year |  |                            | 21,134 |   |                       |   | 696    |                            |  |   | 17,770                |   |  |                            | 342   |   |                       |   | 15,890 |   |  |   | 4,181  |  
|Maximum month-end balance       |  |                            | 27,786 |   |                       |   | 20,000 |                            |  |   | 21,338                |   |  |                            | 2,625 |   |                       |   | 15,913 |   |  |   | 11,425 |  
|Weighted average interest rate: |  |                            |        |   |                       |   |        |                            |  |   |                       |   |  |                            |       |   |                       |   |        |   |  |   |        |  
|At December 31                  |  |                            | 4.67   | % |                       |   |       | %                          |  |   | 3.68                  | % |  |                            |      | % |                       |   | 1.90   | % |  |   | 2.57   | %
|During the year                 |  |                            | 4.37   |   |                       |   | 5.71   |                            |  |   | 2.83                  |   |  |                            | 2.53  |   |                       |   | 0.99   |   |  |   | 1.70   |  



Federal Home Loan
Bank (FHLB) Advances



First National Bank had a $235.7
million line of credit with the FHLB at December 31, 2006, secured by blanket collateral agreements on qualifying mortgage loans and, as required, by other qualifying collateral. At December 31, 2006, FHLB advances under these lines
amounted to $65.8 million and were at interest rates ranging from 2.88% to 6.15%. At December 31, 2005, FHLB advances amounted to $86.2 million and were at interest rates ranging from 2.16% to 5.92%.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 10BORROWED
FUNDS(Continued)



At December 31,
2006, the scheduled maturities of FHLB advances, certain of which are callable at the option of the FHLB before scheduled maturity, are as follows (in thousands):



|                         |  |   |       
|------------------------ |  | - | ------
|Years ending December 31 |  |  
|2007                     |  | $ | 3,750 
|2008                     |  |   | 1,500 
|2009                     |  |   | 13,500
|2010                     |  |   | 9,000 
|2011                     |  |   |      
|2012 and later years     |  |   | 38,075
|                         |  |   |       
|Total FHLB Advances      |  | $ | 65,825
|                         |  |   |       



First National Bank
has obtained irrevocable letters of credit from the FHLB amounting to $81.0 million at December 31, 2006. These letters of credit, which expire in 2014, 2015 and 2016, were issued in favor of the State of North Carolina to secure public funds
on deposit.



Junior Subordinated Deferrable Interest
Debentures



FNB United Corp. has Junior
Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) outstanding. Two issues of Junior Subordinated Debentures resulted from funds invested from the sale of trust preferred securities by FNB United Statutory Trust
I (FNB Trust I) and by FNB United Statutory Trust II (FNB Trust II), which are owned by FNB United Corp. Two additional issues of Junior Subordinated Debentures were acquired on April 28, 2006 as a result of the merger
with Integrity Financial Corporation. These acquired issues resulted from funds invested from the sale of trust preferred securities by Catawba Valley Capital Trust I (Catawba Trust I) and by Catawba Valley Capital Trust II
(Catawba Trust II), which are now owned by FNB United Corp.



FNB Corp. fully and unconditionally guarantees the preferred securities issued by each trust through the combined operation of the debentures and other related documents. Obligations under these guarantees are unsecured and subordinate to
senior and subordinated indebtedness of the Corporation. The preferred securities qualify as Tier 1 and Tier 2 capital for regulatory capital purposes.



Information concerning the Junior Subordinated Debentures at December 31, 2006 and 2005 is as follows:



|                                     |  |                    |            |                                      |            |                               |        |               |   |        |  |                                        
|------------------------------------ |  | ------------------ | ---------- | ------------------------------------ | ---------- | ----------------------------- | ------ | ------------- | - | ------ |  | ---------------------------------------
|Issuer                               |  | StatedMaturityDate |            | Commencementof EarlyRedemptionPeriod |            | Carrying Amount(in thousands) |        | Interest Rate
|                                     |  |                    |           
|                                     |  |                    | 12/31/2006 |                                      | 12/31/2005 |                              
|FNB Trust I                          |  | 12/15/2035         |            | 12/15/2010                           |            | $                             | 20,619 |               | $ | 20,619 |  | 3 month LIBOR + 1.37% 6.73% at 12/31/06
|FNB Trust II                         |  | 6/30/2036          |            | 6/30/2011                            |            |                               | 30,928 |               |   |       |  | 3 month LIBOR + 1.32% 6.68% at 12/31/06
|Catawba Trust I                      |  | 12/30/2032         |            | 12/30/2007                           |            |                               | 5,152  |               |   |       |  | 3 month LIBOR + 3.35% 8.71% at 12/31/06
|Catawba Trust II                     |  | 12/30/2032         |            | 12/30/2007                           |            |                               | 5,047  |               |   |       |  | 6.85% fixed rate                       
|                                     |  |                    |            |                                      |            |                               |        |               |   |        |  |                                        
|Total Junior Subordinated Debentures |  |                    |            |                                      |            | $                             | 61,746 |               | $ | 20,619 |  |                                        
|                                     |  |                    |            |                                      |            |                               |        |               |   |        |  |                                        



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 10BORROWED
FUNDS(Continued)



Other Borrowed Funds



Dover mortgage Company has a line of credit
totaling $20.0 million with an external financial institution, secured by a blanket collateral agreement on the mortgage loans and certain other assets of Dover and separately guaranteed by FNB United Corp. Interest is payable on a variable rate
basis and the line of credit is subject to annual renewal. At December 31, 2006, the balance outstanding on the line of credit was $16.3 million at a current interest rate of 6.99%. At December 31, 2005, the balance outstanding on the line
of credit was $15.9 million at a current interest rate of 6.15%.



NOTE 11EMPLOYEE BENEFIT PLANS



Pension Plan



The Corporation has a noncontributory defined benefit pension plan covering substantially all full-time employees who qualify as to age and length of
service. Benefits are based on the employees compensation, years of service and age at retirement. The Corporations funding policy is to contribute annually to the plan an amount which is not less than the minimum amount required by the
Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes.



In September 2006, the Board of Directors of the Corporation approved a modified freeze to the pension plan. Effective December 31, 2006, no new
employees are eligible to enter the plan. Participants who are at least age 40, have earned 10 years of vesting service as an employee of the the Corporation and remain an active employee as of December 31, 2006 will qualify for a
grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. Additionally, the plans definition of final average compensation will be improved
from a 10-year averaging period to a 5-year averaging period as of January 1, 2007. All other eligible participants in the plan will have their retirement benefit frozen as of December 31, 2006.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



The following table sets
forth the plans change in benefit obligation, plan assets and the funded status of the pension plan, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:



|                                                                |  |                        |        |   |      |   |        |  
|--------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | -
|                                                                |  | 2006                   |        |   | 2005 |  
|                                                                |  | (dollars in thousands) |       
|Change in Benefit Obligation:                                   |  |                        |        |   |      |   |        |  
|Benefit obligation at beginning of year                         |  | $                      | 11,548 |   |      | $ | 10,202 |  
|Service cost                                                    |  |                        | 835    |   |      |   | 614    |  
|Interest cost                                                   |  |                        | 656    |   |      |   | 604    |  
|Net actuarial loss                                              |  |                        | 238    |   |      |   | 525    |  
|Benefits paid                                                   |  |                        | (414   | ) |      |   | (397   | )
|Curtailment                                                     |  |                        | (1,916 | ) |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Benefit obligation at end of year                               |  | $                      | 10,947 |   |      | $ | 11,548 |  
|                                                                |  |                        |        |   |      |   |        |  
|Change in Plan Assets:                                          |  |                        |        |   |      |   |        |  
|Fair value of plan assets at beginning of year                  |  | $                      | 10,142 |   |      | $ | 9,384  |  
|Actual return on plan assets                                    |  |                        | 909    |   |      |   | 625    |  
|Employer contributions                                          |  |                        |       |   |      |   | 530    |  
|Benefits paid                                                   |  |                        | (414   | ) |      |   | (397   | )
|Other                                                           |  |                        |       |   |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Fair value of plan assets at December 31                        |  | $                      | 10,637 |   |      | $ | 10,142 |  
|                                                                |  |                        |        |   |      |   |        |  
|Funded Status at End of Year                                    |  | $                      | (310   | ) |      | $ | (1,406 | )
|Unrecognized net actuarial loss                                 |  |                        |       |   |      |   | 3,621  |  
|Unrecognized prior service cost                                 |  |                        |       |   |      |   | 129    |  
|                                                                |  |                        |        |   |      |   |        |  
|(Accrued) prepaid pension cost at December 31                   |  | $                      | (310   | ) |      | $ | 2,344  |  
|                                                                |  |                        |        |   |      |   |        |  
|Amounts Recognized in the Consolidated Statements of Condition: |  |                        |        |   |      |   |        |  
|Other Assets                                                    |  | $                      |       |   |      | $ | 2,344  |  
|Other Liabilities                                               |  |                        | (310   | ) |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|                                                                |  |                        | (310   | ) |      |   | 2,344  |  
|                                                                |  |                        |        |   |      |   |        |  
|Amounts Recognized in Accumulated Other Comprehensive Income:   |  |                        |        |   |      |   |        |  
|Net actuarial loss                                              |  | $                      | 1,049  |   |      | $ |       |  
|Prior service credit                                            |  |                        | 7      |   |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Net amount recognized                                           |  | $                      | 1,056  |   |      | $ |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Weighted-Average Allocation of Plan Assets at End of Year:      |  |                        |        |   |      |   |        |  
|Equity securities                                               |  |                        | 68     | % |      |   | 66     | %
|Debt securities                                                 |  |                        | 30     | % |      |   | 29     | %
|Cash and cash equivalents                                       |  |                        | 1      | % |      |   | 5      | %
|                                                                |  |                        |        |   |      |   |        |  
|Total                                                           |  |                        | 100    | % |      |   | 100    | %
|                                                                |  |                        |        |   |      |   |        |  
|Weighted-Average Plan Assumptions at End of Year:               |  |                        |        |   |      |   |        |  
|Discount rate                                                   |  |                        | 6.00   | % |      |   | 5.75   | %
|Expected long-term rate of return on plan assets                |  |                        | 9.00   |   |      |   | 9.00   |  
|Rate of increase in compensation levels                         |  |                        | 6.00   |   |      |   | 6.00   |  



66



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



The expected long-term
rate of return on plan assets considers the portfolio as a whole and not on the sum of the returns on individual asset categories. The return is based exclusively on historical returns, without adjustments.



Net periodic pension cost included the following components:



|                                          |  |                        |      |   |      |   |      |      |  |   |      |  
|----------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                          |  | 2006                   |      |   | 2005 |   |      | 2004 | 
|                                          |  | (dollars in thousands) |     
|Service cost                              |  | $                      | 835  |   |      | $ | 614  |      |  | $ | 567  |  
|Interest cost                             |  |                        | 656  |   |      |   | 604  |      |  |   | 576  |  
|Expected return on plan assets            |  |                        | (897 | ) |      |   | (851 | )    |  |   | (658 | )
|Amortization of prior service cost        |  |                        | 23   |   |      |   | 29   |      |  |   | 110  |  
|Amortization of net actuarial (gain)/loss |  |                        | 198  |   |      |   | 130  |      |  |   | 158  |  
|                                          |  |                        |      |   |      |   |      |      |  |   |      |  
|Net periodic pension cost                 |  |                        | 815  |   |      |   | 526  |      |  |   | 753  |  
|Effect of curtailment                     |  |                        | 93   |   |      |   |     |      |  |   |     |  
|                                          |  |                        |      |   |      |   |      |      |  |   |      |  
|Total pension cost                        |  | $                      | 908  |   |      | $ | 526  |      |  | $ | 753  |  
|                                          |  |                        |      |   |      |   |      |      |  |   |      |  



The estimated net loss
and prior service cost that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next year are approximately $64,000 and $4,000 respectively.



The Corporations investment policies and strategies for the pension
plan use a target allocation of 50% to 70% for equity securities and 30% to 50% for debt securities. The investment goals attempt to maximize returns while remaining within specific risk management policies. While the risk management policies permit
investment in specific debt and equity securities, a significant percentage of total plan assets is maintained in mutual funds, approximately 63% at December 31, 2006, to assist in investment diversification. Generally the investments are
readily marketable and can be sold to fund benefit payment obligations as they become payable.



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



The estimated benefit payments for each year ending December 31 from 2007 through 2011 are as follows: $399,000 in 2007, $466,000 in 2008, $545,000
in 2009, $571,000 in 2010 and $596,000 in 2011. The estimated benefit payments to be paid in the aggregate for the five year period from 2012 through 2016 are $3,670,000. The estimated benefit payments are based on the same assumptions used to
measure the benefit obligation at December 31, 2006 and include estimated future employee service.



Supplemental Executive Retirement Plan



The Corporation has a noncontributory, nonqualified supplemental executive retirement plan (the SERP) covering certain executive employees.
Annual benefits payable under the SERP are based on factors similar to those for the pension plan, with offsets related to amounts payable under the pension plan and social security benefits.



67



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



The following table sets
forth the plans change in benefit obligation, plan assets and the funded status of the SERP plan, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:



|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|--------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ---
|                                                                |  | 2006                   |        |   | 2005 |   |        |     
|                                                                |  | (dollars in thousands) |        |   |     
|Change in Benefit Obligation:                                   |  |                        |        |   |      |   |        |      |  |   |    
|Benefit obligation at beginning of year                         |  | $                      | 1,594  |   |      | $ | 1,197  |      |  |   |    
|Service cost                                                    |  |                        | 105    |   |      |   | 86     |      |  |   |    
|Interest cost                                                   |  |                        | 99     |   |      |   | 83     |      |  |   |    
|Amendments to plan                                              |  |                        | 363    |   |      |   |       |      |  |   |    
|Net actuarial loss                                              |  |                        | 109    |   |      |   | 250    |      |  |   |    
|Benefits paid                                                   |  |                        | (22    | ) |      |   | (22    | )    |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Benefit obligation at end of year                               |  | $                      | 2,248  |   |      | $ | 1,594  |      |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Change in Plan Assets:                                          |  |                        |        |   |      |   |        |      |  |   |    
|Fair value of plan assets at beginning of year                  |  | $                      |       |   |      | $ |       |      |  |   |    
|Actual return on plan assets                                    |  |                        |       |   |      |   |       |      |  |   |    
|Employer contributions                                          |  |                        | 22     |   |      |   | 22     |      |  |   |    
|Benefits paid                                                   |  |                        | (22    | ) |      |   | (22    | )    |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Fair value of plan assets at end of year                        |  | $                      |       |   |      | $ |       |      |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Funded Status at December 31                                    |  | $                      | (2,248 | ) |      | $ | (1,594 | )    |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Amounts Recognized in the Consolidated Statements of Condition: |  |                        |        |   |      |   |        |      |  |   |    
|Other Liabilities                                               |  | $                      | 2,248  |   |      | $ | 1,594  |      |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Amounts Recognized in Accumulated Other Comprehensive Income:   |  |                        |        |   |      |   |        |      |  |   |    
|Net actuarial loss                                              |  | $                      | 346    |   |      | $ |       |      |  |   |    
|Prior service credit                                            |  |                        | 239    |   |      |   |       |      |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Net amount recognized                                           |  | $                      | 585    |   |      | $ |       |      |  |   |    
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Weighted-Average Plan Assumption at End of Year:                |  |                        |        |   |      |   |        |      |  |   |    
|Discount rate                                                   |  |                        | 6.00   | % |      |   | 5.75   | %    |  |   |    
|                                                                |  |                        |       
|                                                                |  | 2006                   |        |   | 2005 |   |        | 2004
|                                                                |  | (dollars in thousands)
|Components of Net Periodic SERP Cost:                           |  |                        |        |   |      |   |        |      |  |   |    
|Service cost                                                    |  | $                      | 105    |   |      | $ | 86     |      |  | $ | 63 
|Interest cost                                                   |  |                        | 99     |   |      |   | 83     |      |  |   | 68 
|Expected return on plan assets                                  |  |                        |       |   |      |   |       |      |  |   |   
|Amortization of prior service cost                              |  |                        | 56     |   |      |   | 50     |      |  |   | 46 
|Amortization of net actuarial (gain)/loss                       |  |                        | 38     |   |      |   | 29     |      |  |   | 22 
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Net periodic SERP cost                                          |  |                        | 298    |   |      |   | 248    |      |  |   | 199
|Effect of special termination costs                             |  |                        | 174    |   |      |   |       |      |  |   |   
|                                                                |  |                        |        |   |      |   |        |      |  |   |    
|Total SERP cost                                                 |  | $                      | 472    |   |      | $ | 248    |      |  | $ | 199
|                                                                |  |                        |        |   |      |   |        |      |  |   |    



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



The estimated net loss
and prior service cost that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next year are approximately $28,000 and $72,000 respectively.



The SERP is an unfunded plan. Consequently, there are no plan assets or cash
contribution requirements other than for the direct payment of benefits.



The estimated benefit payments for each year ending December 31 from 2007 through 2011 are as follows: $39,000 in 2007, $72,000 in 2008, $72,000 in 2009, $71,000 in 2010 and $71,000 in 2011. The estimated benefit
payments to be paid in the aggregate for the five year period from 2012 through 2016 are $542,000. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2006 and include
estimated future employee service.



As a result of the merger
with Integrity, the Bank assumed the obligations of a non-qualifying deferred compensation plan for the former president of Integrity. Under the plan provisions, benefit payments began in 2006 and are payable for 10 years. During 2006, provisions of
$86,387 were expensed for future benefits to be provided under this plan. The total liability under this plan was $521,730 at December 31, 2006 and is included in other liabilities in the accompanying consolidated balance sheets. Payments
amounting to $46,512 were made under the provisions of the plan.



Other Postretirement Defined Benefit Plans



The Corporation has postretirement medical and life insurance plans covering substantially all full-time employees who qualify as to age and length of service. The medical plan is contributory, with retiree contributions adjusted whenever
medical insurance rates change. The life insurance plan is noncontributory.



In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees are eligible to enter the plan.
Participants who are at least age 40, have earned 10 years of vesting service as an employee of the Corporation and remain an active employee as of December 31, 2006 will qualify for a grandfathering provision. Under the grandfathering
provision, the participant will continue to accrue benefits under the plan through December 31, 2011.



69



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



The following table sets
forth the plans change in benefit obligation, plan assets and the funded status of the postretirement plans, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:



|                                                                |  |                        |        |   |      |   |        |  
|--------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | -
|                                                                |  | 2006                   |        |   | 2005 |  
|                                                                |  | (dollars in thousands) |       
|Change in Benefit Obligation:                                   |  |                        |        |   |      |   |        |  
|Benefit obligation at beginning of year                         |  | $                      | 1,531  |   |      | $ | 1,375  |  
|Service cost                                                    |  |                        | 67     |   |      |   | 66     |  
|Interest cost                                                   |  |                        | 82     |   |      |   | 80     |  
|Net actuarial (gain) loss                                       |  |                        | (110   | ) |      |   | 43     |  
|Plan participant contributions                                  |  |                        | 81     |   |      |   | 76     |  
|Benefits paid                                                   |  |                        | (87    | ) |      |   | (109   | )
|Curtailment                                                     |  |                        | (307   | ) |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Benefit obligation at end of year                               |  | $                      | 1,257  |   |      | $ | 1,531  |  
|                                                                |  |                        |        |   |      |   |        |  
|Change in Plan Assets:                                          |  |                        |        |   |      |   |        |  
|Fair value of plan assets at beginning of year                  |  | $                      |       |   |      | $ |       |  
|Actual return on plan assets                                    |  |                        |       |   |      |   |       |  
|Employer contributions                                          |  |                        | 6      |   |      |   | 33     |  
|Plan participant contributions                                  |  |                        | 81     |   |      |   | 76     |  
|Benefits paid                                                   |  |                        | (87    | ) |      |   | (109   | )
|                                                                |  |                        |        |   |      |   |        |  
|Fair value of plan assets at end of year                        |  | $                      |       |   |      | $ |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Funded Status at December 31                                    |  | $                      | (1,257 | ) |      | $ | (1,531 | )
|                                                                |  |                        |        |   |      |   |        |  
|Amounts Recognized in the Consolidated Statements of Condition: |  |                        |        |   |      |   |        |  
|Other Liabilities                                               |  | $                      | 1,257  |   |      | $ | 1,531  |  
|                                                                |  |                        |        |   |      |   |        |  
|Amounts Recognized in Accumulated Other Comprehensive Income:   |  |                        |        |   |      |   |        |  
|Net actuarial loss                                              |  | $                      | 180    |   |      | $ |       |  
|Prior service credit                                            |  |                        | (28    | ) |      |   |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Net amount recognized                                           |  | $                      | 152    |   |      | $ |       |  
|                                                                |  |                        |        |   |      |   |        |  
|Weighted-Average Plan Assumption at End of Year:                |  |                        |        |   |      |   |        |  
|Discount rate                                                   |  |                        | 6.00   | % |      |   | 5.75   | %



Increasing or
decreasing the assumed medical cost trend rate by one percentage point would not have a significant effect on either the postretirement benefit obligation at December 31, 2006 or the aggregate of the service and interest cost components of net
periodic postretirement benefit cost for the year ended December 31, 2006.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



Net periodic
postretirement benefit cost included the following components:



|                                          |  |                        |      |   |      |   |      |  |   |    
|----------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- |  | - | ---
|                                          |  | 2006                   |      |   | 2005 |   | 2004
|                                          |  | (dollars in thousands)
|Service cost                              |  | $                      | 67   |   |      | $ | 66   |  | $ | 60 
|Interest cost                             |  |                        | 82   |   |      |   | 80   |  |   | 78 
|Expected return on plan assets            |  |                        |     |   |      |   |     |  |   |    
|Amortization of prior service cost        |  |                        | (24  | ) |      |   | 10   |  |   | 10 
|Amortization of transition obligation     |  |                        |     |   |      |   | 20   |  |   | 20 
|Amortization of net actuarial (gain)/loss |  |                        | 35   |   |      |   | 6    |  |   | 8  
|                                          |  |                        |      |   |      |   |      |  |   |    
|Net periodic SERP cost                    |  |                        | 160  |   |      |   | 182  |  |   | 176
|Effect of curtailment                     |  |                        | (212 | ) |      |   |     |  |   |   
|                                          |  |                        |      |   |      |   |      |  |   |    
|Total postretirement benefit cost         |  | $                      | (52  | ) |      | $ | 182  |  | $ | 176
|                                          |  |                        |      |   |      |   |      |  |   |    



The estimated net loss
and prior service cost that will be amortized from accumulated other comprehensive income into net periodic postretirment benefit cost over the next year are approximately $17,000 and $5,000 respectively.



The postretirement medical and life insurance plans are unfunded plans.
Consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.



The estimated benefit payments for each year ending December 31 from 2007 through 2011 are as follows: $68,000 in 2007, $69,000 in 2008, $74,000 in
2009, $73,000 in 2010 and $75,000 in 2010. The estimated benefit payments to be paid in the aggregate for the five year period from 2012 through 2016 are $423,000. The estimated benefit payments are based on the same assumptions used to measure the
benefit obligation at December 31, 2006 and include estimated future employee service.



SFAS 158 amends several existing pronouncements that address employers accounting and reporting for defined benefit pension and other postretirement plans and represents the initial phase of a comprehensive
project on employers accounting for these plans. SFAS 158 requires an employer to recognize the overfunded or underfunded status of defined benefit pension and other postretirement plans, measured solely as the difference between the fair
value of plan assets and the benefit obligation, as an asset or liability on the balance sheet. Unrecognized actuarial gains and losses and unrecognized prior service costs, which have previously been recorded as part of the postretirement asset or
liability, are to be included as a component of accumulated other comprehensive income. Actuarial gains and losses and prior service costs and credits that arise during a period will be included in other comprehensive income to the extent they are
not included in net periodic pension cost (a component of salaries and employee benefits expense for the Corporation). The Corporation adopted SFAS 158 on its effective date of December 31, 2006. The following table summarizes the effect on
retirement benefit-related amounts reported in the consolidated statements of condition.



71



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11EMPLOYEE BENEFIT
PLANS(Continued)



|                                       |  |                |       |   |             |   |        |               |  |   |        |  
|-------------------------------------- |  | -------------- | ----- | - | ----------- | - | ------ | ------------- |  | - | ------ | -
|                                       |  | BeforeAdoption |       |   | Adjustments |   |        | AfterAdoption | 
|Other Assets:                          |  |                |       |   |             |   |        |               |  |   |        |  
|Prepaid pension cost                   |  | $              | 1,435 |   |             | $ | (1,435 | )             |  | $ |       |  
|Deferred tax asset                     |  |                | (566  | ) |             |   | 1,169  |               |  |   | 603    |  
|Other Liabilities:                     |  |                |       |   |             |   |        |               |  |   |        |  
|Benefit liability                      |  |                | 2,288 |   |             |   | 1,527  |               |  |   | 3,815  |  
|Shareholders Equity                   |  |                |       |   |             |   |        |               |  |   |        |  
|Accumulated other comprehensive income |  |                |      |   |             |   | (1,793 | )             |  |   | (1,793 | )



Matching
Retirement/Savings Plan



The Corporation has a matching
retirement/savings plan which permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. A portion of the employee contributions are matched by the Corporation based on the plan
formula. The matching contributions amounted to $642,000 in 2006, $379,000 in 2005 and $322,000 in 2004.



NOTE 12LEASES



Future obligations at December 31, 2006 for minimum rentals under noncancellable operating lease commitments, primarily
relating to premises, are as follows (in thousands):



|                             |  |   |       
|---------------------------- |  | - | ------
|Years ending December 31     |  |  
|2007                         |  | $ | 1,225 
|2008                         |  |   | 1,153 
|2009                         |  |   | 1,035 
|2010                         |  |   | 993   
|2011                         |  |   | 831   
|2012 and later years         |  |   | 9,613 
|                             |  |   |       
|Total minimum lease payments |  | $ | 14,850
|                             |  |   |       



Net rental expense for
all operating leases amounted to $1,149,000 in 2006, $472,000 in 2005 and $359,000 in 2004.



The Corporation leases a two-story regional and branch office building in Salisbury, North Carolina from a director. The lease is for a 15-year term expiring in 2021 with annual rentals of approximately $296,000 per
year. The lease may be extended for four consecutive five-year periods.



NOTE 13SUPPLEMENTARY INCOME STATEMENT INFORMATION



Significant components of other expense were as follows:



|                                  |  |                |       |      |   |      |  |   |    
|--------------------------------- |  | -------------- | ----- | ---- | - | ---- |  | - | ---
|                                  |  | 2006           |       | 2005 |   | 2004
|                                  |  | (in thousands)
|Professional fees                 |  | $              | 1,624 |      | $ | 742  |  | $ | 681
|Stationery, printing and supplies |  |                | 1,430 |      |   | 814  |  |   | 711
|Advertising and marketing         |  |                | 1,144 |      |   | 903  |  |   | 809



72



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 14FNB CORP. (PARENT COMPANY) FINANCIAL DATA



The Parent Companys principal asset is its investment in the subsidiary companies, and its principal source of income is dividends from those
subsidiaries.



The Parent Companys condensed balance
sheets as of December 31, 2006 and 2005, and the related condensed statements of income and cash flows for each of the years in the three-year period ended December 31, 2006 are as follows:



Condensed Balance Sheets



|                                           |  |  |  |                |         |      |   |        
|------------------------------------------ |  |  |  | -------------- | ------- | ---- | - | -------
|                                           |  |  |  | December 31   
|                                           |  |  |  | 2006           |         | 2005
|                                           |  |  |  | (in thousands)
|Assets:                                    |  |  |  |                |         |      |   |        
|Cash                                       |  |  |  | $              | 596     |      | $ | 1,413  
|Investment in subsidiaries                 |  |  |  |                | 264,302 |      |   | 121,130
|Other assets                               |  |  |  |                | 6,572   |      |   | 1,550  
|                                           |  |  |  |                |         |      |   |        
|Total Assets                               |  |  |  | $              | 271,470 |      | $ | 124,093
|                                           |  |  |  |                |         |      |   |        
|Liabilities and Shareholders Equity:      |  |  |  |                |         |      |   |        
|Accrued liabilities                        |  |  |  | $              | 2,056   |      | $ | 1,159  
|Borrowed funds                             |  |  |  |                | 61,746  |      |   | 20,619 
|Shareholders equity                       |  |  |  |                | 207,668 |      |   | 102,315
|                                           |  |  |  |                |         |      |   |        
|Total liabilities and shareholders equity |  |  |  | $              | 271,470 |      | $ | 124,093
|                                           |  |  |  |                |         |      |   |        



Condensed Statements of Income



|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|--------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                  |  | Years Ended December 31 |       
|                                                                                  |  | 2006                    |        |   | 2005 |   |       | 2004 | 
|                                                                                  |  | (in thousands)          |       
|Income:                                                                           |  |                         |        |   |      |   |       |      |  |   |       |  
|Dividends from subsidiaries                                                       |  | $                       | 5,930  |   |      | $ | 3,606 |      |  | $ | 4,140 |  
|Other income                                                                      |  |                         | 100    |   |      |   | 6     |      |  |   |      |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Total income                                                                      |  |                         | 6,030  |   |      |   | 3,612 |      |  |   | 4,140 |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Expenses:                                                                         |  |                         |        |   |      |   |       |      |  |   |       |  
|Interest                                                                          |  |                         | 3,393  |   |      |   | 632   |      |  |   | 352   |  
|Operating                                                                         |  |                         | 304    |   |      |   | 99    |      |  |   | 125   |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Total expenses                                                                    |  |                         | 3,697  |   |      |   | 731   |      |  |   | 477   |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Income before income taxes and equity in undistributed net income of subsidiaries |  |                         | 2,333  |   |      |   | 2,881 |      |  |   | 3,663 |  
|Income tax benefit                                                                |  |                         | (1,259 | ) |      |   | (254  | )    |  |   | (162  | )
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Income before equity in undistributed net income of subsidiaries                  |  |                         | 3,592  |   |      |   | 3,135 |      |  |   | 3,825 |  
|Equity in undistributed net income of subsidiaries                                |  |                         | 8,595  |   |      |   | 6,802 |      |  |   | 2,773 |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  
|Net income                                                                        |  | $                       | 12,187 |   |      | $ | 9,937 |      |  | $ | 6,598 |  
|                                                                                  |  |                         |        |   |      |   |       |      |  |   |       |  



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 14FNB CORP. (PARENT
COMPANY) FINANCIAL DATA(Continued)



Condensed Statements of Cash Flows



|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|--------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                  |  | Years Ended December 31 |        
|                                                                                  |  | 2006                    |         |   | 2005 |   |        | 2004 | 
|                                                                                  |  | (in thousands)          |        
|Operating Activities:                                                             |  |                         |         |   |      |   |        |      |  |   |        |  
|Net Income                                                                        |  | $                       | 12,187  |   |      | $ | 9,937  |      |  | $ | 6,598  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                         |         |   |      |   |        |      |  |   |        |  
|Equity in undistributed net income of subsidiaries                                |  |                         | (8,595  | ) |      |   | (6,802 | )    |  |   | (2,773 | )
|Other, net                                                                        |  |                         | (2,290  | ) |      |   | (211   | )    |  |   | 59     |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Net cash provided by operating activities                                         |  |                         | 1,302   |   |      |   | 2,924  |      |  |   | 3,884  |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Investing Activities:                                                             |  |                         |         |   |      |   |        |      |  |   |        |  
|Net cash paid in merger acquisition of subsidiary company                         |  |                         | (28,897 | ) |      |   | (8,685 | )    |  |   |       |  
|Other, net                                                                        |  |                         | 53      |   |      |   | 17     |      |  |   | 476    |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) investing activities                               |  |                         | (28,844 | ) |      |   | (8,668 | )    |  |   | 476    |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Financing activities:                                                             |  |                         |         |   |      |   |        |      |  |   |        |  
|Increase (decrease) in borrowed funds                                             |  |                         | 30,000  |   |      |   | 8,307  |      |  |   | 1,793  |  
|Common stock issued                                                               |  |                         | 2,117   |   |      |   | 804    |      |  |   | 791    |  
|Common stock repurchased                                                          |  |                         |        |   |      |   | (499   | )    |  |   | (2,830 | )
|Cash dividends paid                                                               |  |                         | (5,392  | ) |      |   | (3,370 | )    |  |   | (3,515 | )
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) financing activities                               |  |                         | 26,725  |   |      |   | 5,242  |      |  |   | (3,761 | )
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash                                                   |  |                         | (817    | ) |      |   | (502   | )    |  |   | 599    |  
|Cash at beginning of year                                                         |  |                         | 1,413   |   |      |   | 1,915  |      |  |   | 1,316  |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  
|Cash at end of year                                                               |  | $                       | 596     |   |      | $ | 1,413  |      |  | $ | 1,915  |  
|                                                                                  |  |                         |         |   |      |   |        |      |  |   |        |  



NOTE 15CAPITAL ADEQUACY REQUIREMENTS



Certain regulatory requirements restrict the lending of funds by First National Bank to FNB United Corp. and the amount of dividends which can be paid to
FNB United Corp. In 2007, the maximum amount of dividends First National Bank can pay to FNB United Corp., without the approval of the Comptroller of the Currency, is $16,685,000 plus an additional amount equal to the retained net income in 2007 up
to the date of any dividend declaration.



First National
Bank is required to maintain average reserve balances with the Federal Reserve Bank based on a percentage of deposits. For the reserve maintenance period in effect at December 31, 2006, the average daily reserve requirement was $3,897,000.



FNB United Corp. and First National Bank are required
to comply with capital adequacy standards established by the Board of Governors of the Federal Reserve System. In addition, First National Bank is required to comply with prompt corrective action provisions established by the Federal Deposit
Insurance Corporation Improvement Act. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, there are minimum ratios of capital to risk-weighted assets. The capital amounts and classifications are also subject
to qualitative judgments by the regulators about components, risk weightings, and other factors. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could
have a material effect on the consolidated financial statements.



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 15CAPITAL ADEQUACY
REQUIREMENTS(Continued)



Regulatory
capital amounts and ratios are set forth in the table below. 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 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 December 31, 2006, FNB United Corp. 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.



First National Bank is well-capitalized under the prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. To be categorized as well-capitalized, First National
Bank must meet minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below.



|                                          |  |                        |         |       |   |         |                            |       |      |                                                              |       |   |  |      |   |  |       |  
|----------------------------------------- |  | ---------------------- | ------- | ----- | - | ------- | -------------------------- | ----- | ---- | ------------------------------------------------------------ | ----- | - |  | ---- | - |  | ----- | -
|                                          |  |                        |         |       |   |         | Minimum Ratios             |      
|                                          |  | Capital Amount         |         | Ratio |   |         | ForCapitalAdequacyPurposes |       |      | To Be WellCapitalizedUnder PromptCorrectiveAction Provisions |      
|                                          |  | 2006                   |         | 2005  |   | 2006    |                            |       | 2005 |                                                              |       |  
|                                          |  | (dollars in thousands) |        
|As of December 31                         |  |                        |         |       |   |         |                            |       |      |                                                              |       |   |  |      |   |  |       |  
|Total capital (to risk-weighted assets):  |  |                        |         |       |   |         |                            |       |      |                                                              |       |   |  |      |   |  |       |  
|FNB United Corp.                          |  | $                      | 166,442 |       | $ | 100,182 |                            | 11.53 | %    |                                                              | 11.46 | % |  | 8.00 | % |  | N/A   |  
|First National Bank                       |  |                        | 161,592 |       |   | 96,773  |                            | 11.30 |      |                                                              | 11.20 |   |  | 8.00 |   |  | 10.00 | %
|Tier 1 capital (to risk-weighted assets): |  |                        |         |       |   |         |                            |       |      |                                                              |       |   |  |      |   |  |       |  
|FNB United Corp.                          |  |                        | 120,705 |       |   | 89,231  |                            | 8.36  |      |                                                              | 10.21 |   |  | 4.00 |   |  | N/A   |  
|First National Bank                       |  |                        | 144,965 |       |   | 86,070  |                            | 10.14 |      |                                                              | 9.96  |   |  | 4.00 |   |  | 6.00  | %
|Tier 1 capital (to average assets):       |  |                        |         |       |   |         |                            |       |      |                                                              |       |   |  |      |   |  |       |  
|FNB United Corp.                          |  |                        | 120,705 |       |   | 89,231  |                            | 7.16  |      |                                                              | 8.81  |   |  | 4.00 |   |  | N/A   |  
|First National Bank                       |  |                        | 144,965 |       |   | 86,070  |                            | 8.72  |      |                                                              | 8.26  |   |  | 4.00 |   |  | 5.00  | %



NOTE 16SHAREHOLDERS EQUITY



Stock Buyback Program



There was no stock buyback program in effect at December 31, 2006. Under prior stock buyback programs authorized by the Board of Directors for the repurchase of shares of common stock, the Corporation repurchased 24,800 shares
in 2005 and 66,303 shares in 2004.



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



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16SHAREHOLDERS
EQUITY(CONTINUED)



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:



|                                                                           |  |           |  |           |  |          
|-------------------------------------------------------------------------- |  | --------- |  | --------- |  | ---------
|                                                                           |  | 2006      |  | 2005      |  | 2004     
|Basic EPS denominatorWeighted average number of common shares outstanding |  | 9,619,870 |  | 5,731,966 |  | 5,663,173
|Dilutive share effect arising from potential common stock issuances        |  | 95,715    |  | 137,057   |  | 158,874  
|                                                                           |  |           |  |           |  |          
|Diluted EPS denominator                                                    |  | 9,715,585 |  | 5,869,023 |  | 5,822,047
|                                                                           |  |           |  |           |  |          



For the years 2006,
2005 and 2004, there were 271,069, 236,730 and 175,400 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 years.



Stock-Based Compensation



Effective January 1, 2006, the Corporation adopted
Statement of Financial Accounting Standards No. 123R (revised 2004), Share-Based Payment, (SFAS 123R) which was issued by the FASB in December 2004. SFAS No. 123R revises FASB Statement No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition
of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS
No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95, Statement of Cash Flows, to
require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.



The Corporation adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period
amounts have not been restated. Under this application, compensation expense is required to be recorded for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date
of adoption.



Prior to the adoption of SFAS No. 123R, the
Corporation used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the common stock on the date of grant.



As of December 31, 2006, the Corporation had six share-based
compensation plans in effect. The compensation expense charged against income for those plans in 2006 was $673,000 and the related income tax benefit was $92,000.



The Corporation adopted stock compensation plans in 1993 and 2003 that allow for the granting of incentive and nonqualified
stock options to key employees and directors. The 2003 stock compensation plan also allows for the granting of restricted stock. Under terms of both the 1993 and 2003 plans, options are granted at prices equal to the fair market value of the common
stock on the date of grant. Options become exercisable after one



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16SHAREHOLDERS
EQUITY(Continued)



year in equal, cumulative installments over a five-year period. No option shall expire later than ten years from the date of grant. No further grants can be
made under the 1993 stock compensation plan after March 10, 2003. Based on the stock options outstanding at December 31, 2006, a maximum of 345,555 shares of common stock has been reserved for issuance under the 1993 stock compensation
plan. A maximum of 419,375 shares of common stock has been reserved for issuance under the 2003 stock compensation plan. At December 31 2006, there were 40,000 shares available under the 2003 plan for the granting of additional options or stock
awards.



The Corporation assumed a stock compensation plan in
its merger acquisition of Carolina Fincorp in 2000. One grant of qualified and nonqualified stock options was made under the plan in 1999 to key employees and directors at a price equal to fair market value on the date of grant. No additional grants
will be made under the plan. Based on the stock options outstanding at December 31, 2006, a maximum of 39,408 shares of common stock has been reserved for issuance under the stock compensation plan.



The Corporation assumed three stock compensation plans in its merger
acquisition of Integrity Financial Corporation on April 28, 2006. Qualified and nonqualified stock options are outstanding under these plans for grants issued from 1997 to 2004 to key employees and directors at a price equal to fair market
value on the date of grant. No additional grants will be made under these plans. Based on the stock options outstanding at December 31, 2006, a maximum of 164,416 shares of common stock has been reserved for issuance under these stock
compensation plans.



The fair market value of each option award
is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based on
the historical volatility of the Corporations common stock over approximately the previous 6 years. The expected life of the options has historically been considered to be approximately 6 years. The expected dividend yield is based upon the
current yield in effect at the date of grant. Forfeitures are estimated at a 3.00% rate, adjusted to 1.75% for 5-year vesting.



The weighted-average fair value per share of options granted in 2006, 2005 and 2004 amounted to $4.93, $5.04 and $5.64, respectively. Fair values were
estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                        |  |         |   |  |         |   |  |         |  
|----------------------- |  | ------- | - |  | ------- | - |  | ------- | -
|                        |  | 2006    |   |  | 2005    |   |  | 2004    |  
|Risk-free interest rate |  | 4.73    | % |  | 4.40    | % |  | 3.80    | %
|Dividend yield          |  | 3.25    |   |  | 2.75    |   |  | 2.75    |  
|Volatility              |  | 31.00   |   |  | 31.00   |   |  | 33.05   |  
|Expected life           |  | 6 years |   |  | 6 years |   |  | 6 years |  



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16SHAREHOLDERS
EQUITY(Continued)



The following is a
summary of stock option activity:



|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|-------------------------------------------------------- |  | ----------------------- | -------- | ---- | ---------------------------- | ---- | ------ |  | - | ---------------------------- | - | ------ | - | ----- | ---------------------------- | - | ------- | - |  | - | -----
|                                                         |  | Years Ended December 31
|                                                         |  | 2006                    |          | 2005 |                              | 2004
|                                                         |  | Shares                  |          |      | WeightedAverageExercisePrice |      | Shares |  |   | WeightedAverageExercisePrice |   | Shares |   |       | WeightedAverageExercisePrice
|Outstanding at beginning of year                         |  |                         | 768,963  |      |                              | $    | 14.72  |  |   | 841,822                      |   |        | $ | 16.27 |                              |   | 765,345 |   |  | $ | 15.11
|Granted                                                  |  |                         | 16,000   |      |                              |      | 18.31  |  |   | 11,000                       |   |        |   | 17.97 |                              |   | 161,000 |   |  |   | 19.79
|Assumed in merger                                        |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Acquisition                                              |  |                         | 325,384  |      |                              |      | 9.44   |  |   |                             |   |        |   |      |                              |   |        |   |  |   |     
|Exercised                                                |  |                         | (214,502 | )    |                              |      | 9.87   |  |   | (61,559                      | ) |        |   | 12.12 |                              |   | (66,303 | ) |  |   | 10.47
|Forfeited                                                |  |                         | (20,966  | )    |                              |      | 15.75  |  |   | (22,300                      | ) |        |   | 19.24 |                              |   | (18,220 | ) |  |   | 19.61
|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Outstanding at end of year                               |  |                         | 874,879  |      |                              |      | 15.59  |  |   | 768,963                      |   |        |   | 16.54 |                              |   | 841,822 |   |  |   | 16.27
|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Options exercisable at end of year                       |  |                         | 650,020  |      |                              |      | 14.36  |  |   | 483,763                      |   |        |   | 14.72 |                              |   | 418,852 |   |  |   | 13.65
|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Aggregate intrinsic value at end of year (in thousands): |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Options outstanding                                      |  | $                       | 2,406    |      |                              |      |        |  | $ | 1,892                        |   |        |   |       |                              | $ | 2,416   |   |  |   |      
|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      
|Options exercisable                                      |  | $                       | 2,587    |      |                              |      |        |  | $ | 2,071                        |   |        |   |       |                              | $ | 2,299   |   |  |   |      
|                                                         |  |                         |          |      |                              |      |        |  |   |                              |   |        |   |       |                              |   |         |   |  |   |      



At December 31,
2006, information concerning stock options outstanding and exercisable is as follows:



|                        |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      
|----------------------- |  | ------------------- |  | ----------------------------------------------- |  | ---------------------------- | ----- | ----------------- | ------- | ---------------------------- | - | -----
|                        |  | Options Outstanding |  | Options Exercisable                            
|Range ofExercise Prices |  | Shares              |  | WeightedAverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |       | NumberExercisable |         | WeightedAverageExercisePrice
|$ 5.29  9.97           |  | 136,065             |  | 2.02                                            |  | $                            | 9.07  |                   | 136,065 |                              | $ | 9.07 
|10.00  14.20           |  | 265,544             |  | 4.14                                            |  |                              | 12.31 |                   | 244,285 |                              |   | 12.17
|15.00  19.82           |  | 321,670             |  | 6.94                                            |  |                              | 18.02 |                   | 177,470 |                              |   | 17.41
|20.00  27.00           |  | 151,600             |  | 6.87                                            |  |                              | 22.03 |                   | 92,200  |                              |   | 22.09
|                        |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      
|                        |  | 874,879             |  | 5.31                                            |  |                              | 15.59 |                   | 650,020 |                              |   | 14.36
|                        |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      



In 2006, 2005 and
2004, the intrinsic value of options exercised was $1,558,00, $447,000 and $641,000, respectively, and the grant-date fair value of options vested was $482,000, $369,000 and $603,000, respectively.



The cash proceeds from options exercised in 2006 amounted to $2,117,000 and
the related tax benefit recorded in shareholders equity for the tax deduction realized from these exercised options amounted to $279,000.



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16SHAREHOLDERS
EQUITY(Continued)



The following is a
summary of non-vested restricted stock activity for the year ended December 31, 2006:



|                                |  |        |   |  |                                     |      
|------------------------------- |  | ------ | - |  | ----------------------------------- | -----
|                                |  | Shares |   |  | WeightedAverageGrant DateFair Value
|Non-vested at December 31, 2005 |  |       |   |  | $                                   |     
|Granted                         |  | 55,875 |   |  |                                     | 18.30
|Vested                          |  |       |   |  |                                     |     
|Forfeited                       |  | (2,000 | ) |  |                                     | 18.26
|                                |  |        |   |  |                                     |      
|Non-vested at December 31, 2006 |  | 53,875 |   |  |                                     | 18.30
|                                |  |        |   |  |                                     |      



Restricted stock was
first granted by the Corporation during the three months ended September 30, 2006. Accordingly, based on the vesting schedule, there is no fair value information to be reported for restricted stock that has vested.



As of December 31, 2006, there was $1,979,000 of total unrecognized
compensation cost related to non-vested share-based compensation arrangements granted under all of the Corporations stock benefit plans. That cost is expected to be recognized over a weighted-average period of 2.6 years.



The Corporation funds the option shares and restricted stock from authorized
but unissued shares. The Corporation does not typically purchase shares to fulfill the obligations of the stock benefit plans. Corporation policy does allow option holders under certain plans to exercise options with seasoned shares.



NOTE
17COMMITMENTS



In the normal course of
business, various commitments are outstanding that are not reflected in the consolidated financial statements. Significant commitments at December 31, 2006 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 December 31, 2006, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $303.5 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 $6.6 million at December 31, 2006 and $7.8 million at December 31, 2005. Due to insignificance, the Corporation has recorded no liability at December 31, 2006 for the current carrying amount of the obligation to perform
as a guarantor.



Dover Mortgage Company originates certain
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 residential



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 17COMMITMENTS(Continued)



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 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 residential mortgage loans totaled $19.3 million at December 31, 2006, and the related forward sales commitments totaled $19.3 million. Loans held for sale by Dover
Mortgage Company totaled $16.3 million at December 31, 2006, and the related forward sales commitments totaled $16.3 million.



First National Bank had loans held for sale of $4.6 million at December 31, 2006. Binding commitments of First National Bank for the origination of
mortgage loans intended to be held for sale at December 31, 2006 were not material.



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



NOTE 18FAIR VALUE OF FINANCIAL
INSTRUMENTS



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



Cash and Cash Equivalents.    For cash on hand, amounts due from banks, and federal funds sold, the carrying value is considered to be a reasonable estimate of fair value.



Investment
Securities.    The fair value of investment securities is based on quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar
securities.



Loans.    The fair value of 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.



Bank Owned Life
Insurance.    The carrying value of life insurance is considered to approximate fair value because this investment is carried at cash surrender value, as determined by the insurer.



Deposits.    The fair value of
demand, savings and money market deposits is the amount 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 amount of accrued interest is considered to approximate fair value.



Commitments.    The fair value of commitments to extend credit is considered to approximate carrying value, since
the large majority of these commitments would result in loans that have variable rates and/or relatively short



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##### Table of Contents

FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 18FAIR VALUE
OF FINANCIAL INSTRUMENTS(Continued)



terms to maturity or sale. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair
value. The various commitment items are disclosed in Note 17.



The estimated fair values of financial instruments are as follows:



|                                |  |                   |           |                     |   |               |  |                     |         |  |   |        
|------------------------------- |  | ----------------- | --------- | ------------------- | - | ------------- |  | ------------------- | ------- |  | - | -------
|                                |  | December 31, 2006 |           | December 31, 2005  
|                                |  | CarryingValue     |           | EstimatedFair Value |   | CarryingValue |  | EstimatedFair Value
|                                |  | (in thousands)   
|Financial Assets                |  |                   |           |                     |   |               |  |                     |         |  |   |        
|Cash and cash equivalents       |  | $                 | 108,340   |                     | $ | 108,340       |  | $                   | 44,879  |  | $ | 44,879 
|Investment securities:          |  |                   |           |                     |   |               |  |                     |        |  |   |       
|Available for sale              |  |                   | 128,945   |                     |   | 128,945       |  |                     | 110,693 |  |   | 110,918
|Held to maturity                |  |                   | 42,870    |                     |   | 41,865        |  |                     | 48,888  |  |   | 47,508 
|Net loans                       |  |                   | 1,306,082 |                     |   | 1,367,333     |  |                     | 802,721 |  |   | 796,202
|Accrued interest receivable     |  |                   | 8,718     |                     |   | 8,718         |  |                     | 5,003   |  |   | 5,003  
|Bank owned life insurance       |  |                   | 28,303    |                     |   | 28,303        |  |                     | 17,334  |  |   | 17,334 
|                                |  |                   |           |                    
|Financial Liabilities           |  |                   |           |                     |   |               |  |                     |         |  |   |        
|Deposits                        |  |                   | 1,421,013 |                     |   | 1,420,480     |  |                     | 841,609 |  |   | 843,945
|Retail repurchase agreements    |  |                   | 23,161    |                     |   | 23,155        |  |                     | 21,338  |  |   | 21,338 
|Federal Home Loan Bank advances |  |                   | 65,825    |                     |   | 62,805        |  |                     | 86,225  |  |   | 84,512 
|Other borrowed funds            |  |                   | 78,032    |                     |   | 78,032        |  |                     | 39,004  |  |   | 39,004 
|Accrued interest payable        |  |                   | 4,593     |                     |   | 4,593         |  |                     | 2,280   |  |   | 2,280  



The fair value
estimates are made at a specific point in time based on relevant market and other information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the
Corporations entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be considered in an actual sale considered. Because no market exists for a significant portion of the Corporations
financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and such other factors. These estimates are subjective
in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization
of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.



81



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 19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 on trust preferred securities, and eliminations of intersegment transactions.



|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|----------------------------------------------------- |  | ---------------------------- | --------- | -------------------- | - | ------ | ----- |  | - | ------ | - |  | - | ---------
|                                                      |  | Year Ended December 31, 2006
|                                                      |  | FirstNationalBank            |           | DoverMortgageCompany |   |        | Other |  |   | Total 
|                                                      |  | (in thousands)              
|Interest Income                                       |  | $                            | 102,461   |                      | $ | 907    |       |  | $ | 1      |   |  | $ | 103,369  
|Interest Expense                                      |  |                              | 42,952    |                      |   | 812    |       |  |   | 3,391  |   |  |   | 47,155   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Net interest income                                   |  |                              | 59,509    |                      |   | 95     |       |  |   | (3,390 | ) |  |   | 56,214   
|Provision for credit losses                           |  |                              | 2,526     |                      |   |       |       |  |   |       |   |  |   | 2,526    
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Net interest income after provision for credit losses |  |                              | 56,983    |                      |   | 95     |       |  |   | (3,392 | ) |  |   | 53,688   
|Noninterest income                                    |  |                              | 15,272    |                      |   | 3,727  |       |  |   | 216    |   |  |   | 19,215   
|Noninterest expense                                   |  |                              | 47,914    |                      |   | 5,080  |       |  |   | 447    |   |  |   | 53,441   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Income (loss) before income taxes                     |  |                              | 24,341    |                      |   | (1,258 | )     |  |   | (3,623 | ) |  |   | 19,462   
|Income taxes (benefit)                                |  |                              | 8,365     |                      |   | 177    |       |  |   | (1,267 | ) |  |   | 7,275    
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Net income (loss)                                     |  | $                            | 15,976    |                      | $ | (1,435 | )     |  | $ | (2,356 | ) |  | $ | 12,187   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Total assets                                          |  | $                            | 1,791,507 |                      | $ | 21,339 |       |  | $ | 2,059  |   |  | $ | 1,814,905
|Net loans                                             |  |                              | 1,289,792 |                      |   | 16,290 |       |  |   |       |   |  |   | 1,306,082
|Goodwill                                              |  |                              | 108,797   |                      |   | 2,159  |       |  |   |       |   |  |   | 110,956  
|                                                      | 
|                                                      |  | Year Ended December 31, 2005
|                                                      |  | FirstNationalBank            |           | DoverMortgageCompany |   |        | Other |  |   | Total 
|                                                      |  | (in thousands)              
|Interest Income                                       |  | $                            | 53,439    |                      | $ | 971    |       |  | $ | 5      |   |  | $ | 54,415   
|Interest Expense                                      |  |                              | 18,623    |                      |   | 796    |       |  |   | 631    |   |  |   | 20,050   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Net interest income                                   |  |                              | 34,816    |                      |   | 175    |       |  |   | (626   | ) |  |   | 34,365   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Provision for credit losses                           |  |                              | 2,842     |                      |   |       |       |  |   |       |   |  |   | 2,842    
|Net interest income after provision for credit losses |  |                              | 31,974    |                      |   | 175    |       |  |   | (626   | ) |  |   | 31,523   
|Noninterest income                                    |  |                              | 11,196    |                      |   | 3,780  |       |  |   | (50    | ) |  |   | 14,926   
|Noninterest expense                                   |  |                              | 27,740    |                      |   | 3,911  |       |  |   | 27     |   |  |   | 31,678   
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Income (loss) before income taxes                     |  |                              | 15,430    |                      |   | 44     |       |  |   | (703   | ) |  |   | 14,771   
|Income taxes (benefit)                                |  |                              | 5,057     |                      |   | 22     |       |  |   | (245   | ) |  |   | 4,834    
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Net income (loss)                                     |  | $                            | 10,373    |                      | $ | 22     |       |  | $ | (458   | ) |  | $ | 9,937    
|                                                      |  |                              |           |                      |   |        |       |  |   |        |   |  |   |          
|Total assets                                          |  | $                            | 1,078,367 |                      | $ | 22,554 |       |  | $ | 1,164  |   |  | $ | 1,102,085
|Net loans                                             |  |                              | 786,439   |                      |   | 16,282 |       |  |   |       |   |  |   | 802,721  
|Goodwill                                              |  |                              | 27,605    |                      |   | 3,776  |       |  |   |       |   |  |   | 31,381   



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FNB UNITED CORP. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 19BUSINESS SEGMENT
INFORMATION(Continued)



|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|----------------------------------------------------- |  | ---------------------------- | ------- | -------------------- | - | ------ | ----- |  | - | ----- | - |  | - | -------
|                                                      | 
|                                                      |  | Year Ended December 31, 2004
|                                                      |  | FirstNationalBank            |         | DoverMortgageCompany |   |        | Other |  |   | Total
|                                                      |  | (in thousands)              
|Interest Income                                       |  | $                            | 39,835  |                      | $ | 601    |       |  | $ |      |   |  | $ | 40,436 
|Interest Expense                                      |  |                              | 11,749  |                      |   | 301    |       |  |   | 352   |   |  |   | 12,402 
|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|Net interest income                                   |  |                              | 28,086  |                      |   | 300    |       |  |   | (352  | ) |  |   | 28,034 
|Provision for credit losses                           |  |                              | 4,030   |                      |   |       |       |  |   |      |   |  |   | 4,030  
|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|Net interest income after provision for credit losses |  |                              | 24,056  |                      |   | 300    |       |  |   | (352  | ) |  |   | 24,004 
|Noninterest income                                    |  |                              | 10,781  |                      |   | 3,058  |       |  |   | (166  | ) |  |   | 13,673 
|Noninterest expense                                   |  |                              | 25,209  |                      |   | 3,587  |       |  |   | (41   | ) |  |   | 28,755 
|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|Income (loss) before income taxes                     |  |                              | 9,628   |                      |   | (229   | )     |  |   | (477  | ) |  |   | 8,922  
|Income taxes (benefit)                                |  |                              | 2,562   |                      |   | (76    | )     |  |   | (162  | ) |  |   | 2,324  
|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|Net income (loss)                                     |  | $                            | 7,066   |                      | $ | (153   | )     |  | $ | (315  | ) |  | $ | 6,598  
|                                                      |  |                              |         |                      |   |        |       |  |   |       |   |  |   |        
|Total assets                                          |  | $                            | 845,402 |                      | $ | 17,174 |       |  | $ | 315   |   |  | $ | 862,891
|Net loans                                             |  |                              | 646,542 |                      |   | 10,919 |       |  |   |      |   |  |   | 657,461
|Goodwill                                              |  |                              | 12,583  |                      |   | 3,752  |       |  |   |      |   |  |   | 16,335 



83



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CONTROLS AND PROCEDURES



As of December 31, 2006, 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 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, except for 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 quarterly period ended December 31, 2006, the
Corporations management learned that FNB United did not maintain effective internal control over financial reporting. Specifically, FNB United 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. These events necessitated the restatement of FNB Uniteds Consolidated Financial Statements and other financial information for the three and nine months
ended September 30, 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.



The annual report of management on the
effectiveness of internal control over financial reporting and the attestation report thereon issued by the Corporations independent registered public accounting firm are set forth below under Managements Report on Internal Control
Over Financial Reporting and Report of Independent Registered Public Accounting Firm.



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MANAGEMENTS ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING



Management of FNB United Corp. (the Corporation) is responsible
for preparing the Corporations annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting for the Corporation. Management has evaluated the effectiveness of the
Corporations internal control over financial reporting, including controls over the preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C), as
of December 31, 2006 based on criteria established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.



A material weakness is a control deficiency, or combination of control
deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statement will not be prevented or detected. As of December 31, 2006, the Corporation 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. This control deficiency resulted in the restatement of the Corporations interim consolidated
financial statements for the third quarter of 2006. Because of this material weakness, management has concluded that the Corporation did not maintain effective internal control over financial reporting as of December 31, 2006 based on criteria
established in Internal ControlIntegrated Framework issued by the COSO.



Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that
involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of
such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



Management has excluded certain controls of Integrity Financial Corporation, which was acquired by the Corporation on April 28, 2006, from its
assessment. While many of the internal controls over financial reporting applicable to Integrity were integrated with those of the Corporation as of December 31, 2006, and therefore included in managements assessment, the controls
regarding the Integrity branch locations had not yet been integrated as of December 31, 2006.



Dixon Hughes PLLC, an independent, registered public accounting firm, has audited the Corporations consolidated financial statements as of and for
the year ended December 31, 2006 included in this annual report, and has issued an attestation report on managements assessment of the effectiveness of the Corporations internal control over financial reporting as of
December 31, 2006, which is included herein.



Management
is also responsible for compliance with laws and regulations relating to safety and soundness which are designated by the FDIC and the appropriate federal banking agency. Management assessed its compliance with these designated laws and regulations
relating to safety and soundness and believes that the Corporation complied, in all significant respects, with such laws and during the year ended December 31, 2006.



March 26, 2007

FNB United Corp.



|                         |  |  |  |                         |  | 
|------------------------ |  |  |  | ----------------------- |  | 
|/s/    MICHAEL C.
MILLER |  |  |  | /s/    JERRY A.
LITTLE  |  | 
|Michael C. Miller        |  |  |  | Jerry A. Little         |  | 
|Chief Executive Officer  |  |  |  | Chief Financial Officer |  | 



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LOGO



REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM



To the Stockholders and the Board of Directors

FNB United Corp. and Subsidiaries



We have audited managements assessment, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting,
that FNB United Corp. and subsidiaries (the Corporation) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Corporations internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A Corporations internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because managements assessment and our audit were conducted to also meet the reporting
requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), managements assessment and our audit of the Corporations internal control over financial reporting included controls over the
preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (form FR Y-9 C). A Corporations internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of
management and directors of the Corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Corporations assets that could have a material effect on
the financial statements.



Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.



86



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A material weakness is a control deficiency, or combination of control deficiencies, that results in more
than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in managements assessment: As of December
31, 2006, the Corporation 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. This control deficiency has
resulted in the restatement of the Corporations interim consolidated financial statements for the third quarter of 2006. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of
the 2006 consolidated financial statements, and this report does not affect our report dated March 26, 2007 on those consolidated financial statements.



Management has excluded certain controls of Integrity Financial Corporation, which was acquired by the Corporation on April 28, 2006, from its
assessment. While many of the internal controls over financial reporting applicable to Integrity were integrated with those of the Corporation as of December 31, 2006, and therefore included in managements assessment, the controls
regarding the Integrity branch locations had not yet been integrated as of December 31, 2006.



In our opinion, managements assessment that FNB United Corp. and subsidiaries did not maintain effective internal control over financial reporting
as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also, in our
opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, FNB United Corp. and subsidiaries has not maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated financial statements of FNB United Corp. and subsidiaries as of and for the year ended December 31, 2006, and our report dated March 26, 2007, expressed an unqualified opinion on those consolidated financial statements.



We do not express an opinion or any other form of assurance on
managements statement referring to compliance with designated laws and regulations related to safety and soundness.



LOGO



Raleigh, North Carolina

March 26, 2007



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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, as of March 26, 2007.



FNB United Corp.(Registrant)By:

/s/     MICHAEL C.
MILLERMichael C. MillerChairman and President




Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, as of March 26, 2007.



|                                                                          |  |                                                                    
|------------------------------------------------------------------------- |  | -------------------------------------------------------------------
|Signature                                                                 |  | Title                                                              
|                                                                          | 
|/s/                           MICHAEL C. MILLER Michael C. Miller         |  | Chairman and President(Principal Executive Officer)                
|                                                                          | 
|/s/                               JERRY A. LITTLE
Jerry A. Little         |  | Treasurer and Secretary(Principal Financial and Accounting Officer)
|                                                                          | 
|/s/                         JACOB F. ALEXANDER III Jacob F. Alexander III |  | Director                                                           
|                                                                          | 
|/s/                             LARRY E. BROOKS Larry E. Brooks           |  | Director                                                           
|                                                                          | 
|/s/                       JAMES M. CAMPBELL, JR. James M. Campbell, Jr.   |  | Director                                                           
|                                                                          | 
|/s/                           R. LARRY CAMPBELL R. Larry Campbell         |  | Director                                                           
|                                                                          | 
|/s/                               DAVID E.CLINE
David E. Cline            |  | Director                                                           
|                                                                          | 
|/s/                               DARRELL L. FRYE
Darrell L. Frye         |  | Director                                                           
|                                                                          | 
|/s/                           WILBERT L. HANCOCK Wilbert L. Hancock       |  | Director                                                           
|                                                                          | 
|/s/                           ROBERT P. HUNTLEY Robert P. Huntley         |  | Director                                                           
|                                                                          | 
|/s/                            THOMAS A. JORDAN Thomas A. Jordan          |  | Director                                                           
|                                                                          | 
|/s/                               LYNN S. LLOYD
Lynn S. Lloyd             |  | Director                                                           



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|                                                                          |  |         
|------------------------------------------------------------------------- |  | --------
|Signature                                                                 |  | Title   
|                                                                          | 
|/s/                           RAY H. MCKENNEY,
JR. Ray H. McKenney, Jr.   |  | Director
|                                                                          | 
|/s/                       EUGENE B. MCLAURIN, II Eugene B. McLaurin, II   |  | Director
|                                                                          | 
|/s/                         R. REYNOLDS NEELY, JR. R. Reynolds Neely, Jr. |  | Director
|                                                                          | 
|/s/                              RICHARD K. PUGH Richard K. Pugh          |  | Director
|                                                                          | 
|/s/                              J. M. RAMSAY III J. M. Ramsay III        |  | Director
|                                                                          | 
|/s/                                   CARL G.
YALE Carl G. Yale           |  | Director



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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 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.          
|            | 
|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.                                                                                  



90



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|            |  |                                                                                                                                                                                                                                                                                                                              
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                                                                                                                                                                       
|            | 
|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. Stock Incentive Plan, as amended.                                                                                                                                                                                                                                                                           
|            | 
|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.                               
|            | 
|10.30*      |  | 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 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*      |  | 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.                                                                            
|            | 
|14          |  | Code of Ethics for Senior Financial Officers, incorporated herein by reference to Exhibit 14 to the Registrants Form 10-K Annual Report for the fiscal year ended December 31,
2003.                                                                                                                                        
|            | 
|21          |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                              
|            | 
|23.10       |  | Consent of Independent Registered Public Accounting FirmDixon Hughes PLLC                                                                                                                                                                                                                                                   
|            | 
|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.                                                                                                                                                                                                                                                     

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|* |  | Management contract, or compensatory plan or arrangement.
|- |  | ---------------------------------------------------------



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