The following presents management's discussion and analysis of the financial condition, changes in financial condition and results of operations of FNB United Corp. ("FNB United") and its wholly owned subsidiary, CommunityONE Bank, National Association ("CommunityONE"), formerly known as First National Bank and Trust Company, prior to June 4, 2007. FNB United and its subsidiary are collectively referred to as the "Company." This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this quarterly report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. This discussion is intended to assist in understanding the financial condition and results of operations of the Company.

Overview

Description of Operations

FNB United is a bank holding company with a full-service subsidiary bank, CommunityONE, which offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers. CommunityONE 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, CommunityONE has a mortgage banking subsidiary, Dover Mortgage Company, which originates, underwrites and closes loans for sale into the secondary market. Dover, based in Charlotte, North Carolina, joined FNB United in 2003 and has a retail origination network based in Charlotte and conducts wholesale operations in the states of North Carolina, South Carolina, Tennessee, Virginia, Georgia and Maine. Effective August 1, 2007, Dover became a subsidiary of CommunityONE.

First National Investor Services, Inc. services used car loans purchased by CommunityONE.

Executive Summary

The Company had a net loss of $1.7 million in the third quarter of 2008, a 146.7% decline from net income of $3.7 million in the same period of 2007. The decrease in net income resulted primarily from a significantly higher level of the provision for loan losses. Given the current economic environment, FNB United performed a thorough analysis of its loan portfolio. As a result, certain loans migrated to higher, more adverse risk grades and necessitated increases to our allowance for loan losses. Noninterest income decreased 10.9% primarily related to the $1.3 million gain on the sale of the credit card portfolio in the third quarter of 2007. Noninterest expense was essentially flat, decreasing 1.2%. Quarterly basic and fully diluted earnings per common share decreased from $0.32 to ($0.15).

Total assets were $2.1 billion at September 30, 2008, up 9.4% from September 30, 2007 and up 8.6% from December 31, 2007. Gross loans held for investment of $1.6 billion at September 30, 2008 represented an increase of $206.2 million, or 14.9%, from $1.4 billion at September 30, 2007 and an increase of $143.0 million, or 9.9%, from $1.4 billion at December 31, 2007. Total deposits of $1.5 billion at September 30, 2008 represented an increase of $67.6 million, or 4.7%, from $1.5 billion at September 30, 2007 and an increase of $78.6 million, or 5.5%, from $1.4 billion at December 31, 2007.

Financial highlights are presented in the accompanying table.

Table 1
Selected Financial Data

(dollars in thousands, except per
share data)                                   As of / For the Quarter Ended
                                      9/30/2008         9/30/2007         9/30/2008         9/30/2007
Selected Components Income
Statement Data
 Interest income                     $     28,856      $     32,173      $     87,391      $     94,759
 Interest expense                          13,255            16,175            41,410            46,875
 Net interest income                       15,601            15,998            45,981            47,884
 Provision for loan losses                  9,370             1,470            12,267             2,470
 Net interest income after
provision for loan losses                   6,231            14,528            33,714            45,414
 Noninterest income                         5,920             6,642            15,693            17,062
 Noninterest expense                       15,432            15,620            48,292            45,622
 Income (loss) before income
taxes                                      (3,281 )           5,550             1,115            16,854
 Income taxes                              (1,570 )           1,884               363             5,744
 Net Income (Loss)                   $     (1,711 )    $      3,666      $        752      $     11,110

Common Share Data
 Basic earnings per share            $      (0.15 )    $       0.32      $       0.07      $       0.98
 Diluted earnings per share                 (0.15 )            0.32      $       0.07              0.98
 Dividends declared per share                0.10              0.15              0.35              0.45
 Book value per share                       18.51             18.89             18.51             18.89
 Weighted average shares
outstanding-basic                      11,404,885        11,335,672        11,408,037        11,306,233
 Weighted average shares
outstanding-diluted                    11,404,885        11,352,625        11,410,830        11,330,614

Financial Condition Data
 Total assets                        $  2,071,126      $  1,893,546      $  2,071,126      $  1,893,546
 Securities                               221,384           234,148           221,384           234,148
 Loans held for sale                       20,261            21,653            20,261            21,653
 Net loans held for investment          1,562,351         1,366,801         1,562,351         1,366,801
 Deposits                               1,519,682         1,452,099         1,519,682         1,452,099
 Goodwill and core deposit
intangible                                114,356           117,319           114,356           117,319
 Borrowings                               298,089           176,055           298,089           176,055
 Shareholders' equity                     211,417           214,931           211,417           214,931

Average Balances
 Total assets                        $  2,067,661      $  1,868,412      $  2,024,784      $  1,851,573
 Securities                               213,930           246,645           218,094           220,973
 Loans                                  1,566,837         1,386,773         1,525,780         1,358,584
 Interest-earning assets                1,824,809         1,637,632         1,784,210         1,612,072
 Goodwill and core deposit
intangible                                114,486           117,415           115,901           117,888
 Deposits                               1,489,468         1,441,866         1,476,390         1,438,898
 Total interest-bearing
liabilities                             1,670,932         1,476,209         1,627,369         1,459,961
 Shareholders' equity                     215,737           214,052           216,958           211,654

Performance Ratios
 Return on average assets                   -0.33 %            0.78 %            0.05 %            0.80 %
 Return on tangible assets                  -0.35 %            0.83 %            0.05 %            0.86 %
 Return on average equity                   -3.16 %            6.79 %            0.46 %            7.02 %
 Return on tangible equity                  -6.72 %           15.05 %            0.99 %           15.84 %
 Net interest margin                         3.48 %            3.96 %            3.52 %            4.05 %
 Noninterest income to average
assets                                       1.14 %            1.41 %            1.04 %            1.23 %
 Noninterest expense to average
assets                                       2.97 %            3.32 %            3.19 %            3.29 %
 Efficiency ratio                           71.71 %           68.99 %           78.30 %           70.25 %

Application of Critical Accounting Policies

The Company's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry and are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company's significant accounting policies are discussed in detail in Note 1 to the Consolidated Financial Statements contained in the Annual Report on Form 10-K for the year ended December 31, 2007.

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

Allowance for Loan Losses

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

Goodwill

We have developed procedures to test goodwill for impairment on an annual basis. This testing procedure evaluates possible impairment based on the following:

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

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

During the second quarter of 2008, FNB United commenced an impairment evaluation of the Dover Mortgage goodwill as a result of changes in the Dover business model, which included the closing of certain offices and loss of personnel at those locations. As a result, the impairment evaluation determined the carrying value exceeded fair value. The Company made the decision to take a goodwill impairment charge for the entire remaining carrying value of $1.8 million (pre-tax and after-tax), and this non-cash charge was recorded as a component of noninterest expense for the second quarter.

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the goodwill impairment analysis of Dover Mortgage as of June 30, 2008 necessitated an impairment analysis of the entity-wide goodwill of $108.4 million as of September 30, 2008. This analysis has been performed as of September 30, 2008 and the fair value of the reporting unit exceeded its carrying amount as of June 30 and September 30, 2008.

Summary

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

Results of Operations

Net Interest Income

Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits. Changes in net interest income result from changes in interest rates and in the volume, or average dollar level, and mix of earning assets and interest-bearing liabilities. Analyses are presented in Table 2 (three months ended September 30, 2008 and 2007) and Table 3 (nine months ended September 30, 2008 and 2007) of the Company's net interest income on a taxable-equivalent basis and average balance sheets.

For the three months ended September 30, 2008, net interest income before the provision for loan losses was $15.9 million, a decrease of $0.4 million, or 2.3%, from $16.3 million for the same quarter in 2007. The decrease was primarily due to a 150 basis point decrease in the yield on average earning assets, which increased $187.2 million, partially offset by a 118 basis point decrease in the cost of average interest bearing liabilities, which increased $194.7 million.

The net interest margin (taxable-equivalent net interest income divided by average earning assets) compressed 48 basis points, to 3.48 % for the three months ended September 30, 2008, compared to 3.96% in the same period in 2007. The decline in the net interest margin can be primarily attributed to the rapid decline in the Wall Street prime lending rate, from 7.75% at September 30, 2007 to 5.00% at September 30, 2008. This decline occurred between September 2007 and April 2008. Approximately two-thirds of our loan portfolio reprices based on prime whereas our cost of interest-bearing liabilities does not react as quickly. Another variable impacting the margin was the increased market demand for liquidity which we built into our funding cost beginning in the second half of 2007. While the Company experienced a 150 basis point decrease in the yield on earning assets, the cost of interest bearing liabilities decreased only 118 basis points. Growth in earning assets was funded by higher cost deposits and wholesale borrowings.

For the nine months ended September 30, 2008, net interest income before the provision for loan losses was $47.0 million, a decrease of $1.9 million, or 3.8%, from $48.9 million for the same period in 2007. The net interest margin
(taxable-equivalent net interest income divided by average earning assets)
compressed 53 basis points, to 3.52% for the nine months ended September 30, 2008, compared to 4.05% in the same period in 2007. While the Company experienced a 132 basis point decrease in the yield on earning assets, the cost of interest bearing liabilities only decreased 89 basis points. Growth in earning assets was funded by higher cost deposits and wholesale borrowings.

Table 2
Average Balances and Net Interest Income Analysis

                                                                             Three Months Ended September 30,
                                                                    2008                                                  2007
(dollars in thousands)                                                 Interest        Average                          Interest        Average
                                                 Average               Income /        Yield /          Average         Income /        Yield /
                                                Balance(3)             Expense           Rate         Balance(3)        Expense           Rate
Interest earning assets:
Loans (1)                                 $            1,607,289      $   26,484            6.56 %    $ 1,386,773      $   29,333            8.39 %
Taxable investment securities                            164,625           1,982            4.79          191,763           2,298            4.75
Tax-exempt investment securities (1)                      49,305             725            5.85           54,882             798            5.77
Other earning assets                                       3,590              17            1.91            4,214              49            4.61
  Total earning assets                                 1,824,809          29,208            6.37        1,637,632          32,478            7.87

Non-earning assets:
Cash and due from banks                                   30,571                                           33,785
Goodwill and core deposit premiums                       114,486                                          117,415
Other assets, net                                         97,795                                           79,580
  Total assets                            $            2,067,661                                      $ 1,868,412

Interest bearing liabilities:
Interest-bearing demand deposits                         167,799             507            1.20          158,885             623            1.56
Savings deposits                                          40,789              29            0.28           46,222              33            0.28
Money market deposits                                    285,774           1,668            2.32          262,288           2,751            4.16
Time deposits                                            833,920           7,947            3.79          815,365          10,081            4.91
Retail repurchase agreements                              37,934             148            1.55           28,616             344            4.77
Federal Home Loan Bank advances                          212,970           1,923            3.59           87,509             869            3.94
Federal funds purchased                                   19,804             170            3.41            4,596              62            5.35
Other borrowed funds                                      71,942             865            4.78           72,728           1,386            7.56
  Total interest bearing liabilities                   1,670,932          13,257            3.16        1,476,209          16,149            4.34

Other liabilities and shareholders' equity:
Noninterest-bearing demand deposits                      161,186                                          159,106
Other liabilities                                         19,806                                           19,045
Shareholders' equity                                     215,737                                          214,052
 Total liabilities and equity             $            2,067,661                                      $ 1,868,412

Net interest income and net yield on earning assets (3) (4) $ 15,951 3.48 % $ 16,329 3.96 %

Interest rate spread (5) 3.21 % 3.53 %

(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) The average loan balances include nonaccruing loans.
(3) The average balances for all years include market adjustments to fair value for securities and loans available/held for sale.
(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.
(5) Earning asset yield minus interest bearing liabilities rate.

Table 3
Average Balances and Net Interest Income Analysis

                                                                         Nine Months Months Ended September 30,
                                                                   2008                                                  2007
(dollars in thousands)                                                Interest        Average                          Interest        Average
                                                Average               Income /        Yield /          Average         Income /        Yield /
                                                Balance(3)            Expense           Rate         Balance(3)        Expense           Rate
Interest earning assets:
Loans (1)                                $            1,564,070      $   80,002            6.83 %    $ 1,358,584      $   85,883            8.45 %
Taxable investment securities                           165,094           6,075            4.92          165,601           6,185            4.99
Tax-exempt investment securities (1)                     53,000           2,309            5.82           55,372           2,406            5.81
Other earning assets                                      2,046              34            2.23           32,515           1,289            5.30
  Total earning assets                                1,784,210          88,420            6.62        1,612,072          95,763            7.94

Non-earning assets:
Cash and due from banks                                  31,249                                           33,143
Goodwill and core deposit premiums                      115,901                                          117,888
Other assets, net                                        93,424                                           88,470
  Total assets                           $            2,024,784                                      $ 1,851,573

Interest bearing liabilities:
Interest-bearing demand deposits                        166,948           1,548            1.24          164,665           2,005            1.63
Savings deposits                                         41,367              87            0.28           48,677             103            0.28
Money market deposits                                   277,789           5,049            2.43          253,761           7,865            4.14
Time deposits                                           828,975          25,895            4.17          812,516          29,558            4.86
Retail repurchase agreements                             34,041             560            2.20           27,717             969            4.67
Federal Home Loan Bank advances                         194,736           5,444            3.73           72,748           2,278            4.19
Federal funds purchased                                  21,705             468            2.88            2,170              90            5.55
Other borrowed funds                                     61,808           2,361            5.10           77,707           4,007            6.89
  Total interest bearing liabilities                  1,627,369          41,412            3.40        1,459,961          46,875            4.29

Other liabilities and shareholders' equity:
Noninterest-bearing demand deposits                     161,311                                          159,279
Other liabilities                                        19,146                                           20,679
Shareholders' equity                                    216,958                                          211,654
 Total liabilities and equity            $            2,024,784                                      $ 1,851,573

Net interest income and net yield on earning assets (3) (4) $ 47,008 3.52 % $ 48,888 4.05 %

Interest rate spread (5) 3.22 % 3.65 %

(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) The average loan balances include nonaccruing loans.
(3) The average balances for all years include market adjustments to fair value for securities and loans available/held for sale.
(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.
(5) Earning asset yield minus interest bearing liabilities rate.

Provision for Loan Losses

The provision for loan losses is charged against earnings in order to maintain the allowance for loan losses at a level that reflects management's evaluation of the losses inherent in the portfolio. The amount of the provision is based on continuing assessments of nonperforming and "watch list" loans, analytical reviews of loan loss experience in relation to outstanding loans, loan charge offs, nonperforming asset trends and management's judgment with respect to current and expected economic conditions and their impact on the existing credit portfolio.

During the three-month period ended September 30, 2008, management determined a charge to operations of $9.4 million would bring the allowance for loan losses to a balance considered to be adequate to reflect the growth in loans and to absorb probable losses inherent in the portfolio, compared to $1.5 million for the third quarter of 2007. The level of the provision was primarily driven by deteriorating loan quality as well as growth in the loan portfolio. Net charge offs for the three months ended September 30, 2008 totaled $1.5 million or 0.37% of annualized average loans, compared to $757,000, or 0.22% of annualized average loans for the same period in 2007.

For the nine-month period ended September 30, 2008, the provision for loan losses was $12.3 million, compared to $2.5 million in the same period of 2007. The level of the provision was primarily driven by deteriorating loan quality as well as growth in the loan portfolio. Net charge offs for the nine months ended September 30, 2008 totaled $2.9 million, or 0.25% of annualized average loans, compared to $2.0 million, or 0.20% of annualized average loans for the same period in 2007.

Noninterest Income

For the three months ended September 30, 2008, total noninterest income was $5.9 million, a decrease of $722,000, or 10.9%, compared to the same period in 2007. The majority of this decrease was the result of the sale of the bank's credit card portfolio in the third quarter of 2007 which yielded noninterest income of $1.3 million. All other components of noninterest income represent a net increase compared to the prior year.

For the nine months ended September 30, 2008, total noninterest income was $15.7 million, a decrease of $1.4 million, or 8.0%, compared to the same period in 2007. As noted above, this decrease is largely attributable to the $1.3 million . . .