10-Q 1 fnbn-20120630x10q.htm FORM 10-Q FNBN-2012.06.30-10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q

 
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 
     
For the quarterly period ended June 30, 2012
 
Commission File Number 0-13823


FNB UNITED CORP.
(Exact name of Registrant as specified in its Charter)
 
North Carolina
 
56-1456589
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
150 South Fayetteville Street
 
 
Asheboro, North Carolina
 
27203
(Address of principal executive offices)
 
(Zip Code)

 
(336) 626-8300
(Registrant's telephone number, including area code)
  

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of August 6, 2012 (the most recent practicable date), the Registrant had outstanding approximately 21,588,034 shares of Common Stock.



FNB United Corp. and Subsidiaries
Report on Form 10-Q
June 30, 2012

TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
Item 1
 
 
 
 
 

 
Item 2
Item 3
Item 4
PART II. OTHER INFORMATION
 
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6
 



i

PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements
FNB United Corp. and Subsidiaries
Consolidated Balance Sheets (unaudited)
(in thousands, except share and per share data)
 
June 30, 2012
 
December 31, 2011
Assets
 
 
 
 
Cash and due from banks
 
$
32,733

 
$
35,773

Interest-bearing bank balances
 
331,146

 
517,643

Investment securities:
 
 
 
 
Available-for-sale, at estimated fair value (amortized cost of $473,438 in 2012
and $430,836 in 2011)
 
477,136

 
431,306

Loans held for sale
 
1,324

 
4,529

Loans held for investment
 
1,281,823

 
1,217,535

Less: Allowance for loan losses
 
(38,551
)
 
(39,360
)
Net loans held for investment
 
1,243,272

 
1,178,175

Premises and equipment, net
 
52,893

 
53,763

Other real estate owned
 
86,183

 
110,009

Core deposit premiums
 
7,473

 
8,177

Goodwill
 
4,205

 
3,905

Bank-owned life insurance
 
38,172

 
37,515

Other assets
 
27,224

 
28,068

Assets from discontinued operations
 
—

 
245

Total Assets
 
$
2,301,761

 
$
2,409,108

Liabilities
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing demand deposits
 
$
262,087

 
$
234,673

Interest-bearing deposits:
 
 
 
 
Demand, savings and money market deposits
 
868,335

 
849,828

Time deposits of $100,000 or more
 
343,235

 
394,431

Other time deposits
 
568,113

 
650,179

Total deposits
 
2,041,770

 
2,129,111

Retail repurchase agreements
 
11,455

 
8,838

Federal Home Loan Bank advances
 
58,350

 
58,370

Junior subordinated debentures
 
56,702

 
56,702

Other liabilities
 
25,482

 
25,980

Liabilities from discontinued operations
 
—

 
1,092

Total Liabilities
 
2,193,759

 
2,280,093

Shareholders' Equity
 
 
 
 
Preferred stock Series A, $10.00 par value; authorized 200,000 shares, no shares issued and outstanding in 2012 and 2011
 
—

 
—

Preferred stock, $1.00 par value, authorized 15,000,000 shares, no shares issued and outstanding in 2012 and 2011
 
—

 
—

Common stock, no par value; authorized 2,500,000,000 shares, issued 21,587,880 shares
in 2012 and 21,102,668 shares in 2011
 
461,169

 
455,166

Accumulated deficit
 
(351,179
)
 
(322,182
)
Accumulated other comprehensive loss
 
(1,988
)
 
(3,969
)
Total Shareholders' Equity
 
108,002

 
129,015

Total Liabilities and Shareholders' Equity
 
$
2,301,761

 
$
2,409,108

See accompanying notes to consolidated financial statements.

1

FNB United Corp. and Subsidiaries
Consolidated Statements of Operations (unaudited)
(in thousands, except share and per share data)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Interest Income
 
 
 
 
 
 
 
Interest and fees on loans
$
17,235

 
$
12,221

 
$
34,194

 
$
25,282

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable income
2,887

 
2,717

 
5,571

 
4,798

Non-taxable income
—

 
134

 
—

 
297

Other interest income
310

 
118

 
660

 
284

Total interest income
20,432

 
15,190

 
40,425

 
30,661

Interest Expense
 
 
 
 
 
 
 
Deposits
3,701

 
4,963

 
7,924

 
10,132

Retail repurchase agreements
9

 
14

 
17

 
31

Federal Home Loan Bank advances
387

 
703

 
666

 
1,401

Other borrowed funds
286

 
318

 
589

 
696

Total interest expense
4,383

 
5,998

 
9,196

 
12,260

Net Interest Income before Provision for Loan Losses
16,049

 
9,192

 
31,229

 
18,401

Provision for loan losses
7,778

 
33,580

 
10,845

 
53,763

Net Interest Income/(Loss) after Provision for Loan Losses
8,271

 
(24,388
)
 
20,384

 
(35,362
)
Noninterest Income
 
 
 
 
 
 
 
Service charges on deposit accounts
1,960

 
1,485

 
3,920

 
2,929

Mortgage loan income
287

 
(14
)
 
323

 
107

Cardholder and merchant services income
1,046

 
841

 
2,043

 
1,607

Trust and investment services
256

 
350

 
458

 
752

Bank owned life insurance
314

 
266

 
620

 
666

Other service charges, commissions and fees
271

 
216

 
525

 
356

Securities (loss)/gains, net
2,002

 
(98
)
 
1,956

 
(84
)
Gain on fair value swap
—

 
77

 
—

 
169

Other income
396

 
162

 
513

 
365

Total noninterest income
6,532

 
3,285

 
10,358

 
6,867

Noninterest Expense
 
 
 
 
 
 
 
Personnel expense
10,541

 
6,231

 
20,528

 
12,725

Net occupancy expense
1,603

 
1,117

 
3,156

 
2,303

Furniture, equipment and data processing expense
2,020

 
1,613

 
3,996

 
3,219

Professional fees
1,109

 
1,628

 
2,373

 
2,879

Stationery, printing and supplies
153

 
99

 
294

 
218

Advertising and marketing
125

 
196

 
254

 
336

Other real estate owned expense
12,473

 
10,586

 
17,992

 
26,773

Credit/debit card expense
437

 
427

 
847

 
818

FDIC insurance
1,225

 
1,575

 
1,823

 
3,438

Loan collection expense
514

 
1,651

 
1,260

 
2,651

Merger-related expense
(840
)
 
—

 
1,418

 
—

Core deposit intangible amortization
352

 
199

 
704

 
397

Other expense
3,203

 
1,008

 
5,118

 
3,323

Total noninterest expense
32,915

 
26,330

 
59,763

 
59,080

Loss from continuing operations, before income taxes
(18,112
)
 
(47,433
)
 
(29,021
)
 
(87,575
)
Income tax expense (benefit) - continuing operations
26

 
(448
)
 
(51
)
 
(576
)
Loss from continuing operations, net of tax
(18,138
)
 
(46,985
)
 
(28,970
)
 
(86,999
)
Loss from discontinued operations, net of tax
—

 
(1,989
)
 
(27
)
 
(5,682
)
Net loss
(18,138
)
 
(48,974
)
 
(28,997
)
 
(92,681
)
Dividends on preferred stock
—

 
(1,087
)
 
—

 
(2,104
)
Net loss to common shareholders
(18,138
)
 
(50,061
)
 
$
(28,997
)
 
$
(94,785
)
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding - basic and diluted
21,190,848

 
114,265

 
21,146,758

 
114,256

Net loss per common share from continuing operations - basic and diluted
$
(0.86
)
 
$
(420.71
)
 
$
(1.37
)
 
$
(779.85
)
Net loss per common share from discontinued operations - basic and diluted
—

 
(17.40
)
 
—

 
(49.73
)
Net loss per common share - basic and diluted
(0.86
)
 
(438.11
)
 
(1.37
)
 
(829.58
)

See accompanying notes to consolidated financial statements.

2

FNB United Corp. and Subsidiaries
Consolidated Statements of Comprehensive Loss (unaudited)
(dollars in thousands)
Three Months Ended June 30,
 
2012
 
2011
Net loss
$
(18,138
)
 
$
(48,974
)
Other comprehensive income:

 

Unrealized holdings gains arising during the period on available-for-sale securities
4,026

 
4,785

 Tax effect
(1,563
)
 
(1,890
)
Unrealized holdings gains arising during the period on available-for-sale securities, net of tax
2,463

 
2,895

Reclassification adjustment for (gain) loss on available-for-sale securities included in net income
(2,002
)
 
98

     Tax effect
790

 
(39
)
Reclassification adjustment for (gain) loss on available-for-sale securities included in net income, net of tax
(1,212
)
 
59

Other comprehensive income, net of tax:
1,251

 
2,954

Comprehensive loss
$
(16,887
)
 
$
(46,020
)

(dollars in thousands)
 
Six Months Ended June 30,
 
 
2012
 
2011
Net loss
 
$
(28,997
)
 
$
(92,681
)
Other comprehensive income:
 
 
 
 
Unrealized holdings gains arising during the period on available-for-sale securities
 
5,184

 
4,524

 Tax effect
 
(2,020
)
 
(1,787
)
Unrealized holdings gains arising during the period on available-for-sale securities, net of tax
 
3,164

 
2,737

Reclassification adjustment for (gain) loss on available-for-sale securities included in net income
 
(1,956
)
 
84

     Tax effect
 
773

 
(33
)
Reclassification adjustment for (gain) loss on available-for-sale securities included in net income, net of tax
 
(1,183
)
 
51

Other comprehensive income, net of tax:
 
1,981

 
2,788

Comprehensive loss
 
$
(27,016
)
 
$
(89,893
)

See accompanying notes to consolidated financial statements.


3

FNB United Corp. and Subsidiaries
Consolidated Statements of Shareholders’ Equity (unaudited)
For Six Months Ended June 30, 2012 and 2011
 
 
 
 
 
 
 
 
 
 
 
 
Retained
 
Accumulated
 
 
(dollars in thousands, except share and per share data)
 
 
 
 
 
 
 
 
 
Common
 
Earnings/
 
Other
 
 
 
Preferred Stock
 
Common Stock
 
Stock
 
(Accumulated
 
Comprehensive
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Warrant
 
Deficit)
 
Loss
 
Total
Balance, December 31, 2010
 
7,551,500

 
$
56,424

 
114,246

 
$
143,634

 
$
3,891

 
$
(229,095
)
 
$
(3,691
)
 
$
(28,837
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
—

 
—

 
—

 
—

 
—

 
(92,681
)
 
—

 
(92,681
)
Other comprehensive income, net of tax
 
—

 
—

 
—

 
—

 
—

 
—

 
2,788

 
2,788

Total comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(89,893
)
Issuance of preferred stock, series A
 
5,000,000

 
5,000

 
—

 
—

 
—

 
—

 
—

 
5,000

Accretion of discount on preferred stock
 
—

 
378

 
—

 
—

 
—

 
(378
)
 
—

 
—

Stock options:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Compensation expense recognized
 
—

 
—

 
—

 
12

 
—

 
—

 
—

 
12

Balance, June 30, 2011
 
12,551,500

 
$
61,802

 
114,246

 
$
143,646

 
$
3,891

 
$
(322,154
)
 
$
(903
)
 
$
(113,718
)
Balance, December 31, 2011
 
—

 
$
—

 
21,102,668

 
$
455,166

 
$
—

 
$
(322,182
)
 
$
(3,969
)
 
$
129,015

Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
—

 
—

 
—

 
—

 
—

 
(28,997
)
 
—

 
(28,997
)
Other comprehensive income, net of tax
 
—

 
—

 
—

 
—

 
—

 
—

 
1,981

 
1,981

Total comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(27,016
)
Stock options:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Compensation expense recognized
 
—

 
—

 
—

 
1

 
—

 
—

 
—

 
1

Expense related to 2011 issuance of common stock
 
—

 
—

 
—

 
(913
)
 
—

 
—

 
—

 
(913
)
Return of common stock not received for fractional shares rounding purposes in the 1:100 reverse stock split
 
—

 
—

 
(586
)
 
—

 
—

 
—

 
—

 
—

Exercise of warrants related to stock offering
 
—

 
—

 
10

 
—

 
—

 
—

 
—

 
—

Stock offering, net of issuance costs of $158
 
—

 
—

 
485,788

 
6,915

 
—

 
—

 
—

 
6,915

Balance, June 30, 2012
 
—

 
$
—

 
21,587,880

 
$
461,169

 
$
—

 
$
(351,179
)
 
$
(1,988
)
 
$
108,002


See accompanying notes to consolidated financial statements.    

4

FNB United Corp. and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
 (dollars in thousands)
 
Six Months Ended June 30,
 
 
2012
 
2011
Operating Activities
 
 
 
 
Net loss
 
$
(28,997
)
 
$
(92,681
)
Net loss from discontinued operations
 
(27
)
 
(5,682
)
Net loss from continuing operations
 
(28,970
)
 
(86,999
)
Adjustments to reconcile net loss to cash provided by operating activities:
 
 
 
 
Depreciation and amortization of premises and equipment
 
1,957

 
1,602

Provision for loan losses
 
10,845

 
53,763

Deferred income taxes
 
(51
)
 
(1,228
)
Deferred loan fees and costs, net
 
(3,648
)
 
(237
)
Premium amortization and discount accretion of investment securities, net
 
4,700

 
1,815

Net loss/(gain) on sale of investment securities
 
(1,956
)
 
84

Amortization of core deposit premiums
 
704

 
397

Net accretion of purchase accounting adjustments
 
(14,397
)
 
—

Adjustment to goodwill
 
(300
)
 
—

Stock compensation expense
 
1

 
12

Increase in cash surrender value of bank-owned life insurance, net
 
(657
)
 
(543
)
Loans held for sale:
 
 
 
 
Origination of loans held for sale
 
(3,039
)
 
—

Net proceeds from sale of loans held for sale
 
1,749

 
107

Net loss/(gain) on sale of loans held for sale
 
(34
)
 
(107
)
Mortgage servicing rights capitalized
 
—

 
145

Net loss on sales and write-downs of other real estate owned
 
14,470

 
24,242

Changes in assets and liabilities:
 
 
 
 
(Increase)/decrease in accrued interest receivable and other assets
 
(605
)
 
15,046

Decrease in accrued interest payable and other liabilities
 
(498
)
 
(2,126
)
Net cash (used in)/provided by operating activities of continuing operations
 
(19,729
)
 
5,973

Net effect of discontinued operations
 
(874
)
 
33,103

Net cash (used in)/provided by operating activities
 
(20,603
)
 
39,076

Investing Activities
 
 
 
 
Available-for-sale securities:
 
 
 
 
Proceeds from sales
 
118,049

 
30,117

Proceeds from maturities, calls and principal repayments
 
83,454

 
23,687

Purchases
 
(245,492
)
 
(126,446
)
Net (increase)/decrease in loans held for investment
 
(69,984
)
 
114,460

Proceeds from sales of other real estate owned
 
23,878

 
10,399

Purchases of premises and equipment
 
(1,163
)
 
(139
)
Proceeds from sales of premises and equipment
 
34

 
—

Expenses paid in 2012 related to 2011 capital raise
 
(913
)
 
—

Net cash (used in) provided by investing activities of continuing operations
 
(92,137
)
 
52,078

Net effect of discontinued operations
 
—

 
70

Net cash (used in) provided by investing activities
 
(92,137
)
 
52,148

Financing Activities
 
 
 
 
Net decrease in deposits
 
(86,309
)
 
(91,436
)
Increase in retail repurchase agreements
 
2,617

 
428

Decrease in Federal Home Loan Bank advances
 
(20
)
 
(19
)
Issuance of common stock, net of expense
 
6,915

 
—

Net cash used in financing activities of continuing operations
 
(76,797
)
 
(91,027
)
Net effect of discontinued operations
 
—

 
—

Net cash used in financing activities
 
(76,797
)
 
(91,027
)
Net (Decrease) Increase in Cash and Cash Equivalents
 
(189,537
)
 
197

Cash and Cash Equivalents at Beginning of Period
 
553,416

 
160,594

Cash and Cash Equivalents at End of Period
 
$
363,879

 
$
160,791

 
 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
Interest
 
$
9,657

 
$
11,832

Noncash transactions:
 
 
 
 
Foreclosed loans transferred to other real estate owned
 
15,020

 
73,967

Loans to facilitate the sale of other real estate owned
 
778

 
—

Transfer of loans from held for investment to held for sale
 
600

 
—

Transfer of loans from held for sale to held for investment
 
(3,885
)
 
—

Unrealized securities gains/(losses), net of income taxes
 
1,981

 
2,788

Conversion of subordinated debt to preferred stock
 
—

 
(5,000
)
Issuance of preferred stock in subordinated debt conversion
 
—

 
5,000

See accompanying notes to consolidated financial statements.

5


FNB United Corp. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation
Nature of Operations
FNB United Corp. we or us (which also refers to FNB and our subsidiaries on a consolidated basis) ("FNB") is a bank holding company incorporated under the laws of the State of North Carolina in 1984. We own two bank subsidiaries: CommunityOne Bank, N.A. (“CommunityOne”), a national banking association headquartered in Asheboro, North Carolina and, through Bank of Granite Corporation (“Granite Corp.”), Bank of Granite (“Granite”), a state chartered bank headquartered in Granite Falls, North Carolina.
Through our bank subsidiaries, we offer 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 through operations located throughout central, southern and western North Carolina, including the counties of Alamance, Alexander, Ashe, Burke, Caldwell, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes. Management believes that the banks have a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors, including federal, state and local governments.
CommunityOne owns two subsidiaries: Dover Mortgage Company, (“Dover”) and First National Investor Services, Inc. Dover previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012. First National Investor Services, Inc. holds deeds of trust for CommunityOne. Through Granite Corp., we also own Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012. FNB also owns FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities.
On October 21, 2011, as part of the recapitalization of FNB, FNB acquired Granite Corp., through the merger of a wholly owned subsidiary of FNB merging into Granite Corp (the "Merger"). The Merger was part of FNB's recapitalization strategy.
General
The accompanying consolidated financial statements, prepared without audit, include the accounts of FNB and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Descriptions of the organization and business of FNB, accounting policies followed by FNB and other relevant information are contained in FNB's Annual Report on Form 10-K for the year ended December 31, 2011, as amended by its Amendment No. 1 (the "Form 10-K"), including the notes to the consolidated financial statements filed as part of that report. This quarterly report should be read in conjunction with the Form 10-K.
In the opinion of management, the accompanying condensed consolidated financial statements contain all the adjustments, all of which are normal recurring adjustments, necessary to present fairly the financial position of FNB as of June 30, 2012 and December 31, 2011, and the results of its operations and cash flows for the three and six months ended June 30, 2012 and 2011, respectively.
All financial information is reported on a continuing operations basis, unless otherwise noted. See Note 2 to the consolidated financial statements for a discussion regarding discontinued operations and certain assets and liabilities at June 30, 2012 and December 31, 2011.
Use of Estimates
We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States ("GAAP"). Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowances for loan losses (“ALL”), the carrying value of other real estate owned (“OREO”), the carrying value of intangible assets, the fair value of net assets acquired in the Merger and the realization of deferred tax assets.
Reclassification
Certain reclassifications have been made to the prior period consolidated financial statements to place them on a comparable basis with the current period consolidated financial statements. These reclassifications have no effect on net income or shareholders' equity as previously reported.
During the first quarter of 2012, FNB implemented a purchased loan accounting system and finalized its methodology to allocate the fair value of purchased impaired loans in pools to individual loans for purposes of several of the loan disclosure tables in Notes 5 and

6

6 to the consolidated financial statements. In order to present these tables for prior periods on a comparable basis to current period tables in these consolidated financial statements, we have reclassified certain amounts as of December 31, 2011 in the tables between loan portfolio segments and classes, between purchased contractual and purchased impaired loans, and between risk grade categories. These reclassifications have no effect on net income, the loan fair value mark, total loans or shareholders' equity as of or for the period ended December 31, 2011.
Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through the date of this filing and has concluded that no subsequent events have occurred requiring accrual or disclosure in addition to that included herein.
Recent Accounting Pronouncements
Disclosures about Fair Value - Accounting Standards Update ("ASU") 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the Accounting Standards Codification ("ASC") by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendment was effective for FNB on January 1, 2012, and the related disclosures are presented in Note 10.
Comprehensive Income - The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in shareholders' equity and requires consecutive presentation of the statement of net income and other comprehensive income. The amendments were to become applicable to FNB on January 1, 2012 and were to be applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements. The remaining provisions of this update took effect for FNB on January 1, 2012.
2. Discontinued Operations
All operations of Dover, a subsidiary of CommunityOne, were discontinued as of March 17, 2011. Dover, acquired by FNB in 2003, originated, underwrote and closed mortgage loans for sale into the secondary market. It maintained a retail origination network based in Charlotte, North Carolina, which originated loans for properties located in North Carolina. Dover also engaged in the wholesale mortgage origination business and conducted retail mortgage origination business outside of North Carolina. Operations outside of the State of North Carolina and the wholesale mortgage origination business were discontinued in February 2011, and all remaining operations were discontinued on March 17, 2011. Dover filed for Chapter 11 bankruptcy on February 15, 2012 in the United States Bankruptcy Court for the Western District of North Carolina. All of the assets and liabilities of Dover were written off at that time.
The results of operations of a component of an entity that has been disposed of shall be reported in discontinued operations if both the operations and cash flows of the component have been, or will be, eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. As a result, the Consolidated Balance Sheets, Statements of Operations and Statement of Cash Flows for all periods reflect retrospective application of Dover's classification as a discontinued operation.
Assets and liabilities of discontinued operations at the dates indicated were as follows:
(dollars in thousands)
 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
 
Loans held for sale
 
$
—

 
$
233

Premises and equipment, net
 
—

 
5

Other real estate owned
 
—

 
—

Other assets
 
—

 
7

Assets of discontinued operations
 
$
—

 
$
245

Liabilities
 
 
 
 
Other liabilities
 
$
—

 
$
1,092

Liabilities of discontinued operations
 
$
—

 
$
1,092


7

Net loss from discontinued operations, net of tax, at the dates indicated were as follows:
(dollars in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Interest Income
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
—

 
$
13

 
$
—


$
56

Total interest income
 
—

 
13

 
—

 
56

Interest Expense
 
 
 
 
 
 
 
 
Other borrowed funds
 
—

 
—

 
—

 
—

Total interest expense
 
—

 
—

 
—

 
—

Net Interest Income before Provision for Loan Losses
 
—

 
13

 
—

 
56

Provision for loan losses
 
—

 
—

 
—

 
—

Net Interest Income after Provision for Loan Losses
 
—

 
13

 
—

 
56

Noninterest Income
 
 
 
 
 
 
 
 
Mortgage loan loss
 
—

 
(113
)
 
—

 
(165
)
Other service charges, commissions and fees, net
 
—

 
(2
)
 
—

 
(11
)
Other income
 
—

 
—

 
—

 
10

Total noninterest loss
 
—

 
(115
)
 
—

 
(166
)
Noninterest Expense
 
 
 
 
 
 
 
 
Personnel expense
 
—

 
490

 
1

 
1,443

Net occupancy expense
 
—

 
142

 
1

 
211

Furniture, equipment and data processing expense
 
—

 
94

 
—

 
171

Professional fees
 
—

 
80

 
25

 
177

Stationery, printing and supplies
 
—

 
3

 
—

 
8

Advertising and marketing
 
—

 
(6
)
 
—

 
28

Other real estate owned expense
 
—

 
45

 
—

 
166

Provision for recourse loans
 
—

 
1,146

 
—

 
3,324

Other expense
 
—

 
106

 
—

 
257

Total noninterest expense
 
—

 
2,100

 
27

 
5,785

Loss before income taxes
 
—

 
(2,202
)
 
(27
)
 
(5,895
)
Income tax (benefit)/expense
 
—

 
(213
)
 
—

 
(213
)
Net loss from discontinued operations, net of tax
 
$
—

 
$
(1,989
)
 
$
(27
)
 
$
(5,682
)
All financial information in the consolidated financial statements and notes to the consolidated financial statements reflects continuing operations, unless otherwise noted.
3. Goodwill and Other Intangible Assets
We have accounted for the Merger as a business combination under the acquisition method of accounting. As a result, we have recognized in our financial statements the identifiable net assets acquired and an amount of goodwill (representing the difference between the purchase price and the identifiable net assets). During the measurement period following a business combination, the amount of identifiable net assets recognized is subject to further adjustment to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. GAAP requires that the measurement period cannot exceed one year from the acquisition date.
Goodwill and other intangible assets deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead tested for impairment no less than annually. Impairment exists when the carrying value of goodwill exceeds its implied fair value. An impairment loss would be recognized in an amount equal to that excess and would be included in noninterest expense in the Consolidated Statements of Operations. None of the goodwill recognized in the Merger is expected to be deductible for income tax purposes.
During the six months ending June 30, 2012, we recognized $0.3 million in additional goodwill from the Merger. This additional amount was due to new valuations received on OREO acquired in the Merger, which were written down to our best estimate of fair value.

8

Our intangible assets with definite lives are core deposit premiums ("CDP"). This intangible asset is amortized over its useful life to its estimated residual value and reviewed for impairment at least quarterly. The amortization expense represents the estimated decline in the value of the underlying deposits.
4. Investment Securities
The primary objective of FNB's management of the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. FNB is required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. FNB maintains investment balances based on a continuing assessment of cash flows, the level of loan production, current interest rate risk strategies and an assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risks.
The following table summarizes the amortized cost and estimated fair value of available-for-sale investment securities and presents the related gross unrealized gains and losses:
June 30, 2012
 
 
 
 
 
 
 
 
(dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Obligations of:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
$
6,864

 
$
232

 
$
—

 
$
7,096

U.S. government sponsored enterprises
 
3,586

 
30

 
—

 
3,616

States and political subdivisions
 
5,988

 
78

 
—

 
6,066

Residential mortgage-backed securities-GSE
 
381,857

 
3,904

 
259

 
385,502

Residential mortgage-backed securities-Private
 
32,797

 
652

 
769

 
32,680

Commercial mortgage-backed securities-Private
 
5,354

 
—

 
15

 
5,339

Corporate notes
 
36,992

 
—

 
155

 
36,837

Total
 
$
473,438

 
$
4,896

 
$
1,198

 
$
477,136

 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
(dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Obligations of:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
$
7,081

 
$
107

 
$
—

 
$
7,188

U.S. government sponsored enterprises
 
32,479

 
36

 
151

 
32,364

States and political subdivisions
 
6,075

 
16

 
1

 
6,090

Residential mortgage-backed securities-GSE
 
348,884

 
2,611

 
1,222

 
350,273

Residential mortgage-backed securities-Private
 
33,111

 
73

 
967

 
32,217

Corporate notes
 
3,206

 
—

 
32

 
3,174

Total
 
$
430,836

 
$
2,843

 
$
2,373

 
$
431,306

CommunityOne and Granite, as members of the Federal Home Loan Bank of Atlanta (“FHLB”), are required to own capital stock in the FHLB 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. The combined banks owned a total of $7.3 million of FHLB stock at June 30, 2012 and at December 31, 2011. Due to the redemption provisions of FHLB stock, FNB estimated that fair value approximated cost and that this investment was not impaired at June 30, 2012. FHLB stock is included in other assets at its original cost basis.
CommunityOne, as a member bank of the Federal Reserve Bank of Richmond (“FRBR”), is required to own capital stock of the FRBR based upon a percentage of the bank's common stock and surplus. This investment is carried at cost since no ready market exists for FRBR stock and there is no quoted market value. At both June 30, 2012 and December 31, 2011, CommunityOne owned a total of $3.7 million, of FRBR stock. Due to the nature of this investment in an entity of the U.S. government, FNB estimated that fair value approximated the cost and that this investment was not impaired at June 30, 2012. FRBR stock is included in other assets at its original cost basis.
At June 30, 2012, $82.0 million of the investment securities portfolio was pledged to secure public deposits, $12.3 million was

9

pledged to retail repurchase agreements, $4.1 million was pledged to the FRBR and $0.7 million was pledged to others, leaving $378.2 million available as lendable collateral.
During the three and six months ended June 30, 2012, the banks sold securities with a book value of $112.7 million and recognized a gain of $2.0 million. The banks sold these securities in order to modify our interest rate sensitivity profile.
The following tables show investments' estimated fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2012 and December 31, 2011. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities or the short duration of the unrealized loss or both.
 
Less than 12 Months
 
12 Months or More
 
Total
(dollars in thousands)
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
June 30, 2012
 
 
 
 
 
 
 
 
Residential mortgage-backed securities-GSE
$
43,983

$
167

 
$
12,594

$
92

 
$
56,577

$
259

Residential mortgage-backed securities-Private
13,061

769

 
—

—

 
13,061

769

Commercial mortgage-backed securities-Private
5,339

15

 
—

—

 
5,339

15

Corporate notes
36,837

155

 
—

—

 
36,837

155

Total
$
99,220

$
1,106

 
$
12,594

$
92

 
$
111,814

$
1,198

 
 
 
 
 
 
 
 
 
 
Less than 12 Months
 
12 Months or More
 
Total
(dollars in thousands)
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
December 31, 2011
 
 
 
 
 
 
 
 
Obligations of:
 
 
 
 
 
 
 
 
U.S. government sponsored enterprises
$
21,248

$
151

 
$
—

$
—

 
$
21,248

$
151

States and political subdivisions
1,907

1

 
—

—

 
1,907

1

Residential mortgage-backed securities-GSE
89,730

1,042

 
16,552

180

 
106,282

1,222

Residential mortgage-backed securities-Private
21,519

967

 
—

—

 
21,519

967

Corporate notes
3,173

32

 
—

—

 
3,173

32

Total
$
137,577

$
2,193

 
$
16,552

$
180

 
$
154,129

$
2,373

At June 30, 2012, 10 available-for-sale securities were in an unrealized loss position less than 12 months compared to 32 at December 31, 2011. At June 30, 2012, there were 3 available-for-sale securities that were in an unrealized loss position for longer than 12 months, compared to seven at December 31, 2011.
If an entity intends to sell a debt security or cannot assert it is more likely than not that it will not have to sell the security before recovery, other than temporary impairment ("OTTI") must be taken. If the entity does not intend to sell the debt security before recovery, but the entity does not expect to recover the entire amortized cost basis, then OTTI must be taken, but the amount of impairment is to be bifurcated between impairment due to credit (which is recorded through earnings) and noncredit impairment (which becomes a component of other comprehensive income (“OCI”) for both available-for-sale and held-to-maturity securities). For held-to-maturity securities, the amount in OCI will be amortized prospectively over the security's remaining life. FNB did not have any OTTI during the three and six months ended June 30, 2012 and June 30, 2011.
As of June 30, 2012, FNB had four private residential mortgage-backed securities that were rated as below investment grade by one or more rating agencies. These securities were acquired in the Merger and have a current fair value of $8.1 million. It is our intention to continue to hold these securities.
FNB analyzed its securities portfolio at June 30, 2012, paying particular attention to its private label mortgage-backed securities. After considering ratings, fair value, cash flows and other factors, FNB does not believe securities to be other-than-temporary impaired.
The aggregate amortized cost and fair value of securities at June 30, 2012, by remaining contractual maturity, are shown in the following table. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.


10

 
 
Available-for-Sale
(dollars in thousands)
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
 
$
8,436

 
$
8,407

Due after one one year through five years
 
33,381

 
33,459

Due after five years through 10 years
 
4,749

 
4,653

Due after 10 years
 
6,864

 
7,096

Total
 
53,430

 
53,615

Mortgage-backed securities
 
420,008

 
423,521

Total
 
$
473,438

 
$
477,136


5. Loans
Loans held for investment are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income.  Classes are disaggregations of a portfolio segment.  FNB's portfolio segments are:  Commercial and agricultural, Real estate, and Consumer loans.  The Commercial and agricultural loan portfolio is not further segregated into classes.  The classes within the Real estate portfolio segment include Real estate - construction and real estate mortgage, broken into 1-4 family residential mortgage and commercial real estate mortgage loans. The Consumer loan portfolio is not further segregated into classes.

Loan fees and the incremental direct costs associated with originating loans are deferred and subsequently recognized over the life of the loan as an adjustment to interest income.
In addition to originating loans we also purchase loans. At acquisition purchased loans are designated as either purchased contractual loans or purchased impaired loans. Purchase contractual loans ("PC Loans") are acquired loans where management feels it is probable that it will receive all principal as of the date of acquisition.  These loans are accounted for under the contractual cash flow method, under ASC 310-20. Any discount or premium paid on purchased contractual loans is recorded in interest income on the effective yield method over the expected life of the loan.
Purchased impaired loans ("PI Loans") are acquired loans where, in management's estimation, it is probable that all principal on the acquired loans will not be received as of acquisition date.  PI loans are placed in homogeneous risk based pools where accounting for projected cash flows is performed, as allowed under ASC 310-30.  Once a pool is established the individual loans within each pool do not change.  As management obtains new information related to changes in expected principal loss and expected cash flows, by pool, we record either an increase in yield when new expected cash flows increase, or an allowance for loan losses when new expected cash flows decline.  
Loans acquired in the Merger ("Granite Purchased Loans") included PI Loans and PC Loans. Loans designated as PC Loans included performing revolving consumer and commercial loans on acquisition date.
During February 2012, we purchased $61.9 million of performing residential mortgage loans, including a premium of $2.3 million, and during April 2012 we purchased an additional $75.5 million of performing residential mortgage loans, including a premium of $1.4 million. These loan purchases are accounted for as PC loans.
The following is a summary of Granite Purchased Loans and total loans for the periods as presented.



11

(dollars in thousands)
 
June 30, 2012
 
December 31, 2011
 
 
Granite Purchased Loans
 
Total Loans
 
 
Granite Purchased Loans
 
Total Loans
Loans held for sale
 
$
—

 
$
1,324

 
$
—

$
—

 
$
4,529

Loans held for investment:
 
 
 
 
 
 
 
 
 
Commercial and agricultural
 
$
26,560

 
$
78,367

 
 
$
36,933

 
$
95,089

Real estate - construction
 
5,671

 
75,576

 
 
7,641

 
92,806

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
1-4 family residential
 
76,523

 
589,972

 
 
87,484

 
453,725

Commercial
 
213,750

 
493,721

 
 
239,621

 
531,383

Consumer
 
1,244

 
44,187

 
 
1,809

 
44,532

Gross loans held for investment
 
323,748

 
1,281,823

 
 
373,488

 
1,217,535

Less: Allowance for loan losses
 
(3,336
)
 
(38,551
)
 
 
—

 
(39,360
)
   Loans held for investment, net of allowance
 
$
320,412

 
$
1,243,272

 
 
$
373,488

 
$
1,178,175

At June 30, 2012 loans held for sale consisted of originated residential mortgage loans held for sale at the lower of cost or fair market value. At December 31, 2011, loans held for sale consisted of nonperforming loans transferred from loans held for investment under sales contracts recorded at the contractual sales price.
Loans included in the preceding loan composition table are net of participations sold. Loans are increased by net deferred loan premiums or expenses of $2.6 million at June 30, 2012. Loans are decreased by net deferred loan discounts or fees of $1.8 million at December 31, 2011.
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 $2.5 million at June 30, 2012 and $0.7 million at December 31, 2011.
To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. Gross loans of $309.9 million and $339.4 million were pledged to collateralize FHLB advances and letters of credit at June 30, 2012 and December 31, 2011, respectively, of which there was $58.0 million and $69.5 million of credit availability for borrowing, respectively. Lendable collateral values are subject to change as a result of periodic reviews by the FHLB. At June 30, 2012, $46.0 million of loans and $4.1 million of securities were pledged to collateralize potential borrowings from the Federal Reserve Discount Window, of which $29.0 million was available as borrowing capacity.
Interest income on loans is calculated by using the interest 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 collectability 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. Had nonaccruing loans been on accruing status, interest income would have been higher by $1.5 million and $3.5 million for the three months ended June 30, 2012 and June 30, 2011, respectively, and higher by $2.9 million and $7.6 million for the six months ended June 30, 2012 and June 30, 2011, respectively. At June 30, 2012 and December 31, 2011, FNB had certain impaired loans of $95.1 million and $103.0 million, respectively, which were on nonaccruing interest status.
Nonperforming assets include nonaccrual loans, accruing loans in excess of 90 days delinquent, OREO and other foreclosed assets. The following is a summary of nonperforming assets for the periods ended as presented.
(dollars in thousands)
 
June 30, 2012
 
December 31, 2011
Loans on nonaccrual status:
 
 
 
 
Held for sale
 
$
—

 
$
4,529

Held for investment
 
95,110

 
98,444

Loans more than 90 days delinquent, still on accrual
 
427

 
3,000

Real estate owned/repossessed assets
 
86,400

 
110,386

Total nonperforming assets
 
$
181,937

 
$
216,359


12

An impaired loan is one for which FNB will not be repaid all principal and interest due per the terms of the original contract or within reasonably modified contracted terms.  If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract. All loans meeting the definition of Doubtful should be considered impaired. Loan risk grade categories are defined in Note 6.
When a loan in any class has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan changes over time. A specific reserve is established as a component of the ALL when a loan has been determined to be impaired. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan's expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, FNB recalculates the impairment and appropriately adjusts the specific reserve. Similarly, if FNB measures impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, FNB will adjust the specific reserve if there is a significant change in either of those bases.
When a loan within any class is impaired and principal and interest is in doubt when contractually due, interest income is not recognized. Cash receipts received on nonaccruing impaired loans within any class are generally applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.
The following table summarizes information relative to impaired loans for the quarters ended on the dates indicated.
 
 
June 30, 2012
 
December 31, 2011
(dollars in thousands)
 
Balance
Associated Reserves
 
Balance
Associated Reserves
Impaired loans, held for sale
 
$
—

$
—

 
$
4,529

$
—

Impaired loans, not individually reviewed for impairment
 
6,750

—

 
5,127

—

Impaired loans, individually reviewed, with no impairment
 
55,160

—

 
53,884

—

Impaired loans, individually reviewed, with impairment
 
40,778

8,724

 
42,357

11,090

Total impaired loans, excluding purchased impaired *
 
$
102,688

$
8,724

 
$
105,897

$
11,090

 
 
 
 
 
 
 
Purchased impaired loans with subsequent deterioration
 
$
36,659

3,336

 
$
—

—

Purchased impaired loans with no subsequent deterioration
 
$
250,433

—

 
$
330,836

—

Total Reserves
 
 
$
12,060

 
 
$
11,090

 
 
 
 
 
 
 
Average impaired loans calculated using a simple average
 
$
107,263

 
 
$
112,600

 
* Included at June 30, 2012 and December 31, 2011 were $3.9 million and $2.9 million, respectively, in restructured and performing loans.
Impaired loans also include loans for which FNB may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower. Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that the Bank otherwise may have to incur. If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans. Nonperforming restructured loans will remain as nonperforming until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months and when it is otherwise determined that continued adherence is reasonably assured. Some restructured loans continue as accruing loans after restructuring if the borrower is not past due at the time of restructuring, adequate collateral valuations support the restructured loans, and the cash flows of the underlying business appear adequate to support the restructured debt service. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date. At June 30, 2012, there was $27.3 million in restructured loans, of which $3.9 million in loans were accruing and in a performing status. At December 31, 2011, there was $28.3 million in restructured loans, of which loans amounting to $2.9 million were accruing and in a performing status.
All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. When FNB cannot reasonably expect full and timely repayment of its loan, the loan is placed on nonaccrual.

13

All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. A debt is "well-secured" if collateralized by liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full; or by the guarantee of a financially responsible party. A debt is "in process of collection" if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action that are reasonably expected to result in repayment of the debt or its restoration to a current status.
Loans that are less than 90 days delinquent may also be placed on nonaccrual if deterioration in the financial condition of the borrower has increased the probability of less than full repayment.
At the time a loan is placed on nonaccrual, all accrued, unpaid interest is charged off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable. Charge-offs of accrued and unpaid interest are charged against the current year's interest income and not against the current ALL.
For all loan classes a nonaccrual loan may be returned to accrual status when FNB can reasonably expect continued timely payments until payment in full. All prior arrearage does not have to be eliminated, nor do all previously charged-off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met: (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.
For all classes within all loan portfolios, cash receipts received on nonaccrual loans are applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income.
For all loan classes, as soon as any loan becomes uncollectible, the loan will be charged down or charged off as follows:
•
If unsecured, the loan must be charged off in full.
•
If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral.
Loans should be considered uncollectible when:
•
No regularly scheduled payment has been made within four months and the determination is made that any further payment is unlikely, or
•
The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.
Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectible.
Potential problem loans that are not included in nonperforming assets are classified separately within FNB's portfolio as Special Mention and carry a risk grade rating of “6.” These loans are defined as those with potential weaknesses that may affect repayment capacity but do not pose sufficient risk as to require an adverse classification. As of June 30, 2012, the balance of such loans was $91.7 million compared to a balance of $130.7 million as of December 31, 2011.
During 2011, FNB sold loans to third party buyers in order to reduce its classified loan exposure. These loans were transferred to loans held for sale at the time FNB received a signed contract for the purchase of the loans. Prior to transferring these loans to loans held for sale, the loans were marked down to the contract price less associated selling costs. All transactions were conducted at arm's length and loans were sold without recourse.
The following table presents sold loans by portfolio segment for the periods indicated below:
 
For Three Months Ended June 30, 2012
 
For Three Months Ended June 30, 2011
(dollars in thousands)
Number
 
Recorded
 
Contract
 
Number
 
Recorded
 
Contract
 
of Loans
 
Investment
 
Pricing
 
of Loans
 
Investment
 
Pricing
Commercial and agricultural
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
—

 
—

 
—

 
—

 
—

 
—

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
6

 
1,715

 
1,746

 
—

 
—

 
—

Commercial
—

 
—

 
—

 
—

 
—

 
—

Consumer
—

 
—

 
—

 
—

 
—

 
—

Total
6

 
$
1,715

 
$
1,746

 
—

 
$
—

 
$
—


14

 
For Six Months Ended June 30, 2012
 
For Six Months Ended June 30, 2011
(dollars in thousands)
Number
 
Recorded
 
Contract
 
Number
 
Recorded
 
Contract
 
of Loans
 
Investment
 
Pricing
 
of Loans
 
Investment
 
Pricing
Commercial and agricultural
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
—

 
—

 
—

 
4

 
13,342

 
5,813

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
7

 
1,865

 
1,896

 
—

 
—

—

—

Commercial
1

 
3,800

 
4,050

 
1

—

321

—

350

Consumer
—

 
—

 
—

 
—

—

—

—

—

Total
8

 
$
5,665

 
$
5,946

 
5

 
$
13,663

 
$
6,163

During the three-month period ending June 30, 2012, there were six non-performing loans placed under contract for sale and then sold by June 30, 2012.
Granite Purchased Loans
Granite Purchased Loans include PI Loans and PC Loans. PC Loans included performing revolving consumer and commercial loans on the acquisition date.
PI Loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL. PI Loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade. PI Loans generally meet FNB's definition for nonaccrual status, however, even if the borrower is not currently making payments, FNB will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.
Periodically, we estimate the expected cash flows for each pool of the PI Loans and evaluate whether the expected cash flows for each pool have changed from prior estimates. Decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income. Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
We have elected to account for the Granite Purchased PI Loans under ASC 310-30 and the Granite Purchased PC Loans under ASC 310-20.
At June 30, 2012, we established a PI Loan ALL of $3.3 million and an ALL for originated and PC Loans of $0.4 million relating to Granite Purchased loans. All Granite Purchased PI Loans are presented on an accruing basis.
The following table presents the balance of all Granite Purchased Loans:
 
 
At June 30, 2012
(dollars in thousands)
 
Purchased Impaired
 
Purchased Contractual
 
Total Purchased Loans
 
Unpaid
Principal
Balance
Commercial and agricultural
 
$
20,277

 
$
6,283

 
$
26,560

 
$
26,793

Real estate - construction
 
5,671

 
—

 
5,671

 
6,101

Real estate - mortgage:
 
 
 
 
 
 
 
 
   1-4 family residential
 
46,150

 
30,373

 
76,523

 
79,980

   Commercial
 
213,750

 
—

 
213,750

 
224,208

Consumer
 
1,244

 
—

 
1,244

 
1,434

       Total
 
$
287,092

 
$
36,656

 
$
323,748

 
$
338,516


15

 
 
At December 31, 2011
(dollars in thousands)
 
Purchased Impaired
 
Purchased Contractual
 
Total
Purchased Loans
 
Unpaid
Principal
Balance
Commercial and agricultural
 
$
28,872

 
$
8,061

 
$
36,933

 
$
39,531

Real estate - construction
 
7,641

 
—

 
7,641

 
8,413

Real estate - mortgage:
 
 
 
 
 
 
 
 
   1-4 family residential
 
52,894

 
34,590

 
87,484

 
93,310

   Commercial
 
239,621

 
—

 
239,621

 
261,076

Consumer
 
1,808

 
1

 
1,809

 
1,800

       Total
 
$
330,836

 
$
42,652

 
$
373,488

 
$
404,130

The tables below include only those Granite Purchased Loans accounted for under the expected cash flow method (PI Loans) for the periods indicated. These tables do not include PC Loans, including Granite Purchased PC Loans or purchased performing residential mortgage loans.
 
 
For Six Months Ended June 30, 2012
 
For Six Months Ended December 31, 2011
 
 
Purchased Impaired
 
Purchased Impaired
(dollars in thousands)
 
Carrying
Amount
 
Future
Accretion
 
Carrying
Amount
 
Future Accretion
Balance, beginning of period
 
$
330,836

 
$
47,804

 
$
—

 
$
—

  Addition from Bank of Granite Corp acquisition
 
—

 
—

 
351,121

 
52,581

  Accretion
 
11,263

 
(11,263
)
 
4,777

 
(4,777
)
  Reclass from non-accretable
 
—

 
4,592

 
—

 
—

  Payments received
 
(50,901
)
 
—

 
(24,467
)
 
—

  Foreclosed and transferred to OREO
 
(4,106
)
 
—

 
(595
)
 
—

Subtotal before provision
 
287,092

 
41,133

 
330,836

 
47,804

Provision for credit losses
 
(3,336
)
 
—

 
—

 
—

Balance, end of period
 
$
283,756

 
$
41,133

 
$
330,836

 
$
47,804


6. Allowance for Loan Losses
ALL, 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 to be incurred as of the balance sheet date. FNB's ALL is assessed quarterly by management. This assessment 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. FNB has grouped its loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income. 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.
FNB lends primarily in North Carolina. As of June 30, 2012, a substantial majority of the principal amount of the loans held for investment in its portfolio was to businesses and individuals in North Carolina. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the adequacy of the ALL. Management believes the ALL is adequate to cover estimated losses on loans at each balance sheet date.
During the three month period ended June 30, 2012, FNB charged off $10.3 million in loans and realized $1.3 million in recoveries, for $9.0 million of net charge-offs. The majority of the loans that were charged off were loans that had been in impairment status and had specific reserves assigned to them in prior periods.

16


An analysis of the changes in the ALL is as follows:
 
 
For Three Months Ended
 
For Six Months Ended
(dollars in thousands)
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
Balance, beginning of period
 
$
39,795

 
$
68,729

 
$
39,360

 
$
93,687

Provision for losses charged to continuing operations
 
7,778

 
33,580

 
10,845

 
53,763

Net charge-offs:
 
 
 
 
 
 
 
 
Charge-offs
 
(10,285
)
 
(45,662
)
 
(14,300
)
 
(91,571
)
Recoveries
 
1,263

 
2,719

 
2,646

 
3,487

Net charge-offs
 
(9,022
)
 
(42,943
)
 
(11,654
)
 
(88,084
)
Provision for losses charged to discontinued operations
 
—

 
—

 
—

 
—

Balance, end of period
 
$
38,551

 
$
59,366

 
$
38,551

 
$
59,366

Annualized net charge-offs during the period to average loans
 
2.83
%
 
15.06
%
 
1.87
%
 
14.76
%
Annualized net charge-offs during the period to ALL
 
94.13
%
 
290.14
%
 
60.79
%
 
299.21
%
Allowance for loan losses to loans held for investment (1)
 
3.01
%
 
5.83
%
 
3.01
%
 
5.83
%
(1) Excludes discontinued operations.
The ALL, as a percentage of loans held for investment, was 3.01% at June 30, 2012, compared to 5.83% at June 30, 2011. At December 31, 2011, the ALL, as a percentage of loans held for investment, was 3.23%.
The credit quality indicator presented for all classes within the loan portfolio is a widely used and standard system representing the degree of risk of nonpayment. The risk-grade categories presented in the following table are:
Pass - Loans categorized as Pass are higher quality loans that have adequate sources of repayment and little risk of collection.
Special Mention - A Special Mention loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that FNB will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual assets classified Substandard.
Doubtful - A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors, which may work to the advantage of strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
Loans categorized as Special Mention or worse are considered Criticized. Loans categorized as Substandard or Doubtful are considered Classified. Purchased loans acquired in the Merger are recorded at estimated fair value on the date of acquisition without the carryover of related ALL. The table below includes $81.9 million and $63.6 million in purchased loans categorized as Substandard or Doubtful at June 30, 2012 and December 31, 2011, respectively.

17

The following table presents loan and lease balances by credit quality indicator as of June 30, 2012:
(dollars in thousands)
 
Pass
 
Special Mention
 
Substandard*
 
Doubtful*
 
 
 
 
(Ratings 1-5)
 
(Rating 6)
 
(Rating 7)
 
(Rating 8)
 
Total
Commercial and agricultural
 
$
64,091

 
$
4,591

 
$
9,685

 
$
—

 
$
78,367

Real estate - construction
 
44,799

 
3,266

 
27,511

 
—

 
75,576

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
533,265

 
19,412

 
37,070

 
225

 
589,972

Commercial
 
312,648

 
64,189

 
116,757

 
127

 
493,721

Consumer
 
43,222

 
197

 
681

 
87

 
44,187

Total
 
$
998,025

 
$
91,655

 
$
191,704

 
$
439

 
$
1,281,823

*Includes $81.9 million of loans purchased in the Merger categorized as Substandard and Doubtful.
The following table presents loan and lease balances by credit quality indicator as of December 31, 2011:
(dollars in thousands)
 
Pass
 
Special Mention
 
Substandard*
 
Doubtful*
 
 
 
 
(Ratings 1-5)
 
(Rating 6)
 
(Rating 7)
 
(Rating 8)
 
Total
Commercial and agricultural
 
$
77,305

 
$
7,373

 
$
9,921

 
$
490

 
$
95,089

Real estate - construction
 
53,105

 
5,797

 
33,886

 
18

 
92,806

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
385,022

 
25,864

 
42,630

 
209

 
453,725

Commercial
 
351,731

 
91,364

 
87,971

 
317

 
531,383

Consumer
 
43,487

 
279

 
387

 
379

 
44,532

Total
 
$
910,650

 
$
130,677

 
$
174,795

 
$
1,413

 
$
1,217,535

*Includes $63.6 million of loans purchased in the Merger categorized as Substandard and Doubtful.
The following table presents ALL activity by portfolio segment for the three months ended June 30, 2012:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total

 
 
 
 
 
 
 
 
 
 
 
 
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at April 1, 2012
 
$
6,005

 
$
10,912

 
$
12,103

 
$
8,799

 
$
1,976

 
$
39,795

Charge-offs
 
(937
)
 
(4,521
)
 
(2,454
)
 
(954
)
 
(1,419
)
 
(10,285
)
Recoveries
 
235

 
244

 
244

 
262

 
278

 
1,263

Provision
 
1,848

 
4,685

 
(1,109
)
 
1,111

 
1,243

 
7,778

Ending balance at June 30, 2012
 
$
7,151

 
$
11,320

 
$
8,784

 
$
9,218

 
$
2,078

 
$
38,551



18

The following table presents ALL activity by portfolio segment for the three months ended June 30, 2011:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at April 1, 2011
 
$
8,719

 
$
32,947

 
$
9,751

 
$
15,668

 
$
1,644

 
$
68,729

Charge-offs
 
(4,192
)
 
(21,510
)
 
(4,585
)
 
(14,002
)
 
(1,373
)
 
(45,662
)
Recoveries
 
467

 
714

 
469

 
693

 
376

 
2,719

Provision
 
1,533

 
16,268

 
3,395

 
11,260

 
1,124

 
33,580

Ending balance at June 30, 2011
 
$
6,527

 
$
28,419

 
$
9,030

 
$
13,619

 
$
1,771

 
$
59,366


The following table presents ALL activity by portfolio segment for the six months ended June 30, 2012:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at January 1, 2012
 
$
5,776

 
$
11,995

 
$
8,885

 
$
11,063

 
$
1,641

 
$
39,360

Charge-offs
 
(1,631
)
 
(6,296
)
 
(3,159
)
 
(992
)
 
(2,222
)
 
(14,300
)
Recoveries
 
489

 
845

 
377

 
336

 
599

 
2,646

Provision
 
2,517

 
4,776

 
2,681

 
(1,189
)
 
2,060

 
10,845

Ending balance at June 30, 2012
 
$
7,151

 
$
11,320

 
$
8,784

 
$
9,218

 
$
2,078

 
$
38,551

The following table presents ALL activity by portfolio segment for the six months ended June 30, 2011:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 
 
Beginning balance at January 1, 2011
 
$
11,144

 
$
46,792

 
$
7,742

 
$
26,851

 
$
1,158

 
$
93,687

Charge-offs
 
(8,467
)
 
(44,172
)
 
(6,621
)
 
(30,180
)
 
(2,131
)
 
(91,571
)
Recoveries
 
533

 
904

 
562

 
742

 
746

 
3,487

Provision
 
3,317

 
24,895

 
7,347

 
16,206

 
1,998

 
53,763

Ending balance at June 30, 2011
 
$
6,527

 
$
28,419

 
$
9,030

 
$
13,619

 
$
1,771

 
$
59,366


19


The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment methodology at June 30, 2012.
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
1,208

 
$
2,247

 
$
2,056

 
$
3,012

 
$
201

 
$
8,724

  Collectively evaluated for impairment
 
4,105

 
9,002

 
6,093

 
5,488

 
1,803

 
26,491

  PI loans evaluated for credit impairment
 
1,838

 
71

 
635

 
718

 
74

 
3,336

  PI loans with no credit deterioration
 
—

 
—

 
—

 
—

 
—

 
—

Total ALL evaluated for impairment
 
$
7,151

 
$
11,320

 
$
8,784

 
$
9,218

 
$
2,078

 
$
38,551

Loans held for investment
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
3,028

 
$
24,187

 
$
20,778

 
$
47,744

 
$
201

 
$
95,938

  Collectively evaluated for impairment
 
55,062

 
45,716

 
523,044

 
232,229

 
42,742

 
898,793

  PI loans with subsequent credit deterioration
 
18,911

 
2,188

 
3,179

 
12,307

 
74

 
36,659

  PI loans with no credit deterioration
 
1,366

 
3,485

 
42,971

 
201,441

 
1,170

 
250,433

Total loans evaluated for impairment
 
$
78,367

 
$
75,576

 
$
589,972

 
$
493,721

 
$
44,187

 
$
1,281,823

The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment methodology at December 31, 2011.
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
1,506

 
$
4,899

 
$
2,140

 
$
2,415

 
$
130

 
$
11,090

  Collectively evaluated for impairment
 
4,270

 
7,096

 
6,745

 
8,648

 
1,511

 
28,270

  PI loans evaluated for credit impairment
 
—

 
—

 
—

 
—

 
—

 
—

  PI loans with no credit deterioration
 
—

 
—

 
—

 
—

 
—

 
—

Total ALL evaluated for impairment
 
$
5,776

 
$
11,995

 
$
8,885

 
$
11,063

 
$
1,641

 
$
39,360

Loans held for investment
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
3,890

 
$
30,460

 
$
24,886

 
$
36,835

 
$
170

 
$
96,241

  Collectively evaluated for impairment
 
62,327

 
54,705

 
375,945

 
254,927

 
42,554

 
790,458

  PI loans with subsequent credit deterioration
 
—

 
—

 
—

 
—

 
—

 
—

  PI loans with no credit deterioration
 
28,872

 
7,641

 
52,894

 
239,621

 
1,808

 
330,836

Total loans evaluated for impairment
 
$
95,089

 
$
92,806

 
$
453,725

 
$
531,383

 
$
44,532

 
$
1,217,535

The following table presents loans held for investment on nonaccrual status by loan class for the dates indicated below:
(dollars in thousands)
 
June 30,
 
December 31,
 
 
2012
 
2011
Loans held for investment:
 
 
 
 
Commercial and agricultural
 
$
2,855

 
$
4,636

Real estate - construction
 
24,853

 
30,844

Real estate - mortgage:
 
 
 
 
1-4 family residential
 
22,300

 
26,048

Commercial
 
44,469

 
36,666

Consumer
 
633

 
250

Total
 
$
95,110

 
$
98,444


20

The following table presents loans held for sale on nonaccrual status by loan class for the dates indicated below:
(dollars in thousands)
 
June 30,
 
December 31,
 
 
2012
 
2011
Loans held for sale:
 
 
 
 
Real estate - construction
 
$
—

 
$
1,807

Real estate - mortgage:
 
 
 
 
1-4 family residential
 
—

 
517

Commercial
 
—

 
2,205

Consumer
 
—

 
—

Total
 
$
—

 
$
4,529

The following table presents an aging analysis of accruing and nonaccruing loans as of June 30, 2012:
 
 
Past Due
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 

 
 
 
 
 
PI Loans
 
 
 
90 or more
 
 
30-59 Days
 
60-89 Days
 
90 or More Days
 
Total
 
Current
 
No credit deterior- ation
 
Credit deterior-ation
 
Total Loans
 
days past due and Accruing
Commercial and agricultural
 
$
893

 
$
437

 
$
2,681

 
$
4,011

 
$
54,079

 
$
1,366

 
$
18,911

 
$
78,367

 
$
79

Real estate - construction
 
1,353

 
4,813

 
12,844

 
19,010

 
50,893

 
3,485

 
2,188

 
75,576

 
—

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
5,037

 
823

 
13,009

 
18,869

 
524,953

 
42,971

 
3,179

 
589,972

 
—

Commercial
 
4,727

 
1,332

 
29,674

 
35,733

 
244,240

 
201,441

 
12,307

 
493,721

 
348

Consumer
 
464

 
17

 
1

 
482

 
42,461

 
1,170

 
74

 
44,187

 

Total
 
$
12,474

 
$
7,422

 
$
58,209

 
$
78,105

 
$
916,626

 
$
250,433

 
$
36,659

 
$
1,281,823

 
$
427

The following table presents an aging analysis of accruing and nonaccruing loans as of December 31, 2011:
 
 
Past Due
 
 
 
 
(dollars in thousands)
 
 
 
 
 

 
 
 
 
 
PI Loans
 
 
 
90 or more
 
 
30-59 Days
 
60-89 Days
 
90 or More Days
 
Total
 
Current
 
No credit deterior- ation
 
Credit deterior-ation
 
Total Loans
 
days past due and Accruing
Commercial and agricultural
 
$
335

 
$
425

 
$
2,755

 
$
3,515

 
$
62,702

 
$
28,872

 
$
—

 
$
95,089

 
$
305

Real estate - construction
 
1,850

 
2,206

 
21,438

 
25,494

 
59,671

 
7,641

 
—

 
92,806

 
1,400

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
4,544

 
2,253

 
14,125

 
20,922

 
379,909

 
52,894

 
—

 
453,725

 
292

Commercial
 
2,926

 
6,645

 
16,330

 
25,901

 
265,861

 
239,621

 
—

 
531,383

 
1,003

Consumer
 
740

 
278

 
63

 
1,081

 
41,643

 
1,808

 
—

 
44,532

 
—

Total
 
$
10,395

 
$
11,807

 
$
54,711

 
$
76,913

 
$
809,786

 
$
330,836

 
$
—

 
$
1,217,535

 
$
3,000

A loan is considered impaired, based on current information and events, if it is probable that FNB will be unable to collect the scheduled payments or principal and interest when due according to the contractual terms of the loan agreement.

21

The following table presents individually reviewed impaired loans, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of June 30, 2012:
 
 
 
 
Unpaid
 
 
(dollars in thousands)
 
Recorded
 
Principal
 
Related
 
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,254

 
$
1,320

 
$
—

  Real estate - construction
 
9,496

 
14,027

 
—

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
12,197

 
14,119

 
—

Commercial
 
32,213

 
39,590

 
—

  Consumer
 
—

 
—

 
—

Total
 
$
55,160

 
$
69,056

 
$
—

With an allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,774

 
$
2,096

 
$
1,208

  Real estate - construction
 
14,691

 
18,669

 
2,247

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
8,581

 
9,810

 
2,056

Commercial
 
15,531

 
16,200

 
3,012

  Consumer
 
201

 
201

 
201

Total
 
$
40,778

 
$
46,976

 
$
8,724

Total impaired loans
 
 
 
 
 
 
  Commercial and agricultural
 
$
3,028

 
$
3,416

 
$
1,208

  Real estate - construction
 
24,187

 
32,696

 
2,247

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
20,778

 
23,929

 
2,056

Commercial
 
47,744

 
55,790

 
3,012

  Consumer
 
201

 
201

 
201

Total
 
$
95,938

 
$
116,032

 
$
8,724

 
 
 
 
 
 
 
PI loans with subsequent credit deterioration:
 
 
 
 
 
 
  Commercial and agricultural
 
$
18,911

 
$
18,859

 
$
1,838

  Real estate - construction
 
2,188

 
2,244

 
71

  Real estate - mortgage:
 
 
 
 
 
 
     1-4 family residential
 
3,179

 
3,729

 
635

     Commercial
 
12,307

 
12,661

 
718

  Consumer
 
74

 
62

 
74

Total
 
$
36,659

 
$
37,555

 
$
3,336


22

The following table presents individually reviewed impaired loans, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of December 31, 2011:
 
 
 
 
Unpaid
 
 
(dollars in thousands)
 
Recorded
 
Principal
 
Related
 
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
2,354

 
$
4,346

 
$
—

  Real estate - construction
 
16,351

 
25,714

 
—

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
13,003

 
19,657

 
—

Commercial
 
22,176

 
26,964

 
—

  Consumer
 
—

 
102

 
—

Total
 
$
53,884

 
$
76,783

 
$
—

With an allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,536

 
$
2,047

 
$
1,506

  Real estate - construction
 
14,109

 
14,718

 
4,899

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
11,883

 
12,328

 
2,140

Commercial
 
14,659

 
14,943

 
2,415

  Consumer
 
170

 
172

 
130

Total
 
$
42,357

 
$
44,208

 
$
11,090

Total impaired loans
 
 
 
 
 
 
  Commercial and agricultural
 
$
3,890

 
$
6,393

 
$
1,506

  Real estate - construction
 
30,460

 
40,432

 
4,899

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
24,886

 
31,985

 
2,140

Commercial
 
36,835

 
41,907

 
2,415

  Consumer
 
170

 
274

 
130

Total
 
$
96,241

 
$
120,991

 
$
11,090


There were no PI loans with subsequent credit deterioration at December 31, 2011.

23

The following summary includes impaired loans individually reviewed as well as impaired loans held for sale and impaired loans not individually reviewed for impairment. Average recorded investment and interest income recognized on impaired loans, segregated by portfolio segment, is shown in the following table as of June 30, 2012 and June 30, 2011:
 
 
For Three Months Ended
 
For Three Months Ended
 
 
June 30, 2012
 
June 30, 2011
 
 
Average
 
Interest
 
Average
 
Interest
(dollars in thousands)
 
Recorded
 
Income
 
Recorded
 
Income
 
 
Investment
 
Recognized
 
Investment
 
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
2,170

 
$
3

 
$
3,086

 
$
—

  Real estate - construction
 
10,918

 
30

 
61,867

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
15,944

 
60

 
19,685

 
1

Commercial
 
33,630

 
76

 
58,170

 
1

  Consumer
 
1,000

 
15

 
161

 
—

Total
 
$
63,662

 
$
184

 
$
142,969

 
$
2

With an allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,790

 
$
—

 
$
5,879

 
$
—

  Real estate - construction
 
16,567

 
7

 
60,059

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
8,760

 
76

 
17,589

 
—

Commercial
 
15,832

 
151

 
32,829

 
1

  Consumer
 
652

 
13

 
282

 
—

Total
 
$
43,601

 
$
247

 
$
116,638

 
$
1

Total:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
3,960

 
$
3

 
$
8,965

 
$
—

  Real estate - construction
 
27,485

 
37

 
121,926

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
24,704

 
136

 
37,274

 
1

Commercial
 
49,462

 
227

 
90,999

 
2

  Consumer
 
1,652

 
28

 
443

 
—

Total
 
$
107,263

 
$
431

 
$
259,607

 
$
3


24

 
 
For Six Months Ended
 
For Six Months Ended
 
 
June 30, 2012
 
June 30, 2011
 
 
Average
 
Interest
 
Average
 
Interest
(dollars in thousands)
 
Recorded
 
Income
 
Recorded
 
Income
 
 
Investment
 
Recognized
 
Investment
 
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
2,651

 
$
10

 
$
3,756

 
$
—

  Real estate - construction
 
12,166

 
34

 
60,795

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
17,071

 
66

 
20,692

 
1

Commercial
 
31,720

 
106

 
52,421

 
1

  Consumer
 
699

 
15

 
249

 
—

Total
 
$
64,307

 
$
231

 
$
137,913

 
$
2

With an allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,729

 
$
—

 
$
6,738

 
$
—

  Real estate - construction
 
14,308

 
9

 
65,267

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
10,862

 
94

 
17,242

 
—

Commercial
 
15,177

 
159

 
64,386

 
1

  Consumer
 
432

 
13

 
195

 
—

Total
 
$
42,508

 
$
275

 
$
153,828

 
$
1

Total:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
4,380

 
$
10

 
$
10,494

 
$
—

  Real estate - construction
 
26,474

 
43

 
126,062

 
—

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
27,933

 
160

 
37,934

 
1

Commercial
 
46,897

 
265

 
116,807

 
2

  Consumer
 
1,131

 
28

 
444

 
—

Total
 
$
106,815

 
$
506

 
$
291,741

 
$
3

For the three months ended June 30, 2012, the following table presents a breakdown of troubled debt restructurings that were restructured during the quarter segregated by portfolio segment:
 
 
For Three Months Ended June 30, 2012
 
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
 
Outstanding
 
Outstanding
(dollars in thousands)
 
Number
 
Recorded
 
Recorded
 
 
of Loans
 
Investment
 
Investment
Commercial and agricultural
 
—

 
$
—

 
$
—

Real estate - construction
 
4

 
369

 
329

Real estate - mortgage:
 
 
 
 
 
 
   1-4 family residential
 
—

 
—

 
—

   Commercial
 
3

 
617

 
614

Consumer
 
—

 
—

 
—

    Total
 
7

 
$
986

 
$
943


For the six months ended June 30, 2012, the following table presents a breakdown of troubled debt restructurings that were restructured during the six month period segregated by portfolio segment:

25


 
 
For Six Months Ended June 30, 2012
 
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
 
Outstanding
 
Outstanding
(dollars in thousands)
 
Number
 
Recorded
 
Recorded
 
 
of Loans
 
Investment
 
Investment
Commercial and agricultural
 
—

 
$
—

 
$
—

Real estate - construction
 
9

 
2,526

 
1,603

Real estate - mortgage:
 
 
 
 
 
 
   1-4 family residential
 
2

 
58

 
58

   Commercial
 
8

 
1,356

 
1,353

Consumer
 
—

 
—

 
—

    Total
 
19

 
$
3,940

 
$
3,014


During the three months ended June 30, 2012, FNB modified 7 loans that were considered to be troubled debt restructurings. FNB extended the terms for five of these loans, the interest rate was lowered for one of these loans, and the remaining loan was modified in both ways.
There were no loans restructured in the twelve months through June 30, 2012 that went into default during the three months or six months ended June 30, 2012.
In the determination of the ALL, management considers troubled debt restructurings and any subsequent defaults in these restructurings as impaired loans. The amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent.
The reserve for unfunded commitments, which is included in other liabilities, is calculated by determining the type of commitment and the remaining unfunded commitment for each loan. Based on the type of commitment, an expected usage percentage to the remaining unfunded balance is applied. The expected usage percentage is multiplied by the historical losses and qualitative and environmental factors for each loans pool as defined in the regular ALL calculation to determine the appropriate level of reserve. The expected usage percentages for each commitment type are as follows:
•
Construction draws - 100%
•
Equity lines of credit - 50%
•
Letters of Credit - 10%
The reserve for unfunded commitments was $1.1 million as of June 30, 2012 and $0.6 million at December 31, 2011.
7. Other Real Estate Owned and Property Acquired in Settlement of Loans
OREO represents properties acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale. 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.
Total OREO and foreclosed assets decreased $24.0 million during the first six months of 2012 from $110.4 million at December 31, 2011, to $86.4 million at June 30, 2012, which represents 47% of total nonperforming assets. At December 31, 2011, OREO and foreclosed assets represented 51% of total nonperforming assets.
The following table summarizes properties acquired in settlement of loans and personal property acquired in settlement of loans, the latter of which is included within the other assets financial statement line item on the Consolidated Balance Sheet at the periods indicated.
(dollars in thousands)
 
June 30, 2012
 
December 31, 2011

Real estate acquired in settlement of loans
 
$
86,183

 
$
110,009

Personal property acquired in settlement of loans
 
217

 
377

Total property acquired in settlement of loans
 
$
86,400

 
$
110,386


26

The following tables summarize the changes in real estate acquired in settlement of loans at the periods indicated.
 
 
For Three Months Ended
(dollars in thousands)
 
June 30, 2012
 
June 30, 2011
Real estate acquired in settlement of loans, beginning of period
 
$
104,193

 
$
67,331

Plus: New real estate acquired in settlement of loans
 
6,085

 
52,680

Plus: Real estate acquired in BOGC acquisition
 
—

 
—

Less: Sales of real estate acquired in settlement of loans
 
(13,502
)
 
(8,681
)
Less: Write-downs and net loss on sales charged to expense
 
(10,593
)
 
(9,946
)
Real estate acquired in settlement of loans, end of period
 
$
86,183

 
$
101,384

 
 
For Six Months Ended
(dollars in thousands)
 
June 30, 2012
 
June 30, 2011
Real estate acquired in settlement of loans, beginning of period
 
$
110,009

 
$
62,058

Plus: New real estate acquired in settlement of loans
 
15,020

 
73,967

Plus: Real estate acquired in BOGC acquisition
 
—

 
—

Less: Sales of real estate acquired in settlement of loans
 
(24,376
)
 
(10,399
)
Less: Write-downs and net loss on sales charged to expense
 
(14,470
)
 
(24,242
)
Real estate acquired in settlement of loans, end of period
 
$
86,183

 
$
101,384

At June 30, 2012, 41 assets with a net carrying amount of $12.9 million were under contract for sale. Estimated losses with these sales have been recognized in the Consolidated Statements of Operations in the first six months of 2012.
8. Earnings Per Share
Basic net loss per share, or basic earnings/(loss) per share (“EPS”), is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period. FNB retired its preferred stock in 2011 and there were no unpaid preferred dividends or accretion of preferred stock discount at June 30, 2012. At June 30, 2011, FNB had $3.5 million of unpaid cumulative dividends on its Series A preferred stock and had $0.3 million in accretion of the discount on the preferred stock.
Diluted EPS reflects the potential dilution that could occur if FNB's potential common stock, which consists of dilutive stock options and a common stock warrant, were issued. As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation is provided in this note.
(dollars in thousands, except per share data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Net loss from continuing operations before cumulative dividends on preferred stock
 
$
(18,138
)
 
$
(46,985
)
 
$
(28,970
)
 
$
(86,999
)
Dividends on preferred stock
 
—

 
(1,087
)
 
—

 
(2,104
)
Loss from continuing operations, net of tax
 
(18,138
)
 
(48,072
)
 
(28,970
)
 
(89,103
)
Loss from discontinued operations, net of tax
 
—

 
(1,989
)
 
(27
)
 
(5,682
)
Net loss to common shareholders
 
$
(18,138
)
 
$
(50,061
)
 
$
(28,997
)
 
$
(94,785
)
Weighted average number of common shares outstanding - basic and diluted
 
21,190,848

 
114,265

 
21,146,758

 
114,256

Net loss per common share from continuing operations - basic and diluted
 
$
(0.86
)
 
$
(420.71
)
 
$
(1.37
)
 
$
(779.85
)
Net loss per common share from discontinued operations - basic and diluted
 
—

 
(17.40
)
 
—

 
(49.73
)
Net loss per common share - basic and diluted
 
(0.86
)
 
(438.11
)
 
(1.37
)
 
(829.58
)
As a result of the net loss for the three and six months ended June 30, 2012 and 2011, all stock options and the common stock warrant were considered antidilutive and thus are not included in this calculation. For the three and six months ended June 30, 2012 and 2011, there were 23,310 and 27,421 antidilutive shares, respectively. Of the antidilutive shares, the number of shares relating to stock options were 1,238 at June 30, 2012 and 5,349 June 30, 2011.

27

Net loss to common shareholders increased for the three months ended June 30, 2011 by $1.0 million, and for the six months ended June 30, 2011 by $2.1 million, for preferred stock dividends. Accretion on the preferred stock discount associated with the preferred stock of $0.2 million was recognized for the three months ended June 30, 2011. FNB retired its preferred stock in 2011 and there were no preferred stock dividends or accretion on the preferred stock discount for the three and six months ended June 30, 2012.
9. Derivatives and Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest rate swaps, caps, floors, collars, options or other financial instruments designed to hedge exposures to interest rate risk or for speculative purposes.
Accounting guidance 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.
For the three- and six-months ended June 30, 2011, the interest rate swaps designated as a fair value hedge resulted in decreased interest expense of $229,000 and $454,300, respectively, on FHLB advances than would otherwise have been recognized for the liability. The fair value of the swaps at June 30, 2011 was recorded on the Consolidated Balance Sheets as an asset in the amount of $1.6 million.
Because the swaps were terminated in 2011, there were no net gains or losses recognized on the fair value swaps for the three or six months ended June 30, 2012. However, net gains recognized on the fair value swaps during the six months ended June 30, 2011 were $169,000.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts or forward contracts and rate lock loan commitments. The fair value of FNB's derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.
The table below provides data about the amount of gains and losses related to derivative instruments designated as hedges included in “Other income” in the FNB's Consolidated Statements of Operations:
 
 
Gain, Net of Tax
 
 
Recognized in Income
(dollars in thousands)
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
Interest rate swap contracts - FHLB advances
 
$
—

 
$
46

 
$
—

 
$
102

Continued Operations
During 2012, FNB began originating residential mortgage loans for sale in the secondary market. FNB has established new guidelines in originating, selling loans to Fannie Mae, and retaining or selling the loan servicing rights. The commitments to originate residential mortgage loans and the forward sales commitments are freestanding derivative instruments. As such, they do not qualify for hedge accounting treatment, and the fair value adjustments for these instruments is recorded through the income statement in mortgage loan income.

 
 
Gain (Loss) recognized
(dollars in thousands)
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Mortgage loan rate lock commitments (1)
 
$
177

 
$
—

 
$
177

 
$
55

Mortgage loan forward sales and MBS (1)
 
—

 
—

 
—

 
(44
)
Total
 
$
177

 
$
—

 
$
177

 
$
11

 
 
 
 
 
 
 
 
 
(1) For 2011, recognized in "Net loss from discontinued operations" in FNB's Consolidated Statements of Operations.
Discontinued Operations
On April 7, 2009, Dover irrevocably opted to elect the fair value option for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. This election allowed Dover to enter into a hedging arrangement for the

28

purpose of limiting risk inherent in the mortgage loan pipeline and loans held for sale portfolio.
Dover originated certain residential mortgage loans with the intention of selling these loans. Between the time that Dover entered 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, FNB was subject to variability in market prices related to these commitments. FNB believed that it was 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 were freestanding derivative instruments. They did not qualify for hedge accounting treatment so their fair value adjustments were recorded through the income statement in income from mortgage loan sales.
10. Fair Values of Assets and Liabilities
FNB utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, derivative assets, certain FHLB advances hedged by interest rate swaps designated as fair value hedges, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time-to-time, FNB may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as loans held for sale, loans held for investment, impaired loans and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets or liabilities.
Fair Value Hierarchy
FNB groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Investments Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.
Liquidity is a significant factor in the determination of the fair values of available-for-sale debt securities. Market price quotes may not be readily available for some positions, or positions within a market sector where trading activity has slowed significantly or ceased. Some of these instruments are valued using a discounted cash flow model, which estimates the fair value of the securities using internal credit risk, interest rate and prepayment risk models that incorporate management's best estimate of current key assumptions such as default rates, loss severity and prepayment rates. Principal and interest cash flows are discounted using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value for the specific security. Underlying assets are valued using external pricing services, where available, or matrix pricing based on the vintages and ratings. Situations of illiquidity generally are triggered by the market's perception of credit uncertainty regarding a single company or a specific market sector. In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer's financial statements and changes in credit ratings made by one or more ratings agencies.
Loans Held for Sale
At June 30, 2012, loans held for sale included loans originated under various loan programs which are sold in the secondary market. These loans are carried at the lower of cost or market. The company classified loans held for sale on June 30, 2012 as recurring Level 2.
At December 31, 2011, loans held for sale included problem commercial loans under contract to be sold. Problem commercial loans are reclassified from loans held for investment to held for sale when they are under contract to be sold, and are carried at the lower of cost or fair value, based on contractual agreements with independent third-party buyers, less estimated costs to sell. At December 31,

29

2011, FNB classified loans held for sale as nonrecurring Level 2.
Loans
FNB does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management determines the fair value of the loan to quantify impairment, should such exist. The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans. At June 30, 2012 and December 31, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. FNB records impaired loans as nonrecurring Level 3.
Other Real Estate Owned
OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. Given the lack of observable market prices for identical properties, FNB records the OREO as nonrecurring Level 3.
Derivative Assets and Liabilities
Substantially all derivative instruments held or issued by FNB for risk management or customer-initiated activities are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, FNB measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. FNB classifies derivatives instruments held or issued for risk management or customer-initiated activities as Level 2.
Mortgage Servicing Rights
The fair value of mortgage serving rights (MSR) is dependent upon a number of assumptions including the fee per loan, the cost to service, the expected loan prepayment rate, and the discount rate.  In determining the fair value of the existing MSR management reviews the key assumptions, analyzes pricing in the market for comparable MSR, and uses a third party provider to independently calculate the fair value of its MSR. FNB records mortgage servicing rights as recurring Level 3.





30

Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Assets and liabilities carried at fair value on a recurring basis at June 30, 2012 for continuing operations, including financial instruments that FNB accounts for under the fair value option, are summarized in the following table:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Loans held for sale
 
$
1,324

 
$
—

 
$
1,324

 
$
—

Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
7,096

 
—

 
7,096

 
—

U.S. government sponsored agencies
 
3,616

 
—

 
3,616

 
—

States and political subdivisions
 
6,066

 
—

 
6,066

 
—

Residential mortgage-backed securities-GSE
 
385,502

 
—

 
385,502

 
—

Residential mortgage-backed securities-Private
 
32,680

 
—

 
32,680

 
—

Commercial mortgage-backed securities-Private
 
5,339

 
—

 
5,339

 
—

Corporate notes
 
36,837

 
—

 
36,837

 
—

Total available-for-sale debt securities
 
477,136

 
—

 
477,136

 
—

Mortgage servicing rights
 
25

 
—

 
—

 
25

Total assets at fair value from continuing operations
 
$
477,161

 
$
—

 
$
477,136

 
$
25

Assets and liabilities carried at fair value on a recurring basis at December 31, 2011 for continuing operations, including financial instruments that FNB accounts for under the fair value option, are summarized in the following table:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
$
7,188

 
$
—

 
$
7,188

 
$
—

U.S. government sponsored agencies
 
32,364

 
—

 
32,364

 
—

States and political subdivisions
 
6,090

 
—

 
6,090

 
—

Residential mortgage-backed securities-GSE
 
350,273

 
—

 
350,273

 
—

Residential mortgage-backed securities-Private
 
32,217

 
—

 
32,217

 
—

Corporate notes
 
3,174

 
—

 
3,174

 
—

Total available-for-sale debt securities
 
431,306

 
—

 
431,306

 
—

Total assets at fair value from continuing operations
 
$
431,306

 
$
—

 
$
431,306

 
$
—

The following tables present a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the periods indicated.
 
 
Fair Value Measurements Using Significant
 
 
Unobservable Inputs (Level 3)
 
 
Mortgage Servicing Rights
(dollars in thousands)
 
Three Months Ended June 30,
 
 
2012
 
2011
Beginning balance at April 1,
 
$
—

 
$
—

Total gains or losses (realized/unrealized):
 
 
 
 
Included in earnings
 
25

 
—

Purchases, issuances and settlements
 
—

 
—

Servicing rights sold
 
—

 
—

Ending balance at June 30,
 
$
25

 
$
—



31

 
 
Fair Value Measurements Using Significant
 
 
Unobservable Inputs (Level 3)
 
 
Mortgage Servicing Rights
(dollars in thousands)
 
Six Months Ended June 30,
 
 
2012
 
2011
Beginning balance at January 1,
 
$
—

 
$
2,359

Total gains or losses (realized/unrealized):
 
 
 
 
Included in earnings
 
25

 
(117
)
Purchases, issuances and settlements
 
—

 
—

Servicing rights sold
 
—

 
(2,242
)
Ending balance at June 30,
 
$
25

 
$
—

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
FNB may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. This is due to further deterioration in the value of the assets.
Assets measured at fair value on a nonrecurring basis are included in the following table at June 30, 2012 for continuing operations:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Impaired loans, net
 
$
32,054

 
—

 
—

 
$
32,054

Other real estate owned
 
50,126

 
—

 
—

 
50,126

Total assets at fair value from continuing operations
 
$
82,180

 
$
—

 
$
—

 
$
82,180

Subsequent to their initial recognition at fair value during the quarter ended December 31, 2011, purchased impaired loans and purchased contractual loans are no longer recorded at their fair value and therefore these loans are not included in the above table of assets measured at fair value on a nonrecurring basis at June 30, 2012.
Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2011 for continuing operations:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Loans held for sale
 
$
4,529

 
$
—

 
$
4,529

 
$
—

Impaired loans, net
 
31,266

 
—

 
—

 
31,266

Purchased impaired loans
 
308,594

 
—

 
—

 
308,594

Purchased contractual loans
 
65,283

 
—

 
—

 
65,283

Other real estate owned
 
84,794

 
—

 
—

 
84,794

Total assets at fair value from continuing operations
 
$
494,466

 
$
—

 
$
4,529

 
$
489,937

There are no assets measured at fair value on a nonrecurring basis at June 30, 2012 for discontinued operations.
Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2011 for discontinued operations:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Loans held for sale
 
$
233

 
$
—

 
$
233

 
$
—

Total assets at fair value from discontinued operations
 
$
233

 
$
—

 
$
233

 
$
—

Quantitative Information about Level 3 Fair Value Measurements

32

(dollars in thousands)
 
Fair Value at
June 30, 2012
 
Valuation Techniques
 
Unobservable
Input
 
Range
Nonrecurring measurements:
 
 
 
 
 
 
 
 
Impaired loans, net
 
$
32,054

 
Discounted appraisals
 
Collateral discounts
 
6.00%-40.00%
Other real estate owned
 
50,126

 
Discounted appraisals
 
Collateral discounts
 
6.00%-40.00%
Mortgage servicing rights
 
25

 
Discounted cash flows
 
Prepayment rate
 
10.00% - 30.00%
Mortgage servicing rights
 
 
 
 
 
Discount rate
 
4.00% - 12.00%
Level 3 Valuation Methodologies. Following is a description of the unobservable inputs used for Level 3 fair value measurements.
Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time FNB's entire holdings of a particular financial instrument.
Because no market exists for a portion of FNB'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 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.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value for each class of FNB's financial instruments.
Cash and cash equivalents. Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.
Investment securities. The fair value of investment securities is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The fair value of equity investments in the restricted stock of the FRBR and FHLB approximates the carrying value. The fair value of investment securities is classified as Level 2.
Loans held for sale Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. FNB classified the fair value of loans held for sale as Level 2.
Loans. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value. The fair value of loans is further discounted by credit and liquidity factors. FNB classified the fair value of loans as Level 3.
Accrued interest receivable and payable. The carrying amounts of accrued interest payable and receivable approximate fair value and are classified as Level 2.
Deposits. The fair value of noninterest-bearing and interest-bearing demand deposits and savings are the amounts payable on demand because these products have no stated maturity. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities and are classified as Level 2.
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 and are classified as Level 2.
Junior subordinated debentures. Included in junior subordinated debentures are variable rate trust preferred securities issued by FNB. Fair values for the trust preferred securities were estimated by developing cash flow estimates for each of these debt instruments based on scheduled principal and interest payments and current interest rates. Once the cash flows were determined, a rate for comparable subordinated debt was used to discount the cash flows to the present value. The estimated fair value for FNB's junior subordinated debentures is significantly lower than carrying value since credit spreads (i.e., spread to LIBOR) on similar trust preferred issues are currently much wider than when these securities were originally issued. FNB classified the fair value of junior subordinated debentures as Level 3.
Financial instruments with off-balance sheet risk. The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value.

33

The estimated fair values of financial instruments for continuing operations are as follows at the periods indicated.
 
 
At June 30, 2012
(dollars in thousands)
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
363,879

 
$
363,879

 
$
363,879

 
$
—

 
—

Investment securities: Available-for-sale
 
477,136

 
477,136

 
—

 
477,136

 
—

Loans held for sale
 
1,324

 
1,324

 
—

 
1,324

 
—

Loans, net
 
1,243,272

 
1,235,426

 
—

 
—

 
1,235,426

Accrued interest receivable
 
6,143

 
6,143

 
—

 
6,143

 
—

Financial Liabilities of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Deposits
 
2,041,770

 
2,047,053

 
—

 
2,047,053

 
—

Retail repurchase agreements
 
11,455

 
11,455

 
—

 
11,455

 
—

Federal Home Loan Bank advances
 
58,350

 
63,157

 
—

 
63,157

 
—

Junior subordinated debentures
 
56,702

 
36,728

 
—

 
—

 
36,728

Accrued interest payable
 
1,782

 
1,782

 
—

 
1,782

 
—

 
 
At December 31, 2011
(dollars in thousands)
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
553,416

 
$
553,416

 
$
553,416

 
$
—

 
$
—

Investment securities: Available-for-sale
 
431,306

 
431,306

 
—

 
431,306

 
—

Loans held for sale
 
4,529

 
4,529

 
—

 
4,529

 
—

Loans, net
 
1,178,175

 
1,176,795

 
—

 
—

 
1,176,795

Accrued interest receivable
 
5,919

 
5,919

 
—

 
5,919

 
—

Financial Liabilities of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Deposits
 
2,129,111

 
2,139,093

 
—

 
2,139,093

 
—

Retail repurchase agreements
 
8,838

 
8,838

 
—

 
8,838

 
—

Federal Home Loan Bank advances
 
58,370

 
62,555

 
—

 
62,555

 
—

Junior subordinated debentures
 
56,702

 
36,218

 
—

 
—

 
36,218

Accrued interest payable
 
1,654

 
1,654

 
—

 
1,654

 
—

The estimated fair values of financial instruments for discontinued operations are as follows:
 
 
As of June 30, 2012
 
As of December 31, 2011
(dollars in thousands)
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
Financial Assets of Discontinued Operations
 
$
—

 
$
—

 
$
233

 
$
233

Financial Liabilities of Discontinued Operations
 
—

 
—

 
—

 
—

There were no transfers between valuation levels for any assets during the quarter ended June 30, 2012 or the quarter ended June 30, 2011. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.
11. Capital Raise
Between May 21, 2012 and June 26, 2012, the Company issued 485,788shares of common stock at an average price of $15.01 for total proceeds of $7.29 million through its “At The Market” (“ATM”) offering. Net proceeds from the offering of $6.9 million were contributed to CommunityOne Bank, N.A. During July 2012, the Company sold a further 176 shares to holders of warrants issued in connection with the Merger, yielding net proceeds of approximately $3,000.

34

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
The following presents management's discussion and analysis of the financial condition and results of operations of FNB. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this quarterly Report on Form 10-Q. Results of operations for the periods included in this review are not necessarily indicative of results to be obtained during any future period.
Important Note Regarding Forward-Looking Statements
This quarterly Report on Form 10-Q contains statements that FNB believes are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to FNB's financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this quarterly Report on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to us at the time. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Forward-looking statements contained in this quarterly Report on Form 10-Q are based on current expectations, estimates and projections about FNB's business, management's beliefs and assumptions made by management. These statements are not guarantees of FNB's future performance and involve certain risks, uncertainties and assumptions (called Future Factors), which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. Future factors include, without limitation:
•
changes in interest rates, spreads on earning assets and interest-bearing liabilities, the shape of the yield curve and interest rate sensitivity
•
changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
•
continued and increased credit losses and material changes in the quality of our loan portfolio;
•
decline in the value of our OREO;
•
financial resources in the amount, at the times and on the terms required to support our future business;
•
increased competitive pressures in the banking industry or in FNB's markets;
•
less favorable general economic conditions, either nationally or regionally, resulting in, among other things, a reduced demand for credit or other services;
•
deterioration in the housing markets and reduced demand for mortgages;
•
the outcome of legislation and regulation affecting the financial services industry, including FNB, including the effects underway through the continuing implementation of the Dodd-Frank Act, including proposed revisions to the regulatory capital requirements;
•
changes in accounting principles and standards;
•
adverse changes in financial performance or condition of FNB's borrowers, which could affect repayment of such borrowers' outstanding loans;
•
increases in operating costs and expenses;
•
changes in pricing and product/service offerings by competitors;
•
rapid technological development and changes;
•
the effect of any mergers, acquisitions or other transactions to which we or our subsidiaries may from time to time be a party;
•
failure of assumptions underlying the establishment of our ALL; and
•
success at managing the risks involved in the foregoing,
All forward-looking statements speak only as of the date on which such statements are made, and FNB 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.
Important Factors Impacting Comparability of Results
We have accounted for our purchase of Granite Corp. using the acquisition method of accounting as of October 21, 2011, the acquisition date. The results of our operations for the three months and six months ended June 30, 2012 include the results of Granite Corp. The results of operations for the three months and six months ended June 30, 2011 do not include the results of Granite Corp. Our balance sheets as of June 30, 2012 and December 31, 2011 include the assets, liabilities and equity of Granite Corp., while various footnotes and tables presented as of June 30, 2011 do not include the assets, liabilities and equity of Granite Corp.



35

Financial highlights are presented in the accompanying table.
Selected Financial Data
(dollars in thousands, except per share data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Income Statement Data
 
 
 
 
 
 
 
 
Net interest income
 
$
16,049

 
$
9,192

 
$
31,229

 
$
18,401

Provision for loan losses
 
7,778

 
33,580

 
10,845

 
53,763

Noninterest income
 
6,532

 
3,285

 
10,358

 
6,867

Noninterest expense
 
32,915

 
26,330

 
59,763

 
59,080

Loss from continuing operations, before income taxes
 
(18,112
)
 
(47,433
)
 
(29,021
)
 
(87,575
)
Loss from continuing operations, net of tax
 
(18,138
)
 
(46,985
)
 
(28,970
)
 
(86,999
)
Loss from discontinued operations, net of tax
 
—

 
(1,989
)
 
(27
)
 
(5,682
)
Net loss
 
(18,138
)
 
(48,974
)
 
(28,997
)
 
(92,681
)
Dividends on preferred stock
 
—

 
(1,087
)
 
—

 
(2,104
)
Net loss to common shareholders
 
(18,138
)
 
(50,061
)
 
(28,997
)
 
(94,785
)
Period End Balances
 
 
 
 
 
 
 
 
Assets
 
$
2,301,761

 
$
1,722,238

 
$
2,301,761

 
$
1,722,238

Loans held for sale (1)
 
1,324

 
9,450

 
1,324

 
9,450

Loans held for investment (2)
 
1,281,823

 
1,018,274

 
1,281,823

 
1,018,274

Allowance for loan losses (1)
 
38,551

 
59,366

 
38,551

 
59,366

Goodwill
 
4,205

 
—

 
4,205

 
—

Deposits
 
2,041,770

 
1,604,954

 
2,041,770

 
1,604,954

Borrowings
 
126,507

 
213,714

 
126,507

 
213,714

Shareholders' equity/(deficit)
 
108,002

 
(113,718
)
 
108,002

 
(113,718
)
Average Balances
 
 
 
 
 
 
 
 
Assets
 
$
2,328,045

 
$
1,788,465

 
$
2,359,605

 
$
1,839,995

Loans held for sale (1)
 
3,349

 
172

 
4,562

 
87

Loans held for investment (2)
 
1,283,673

 
1,143,641

 
1,251,181

 
1,203,475

Allowance for loan losses (1)
 
38,729

 
70,477

 
39,262

 
79,439

Goodwill
 
4,205

 
—

 
4,055

 
—

Deposits
 
2,058,844

 
1,635,848

 
2,087,464

 
1,662,566

Borrowings
 
123,605

 
212,206

 
123,513

 
214,453

Shareholders' equity/(deficit)
 
119,619

 
(77,015
)
 
123,173

 
(53,981
)
Per Common Share Data
 
 
 
 
 
 
 
 
Net loss per common share from continuing operations - basic and diluted
 
$
—

 
$
(0.42
)
 
$
—

 
$
(0.78
)
Net loss per common share from discontinued operations - basic and diluted
 
—

 
(0.02
)
 
—

 
(0.05
)
Net loss per common share - basic and diluted
 
—

 
(0.44
)
 
—

 
(0.83
)
Book value (3)
 
5.00

 
(1,570.13
)
 
5.00

 
(1,570.26
)
Tangible book value (3)
 
4.46

 
(1,603.18
)
 
4.46

 
(1,603.31
)
Performance Ratios
 
 
 
 
 
 
 
 
Return on average assets
 
(3.13
)%
 
(10.98
)%
 
(2.47
)%
 
(10.16
)%
Return on average tangible assets (3)
 
(3.15
)
 
(10.96
)
 
(2.48
)
 
(10.14
)
Return on average equity (4)
 
(60.99
)
 
NM

 
(47.34
)
 
NM


36

Return on average tangible equity (3)
 
(70.11
)
 
NM

 
(53.00
)
 
NM

Net interest margin (tax equivalent)
 
3.06

 
2.26

 
2.97

 
2.20

Asset Quality Ratios
 
 
 
 
 
 
 
 
Allowance for loan losses to period end loans held for investment (1)
 
3.01
 %
 
5.83
 %
 
3.01
 %
 
5.83
 %
Nonperforming loans to period end allowance for loan losses (1)
 
247.82

 
350.18

 
247.82

 
350.18

Net charge-offs (annualized) to average loans held for investment
 
2.83

 
15.06

 
1.87

 
14.76

Nonperforming assets to period end loans held for investment and foreclosed property (5)
 
13.30

 
27.63

 
13.30

 
27.63

Capital and Liquidity Ratios
 
 
 
 
 
 
 
 
Average equity to average assets
 
5.14
 %
 
(4.31
)%
 
5.22
 %
 
(2.93
)%
Leverage capital
 
5.83

 
(7.23
)
 
5.83

 
(7.23
)
Tier 1 risk-based capital
 
9.62

 
(10.73
)
 
9.62

 
(10.73
)
Total risk-based capital
 
12.19

 
(10.73
)
 
12.19

 
(10.73
)
Average loans to average deposits
 
62.51

 
69.91

 
60.13

 
72.39

Average loans to average deposits and borrowings
 
58.97

 
61.88

 
56.77

 
64.12

NM - Not Meaningful
(1) Excludes discontinued operations.
(2) Loans held for investment, net of unearned income, before allowance for loan losses.
(3) Refer to the "Non-GAAP Measures" section in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(4) Net loss to common shareholders, which excludes preferred stock dividends, divided by average realized common equity which excludes accumulated other comprehensive loss.
(5) Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest.


37

Overview
FNB United Corp. or FNB, we or us (which also refers to FNB and our subsidiaries on a consolidated basis) was incorporated under the laws of the State of North Carolina in 1984. We are a bank holding company with two bank subsidiaries: CommunityOne Bank, N.A. (“CommunityOne”), a national banking association headquartered in Asheboro, North Carolina and, through Bank of Granite Corporation (“Granite Corp.”), Bank of Granite (“Granite”), a state chartered bank headquartered in Granite Falls, North Carolina.
Through our bank subsidiaries, we offer 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 through operations located throughout central, southern and western North Carolina, including the counties of Alamance, Alexander, Ashe, Burke, Caldwell, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes. Management believes that the banks have a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors, including federal, state and local governments.
CommunityOne owns two subsidiaries: Dover Mortgage Company (“Dover”) and First National Investor Services, Inc. Dover previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012. First National Investor Services, Inc. holds deeds of trust for CommunityOne. Through Granite Corp., we also own Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012. FNB also owns FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities.
We earn revenue primarily from interest on loans, securities investments, mortgage banking income and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provision for loan losses and write-downs in the value of our OREO, and other operating costs such as: salaries and employee benefits, occupancy, data processing expenses, merger related expenses and tax expense.
On October 21, 2011, as part of the recapitalization of FNB, FNB acquired Granite Corp., through the merger of a wholly owned subsidiary of FNB merging into Granite Corp (the "Merger"). The Merger was part of FNB's recapitalization strategy.



38

Results of Operations
Net Interest Income
Our principal source of revenue is net interest income. Net interest income is the difference between interest income earned on interest-earning assets, primarily loans and investment securities, and interest expense paid on interest-bearing deposits and other interest-bearing liabilities. This measure represents the largest component of income for FNB. The net interest margin measures how effectively we manage the difference between the interest income earned on interest-earning assets and the interest expense paid for funds to support those assets. Changes in interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities base, the ratio of interest-earning assets to interest-bearing liabilities, and the management of interest rate sensitivity factor into fluctuations within net interest income. An analysis is presented in the Average Balances and Net Interest Income Analysis for the three month and six month periods ended June 30, 2012 and 2011.
Net interest income on a taxable equivalent basis was $16.1 million for the three month period ended June 30, 2012 compared to $9.3 million for the same period in 2011 primarily related to the addition of Granite net interest income of $7.6 million during the second quarter of 2012.
Net interest margin (taxable equivalent) improved 80 basis points from 2.26% in the second quarter of 2011 to 3.06% in the second quarter of 2012. The increase was attributable to the impact of the Merger, management strategies to shift the mix of deposits to lower rate demand, savings and money market deposits, and the reduction of nonperforming loans compared to the second quarter of 2011. The yield on average earning assets increased by 19 basis points during the second quarter of 2012 to 3.89% from 3.70% in the second quarter of 2011. The cost of interest-bearing liabilities declined during the second quarter of 2012 by 51 basis points to 0.91% compared to 1.42% in the second quarter of 2011, primarily as a result of the deposit mix shift, declines in interest rates on all deposit products, and the impact of the accretion of fair value marks at Granite. Importantly, the cost of interest-bearing deposits declined 52 basis points from 1.35% for the second quarter of 2011 to 0.83% for the second quarter of 2012.
Net interest income on a taxable equivalent basis was $31.3 million for the six month period ended June 30, 2012 compared to $18.8 million for the same period in 2011 primarily related to the addition of Granite net interest income of $15.3 million during the first six months of 2012.
Net interest margin (taxable equivalent) improved 77 basis points from 2.20% in the first six months of 2011 to 2.97% in the first six months of 2012. The increase was attributable to the impact of the Merger, the impact of management strategies to shift the mix of deposits to lower rate demand, savings and money market deposits and the Granite acquisition, declines in interest rates on all deposit products, and the reduction of nonperforming loans compared to the first six months of 2011. The yield on average earning assets increased by 19 basis points during the first six months of 2012 to 3.83% from 3.64% in the first six months of 2011. The cost of interest-bearing liabilities declined during the first six months of 2012 by 50 basis points to 0.94% compared to 1.44% in the first six months of 2011, primarily as a result of the deposit mix shift, declines in interest rates on all deposit products, and the impact of the accretion of fair value marks at Granite. The cost of interest-bearing deposits declined 49 basis points from 1.36% for the first six months 2011 to 0.87% for the first six months of 2012.
The following tables summarize the average balance sheets and net interest income/margin analysis for the three-months and six months ended June 30, 2012 and 2011. FNB's interest yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively.

39

Average Balances and Net Interest Income Analysis - Second Quarter
 
Three Months Ended June 30,
 
2012
 
2011
 
 
 
 
 
Average
 
 
 
 
 
Average
(dollars in thousands)
Average
 
Income /
 
Yield /
 
Average
 
Income /
 
Yield /
 
Balance (3)
 
Expense
 
Rate
 
Balance (3)
 
Expense
 
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
1,287,022

 
$
17,283

 
5.40
%
 
$
1,143,813

 
$
12,279

 
4.31
%
Taxable investment securities
457,414

 
2,887

 
2.54

 
363,950

 
2,717

 
2.99

Tax-exempt investment securities (1)
—

 
—

 
—

 
7,741

 
206

 
10.68

Other earning assets
370,593

 
310

 
0.34

 
137,409

 
118

 
0.34

Assets of discontinued operations
—

 
—

 
—

 
7,372

 
13

 
0.71

  Total earning assets
2,115,029

 
20,480

 
3.89

 
1,660,285

 
15,333

 
3.70

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
20,395

 
 
 
 
 
22,627

 
 
 
 
Goodwill and core deposit premium
11,907

 
 
 
 
 
3,905

 
 
 
 
Other assets, net
180,714

 
 
 
 
 
102,667

 
 
 
 
Assets of discontinued operations
—

 
 
 
 
 
(1,019
)
 
 
 
 
  Total assets
$
2,328,045

 
 
 
 
 
$
1,788,465

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
350,235

 
$
379

 
0.44
%
 
$
226,627

 
$
435

 
0.77
%
Savings deposits
72,480

 
27

 
0.15

 
45,647

 
29

 
0.25

Money market deposits
439,132

 
486

 
0.45

 
283,168

 
562

 
0.80

Time deposits
941,206

 
2,809

 
1.20

 
922,947

 
3,937

 
1.71

  Total interest-bearing deposits
1,803,053

 
3,701

 
0.83

 
1,478,389

 
4,963

 
1.35

Retail repurchase agreements
8,547

 
9

 
0.42

 
8,892

 
14

 
0.63

Federal Home Loan Bank advances
58,356

 
387

 
2.67

 
144,112

 
703

 
1.96

Other borrowed funds
56,702

 
286

 
2.03

 
59,202

 
318

 
2.15

  Total interest-bearing liabilities
1,926,658

 
4,383

 
0.91

 
1,690,595

 
5,998

 
1.42

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities and shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
255,791

 
 
 
 
 
157,459

 
 
 
 
Other liabilities
25,977

 
 
 
 
 
16,610

 
 
 
 
Shareholders' equity/(deficit)
119,619

 
 
 
 
 
(77,015
)
 
 
 
 
Liabilities of discontinued operations
—

 
 
 
 
 
816

 
 
 
 
  Total liabilities and shareholders' equity
$
2,328,045

 
 
 
 
 
$
1,788,465

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and net yield on earning assets (4)
 
 
$
16,097

 
3.06
%
 
 
 
$
9,335

 
2.26
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread (5)
 
 
 
 
2.98
%
 
 
 
 
 
2.28
%
(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) Average loan balances include nonaccruing loans and loans held for sale.
(3) Average balances include market adjustments to fair value for securities and loans 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.

40

Average Balances and Net Interest Income Analysis - Six Months
 
Six Months Ended June 30,
 
2012
 
2011
 
 
 
 
 
Average
 
 
 
 
 
Average
(dollars in thousands)
Average
 
Income /
 
Yield /
 
Average
 
Income /
 
Yield /
 
Balance (3)
 
Expense
 
Rate
 
Balance (3)
 
Expense
 
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
1,255,743

 
$
34,289

 
5.49
%
 
$
1,203,562

 
$
25,445

 
4.26
%
Taxable investment securities
447,637

 
5,571

 
2.50

 
345,416

 
4,798

 
2.80

Tax-exempt investment securities (1)
—

 
—

 
—

 
9,066

 
457

 
10.16

Other earning assets
439,172

 
660

 
0.30

 
147,153

 
284

 
0.39

Assets of discontinued operations
—

 
—

 
—

 
14,166

 
56

 
0.80

  Total earning assets
2,142,552

 
40,520

 
3.83

 
1,719,363

 
31,040

 
3.64

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
20,180

 
 
 
 
 
24,413

 
 
 
 
Goodwill and core deposit premium
11,934

 
 
 
 
 
4,005

 
 
 
 
Other assets, net
184,772

 
 
 
 
 
92,080

 
 
 
 
Assets of discontinued operations
167

 
 
 
 
 
134

 
 
 
 
  Total assets
$
2,359,605

 
 
 
 
 
$
1,839,995

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
349,083

 
$
764

 
0.44
%
 
$
227,718

 
$
917

 
0.81
%
Savings deposits
71,239

 
53

 
0.15

 
45,252

 
57

 
0.25

Money market deposits
436,315

 
982

 
0.45

 
293,555

 
1,146

 
0.79

Time deposits
982,680

 
6,125

 
1.25

 
939,824

 
8,012

 
1.72

  Total interest-bearing deposits
1,839,317

 
7,924

 
0.87

 
1,506,349

 
10,132

 
1.36

Retail repurchase agreements
8,450

 
17

 
0.40

 
9,355

 
31

 
0.67

Federal Home Loan Bank advances
58,361

 
666

 
2.29

 
144,294

 
1,401

 
1.96

Other borrowed funds
56,702

 
589

 
2.09

 
60,804

 
696

 
2.31

  Total interest-bearing liabilities
1,962,830

 
9,196

 
0.94

 
1,720,802

 
12,260

 
1.44

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities and shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
248,147

 
 
 
 
 
156,217

 
 
 
 
Other liabilities
24,286

 
 
 
 
 
15,671

 
 
 
 
Shareholders' equity/(deficit)
123,173

 
 
 
 
 
(53,981
)
 
 
 
 
Liabilities of discontinued operations
1,169

 
 
 
 
 
1,286

 
 
 
 
  Total liabilities and shareholders' equity
$
2,359,605

 
 
 
 
 
$
1,839,995

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and net yield on earning assets (4)
 
 
$
31,324

 
2.97
%
 
 
 
$
18,780

 
2.20
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread (5)
 
 
 
 
2.89
%
 
 
 
 
 
2.20
%
(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) Average loan balances include nonaccruing loans and loans held for sale.
(3) Average balances include market adjustments to fair value for securities and loans 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.

41

Provision for Loan Losses
The provision for loan loss provides a level of allowance considered appropriate to absorb estimated losses inherent in the loan portfolio. The amount of this charge is affected by several considerations, including management's evaluation of various risk factors in determining the adequacy of the allowance (see additional discussion under “Asset Quality”), actual loan loss experience and changes in the loan portfolio.

During the three month period ended June 30, 2012, the provision for loan losses, excluding discontinued operations, was $7.8 million, compared to $33.6 million in the same period of 2011 as a result of reductions in nonperforming loans. The Bank has experienced lower net charge-offs and improved classified asset and past due levels compared to 2011. During the second quarter of 2012 management established a $3.3 million allowance related to purchased impaired loans acquired in the Merger. During the six month period ended June 30, 2012, the provision for loan losses, excluding discontinued operations, was $10.8 million, compared to $53.8 million, in the same period of 2011 also due to reductions in nonperforming loans. Net charge-offs for the six months ended June 30, 2012 totaled $11.7 million, or 1.87% of annualized average loans, reduced from $88.1 million, or 14.76% of annualized average loans for the same period in 2011, also as a result of reductions in nonperforming loans.
Noninterest Income
Noninterest income includes mortgage banking income, fees and service charges on deposit accounts, fees from cardholder and merchant services, fees and commissions related to trust and investment services, gains and losses on the sales of securities, and all other types of noninterest revenue.
For the three months ended June 30, 2012, noninterest income, excluding discontinued operations, was $6.5 million compared to $3.3 million for the same period in 2011. The increase was the result of $2.0 million of gains on sales of investment securities in 2012, as well as $1.1 million in other noninterest income, excluding gain on sales of securities, for Granite. For the six months ended June 30, 2012, noninterest income, excluding discontinued operations, was $10.4 million compared to $6.9 million for the same period in 2011. The increase was the result of the securities gains described above, as well as $2.2 million of other noninterest income for Granite, partially offset by declines in service charges on deposits as a result of decreased NSF and overdraft fees.
Noninterest Expense
Noninterest expense includes salary and employee benefits, occupancy and equipment, expenses associated with other real estate owned, including write-downs, and one-time expenses related to the acquisition and integration of Granite.
Noninterest expenses were $32.9 million in the second quarter of 2012 compared to $26.3 million in the same period of 2011, an increase of $6.6 million, or 25%. The increase in noninterest expense was primarily attributable to the addition of $7.3 million in Granite noninterest expenses. Included in the Granite expenses for the second quarter of 2012 was $1.1 million relating to litigation and mortgage claim reserves. For the six months ended June 30, 2012, noninterest expenses were $59.8 million compared to $59.1 million in the same period of 2011. Results for 2012 include $14.3 million of expenses for Granite. That increase is offset by a $10.7 million decrease in OREO expense at CommunityOne, as well as a $2.2 decrease of FDIC insurance costs at CommunityOne as a result of new FDIC assessment rates based on the improved capital position of CommunityOne, among other factors.
Merger-related expenses were reduced by $0.7 million relating to branch closures and $1.0 million in termination costs for information system contracts in the three months ended June 30, 2012. These expenses, which had been properly accrued in the first quarter of 2012 based on management's expectations, were reversed as management does not expect the legal bank merger to occur in 2012.
Full-time equivalent employees averaged 634 employees for the second quarter 2012 versus 474 employees for the second quarter of 2011. The increase is primarily related to the acquisition of Granite in October 2011, as well as increases in staff in credit and problem asset resolution areas.
Provision for Income Taxes
Excluding discontinued operations, FNB had an income tax expense totaling $26,000 for the second quarter of 2012 and an income tax benefit of $51,000 for the first six months of 2012. FNB recorded income tax benefits of $448,000 and $576,000 for the three months and six months ended June 30, 2011, respectively. FNB's provision for income taxes, as a percentage of loss before income taxes, excluding discontinued operations, was 0.14% and 0.18% for the three months and six months ended June 30, 2012, respectively, compared to 0.94% and 0.66% for the three months and six months ended June 30, 2011, respectively.
Balance Sheet Review
Total assets at June 30, 2012 were $2,301.8 million, a decrease of $107.3 million, or 4.5%, compared to total assets of $2,409.1 million at December 31, 2011.
Cash and interest-bearing balances were $363.9 million at June 30, 2012, a decrease of $189.5 million, or 34.2%, compared to $553.4 million at December 31, 2011, primarily attributable to the purchases of $137.4 million of residential mortgage loans and the purchase

42

of $44.0 million of securities (net of sales and repayments), offset by loan repayments and OREO sales.
Investment securities increased $45.8 million during the first six months of 2012, from $431.3 million at December 31, 2011 to $477.1 million at June 30, 2012, an increase of 10.6%. The portfolio is comprised of U.S. federal agency securities and federal agency MBSs (GSE), securities of U.S. state and political subdivisions, private residential MBSs and corporate debt securities.
Gross loans held for investment increased $64.3 million, or 5.3%, during the first quarter of 2012, from $1,217.5 million at December 31, 2011 to $1,281.8 million at June 30, 2012. During the first six months of 2012, FNB purchased $137.4 million of performing residential mortgage loans.
Other real estate owned ("OREO") decreased $23.8 million during the first six months of 2012, from $110.0 million at December 31, 2011 to $86.2 million at June 30, 2012, as a result of OREO sales and writedowns.
Total deposits were $2,041.8 million at June 30, 2012, a decline of $87.3 million, or (4.1)% from $2,129.1 million at December 31, 2011. Management has implemented strategies to shift the mix of deposits from higher cost time deposits, including higher rate CD's and brokered CD's, towards lower rate demand, savings and money market deposits. At June 30, 2012, CD's comprised 44.6% of total deposits compared to 49.1% at December 31, 2011. Noninterest-bearing deposits increased $27.4 million, or 11.7%, from $234.7 million at December 31, 2011 to $262.1 million at June 30, 2012. Total cost of interest-bearing deposits declined by 49 basis points from 1.36% in the first six months of 2011 to 0.87% in the first six months of 2012.
Shareholders' equity at June 30, 2012 was $108.0 million as compared to $129.0 million at December 31, 2011. The book value per share was $5.00 and average equity to average assets was 5.22% at June 30, 2012 as compared to a book value per share of $6.11 and average equity to average assets of (1.19)% at December 31, 2011. The change in shareholders' equity reflects a net loss to common shareholders for the six months ended June 30, 2012 of $29.0 million, offset by $6.9 million in common equity raised during the first six months of 2012, and $2.0 million other comprehensive income, net of tax. FNB did not declare common dividends during the six months ended June 30, 2012, and will not be able to pay any dividends until such time as FNB returns to profitability and either receives or is not required to receive regulatory approval for the payment of dividends. FNB does not expect to pay dividends to shareholders for the foreseeable future.
Investment Securities
FNB evaluates all securities on a quarterly basis, and more frequently as economic conditions warrant, to determine if an other-than-temporary impairment (“OTTI”) exists. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than book value, the financial conditions and near-term prospects of the issuer, and the ability and intent of FNB to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, FNB may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income/(loss) in shareholders' equity) and not recognized in income until the security is ultimately sold. As of June 30, 2012, there were no securities considered by FNB to have OTTI.
Asset Quality
Management considers the asset quality of FNB 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, FNB engages a third-party assessment group to review the underwriting documentation and risk grading analysis. In addition to continuing to rely on third-party loan reviews, a formal internal credit review function commenced in 2011 to provide more timely responses. This function reports directly to the Risk Management Committee of the Board of Directors, and is independent of loan origination.
The allowance for loan losses at December 31, 2011 decreased marginally from $39.4 million to $38.6 million at June 30, 2012. As a percentage of gross loans, the allowance for loan losses declined from 3.23% at December 31, 2011 to 3.01% at June 30, 2012.
During the six month period ended June 30, 2012, FNB charged off $10.3 million in loans and realized $1.3 million in recoveries, for $9.0 million of net charge-offs. The majority of the loans that were charged off were loans that had been in impairment status and had specific reserves assigned to them in prior periods.
Acquired Loans
Loans acquired in the Merger ("Granite Purchased Loans") include purchased impaired loans ("PI Loans") and purchased contractual ("PC Loans") revolving consumer and commercial loans. At June 30, 2012 there were $323.7 million of Granite Purchased Loans, of which $36.7 million were Purchased Contractual Loans, $250.4 million were Purchased Impaired Loans with no subsequent credit deterioration and $36.7 million were Purchased Impaired Loans with subsequent credit deterioration.
PI Loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL. PI Loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is

43

probable at the date of acquisition we will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade. PI Loans generally meet FNB's definition for nonaccrual status, however, even if the borrower is not currently making payments, FNB will classify loans as accruing if FNB can reasonably estimate the amount and timing of future cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.
Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates. Decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income. Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
We have elected to treat the Granite portfolio under ASC 310-30, with the exception of performing revolving consumer and commercial loans, which are being accounted for under ASC 310-20.
At June 30, 2012, an ALL of $3.8 million was required for the Purchased Granite Loans, and in addition, the Purchased Granite Loans are presented on an accruing basis.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more, repossessed assets and OREO. Nonperforming loans are loans placed in nonaccrual status when, in management's opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. OREO represents real estate acquired through foreclosure or deed in lieu of foreclosure and is generally carried at fair value, less estimated costs to sell.
The level of nonperforming loans decreased from $106.0 million or 9.0% of loans held for investment at December 31, 2011, to $95.5 million, or 7.7% of loans held for investment at June 30, 2012. OREO and repossessed assets were $86.4 million at June 30, 2012, compared to $110.4 million at December 31, 2011, a decline of $24.0 million. During the first six months of 2012, we recorded net write-downs and net loss on sales of OREO of $14.5 million as compared to $24.2 million during the first six months of 2011. Depressed market conditions have adversely impacted, and may continue to adversely impact, the financial condition and liquidity position of certain borrowers. Additionally, the value of real estate collateral may come under further pressure from weak economic conditions and prevailing unemployment levels resulting in additional delinquencies and loans being placed on nonaccrual.
The soft real estate market in 2011 and 2012 has adversely affected the financial condition and liquidity position of certain borrowers. Real estate secured lending (including commercial, construction, land development, and residential single family housing) is a large portion of our loan portfolio. These categories constitute $1,159.3 million or approximately 90.5%, of our total loan portfolio. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. The downturn in the real estate markets in which we originate, purchase, and service mortgage and other loans hurt our business because these loans are secured by real estate. Further declines will adversely affect the value of real estate collateral of loans secured by real estate, which could adversely affect our future earnings.
Allowance for Loan Losses
In determining the ALL 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, as well as the economic conditions in our 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, as an integral part of its examination process, the OCC periodically reviews CommunityOne's ALL and the FDIC periodically reviews Granite's ALL. Either the OCC or FDIC may require CommunityOne or Granite, as the case may be, to recognize changes to the allowance based on its judgments about information available to them at the time of its 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.
Estimated credit losses should meet the criteria for accrual of a loss contingency, i.e., a provision to the ALL, set forth in GAAP. Our methodology for determining the ALL is based on the requirements of GAAP, the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other regulatory and accounting pronouncements. The ALL is determined by the sum of three separate components:  (i) the impaired loan component, which addresses specific reserves for impaired loans; (ii) the general reserve component, which addresses reserves for pools of homogeneous loans; and (iii) an unallocated reserve component (if any) based on management's judgment and experience. The loan pools and impaired loans are mutually exclusive; any loan that is impaired should

44

be excluded from its homogenous pool for purposes of that pool's reserve calculation, regardless of the level of impairment. However, FNB has established a de minimis threshold for loan exposures that, if found to be impaired, will have impairment determined by applying the same general reserve rate as nonimpaired loans within the same pool.
Excluding discontinued operations, the ALL, as a percentage of loans held for investment, amounted to 3.01% at June 30, 2012 compared to 3.23% at December 31, 2011. Net charge-offs were $11.6 million in the first six months of 2012 compared to $88.1 million in the first six months of 2011. Annualized charge-offs in the first six months of 2012 fell to 1.87% of average loans, from 14.76% in the same period of 2011. A substantial portion of 2012 charge-offs were related to impaired loans, and consisted of loans considered wholly impaired and loans with partial impairment. The provision for losses charged to operations in the first six months of 2012 decreased to $10.8 million from $53.8 million in 2011.
Management continually performs thorough analyses of the loan portfolio. As a result of these analyses, certain loans have migrated to higher, more adverse risk grades and an aggressive posture towards the timely charge-off of identified impairment has also continued. Actual past due loans and loan charge-offs have remained at manageable levels and management continues to diligently work to improve asset quality. Management believes the ALL of $38.6 million at June 30, 2012 is adequate to cover probable losses inherent in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment. Management's judgments are based on numerous assumptions about current events that 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 FNB. Additional information on the ALL is presented in Note 6 to the consolidated financial statements.
The following table presents FNB's investment in loans considered to be impaired and related information on those impaired loans as of June 30, 2012 and December 31, 2011.
 
 
June 30, 2012
 
December 31, 2011
(dollars in thousands)
 
Balance
Associated Reserves
 
Balance
Associated Reserves
Impaired loans, held for sale
 
$
—

$
—

 
$
4,529

$
—

Impaired loans, not individually reviewed for impairment
 
6,750

—

 
5,127

—

Impaired loans, individually reviewed, with no impairment
 
55,160

—

 
53,884

—

Impaired loans, individually reviewed, with impairment
 
40,778

8,724

 
42,357

11,090

Total impaired loans *
 
$
102,688

$
8,724

 
$
105,897

$
11,090

 
 
 
 
 
 
 
Purchased impaired loans with subsequent deterioration
 
36,659

3,336

 
—

—

Purchased impaired loans with no subsequent deterioration
 
250,433

—

 
330,836

—

Total Reserves
 
 
12,060

 
 
11,090

 
 
 
 
 
 
 
Average impaired loans calculated using a simple average
 
$
107,263

 
 
$
112,600

 
* Included at June 30, 2012 and December 31, 2011 were $3.9 million and $2.9 million, respectively, in restructured and performing loans.
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of FNB's customers. Deposit withdrawals, loan funding and general corporate activity create a need for liquidity for FNB. Liquidity is derived from sources such as deposit growth; maturity, calls, or sales of investment securities; principal and interest payments on loans and access to borrowed funds or lines of credit.
Consistent with the general approach to liquidity, loans and other assets of FNB are funded primarily by of local core deposits. To date, a stable retail deposit base and a modest amount of brokered deposits have been adequate to meet FNB's loan obligations, while maintaining the desired level of immediate liquidity. Additionally, an investment securities portfolio is available for both immediate and secondary liquidity purposes.
During the first quarter of 2012, FNB resumed deferring the payment of cash dividends on its outstanding junior subordinated debentures.
As of June 30, 2012, available borrowing under credit lines totaled $87.0 million, compared to $74.5 million at December 31, 2011. FNB could also access $45.8 million of additional borrowings under credit lines by pledging additional collateral. Lendable collateral

45

values are subject to change as a result of periodic reviews by the FHLB.
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. This method, however, 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 to more accurately measure interest rate risk.
FNB's balance sheet was asset-sensitive at June 30, 2012. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. FNB's asset sensitivity is primarily derived from a large cash and due from banks position, a large concentration in prime-based commercial loans that adjust as the prime interest rate changes and the long duration of its indeterminate term deposits. These prime based loans are primarily funded by deposits that are not expected to reprice as quickly as the loans. Since the prime rate is not expected to decline below current levels, FNB's risk to lower interest rates is low.
Capital Adequacy and Resources
Under guidelines established by the Federal Reserve Board and each federal banking agency, including the OCC and FDIC, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio. The guidelines define an institution's total qualifying capital as having two components: Tier 1 capital, which must be at least 50% of total qualifying capital and is mainly comprised of common equity, retained earnings and qualifying preferred stock, less certain intangibles; and Tier 2 capital, which may include the ALL up to a maximum of 1.25% of risk weighted assets, qualifying subordinated debt, qualifying preferred stock and hybrid capital instruments. The requirements also define the weights assigned to assets and off-balance sheet items to determine the risk weighted asset components of the risk-based capital rules.
Under the requirements, the minimum capital standards that must be met by any bank holding company or bank include a Tier 1 capital ratio of at least 4%, a total risk based capital ratio of at least 8% and a leverage capital ratio of at least 4% (except for those institutions with the highest regulatory ratings and not experiencing significant growth or expansion). 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. Risks such as concentration of credit risks and the risk arising from non-traditional activities, as well as the institution's exposure to a decline in the economic value of its capital due to changes in interest rates, and an institutions ability to manage those risks are important factors that are to be taken into account by the federal banking agencies in assessing an institution's overall capital adequacy.
Under the Consent Order CommunityOne entered into with the OCC on July 22, 2010, CommunityOne is required to maintain a leverage capital ratio of 9% and a total risk based capital ratio of 12%. Under the Order that Granite entered into with the FDIC and the North Carolina Commissioner of Banks ("NCCOB") on August 17, 2009, Granite is required to maintain a leverage capital ratio of 8% and a total risk based ratio of 12%. At June 30, 2012, FNB had a total risk-based capital ratio of 12.19% and a Tier 1 risk-based capital ratio of 9.62%. CommunityOne and Granite had a total risk-based capital ratio of 11.73% and 13.53%, respectively, and a Tier 1 risk-based capital ratio of 10.45% and 13.37%, respectively. FNB had a leverage capital ratio of 5.83% at June 30, 2012, and each of CommunityOne and Granite had leverage capital ratios of 6.35% and 7.61%, respectively. As of June 30, 2012, CommunityOne was not in compliance with either the leverage capital or the total risk based capital requirements of its Order, and Granite was not in compliance with the leverage capital requirement of its Order.
The prompt corrective action provisions of federal law require the federal bank agencies to take prompt corrective action to resolve problems of insured depository institutions such as CommunityOne and Granite. The extent of these powers depends upon whether the institution is designated as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. The minimum capital requirements to be characterized as “well-capitalized” and “adequately capitalized,” as defined by the prompt corrective action provision of federal law, the capital requirements required under the Orders, and each of CommunityOne's and Granite's capital ratios as of June 30, 2012 were as follows:
 
 
 
Minimum Regulatory Requirement
 
 
 
 
 
Pursuant to Order
 
CommunityOne
Bank
Bank of
Granite
Adequately
Capitalized
Well-
Capitalized
CommunityOne
Bank
Bank of
Granite
Leverage capital ratio
6.35%
7.61%
4.00%
5.00%
9.00%
8.00%
Tier 1 risk-based capital ratio
10.45%
13.37%
4.00%
6.00%
—
—
Total risk-based capital ratio
11.73%
13.53%
8.00%
10.00%
12.00%
12.00%

46

As of June 30, 2012, CommunityOne and Granite were designated under these prompt corrective action provisions as "adequately capitalized" by the OCC and FDIC, respectively, because each bank continues to be subject to an Order.
The federal banking agencies have issued notices of proposed rulemakings that would change the leverage and risk-based capital requirements (including the prompt corrective action framework). Under these proposed rulemakings, the definition of the regulatory capital components would materially change. Among the most important of these changes is that a new common equity Tier 1 risk based capital ratio would be added. In addition, net unrealized gains and losses on available for sale debt and equity securities would be included in common equity Tier 1 capital. Certain deductions from common equity would be expanded and others, including mortgage servicing assets and deferred tax assets subject to temporary timing differences, would be subject to threshold deductions. While existing limitations on tier 2 capital would be eliminated, the agencies would also require a capital conservation buffer of up to 2.5% above each of the capital ratio requirements (common equity tier 1, tier 1, and total risk-based capital) which must be met for a bank to pay dividends, engage in share buybacks or make discretionary bonus payments to executive management without restriction. The rulemakings also propose changes in the risk-weighting of certain assets, including, 1 - 4 family residential mortgage loans, “high volatility” commercial real estate, past due assets, structured securities and equity holdings. The methodology for off balance sheet items such as commitments with an original maturity of less than or equity to one year that are not unconditional cancelable and mortgage loans sold with certain credit enhancing representations and warranties, are also revised. The proposals dealing with the regulatory capital components are scheduled to go into effect on January 1, 2013 and the proposals revising the risk weighting of certain assets are scheduled to go into effect on January 1, 2015. These changes, if adopted as proposed, could have a material effect on FNB.
Application of Critical Accounting Policies
FNB's accounting policies are in accordance with GAAP 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. Our significant accounting policies are discussed in detail in Note 1 of the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2011, as amended ("Form 10-K"), and are described below.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of OREO, carrying value of investment securities, business combinations and treatment of deferred tax assets.
Allowance for Loan Losses ("ALL")
The ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses incurred as of the balance sheet date. FNB's ALL is assessed quarterly by management. This assessment 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. FNB has grouped its loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income. 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.
Valuation of Other Real Estate Owned
Other real estate owned represents properties acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale and is 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. An increases in fair value is not recognized until the property is sold.
Carrying Value of Securities
Securities designated as available-for-sale are carried at fair value. However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of shareholders' equity as accumulated other comprehensive income (loss). Securities held-to-maturity are carried at amortized cost, as the banks have the ability, and management has the positive intent, to hold these securities to maturity. Premiums and discounts on securities are amortized and accreted according to the interest method.
Business Combinations
Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method the acquiring entity in a business combination recognizes 100% of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the

47

extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Purchased impaired loans ("PI") are recorded at fair value at acquisition date. Therefore, amounts deemed uncollectible at acquisition date become part of the fair value determination and are excluded from the allowance for loan and lease losses. Following acquisition, we periodically review PI loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan losses and related allowance for loan losses, if any, or prospective adjustment to the accretable yield if no provision for loan losses had been recorded. Results of operations of an acquired business are included in the statement of earnings from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred.
Treatment of Deferred Tax Assets
Management's determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax assets. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, given the current credit crisis and economic conditions, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future. Examinations of the income tax returns or changes in tax law may impact FNB's tax liabilities and resulting provisions for income taxes.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the increased credit losses, the FNB continues to be in a three-year cumulative pre-tax loss position as of June 30, 2012. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome. FNB's estimate of the realization of its deferred tax assets was based on the scheduled reversal of deferred tax liabilities and taxable income available in prior carry back years and estimated unrealized losses in the available-for-sale investment portfolio. In total, FNB has a gross deferred tax asset of $178.3 million which is offset by a valuation allowance of $176.8 million. FNB did not consider future taxable income in determining the realizability of its deferred tax assets. FNB expects its income tax expense (benefit) will be negligible for the next several quarters until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date. If future events differ significantly from our current forecasts, we may need to increase this valuation allowance, which could have a material adverse effect on the results of operations and financial condition.
The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder. Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016. Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires. Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period. As of June 30, 2012, total deferred tax assets attributable to Granite Corp. and subsidiaries were approximately $35.4 million which is offset by a valuation allowance of $34.4 million. We anticipate that some of these benefits from the net operating losses and built-in losses will not ultimately be realized; however, that amount is subject to continuing analysis and has not yet been determined.
Summary
Management believes the accounting estimates related to the ALL, the valuation of OREO, the carrying value of securities, business combination accounting, and the valuation allowance for deferred tax assets are “critical accounting estimates” because: (1) the estimates are highly susceptible to change from period to period as they require management to make assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on the FNB's assets reported on the balance sheet as well as its net earnings.
Non-GAAP Measures
This quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with GAAP. We use these non-GAAP measures in our analysis of FNB's performance. Some of these non-GAAP measures exclude goodwill and core deposit premiums from the calculations of return on average assets and return on average equity. We believe 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 our core businesses. In addition, certain designated net interest income amounts are

48

presented on a taxable equivalent basis. We believe 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. Further, we use other non-GAAP measures that exclude preferred stock and common stock warrants to report equity available to holders of our common stock. We believe that measures that exclude these items provide useful supplemental information that enhances an understanding of the equity that is available to holders of different classes of FNB's stock.
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.
These non-GAAP financial measures are “common shareholders' equity,” “tangible common shareholders' equity,” “tangible equity,” “tangible assets” and “tangible book value.” FNB's management, the entire financial services sector, bank stock analysts, and bank regulators use these non-GAAP measures in their analysis of our performance.
•
“Common shareholders' equity” is shareholders' equity reduced by preferred stock and the common stock warrant.
•
“Tangible common shareholders' equity” is shareholders' equity reduced by preferred stock, the common stock warrant, goodwill and other intangible assets.
•
“Tangible shareholders' equity” is shareholders' equity reduced by recorded goodwill, other intangible assets and preferred stock.
•
“Tangible assets” are total assets reduced by recorded goodwill and other intangible assets.
•
“Tangible book value” is defined as total equity reduced by recorded goodwill, other intangible assets and preferred stock divided by total common shares outstanding. This measure discloses changes from period-to-period in book value per share exclusive of changes in intangible assets and preferred stock. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. Companies utilizing purchase accounting in a business combination, as required by GAAP, must record goodwill related to such transactions.
The following table provides a more detailed analysis of these non-GAAP measures.
(dollars in thousands, except per share data)
 
June 30, 2012
 
December 31, 2011
 
June 30, 2011
Total shareholders' equity/(deficit)
 
$
108,002

 
$
129,015

 
$
(113,718
)
Less:
 
 
 
 
 
 
Preferred stock
 
—

 
—

 
61,802

Common stock warrant
 
—

 
—

 
3,891

Common shareholders' equity/(deficit)
 
$
108,002

 
$
129,015

 
$
(179,411
)
Total shareholders' equity/(deficit)
 
$
108,002

 
$
129,015

 
$
(113,718
)
Less:
 
 
 
 
 
 
Goodwill
 
4,205

 
3,905

 
—

Core deposit intangible
 
7,473

 
8,177

 
3,776

Preferred stock
 
—

 
—

 
61,802

Common stock warrant
 
—

 
—

 
3,891

Tangible common shareholders' equity/(deficit)
 
$
96,324

 
$
116,933

 
$
(183,187
)
Total shareholders' equity/(deficit)
 
$
108,002

 
$
129,015

 
$
(113,718
)
Less:
 
 
 
 
 
 
Goodwill
 
4,205

 
3,905

 
—

Core deposit intangible
 
7,473

 
8,177

 
3,776

Tangible shareholders' equity/(deficit)
 
$
96,324

 
$
116,933

 
$
(117,494
)
Total assets
 
$
2,301,761

 
$
2,409,108

 
$
1,722,238

Less:
 
 
 
 
 
 
Goodwill
 
4,205

 
3,905

 
—

Core deposit intangible
 
7,473

 
8,177

 
3,776

Tangible assets
 
$
2,290,083

 
$
2,397,026

 
$
1,718,462

Book value per common share
 
$
5.00

 
$
6.11

 
$
(1,570.26
)
Effect of intangible assets
 
(0.54
)
 
(0.57
)
 
(33.05
)
Tangible book value per common share
 
4.46

 
5.54

 
(1,603.31
)

49


Item 3.    Quantitative and Qualitative Disclosures About Market Risk
The objective of FNB's asset/liability management function is long term maximization of net interest income within FNB risk guidelines. This objective is accomplished through management of our balance sheet composition, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.
The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity and achieving consistent growth in core deposits.
Management considers interest rate risk FNB's most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of our net interest income is largely dependent upon the effective management of interest rate risk.
To identify and manage its interest rate risk, we employ an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management projections for activity levels in each of the product lines offered by CommunityOne and Granite. Assumptions are inherently uncertain and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest changes as well as changes in market conditions and management strategies. FNB's Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk.
Management does not believe there has been any significant change in the overall performance of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis presented in the Form 10-K.
Item 4.    Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of our disclosure controls and procedures (as defined in Sections 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934), was carried out under the supervision and with the participation of FNB's Chief Executive Officer and Chief Financial Officer and several other members of senior management as of June 30, 2012, the last day of the period covered by this Quarterly Report. FNB's Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2012 in ensuring that the information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 is (i) accumulated and communicated to management (including FNB's Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms.
Internal Control Changes
The Company did not make any substantial changes to its systems of internal control during the second quarter of 2012.

50

PART II. OTHER INFORMATION
Item 1.    Legal Proceedings
In the ordinary course of operations, FNB is party to various legal proceedings. Other than noted below, FNB is not involved in, nor has it terminated during the six months ended June 30, 2012, any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.
As described in Item 3., Legal Proceedings, of the Form 10-K, Howe Barnes Hoefer & Arnett, Inc., an affiliate of Raymond James Financial, Inc., filed a complaint in Wake County Superior Court in North Carolina seeking monetary damages against FNB and CommunityOne. There has been no change in the status of this litigation since the filing date of the complaint.
Item 1A.     Risk Factors
There have been no material changes to the risk factors that we have previously disclosed in Item 1A - “Risk Factors” in our Form 10-K.
Item 2.    Unregistered Sales of Equity Securities and Repurchases
Not Applicable
Item 3.    Defaults Upon Senior Securities
Not Applicable
Item 4.    Mine Safety Disclosures
Not Applicable
Item 5. Other Information
None
Item 6.    Exhibits
Exhibits to this report are listed in the Index to Exhibits on page 53 of this report.

51

SIGNATURES


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


FNB United Corp.
(Registrant)


Date: August 10, 2012                    By:    /s/ DAVID L. NIELSEN        
David L. Nielsen
Executive Vice President and Chief
Financial Officer
(Principal Financial and Accounting Officer)


52

INDEX TO EXHIBITS

Exhibit No.                    Description of Exhibit
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
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.
101     Financial Statements submitted in XBRL format



53