Atlantic Union Bankshares Corp quarterly report, Q2 FY2012

Business context and reporting period

Union First Market Bankshares Corporation, the issuer named in this 10-Q, reported unaudited results for the quarter and six months ended June 30, 2012. The company operated a Virginia community bank with 94 branches and a mortgage origination business serving several Mid-Atlantic states. Amounts below are in U.S. dollars; financial amounts are in millions unless otherwise stated.

Key financial metrics

Metric	Q2 2012	Comparable period
Net interest income	$38.1	$39.6 in Q2 2011
Noninterest income	$14.4	$10.0 in Q2 2011
Net income	$8.4	$6.8 in Q2 2011
Diluted earnings per share	$0.32	$0.24 in Q2 2011
Provision for loan losses	$3.0	$4.5 in Q2 2011
Net interest margin, tax-equivalent	4.36%	4.68% in Q2 2011

• For the first six months, net income was $16.3 million versus $13.0 million; diluted EPS was $0.63 versus $0.46. Net interest income was $76.4 million and noninterest income was $26.2 million.
• Q2 operating revenue, defined as net interest income plus noninterest income, was $52.5 million. Mortgage-loan sale gains were $7.3 million for the quarter and $12.6 million year to date.
• At June 30, total assets were $4.0 billion, net loans $2.85 billion, deposits $3.22 billion and stockholders’ equity $433.4 million. Total borrowings were $291.3 million, including repurchase agreements, trust preferred notes and long-term borrowings.
• Cash and cash equivalents were $72.4 million. For the six months, operating cash flow was $15.2 million, investing cash outflow $89.5 million and financing cash inflow $50.0 million; cash declined $24.3 million. Securities purchases and net loan growth were significant investing uses.
• Management reported $1.2 billion of liquid assets, equal to 32.8% of earning assets, and considered liquidity sufficient. About $964 million of loans were scheduled to mature within one year.
• Regulatory capital ratios were 12.99% Tier 1 risk-based capital and 14.55% total risk-based capital; management said the company met the “well capitalized” definition. Tangible common equity to tangible assets was 9.11%.

Material changes versus prior periods

• Q2 net income increased 23.5% year over year, although net interest income declined as lower asset yields outweighed savings in funding costs. Tax-equivalent net interest margin fell 32 basis points year over year and 8 basis points sequentially.
• Higher mortgage origination volume drove a $3.0 million year-over-year increase in Q2 mortgage-loan sale gains. Total noninterest income rose 44.6%; gains on property sales also contributed to the comparison.
• Q2 noninterest expense increased 5.3% to $37.8 million, primarily from mortgage commissions, staffing, insurance and occupancy costs. Lower FDIC assessments, amortization and certain other operating costs partly offset these increases.
• Loans increased $69.2 million from year-end 2011; deposits increased $43.9 million. Cash and cash equivalents fell from $96.7 million at year-end, while securities available for sale rose from $620.2 million to $627.5 million.
• Credit indicators improved year over year: nonaccrual loans were $39.2 million versus $54.3 million, and nonperforming assets were $75.0 million versus $91.3 million. Allowance for loan losses was $41.0 million, or 1.42% of loans; Q2 net charge-offs were 0.31% annualized.

Outlook, commentary, risks and unusual items

• Management expected net interest margin to decline slightly over the next several quarters as earning-asset yields were expected to fall faster than funding costs.
• Management attributed improving asset quality to lower problem-loan and OREO balances, but warned that results remained dependent on commercial real estate and housing recovery and local economic conditions. Real estate lending, including commercial real estate and construction, is a major portfolio concentration.
• Acquisition-accounting adjustments added approximately $951,000 to Q2 net interest income and $2.3 million for the first half. Management said the acquired-asset accretion was declining; its estimate of the remaining 2012 net accretion benefit was about $1.4 million.
• The mortgage business benefited from historically low rates and newly hired originators. These gains are volume- and rate-sensitive; refinancing represented 45.1% of Q2 originations.
• Proposed Basel III capital rules could raise capital requirements, increase compliance costs, constrain lending and pressure profitability, dividends or shareholder dilution. The company was evaluating the impact; the proposal was not final.
• The company repurchased shares in February 2012 under an agreement with a director: 335,649 shares for $4.36 million, of which 115,384 were transferred to the employee stock ownership plan and 220,265 retired.
• Management reported no material legal-proceeding exposure based on information available and stated disclosure controls were effective. The interim financial statements were reviewed, not audited; the review report expressed no audit opinion.

Important facts for investors to verify

• Whether margin pressure and declining acquisition accretion are offset by loan growth, deposit mix and fee income.
• Whether mortgage production and loan-sale gains remain sustainable if refinancing activity or interest rates change.
• Credit quality trends in commercial real estate, construction and land loans, including nonaccrual loans, OREO, TDRs and charge-offs; Q2 TDRs totaled $80.2 million, including $12.7 million nonperforming.
• The adequacy of the $41.0 million loan-loss allowance relative to portfolio risks and acquired-loan credit marks.
• The effect of final Basel III rules on capital, lending capacity, dividends and returns.
• Liquidity and funding trends, including deposit composition, borrowing levels and the cash decline during the first half.
• That reported non-GAAP “cash basis” earnings exclude intangible amortization and are supplemental, not substitutes for GAAP results.