AUB

Business Context and Reporting Period

Company: Union Bankshares Corporation (Atlantic Union Bankshares Corp)

Filing Type: Form 10-Q (Quarterly Report)

Period Ended: March 31, 2007

Overview: The Company is a community banking organization operating 51 locations in Virginia and the D.C. metro area through five bank subsidiaries and non-bank affiliates (Union Mortgage, Union Investment Services, Union Insurance). The quarter includes the full impact of the April 2006 acquisition of Prosperity Bank & Trust Company.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased 18.4% year-over-year to $5.1 million. Diluted EPS fell 19.1% to $0.38. The decline was driven by a compression in net interest margin and higher noninterest expenses, partially offset by a $0.735 million recapture of loan loss reserves.
• Net Interest Margin Compression: The tax-equivalent net interest margin dropped 45 basis points to 4.09%. This was caused by a 94 basis point increase in the cost of interest-bearing liabilities (driven by a shift to higher-cost certificates of deposit) versus only a 41 basis point increase in asset yields.
• Asset Growth: Total assets increased 12.4% year-over-year to $2.12 billion. Loans grew 13.5% to $1.60 billion, with growth concentrated in commercial real estate and consumer portfolios.
• Noninterest Expenses: Expenses rose 15.0% to $18.0 million. Excluding the impact of the Prosperity acquisition, expenses increased 7.8%, primarily due to salaries, benefits, and occupancy costs associated with branch expansion and technology upgrades.
• Asset Quality Improvement: Nonperforming assets decreased to $8.8 million from $11.0 million in the prior quarter. A specific credit relationship was reduced from $10.6 million to $7.9 million, allowing for the release of $0.75 million in specific reserves.

Outlook, Risks, and Management Commentary

• Margin Outlook: Management anticipates continued declines in net interest margin, albeit at a slower pace, until the yield curve normalizes (short-term rates lower than long-term rates). The current flat/inverted yield curve environment continues to pressure margins.
• Mortgage Segment: The mortgage segment reported a net loss of $0.139 million compared to a profit of $0.062 million in Q1 2006. Loan volume decreased 19.5% year-over-year due to a softening housing market and rising inventory levels. Management does not anticipate significant adverse effects from the sub-prime market deterioration.
• Liquidity: Liquidity is considered sufficient. Liquid assets totaled $1.3 billion (68.4% of earning assets). The Company has access to Federal funds lines and a line of credit with the Federal Home Loan Bank.
• Capital Resources: The Company remains "well capitalized" with a Tier 1 risk-based capital ratio of 11.41% and a total risk-based capital ratio of 12.48%. The equity-to-assets ratio was 9.57%.
• Market Risk: Earnings simulation indicates that a 200 basis point increase in rates would increase net interest income by 2.62%, while a 200 basis point decrease would reduce it by 2.80%.
• Legal Proceedings: No material legal proceedings are expected to have an adverse effect on the Company.

Investor Verification Checklist

• Margin Sustainability: Verify the trajectory of deposit costs versus asset yields to assess the duration of net interest margin compression.
• Nonperforming Asset Resolution: Monitor the $7.9 million nonperforming credit relationship (assisted living facilities) for further resolution or potential additional charge-offs.
• Mortgage Volume Trends: Track mortgage origination volumes and the impact of the softening housing market on the mortgage segment's profitability.
• Expense Management: Review the run-rate of noninterest expenses related to the new operations center and branch expansions to ensure they align with revenue growth.
• Capital Ratios: Confirm that regulatory capital ratios remain above the "well capitalized" thresholds as the company continues to grow assets.