Atlantic Union Bankshares Corp quarterly report, Q3 FY2013

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Business context and reporting period

Union First Market Bankshares Corporation (the registrant named in this 10-Q; headquartered in Richmond, Virginia) reported for the quarter and nine months ended September 30, 2013. Its businesses are community banking and mortgage origination. The interim statements are unaudited; the independent accountant conducted a review, not an audit.

Financial performance and position

  • Third-quarter earnings: Net income was $7.9 million and diluted EPS was $0.32, versus $9.6 million and $0.37 a year earlier. Non-GAAP operating earnings, excluding merger and conversion costs, were $8.4 million ($0.34 per share), down 12.6% year over year.
  • Nine-month earnings: Net income was $26.4 million and diluted EPS was $1.06, compared with $26.0 million and $1.00 in 2012. Non-GAAP operating earnings were $27.8 million versus $26.0 million.
  • Income and margins: Third-quarter net interest income was $37.9 million; noninterest income was $9.2 million. Tax-equivalent net interest margin was 4.20%, down 11 basis points year over year and up 2 basis points sequentially. Nine-month tax-equivalent net interest income was $116.9 million, down 1.2%; margin was 4.20%, down 16 basis points. Management expected modest margin declines over the next several quarters as asset yields were expected to fall faster than funding costs.
  • Credit costs and asset quality: Third-quarter provision for loan losses was $1.8 million, down $0.6 million year over year; nine-month provision was $4.9 million versus $8.9 million. Net charge-offs were $2.3 million in the quarter and $5.9 million year to date. Nonperforming assets were $55.7 million, 1.85% of loans, down from $66.6 million and 2.29% a year earlier. The allowance was $33.9 million, 1.13% of loans; coverage of nonaccrual loans was 169.9%. OREO was $35.7 million, up from $32.8 million at year-end 2012.
  • Expenses and returns: Third-quarter noninterest expense was $34.1 million, up 2.6% year over year; nine-month expense was $101.9 million, up 2.8%, including $1.4 million of merger-related expense. Third-quarter operating ROA and ROE were 0.83% and 7.74%, respectively; the operating efficiency ratio was 69.56%.
  • Balance sheet and liquidity: Total assets were $4.05 billion; loans were $3.00 billion, up 3.2% year over year; deposits were $3.22 billion, up 0.8% year over year but down 2.2% from year-end. Cash and cash equivalents were $75.1 million. Management considered liquidity sufficient; liquid assets and loans maturing within one year totaled $1.1 billion, or 30.9% of earning assets.
  • Debt and capital: Borrowings totaled $350.0 million, including $151.2 million short-term, $138.5 million long-term, and $60.3 million trust preferred notes. The company said it remained well capitalized: total risk-based capital ratio was 14.40%, Tier 1 risk-based ratio 13.13%, and leverage ratio 10.62%. Common equity to assets was 10.72%.
  • Cash flow: Nine-month operating cash flow was $138.6 million, compared with an outflow of $16.2 million in 2012; the reported period included a $109.5 million decrease in loans held for sale. Investing cash outflow was $75.6 million and financing cash outflow was $70.8 million. Cash declined $7.8 million from year-end.

Material changes versus comparable periods

  • Third-quarter GAAP net income and EPS declined year over year, while nine-month GAAP net income rose slightly. Community banking earnings improved; the mortgage segment shifted to a $1.2 million quarterly loss from $0.9 million profit a year earlier.
  • Mortgage originations fell 32.3% year over year in the quarter to $218.9 million as higher mortgage rates reduced refinance demand and compressed gain-on-sale margins. Nine-month mortgage originations increased 2.7%, but the segment recorded a $0.8 million loss versus $1.6 million profit in 2012.
  • Credit indicators improved year over year: nonaccrual loans fell to $19.9 million from $32.2 million, and troubled debt restructurings fell to $47.9 million from $63.8 million. However, quarterly net charge-offs rose sequentially, and OREO increased from year-end.
  • Available-for-sale securities were $589.4 million. Accumulated other comprehensive income moved from $10.1 million at year-end 2012 to a $0.6 million loss, primarily reflecting unrealized securities losses; no other-than-temporary impairment was recognized in 2013.
  • Deposits shifted toward lower-cost transaction accounts; time deposits declined from year-end. The company repurchased 500,000 shares in the first quarter for $9.5 million and paid a quarterly dividend of $0.14 per share.

Outlook, commentary, risks and contingencies

  • The pending StellarOne acquisition was expected to close around January 1, 2014, subject to closing conditions and shareholder approval. Regulatory approvals had been received by October 11, 2013; the filing also described expected bank integration in May 2014. Management cited potential integration costs, deposit or customer attrition, employee departures, disruption, and failure to achieve anticipated savings as risks.
  • A StellarOne shareholder class action sought to enjoin the merger and other relief. The companies considered the claims without merit. If the merger agreement is terminated in specified circumstances, a $21.8 million termination fee may be payable.
  • The mortgage segment’s near-term return to profitability depended on higher production and/or improved sale margins; management was adjusting costs to lower origination levels. The filing gave no specific earnings or revenue guidance.
  • Union Mortgage Group identified Truth in Lending disclosure errors on certain USDA- and FHA-insured loans originated from November 2011 through August 2013. Most had been sold, and purchasers may require repurchase. The company could not reasonably estimate potential liability; its mortgage indemnification reserve was $564,000 at September 30, 2013.
  • Real estate loans comprised 83.7% of the portfolio. Management noted that credit exposure remained dependent on local economic conditions and recovery in residential and commercial real estate. Interest-rate sensitivity models showed lower modeled net interest income under both rising and falling rate shocks; results depend on assumptions.
  • Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting. The statements were prepared under GAAP with normal recurring interim adjustments.

Important facts for investors to verify

  1. Whether the StellarOne merger closed on expected terms and timing, and the eventual integration costs, customer retention, and realized savings.
  2. Whether mortgage production and gain-on-sale margins recovered, and how quickly the mortgage business returned to profitability.
  3. Trends in criticized and nonperforming loans, charge-offs, OREO, and the adequacy of the allowance, particularly given the real-estate concentration.
  4. The potential exposure from the mortgage disclosure errors, including any repurchase demands, indemnification claims, or additional reserves.
  5. Whether falling asset yields continued to pressure net interest margin, and the effect of securities valuation changes on equity and capital.
  6. Reconciliation of non-GAAP operating measures to GAAP results when comparing performance across periods or with other banks.