Atlantic Union Bankshares - 10-Q quarterly report FY

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

          Indicate by checkmark 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.

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b – 2 of the Act).

          As of April 23, 2003, Union Bankshares Corporation had 7,595,302 shares of Common Stock outstanding.

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UNION BANKSHARES CORPORATION
FORM 10-Q
March 31, 2003

INDEX

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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements

UNION BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share information)

See accompanying notes to consolidated financial statements.

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UNION BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(dollars in thousands, except per share amounts)

See accompanying notes to consolidated financial statements.

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UNION BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(dollars in thousands)

See accompanying notes to consolidated financial statements.

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UNION BANKSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 2003 and 2002
(dollars in thousands)

See accompanying notes to consolidated financial statements.

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UNION BANKSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2003

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The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

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Union Bankshares Corporation
Segment Report

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INDEPENDENT ACCOUNTANT’S REVIEW REPORT

To the Board of Directors
Union Bankshares Corporation
Bowling Green, Virginia

We have reviewed the condensed consolidated balance sheet of Union Bankshares Corporation and Subsidiaries as of March 31, 2003 and the related condensed consolidated statements of income, shareholders’ equity and cash flows for the three-month periods ended March 31, 2003 and 2002.  These condensed financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants.  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Union Bankshares Corporation as of December 31, 2002, and the related consolidated statements of income, shareholders’ equity and cash flows for the year ended (not presented herein); and in our report dated January 15, 2003, we expressed an unqualified opinion on those financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2001 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. 

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of the Company.  The analysis focuses on the consolidated financial statements, the footnotes thereto, and the other financial data herein.  Highlighted in the discussion are material changes from prior reporting periods and any identifiable trends affecting the Company.  Amounts are rounded for presentation purposes, while the percentages presented may be computed based on unrounded amounts.

Critical Accounting Policies

General

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred.  A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability.  The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio.  Actual losses could differ significantly from the historical factors that are used. The fair value of the investment portfolio is based on period end valuations but changes daily with the market. In addition, GAAP itself may change from one previously acceptable method to another method.  Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio.  The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standard (“SFAS”) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company’s allowance for loan losses model has three basic components: the formula allowance, the specific allowance and a calculation for unfunded loans.  Each of these components is determined based upon estimates that can and do change when actual events occur. These estimates are reevaluated at least quarterly as part of a review of the adequacy of the allowance for loan loss.  The allowance formula uses historical losses and current economic and business conditions in developing estimated loss factors as an indicator of future losses for various loan classifications; as a result, the estimated losses could differ from the losses incurred in the future. The specific allowance uses various techniques such as historical loss information, expected cash flows and fair market value of collateral to arrive at an estimate of losses. The use of these values is inherently subjective and actual losses could be greater or less than the estimates.  The allowance calculation for unfunded loans uses

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historical factors to determine the losses that are attributable to these loans.  Management periodically reassesses the approach taken in these estimates in order to enhance the process.

Goodwill and Intangibles

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 and prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets will be subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence. SFAS No. 142 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill.

Overview

Net income for the first quarter of 2003 was $3.9 million, up 29.0% from $3.1 million for the same period in 2002. This increase was the result of significant improvement in both business segments.  The community banking segment earnings increased by $664,000 or 24.3% over the prior year’s first quarter driven by growth in loans. The mortgage segment’s performance also improved with net income of $546,000 for the quarter ended March 31, 2003 compared to $324,000 in the comparable quarter of last year. First quarter 2003 diluted earnings per share for the Company amounted to $.52, as compared to $.40 in the same quarter of 2002.  The Company’s annualized return on average assets for the three months ended March 31, 2003 was 1.43% as compared to 1.27% a year ago. The Company’s annualized return on average equity totaled 14.97% and 13.69% for the three months ended March 31, 2003 and 2002, respectively.

Net income from the Company’s community bank segment increased from $2.7 million in the first quarter of 2002 to $3.4 million in the first quarter of 2003.  Much of this increase was attributable to improvements in net interest income and was driven largely by increases in loans and reductions in interest expense.  Loan growth between year end 2002 and March 31, 2003 amounted to $35.3 million while deposits grew $43.4 million over the same period.  This growth in loans helped to offset the impact of declining rates on interest income. In addition, interest expense continued  to decline in a low interest rate environment. Noninterest-bearing deposits grew more than any other deposit category while 36.8% or $15.9 million of the growth was time deposits, primarily certificates of deposit, which locked in lower rates over a longer period of time.

The mortgage segment reported net income of $546,000, an increase of $222,000 or 68.5% in the first quarter of 2003, reflecting continued high levels of mortgage originations in a low mortgage rate environment. The low interest rate environment with strong home sales has led to strong demand for loans to refinance existing loans, as well as mortgages for new and resale home purchases.  MCI’s strategy continues to focus its efforts toward the home purchase market, working with home buyers, builders, realtors and other referral sources to provide a more stable loan production platform. During the first quarter of 2003 mortgage refinancings represented 59% of total originations, up from 39% for the same quarter a year ago.  It is anticipated that

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rising mortgage rates will significantly reduce mortgage refinancing activity and, to a lesser extent, new and resale home financings. The Company will continue to closely monitor production volumes so adjustments in staffing and other areas can be made in an appropriate and timely manner.

Total assets as of March 31, 2003 were $1.155 billion, an increase of 3.5% from $1.116 billion at December 31, 2002.  Loans totaled $750.1 million at March 31, 2003, an increase of  $35.3 million or 4.9% from $714.8 million at December 31, 2002.  The securities portfolio decreased to $267.4 million at the end of the first quarter of 2003 versus $272.8 at year end 2002 as a result of calls, maturities and prepayments of mortgage backed securities. Loans held for sale increased $6.6 million to $46.4 million compared to the December 31, 2002 balance of $39.8 million. Stockholders’ equity totaled $109.4 million at March 31, 2003, which represents a book value of $14.41 per share.

Total deposits at March 31, 2003 were $941.0 million, up 4.8% from $897.6 million at December 31, 2002.  Other borrowings totaled $92.2 million at March 31, 2003, a 13.8% decrease from $107.0 million at year end 2002.  The other borrowings change is the result of a $13.0 million decrease in securities sold under agreements to repurchase (principally with customers). These changes continue to reflect the lower interest rates for overnight funds.

Competition for deposits, particularly as it impacts certificate of deposit (CD) rates, is rate sensitive. Management continues to focus on increasing and retaining lower cost deposit products (including noninterest-bearing demand deposits and savings accounts) and locking in current lower rates with longer term (3-5 year) CD rates in an effort to maintain a lower cost of funds and a strong interest margin.  Increased competition for both loans and deposits is expected to contribute to some narrowing of the net interest margin until rates start to rise.

On a year-to-year basis, deposits at March 31, 2003 are up 16.8% at $941.0 million compared to $805.4 million at the end of March 2002. Loans are up 18.6% at $750.1 million compared to $632.6 million in March 2002. Of the $135.6 million growth in deposits, $68.9 million or 50.8% was in longer term certificates of deposits providing protection for the net interest margin in a rising rate environment.  The growth in loans allows the Company to maintain a good earnings margin in spite of the lower yield on loans.  As investors gain confidence, some of the lower cost deposits, such as demand and NOW accounts, may move back into the stock market and may cause further compression in the net interest margin.

Net Interest Income

Net interest income on a tax-equivalent basis for the first quarter of 2003 increased by 7.7% to $11.1 million from $10.3 million for the same period a year ago.  Over that time, average interest earning assets grew by $143.5 million or 15.7% and average interest-bearing deposits increased by 15.5%. Of the $105.0 million increase in average interest bearing deposits, 59%, or $61.9 million was in certificate of deposits. Total interest-bearing liabilities on a year to year basis were up 13.3% which reflects the Company’s ability to fund growth through its deposit growth.  The net interest margin was 4.26% in March 2003 down 32 basis points from 4.58% in March of 2002.  For this period, the yield on earning assets was 6.59%, down 75 basis points from 7.34% in March of 2002 and the yield on interest-bearing liabilities was 2.80% down 46 basis points from 3.26% for the same period. The net interest margin of 4.26% at March 31, 2003 is down slightly from 4.34% at the end of December 2002. This decline in the net interest margin was the

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result of loans repricing  faster than the deposits over this time period. It is expected that this trend will produce some pressure on the margin until interest rates rise.

In addition, the subsidiary banks have periodically engaged in wholesale leverage transactions to better leverage their capital position by borrowing funds to invest in securities at margins of 150 to 200 basis points. Although such transactions increase net income and return on equity, they negatively impact the net interest margin. As of March 31, 2003 such transactions accounted for $10 million of the Company’s total borrowings.

Included in the average earning assets is $36.8 million in loans held for sale.  These loans are mortgage loans originated by the mortgage segment and held for the short period between closing with the customer and funding by the investor. The loans have their final rates locked and are presold to an investor. While the spread on these short term loans provides a positive contribution to interest income and net income, it negatively impacts the net interest margin as these loans are funded at more narrow, short-term spreads. These loans ultimately generate most of their earnings in the noninterest income category through gains on sales of loans.

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Union Bankshares Corporation
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES (TAXABLE EQUIVALENT BASIS)