FIRST Union Corp. is negotiating to acquire Dominion Bankshares Corp., parent of Virginia's third-largest bank, according to sources.

First Union, based in Charlotte, N.C., issued a statement on Thursday sying it is in merger discussions with an unidentified partner. So did Roanoke-based Dominion.

Wall Street latched on to the likelihood of a merger, driving up Dominion's share price by $2.25 to $16.875 late Thusday.

Earnings Estimation

Analysts speculated that First Union would do a stock swap valued at about $16 to $20 a 4 share, or $618 million to $774 million, to acquire Dominion. That woukd represent a premium of 1.2 to 1.5 times the book value of the $9.4 billion-asset banking company.

First Union also announced Thursday that it expected to earn $139 million, or $1.05 a share, in the third quarter, more than double the earnings of the year-earlier quarter. The anticipated profit was significantly ahead of analysts' consensus estimate of 89 cents a share.

First Union's stock price was $38.25 late Thursday, up $1.25.

Power to Acquire

First Union's increased earings power is giving the $48 billion-asset compaany more opportunity to expand. Since June, First Union has struck deals to acquire two thrifts in South Carolina and Georgia, which will contribute $3.6 billion in additional assets.

Dominion would give First Union an entry to Virginia and expand its minor presence in Tennessee. Dominion owns a $2.1 billion-asset bank in Tennessee, where First Union owns a $147 million-asset bank.

The major disadvantage is asset quality. Dominion is the weakest of Virginia's three major independent banks. Like the others, it got caught up in speculative real estate lending in the metropolitan Washington area, but has been slower to recover.

Dominion's nonperforming assets ratio fell to 6.4% in the second quarter, from 7.1% at yearend. But a continuing high level of chargeoffs and loan-loss provisions produced a $41.3 million loss in the first quarter, when the bank suspended its dividend.

Dominion Tightly Supervised

Dominion did eke out a $3.2 million profit in the second quarter, but it continues to operate under tough regulatory constraints, including a memorandum of understanding imposed by the Office of the Comptroller of the Currency in April.

Recent changes in federal banking law will tighten the supervision of weaker institutions even more. "You think about the FDIC improvement act generally and what that means going forward and the story doesn't get any better," said Susan R. Leadem, banking analyst with the Robinson-Humphrey Co. in Atlanta.

Some analysts are speculating that Richmond-based Crestar Financial Corp., Virginia's largest bank, may ride in as a "white knight" to save Dominion from the clutches of First Union. Crestar, which has $10.2 billion in assets, has been aggressively buying failed thrifts to fill in its Virginia franchise.

But a source close to First Union discounts the idea, noting that Crestar stock trades at 117% of book value compared to First Union's 152%. "If there's any significant premium [for Dominion], it's very difficult to see how Crestar could play," the source said.

First Union was severely criticized by Wall Street at the end of the 1980s for overpaying on acquisitions. But the company has become aggressive again in the wake of 1991's government-assisted takeover of Miami-based Southeast Banking Corp., which provided enormous cost savings and boosted its stock price.

In its press release confirming merger talks, First Union stated that "any dilution would be minimal at most in the first year after consummation and accretive thereafter."

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