Most banks remain stuck in a “hurry up and wait” holding pattern where pressure on net interest margins and weak lending growth constrain near-term earnings growth. BB&T Corp. (NYSE:BBT) certainly fits that description, as the company's good insurance income and cost control can't fully counteract a weak commercial lending environment for small clients and a fiercely competitive environment for larger loans.
The good news for Winston-Salem, N.C.-based BB&T is that the company's capital situation is strong, as its deposit share in its key markets. BB&T management would almost certainly like to find a good acquisition target in markets like Texas or Tennessee, but may instead look to return more capital in 2015 if a suitable deal cannot be found. Although these shares hold pretty good potential for the long term, short-term headwinds in the business could make outperformance in 2014 more challenging.
A Familiar Pattern In Q1 Results
Investors who've followed the reports of other banks like San Francisco's Wells Fargo & Co. (NYSE:WFC), Pittsburgh's PNC Financial Services Group, Inc. (NYSE:PNC), Cincinnati's Fifth Third Bank (Nasdaq:FITB) and Atlanta's SunTrust Banks, Inc. (NYSE:STI) are going to see a lot of familiar trends in BB&T's results.
Revenue fell 5% year-over-year and about 2% sequentially, which is pretty spot-on for the peer group. Net interest income performance (down 5% YOY) was a little weaker than the aforementioned group, but largely due to prior purchase accounting accretion; on a sequential basis, the 1% decline was pretty typical as BB&T saw a 4 basis point decline in net interest margin and a slight increase in average earning assets.
Unlike Wells Fargo, BB&T's insurance operations were stronger than expected this quarter, with income up 15% from the prior quarter. Like Wells Fargo, though, and like so many other banks, mortgage-related fee income and deposit service fee income were both soft.
BB&T is doing a little better than most with its expenses, as operating expenses were basically flat versus the year-ago period and down about 3% sequentially. That led to a double-digit year-over-year decline in pre-provision profits, but a sequential decline of less than 1% - a comparatively good result relative to Wells Fargo, PNC and Fifth Third.
Still Waiting For Lending Growth
A familiar theme with larger banks this quarter has been weak lending growth. Some of this is due to weakness in mortgage lending (which is likely tied at least in part to poor weather in the first quarter), but it also seems to be the case that smaller banks are gaining share in commercial lending. BB&T isn't actually as levered to commercial lending as commonly believed (they're a little above-average in commercial real estate lending, but below average in commercial and industrial lending as a percentage of the loan book), but management is looking for better growth later in the year as small- to mid-sized CRE lending accelerates.
In the meantime, credit and capital look pretty good. Nonperforming loans declined 3% sequentially, and the nonperforming asset (NPA) ratio fell another six basis points to 0.86% (quite good on a peer/comparative basis). Net charge-offs (NCO) ticked up slightly from the fourth quarter, but both the NPA and NCO ratios are down more than 40bp from the prior year's level.
BB&T saw tangible book value grow 4% from the fourth quarter, and the company ended the quarter with a Basel III Tier 1 Common ratio of 10%. Management also submitted a fairly conservative Comprehensive Capital Analysis and Review capital return plan for 2014. Management characterized this as a response to last year's challenges with the process (an initial submission was rejected), but it may well also be the case that management is accumulating capital for an acquisition.
Self-Improvement and Expansion?
Management is looking for meaningful ongoing expense reductions and good loan growth to offset ongoing pressure in net interest margin (with 10bp of decline possible in the second quarter). If CRE lending picks up, particularly in the small- to mid-sized space, there could be upside to net interest margin (NIM) estimates as these loans tend to have higher yields.
There is still a lot that BB&T can do for itself. Its market share in states like North Carolina, South Carolina and Georgia give it access to attractively-priced deposits and make it more difficult for newcomers like Fifth Third to compete apart from pricing. Even so, management has made no secret of the fact that it would like to find deals in certain key markets like Texas, Tennessee, Georgia and Maryland. BB&T's size does create some obstacles to a deal, but the bigger issue right now seems to be the lack of banks that have the right combination of deposit/loan share in attractive markets and reasonable valuations.
The Bottom Line
I favor a two-prong valuation system for banks, and BB&T comes out looking okay by these methods. For the short-term, BB&T's prospective return on tangible equity in 2014 argues for a book value multiple of around 1.9x, suggesting the shares are a little overvalued right now. The longer-term approach of excess returns, though, suggests a fair value of over $41 based on the assumption of long-term returns on equity in the range of 12% to 13%. With that, BB&T looks like an attractive long-term buy, but perhaps not the best stock for the short term given concerns about NIM erosion over the next quarter or two. The number of cheap quality banks is fairly small, though, so BB&T's long-term potential makes it worth consideration today.
Disclosure – As of this writing, the author owns shares of BB&T.