BB&T In Good Shape With Credit, But Growth Is Iffy

By Stephen D. Simpson, CFA | July 18, 2013 AAA

Southeast regional bank BB&T (NYSE:BBT) definitely got the memo this quarter about the themes being higher fee income and lower credit costs. Unfortunately, BB&T also had significantly higher non-operating expenses and a little more covered loan run-off than expected, leading to pretty uninspiring operating profit performance. BB&T should be in a good position to benefit from the above-average population and economic growth expected in the southeast part of the U.S., but it's hard to call the shares a screaming bargain at today's price. Sharp Cross-Currents In Q2 ResultsAlthough BB&T's bottom line reported results looked relatively sound compared to analyst expectations, there were a lot of surprising cross-currents in the details. All told, there was nothing particularly alarming about BB&T's results and the company's core/intrinsic growth and profitability look pretty good. SEE: Bank Of America Brings The GrowthRevenue rose 1% from the year-ago period and about 2% on a sequential basis, good for a roughly 4% beat compared to expectations. Net interest income was down slightly on a sequential basis due in large part to covered loan run-off, as net interest margin erosion wasn't as bad as expected (down 6bp sequentially, or 3bp on a core basis). On a core basis, BB&T's net interest margin of 3.4% compares pretty well with U.S. Bancorp's (NYSE:USB) 3.43%, Wells Fargo's (NYSE:WFC) 3.46%, Comerica's (NYSE:CMA) 2.83%, Fifth Third's (Nasdaq:FITB) 3.33%, and PNC's (NYSE:PNC) 3.58%.  BB&T also did quite well with its fee-generating businesses, as adjusted income rose about 7% here sequentially. Mortgage banking was a headwind as expected (down about 7%), but BB&T saw strong contributions from its large insurance operations (nearly 40% of fee income). Where things got shaky was at the expense line. Expenses jumped 5% sequentially and were considerably higher than expected. That said, a lot of this increase was due to resubmitting the company's CCAR capital plan and preparing for future spending cuts. Moreover, while BB&T's efficiency ratio was inferior to U.S. Bancorp, even this quarter of elevated expenses left BB&T's efficiency ratio pretty good compared to other regionals/money centers like Wells Fargo and PNC.SEE: A Look At Corporate Profit Margins At the bottom line, though, BB&T did log a sizable miss at the pre-provision operating line. Different analysts adjust the numbers differently, but we're talking about a roughly four-cent to eight-cent miss here, with profits down on a year-over-year basis – not what the market wants to see from bank stocks today. Credit Very Solid, And The Loan Book Is GrowingOn a much more positive note, BB&T's credit costs continue to get much better. Non-performing loans dropped 30% from last year and 10% sequentially, a much better performance than its peer group. Likewise, the 64bp decline in the non-performing asset ratio and the 50bp decline in the net charge-off ratio were pretty exceptional (though, to be fair, Wells Fargo had a similar improvement). Although I am a little concerned that BB&T's loan reserves are a bit thin (just under 1.7%), the non-performing loans are well-covered and BB&T's lower credit costs more than compensated for the pre-provision shortfall. BB&T is also still growing. Year-on-year loan growth of 4% (and sequential growth of 1%) is nothing to shout about, but it's no worse than in-line with the peer group. What's more, the loan growth was pretty balanced across the banks business units. The Bottom LineAll things considered, I don't expect a tremendously positive reaction to BB&T's earnings, given the still-sluggish loan growth, the ongoing net interest margin erosion, and the higher expenses. Even so, I continue to believe that this is a quality regional bank with above-average growth potential in the coming years. That potential does seem to be largely in the shares, though. Using a long-term return on equity estimate of 12.5%, an excess returns model suggests a fair value of about $38 to $39 today. On the other hand, looking at the company's return on tangible assets and return on equity net of the cost of capital suggests a price/tangible book value multiple of about 1.8x, which means a $33 target price. Split the difference ($36) and the shares aren't tremendously cheap today. I will continue to hold my BB&T shares, but investors looking to put new money into the sector may want to look at Wells Fargo or U.S. Bancorp first, or even consider a smaller bank like Eagle (Nasdaq: EGBN) in the D.C. area for better near-term capital appreciation potential. Disclosure – As of this writing, the author owns shares of BB&T. 

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