I've tried to make the case before that BB&T (NYSE:BBT) was an underappreciated regional bank that really wasn't getting its due from the sell-side community. Now that management missed numbers with higher expenses and revised guidance lower for the next quarter, it's harder to make that argument. Although I fully expect BB&T to spend at least a quarter or two in the penalty box now, I believe the company's loan growth, credit quality, and expansion potential all will pay off in time. As such, while third quarter results frustrate me as a shareholder, I'm not looking to sell at these prices.
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A Tough Quarter Down the Line
BB&T's third quarter results were somewhat disappointing, but they were hardly a disaster. Nevertheless, this was neither the time nor the place to disappoint the Street.
Operating revenue rose 1% sequentially, but pre-provision net revenue was down about 2%; better than PNC's (NYSE:PNC) 6% decline, but worse than the single-digit improvements from Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB) and Fifth Third (Nasdaq:FITB). BB&T's net interest income rose 1%, and although the bank's net interest margin is the strongest of the group at 3.94%, lower security balances led to a slight disappointment here. It's worth noting that BB&T benefits greatly from purchase accounting accretion and "core NIM" is lower.
Arguably the biggest disappointment was with the company's expenses. Expenses rose about 4%, driving a lot of the company's miss relative to estimates. Even with this disappointment, however, I think it's worth remembering that BB&T's efficiency ratio compares favorably with most banks - it's superior to all of the aforementioned names except U.S Bancorp.
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Good Loans, Good Credit, but NIM Compression Coming
Period-end loans grew about 3% at BB&T, or a little more than 2%, excluding the BankAtlantic loans. With most other banks posting loan growth of around 1%, that's not a bad result, and BB&T continues to see good growth in mortgages and commercial lending.
Credit quality also continues to improve. Non-performing loans fell 6%, and non-performing assets fell about 9%.
Unfortunately, the good times aren't going to continue into the fourth quarter. Not unlike U.S. Bancorp, BB&T management cited significant uncertainty in the commercial lending market tied to the election and the "fiscal cliff" issue. Consequently, loan growth is expected to slow. More significantly, management also sees net interest margin dropping about 20 basis points or so in the next quarter - some from unfavorable runoffs and lower yields, but also less accretion.
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Will a Little Aggressiveness Pay Off?
In many respects, it looks like BB&T management is not afraid to be more aggressive in the pursuit of growth. In addition to the BankAtlantic deal, management has given no particular indication that it's through considering acquisitions. Even though BB&T is already a major player in the Southeast in banking and nationwide in insurance, there could be further scope for deals in both lines.
BB&T also seems to be willing to expand specialty lending. In addition to subprime auto lending, BB&T is expanding its equipment finance lending. The recession wiped out a lot of equipment finance companies, but this can be very profitable lending with sound underwriting.
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The Bottom Line
Given how BB&T still stacks up against other regional/super-regional banks, I'm not inclined to panic over the developments and guidance in this quarter. I still believe that the bank can produce long-term returns on equity in the 13-14% range, and that suggests that these shares are undervalued. With a 13.5% long-term ROE estimate, fair value comes in around $40 to $41, making this is an attractively-priced bank relative to U.S. Bancorp and Wells Fargo today.
With that fair value, I would also offer a warning. BB&T has long had more leverage in commercial real estate than many of its comparables, and its fee income business is generally more volatile as well. So while BB&T may indeed offer more upside than Wells Fargo or U.S. Bancorp, it also offers more risk and a larger probability of disappointment.
At the time of writing, Stephen D. Simpson owned shares of BB&T since 2007.