BB&T (BBT) reported second quarter earnings today that were largely overshadowed by the what TheStreet.com has termed, “Corporate Welfare Friday” because of earnings reports from Bank of America (BAC), Citi (C), and General Electric (GE). All four of these companies are trading lower today, but none more so than BB&T who finished the day 6.5% lower. The company reported net income of $204 million of 20 cents per share. This is 52% lower than the tally from a year ago, and a penny lower than consensus estimates. The company incurred a 9 cent per share charge for repayment of TARP funding, and earnings were also hamstrung through BB&T’s increasing their loan loss provision to $701 million. Revenue was a bright spot as it was 13% higher than the period a year ago aided by strong performance in mortgage banking operations. Revenue of $2.1 billion outpaced the consensus estimates of $2.01 billion.
The market’s reaction tells us a lot about what investors fear the future may hold for BB&T. The bank’s performance was actually pretty decent considering the circumstances, which has been a common story for BB&T throughout the first 19 months of the recession. (See earnings call transcript.) The bank has been insulated against some of the horrendous write downs of other financial stocks because of their conservative underwriting practices. However, there is a sense that BB&T can only stay in front of the credit crisis for so long. They have a tremendous amount of exposure to commercial real estate including $7.5 billion book of residential acquisition, development, and construction loans. BB&T’s footprint is primarily in the southeastern US which has thus far held up relatively well, but with unemployment continuing to grow and overbuilding a concern, the region’s economic strength may be showing cracks.
It was this concern over further deteriorating in BB&T’s credit quality that prompted a credit rating downgrade from Fitch today. From the Associated Press article explaining the downgrade,
The downgrade of issuer default ratings reflects the view that BB&T’s financial profile will continue to be challenged by the current credit environment. Fitch expects that the deteriorating economic environment will increase credit issues across various portions of BB&T’s consumer and commercial loan portfolios, many that have performed well to date. In particular, the company’s commercial real estate portfolio, centered in the southeastern U.S., which has experienced minimal credit issues, is expected to generate higher loss rates in the future.
At Ockham, BB&T is one of the few financial stocks that we have a positive outlook on with a valuation of Undervalued at present levels. We are not dismissing the potential concerns over commercial real estate loans and consumer debt, but the bank has performed well this far in terms of shielding earnings against inhospitable operating conditions. The bank was one of the best capitalized banks at the time of the stress tests, and was the strongest of the regional banking centers like Regions Financial (RF) and Fifth Third Bancorp (FITB). They were among the first group to repay the TARP obligations, made possible by a secondary offering which was priced at $20 per share and raised $1.7 billion.
Because of the concerns over their exposure to somewhat risky loans that as of yet have not soured, we would not be surprised to see the stock break below that $20 level. At that level, we would advocate buying for the long term, because our valuation methodology has a rationally expected price range between $25 and $31 based on current fundamentals. If you believe that the concerns over CRE are overblown than BB&T is an opportunity to buy a stock that is trading below what we consider fair value, largely because of fear of what might become of its commercial real estate portfolio.