Does anyone still own banks? The market hates them and seemingly has been selling them off every day. But amid the pessimism is opportunity, and I believe BB&T (NYSE:BBT) is a great way to play it.
Think of BB&T as a giant local bank. Its customers are local businesses, and its competitors are local banks and thrifts. BB&T isn't trying to lend to HCA (NYSE:HCA) or McDonald's (NYSE:MCD); it is lending to the local hospital and the local McDonald's franchisee. With scale and expertise that its local competition can't match, BB&T competes very effectively for the business it wants. That is why historically the bank has had superior ROEs.
Also consider the footprint. The Southeastern US should have strong growth long-term, and that plays well to BB&T's top 5 deposit market shares in the Carolinas, Virginia, Florida, etc. And the deposit franchise is excellent. The bank has over $100b in deposits, with only 20% in higher cost CDs. That's about the same as its non-interest bearing deposits, so its funding costs are low.
The bank also has excellent brand equity. In other words, BB&T has avoided problems like robo-signing, mortgage repurchases on rep and warranty issues, selling clients worthless assets, etc.. BB&T was among the first to pay back TARP, and surveys suggest its customers appreciate the bank.
Let's not ignore the risks, however, which we hear about almost every day now. Increased regulation and higher capital requirements will have an impact on the industry, including BB&T. Regulations could curtail various fees the banks earn, but ultimately the banks will find a way to offset that. How? Well, the days of the free checking account will probably be over soon, with the industry charging most customers to have a checking account. The transition may be tricky, but that is the long-term solution.
Higher capital requirements are a bigger concern in my mind. BB&T will be hard pressed to get back to the years of 20+% ROE. But mid-teens ROEs should be attainable for BB&T, and I am comfortable with that. Plus, there will be plenty of banks that cannot earn their cost of capital without leveraging the balance sheet, and they should make for very attractive acquisition targets for BB&T.
The weak economy is another risk, and a double dip recession would be bad for the industry (and plenty of others as well). The bank is better positioned today than in 2007, so it should be able to withstand a bad economy better. For example, NPA-generating development and construction loans are down to $3b from $9b a few years ago.
So what is BB&T worth? Let's look at it the way an acquirer of a community bank would. We start with tangible book value - by year-end 2012 I expect that to reach about $19/sh. Then we have to estimate the value of the deposit franchise. Remember, the bank has low funding costs due to its great deposit base. In fact, its interest cost on deposits is just over 1/2%. Long-term debt costs 4%, but they only have to pay depositors 1/2%! Let's say the long-term advantage is really closer to 2% rather than the current 3+%. After tax the advantage falls to 1.5%. So BB&T saves 1.5%, or 1.5 cents, each year after-tax due to its deposit franchise. If we put a 10x multiple on that stream we get $.15 per $1 of deposit. Multiply the $.15 per $1 of deposit by the total deposit base and divide by the number of shares, you get about $22/sh by y/e 2012.
Finally we add in the value of the insurance brokerage business. BB&T has made numerous acquisitions in this area and has been able to turn it into a good business. Based on comparables, I value this piece at $4/sh. And since most of the players in the industry have little or negative tangible book (due to numerous acquisitions and lack of capital requirements), we don't need to allocate any of BB&T's tangible book to this business.
Add it all up, and I come to an estimated value of BB&T of $45/sh by year-end 2012. The stock is currently trading around $26/sh, so if I am right the stock should do very well.
If you want more details, you can listen to my podcast on BB&T.
Disclosure: My clients and I are long BBT.