Although it never swirled the drain like many larger and better-known banks, and was aggressive in dealing with its sour loans, large regional bank BB&T (BBT) has to fight to get much respect from the analyst and institutional investor community. Given that the market seemingly believes that the prior decades of top-tier performance were a mirage, investors can still buy into a solid and growing banking franchise with relatively modest expectations built into the price.
Still Hungry For More
BB&T has seldom been shy about doing deals and little has changed in recent times. The company was able to acquire Colonial as a byproduct of the credit crisis and recently reached a deal with BankAtlantic to essentially buy that company's good assets without taking on the bad. This deal, coming at the cost of a 9% deposit premium) will vault BB&T from #14 in Miami to #6 and significantly enhance its Florida footprint – one of its few remaining market share weak points. Based on other recent deals (including PNC's (PNC) deal for Royal Bank of Canada's (RY) U.S. assets and the Comerica (CMA)-Sterling deal), BBT paid a fair price, particularly given the much-reduced credit risks.
Even with this $300 million deal, the company seems far from satisfied. Company executives have talked openly of wanting more share in Texas, Tennessee, and Maryland and being willing to buy that share if need be. While BB&T lost out to PNC in the RBC deal, perhaps the company would consider having a go at the likes of First Horizon (FHN), Texas Capital (TCBI), Sandy Spring (SASR) or Synovus (SNV) under the right circumstances.
Is The Quality As Good As It Seems?
With BB&T seemingly trading too cheaply, it's worth asking if the bank is as good as it appears. The answer would seem to be “it depends.”
For instance, while the company boasts a strong net interest margin when compared to a group of similar banks that includes Comerica, Fifth Third (FITB), M&T Bank (MTB), PNC, Suntrust (STI), and US Bancorp (USB), much of that above-average performance is an artifact of accounting. Strip out the purchase accounting adjustments and the performance is definitely more average.
Likewise, the company has a rather high exposure to real estate lending. Combined, commercial and residential real estate loans are almost 60% of BB&T book – well above the 40% or so average of that peer group. It's also worth noting that about one-quarter of the company's earning assets are securities and the bank is over-weighted towards agency MBS. Now, investors could argue that real estate has likely bottomed, but it's a risk factor all the same.
Even with those issues in hand, BB&T doesn't seem to get credit for how it handled itself during the crisis. BB&T was unusually aggressive in getting bad assets off the books and out the door, and that should leave the bank in a better starting position for the recovery.
The Bottom Line
Right now an excess returns model suggests that BB&T is priced for future returns on equity of about 10%. That is well below the pre-housing bubble performance that routinely ran in the mid-teens and the company's own future targets of 14-16%. Even granting that the future of bank profitability is not likely to be as strong as it was, it seems harsh to assume such a degradation in profitability – particularly when the Street is willing to expect more for less-well-run banks.
Splitting the difference and assuming a forward ROE of 13% suggests a price target in the low $30s for BB&T. That does not make it the cheapest bank out there today, but it does make for an interesting mix of value and quality. Though it will take more time for investors to warm back up to bank stocks (to say nothing of the sector showing real earnings growth), BB&T looks like a solid enough GARP candidate for most investors.
Disclosure: I am long BBT.