Banks took many different approaches during the crunch that followed the housing bubble; some buried their heads in the sand, some dealt with problems as they appeared, and a few swallowed hard and aggressively wrote off bad debt. BB&T (BBT) fits into the later group and though the decision to write down and sell off bad loans depressed performance for a while (and seemed to confuse or aggravate analysts), the company is seeing the benefits in a healthier balance sheet and more profitable business structure.
Credit And Mortgages Still The Story, But In A Good Way
BB&T reported a 2% sequential increase in operating revenue, but a 1% decline in net interest income. Relative to a broad peer group including Wells Fargo (WFC), U.S. Bancorp (USB), PNC (PNC), and Fifth Third (FITB), that's on the lower end of the range, though still a fair bit better than analysts expected.
While net interest income was hurt by NIM compression (tied both to lower rates and purchase accounting accretion), it dropped less than expected and at 3.93% stacks up very well in that peer group - just ahead of Wells and PNC.
Like most banks, BB&T got a lift from fee income that was spiked by mortgage banking fees. Mortgage banking income jumped 60% from the fourth quarter, as banks have seen higher mortgage refinancing (tied in part to the federal HARP program). Encouragingly, insurance income was also strong with a 7% sequential gain.
Based on first quarter results, it looks like BB&T is also reaping the benefits from its proactive handling of bad debts. Non-performing assets dropped 8% sequentially and the non-performing asset ratio fell 23bp to 2.14%. By way of comparison, Bank of America (BAC), Wells, and Citi (C) all saw the opposite - higher non-performing loans and higher NPAs (and for what it's worth, Fifth Third also posted a laudable improvement in NPA). This makes me feel a little better about both the company's reserve release (which was half the size of the prior quarter's) and its overall credit position.
Now It's Back To Business
With a relatively clean balance sheet and a good expense structure (only U.S. Bancorp boasts a better efficiency ratio of the stocks mentioned in this piece), BB&T can get back to the business of running a very good super-regional bank.
The company found a negotiated solution to a court injunction that would have blocked its deal for BankAtlantic (BBX), and I would expect that the management team is still looking for deals in markets like Texas, Tennessee, Maryland, and Georgia. Perhaps a deal for a company like Synovus (SNV) or Fulton (FULT) could be in the cards, but in the meantime I expect the company will continue to collect and tuck in small insurance and fee-generating businesses.
At the same time, BB&T has to keep its edge in the markets it already serves. PNC made a major commitment when it bought RBC's U.S. operations and other banks like Fifth Third, Wells Fargo, and Bank of America have explicitly targeted the Southeast as an area of expected growth and increased consumer business focus.
The Bottom Line
Now that the benefits of BBT's early moves to handle its balance sheet are becoming obvious, sell-side analysts are coming around to the stock and the average price target has jumped about 15% in the last couple of months.
Right now I expect BB&T to regain and hold a 14% return on equity - on par with Wells Fargo and below U.S. Bancorp. That seems about right given U.S. Bancorp's larger lucrative fee business (especially from transaction processing and treasury operations) and the variables that go with BB&T's large insurance operations.
Nevertheless, even with at 14% estimate, these shares still look underpriced relative to a fair value of about $40. While U.S. Bancorp and Wells Fargo are arguably better buys today, I would not ignore BB&T as I believe there may yet be more upside in this often under-rated bank.
Disclosure: I am long BBT.