UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended:
December 31, 2005
Commission File Number: 1-10853
BB&T CORPORATION
(Exact name of Registrant as specified in its Charter)
(336) 733-2000
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of each class
Name of each exchangeon which registered
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES þ NO ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by references in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer þ
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ¨ NO þ
At February 28, 2006, the Corporation had 535,418,674 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation is approximately $21.6 billion (based on the closing price of such stock as of June 30, 2005.)
Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 25, 2006, are incorporated by reference in Part III of this report.
CROSS REFERENCE INDEX
PART I
Unresolved Staff Comments
None.
Submission of Matters to a Vote of Security Holders
PART II
58
27
70
71
72
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Other Information
PART III
*
PART IV
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The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation of Executive Officers”, “Compensation Committee Report on Executive Compensation”, “Compensation Committee Interlocks and Insider Participation”, “Performance Graph” and “Compensation of Directors” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
The information required by Item 12 is incorporated herein by reference to the information that appears under the headings “Security Ownership” and “Compensation of Executive Officers” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
The information required by Item 13 is incorporated herein by reference to the information that appears under the headings “Compensation Committee Interlocks and Insider Participation” and “Transactions with Executive Officers and Directors” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
The information required by Item 14 is incorporated herein by reference to the information that appears under the headings “Fees to Auditors” and “Corporate Governance Matters-Audit Committee Pre-Approval Policy” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
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OVERVIEW AND DESCRIPTION OF BUSINESS
General
BB&T Corporation (“BB&T”, “the Company” or “the Corporation”), is a financial holding company headquartered in Winston-Salem, North Carolina. BB&T conducts its business operations primarily through its commercial bank subsidiaries, which have offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. Substantially all of the loans by BB&T’s bank and nonbank subsidiaries are to businesses and individuals in these market areas. BB&T’s principal bank subsidiaries are Branch Banking and Trust Company (“Branch Bank”), Branch Banking and Trust Company of South Carolina (“Branch Bank-SC”), Branch Banking and Trust Company of Virginia (“Branch Bank-VA”), and BB&T Bankcard Corporation. BB&T’s principal assets are all of the issued and outstanding shares of common stock of its subsidiary banks and its nonbank subsidiaries.
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements with respect to the financial condition, results of operations and businesses of BB&T. These forward-looking statements involve certain risks and uncertainties and are based on the beliefs and assumptions of the management of BB&T and the information available to management at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following:
Risk Factors Relating to BB&T’s Business
Changes in national and local economic conditions could lead to higher loan charge-offs and reduce BB&T’s net income and growth.
BB&T’s business is subject to periodic fluctuations based on national and local economic conditions. These fluctuations are not predictable, cannot be controlled, and may have materially adverse impact for the Company’s operations and financial condition even if other favorable events occur. BB&T’s banking operations are locally oriented and community-based. Accordingly, the Company expects to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets it serves. For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities BB&T serves. Weakness in BB&T’s market area could depress the Company’s earnings and consequently the financial condition of the Company because:
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Any of the latter three scenarios could require the Company to charge-off a higher percentage of loans and/or increase provisions for credit losses, which would reduce the Company’s net income. For an analysis of the Company’s recent charge-off experience, please refer to the “Asset Quality and Credit Risk Management” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.
Changes in interest rates may have an adverse effect on BB&T’s profitability.
BB&T’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect BB&T’s earnings and financial condition. The Company cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. The Company has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. However, changes in interest rates still may have an adverse effect on BB&T’s profitability. For example, high interest rates could adversely affect BB&T’s mortgage banking business because higher interest rates could cause customers to request fewer mortgage refinancings and purchase money mortgage originations.
BB&T’s accounting policies and methods are key to how the Company reports its financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.
BB&T’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report its financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in the Company reporting materially different amounts than would have been reported under a different alternative. Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” describes the Company’s significant accounting policies. These accounting policies are critical to presenting the Company’s financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions. For additional information regarding the more critical accounting policies, please refer to the “Critical Accounting Policies” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.
Changes in accounting standards could materially impact BB&T’s financial statements.
From time to time the Financial Accounting Standards Board “FASB” changes the financial accounting and reporting standards that govern the preparation of BB&T’s financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.
BB&T may not be able to successfully integrate bank or nonbank mergers and acquisitions.
Difficulties may arise in the integration of the business and operations of bank holding companies, banks and other non-bank entities the Company acquires and, as a result, the Company may not be able to achieve the cost savings and synergies that it expects will result from such transactions. Achieving cost savings is dependent on
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consolidating certain operational and functional areas, eliminating duplicative positions and terminating certain agreements for outside services. Additional operational savings are dependent upon the integration of the acquired or merged entity’s businesses with BB&T or one of BB&T’s subsidiaries, the conversion of core operating systems, data systems and products and the standardization of business practices. Complications or difficulties in the conversion of the core operating systems, data systems and products may result in the loss of customers, damage to BB&T’s reputation within the financial services industry, operational problems, one-time costs currently not anticipated or reduced cost savings resulting from such mergers or acquisitions. Annual cost savings in each such transaction may be materially less than anticipated if the holding company, bank merger or nonbank merger or acquisition is delayed unexpectedly, the integration of operations is delayed beyond what is anticipated or the conversion to a single data system is not accomplished on a timely basis.
Difficulty in integrating an acquired company may cause the Company not to realize expected revenue increases, cost savings, increases in geographic or product presence and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of BB&T’s businesses or the businesses of the acquired company, or otherwise adversely affect the Company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.
BB&T may not receive the regulatory approvals required to complete a bank merger.
BB&T must generally receive federal regulatory approval before it can acquire a bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition and future prospects including current and projected capital ratios and levels, the competence, experience and integrity of management and record of compliance with laws and regulations, the convenience and needs of the communities to be served, including the acquiring institution’s record of compliance under the Community Reinvestment Act and the effectiveness of the acquiring institution in combating money laundering activities. In addition, BB&T cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted. In specific cases the Company may be required to sell banks or branches, or take other actions as a condition to receiving regulatory approval.
BB&T may experience significant competition in its market area, which may reduce the Company’s customer base.
There is intense competition among commercial banks in BB&T’s market area. In addition, BB&T competes with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, commercial finance and leasing companies, the mutual funds industry, full-service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than BB&T is with respect to the products and services they provide. Some of BB&T’s larger competitors, including certain national banks that have a significant presence in the Company’s market area, have greater resources than BB&T, may have higher lending limits and may offer products and services not offered by BB&T.
We also experience competition from a variety of institutions outside of the Company’s market area. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.
Changes in banking laws could have a material adverse effect on BB&T.
BB&T is extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole. In addition, the Company is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. BB&T cannot predict whether any of these changes may adversely and materially affect the Company. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on BB&T’s activities that could have a
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material adverse effect on the Company’s business and profitability. For a further discussion regarding other uncertainties arising from how the Company is regulated and supervised, please refer to the “Regulatory Considerations” section herein.
BB&T’s business could suffer if it fails to attract and retain skilled people.
BB&T’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities the Company engages is intense. The Company may not be able to hire the best people or retain them.
BB&T’s stock price can be volatile.
BB&T’s stock price can fluctuate widely in response to a variety of factors including:
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations could also cause BB&T’s stock price to decrease regardless of the Company’s operating results.
Operating Subsidiaries
At December 31, 2005, the principal operating subsidiaries of BB&T included the following:
Branch Bank, BB&T’s largest subsidiary, was chartered in 1872 and is the oldest bank headquartered in North Carolina. Branch Bank provides a wide range of banking and trust services for retail and commercial clients in its geographic markets, including small and mid-size businesses, public agencies, local governments and individuals through 901 offices (as of December 31, 2005) located in North Carolina, Maryland, Georgia, Kentucky, Florida, West Virginia, Tennessee, Washington D.C., Alabama and Indiana. Branch Bank’s principal operating subsidiaries include:
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Branch Bank-SC, Branch Bank-VA and BB&T Bankcard Corporation
Branch Bank-SC provides a wide range of banking and trust services to retail and commercial clients, including small and mid-size businesses, public agencies, local governments and individuals through 99 banking offices (as of December 31, 2005) located in the State of South Carolina. Branch Bank-VA offers a full range of commercial and retail banking services through 404 banking offices (as of December 31, 2005) located in the Commonwealth of Virginia. BB&T Bankcard Corporation is a special purpose credit card bank.
Major Nonbank Subsidiaries
BB&T also has a number of nonbank subsidiaries, including:
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Services
The primary services offered by BB&T’s subsidiaries include:
The following table reflects BB&T’s deposit market share and branch locations by state at December 31, 2005.
Table 1
BB&T Deposit Market Share and Branch Locations by State
North Carolina (1)
Virginia
Georgia
Kentucky
South Carolina
West Virginia
Maryland
Tennessee
Florida
Washington, D.C.
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In addition to the markets described in the table above, BB&T operates two branches in Alabama and one branch in Indiana. After the completion of pending acquisitions with Main Street Banks, Inc., and First Citizens Bancorp, BB&T will operate 144 branches in Georgia, 63 branches in Tennessee and 336 branches in North Carolina, and increase its deposit market share rank to 5th in Georgia. BB&T’s presence and deposit market share in other states listed in the table above will not change as a result of these pending acquisitions. Please refer to Note 20 “Operating Segments” in the “Notes to Consolidated Financial Statements” for additional disclosures.
Executive Overview
Significant accomplishments in 2005
In the opinion of BB&T’s management, the Corporation’s most significant accomplishments during 2005 were as follows (amounts include the impact of acquisitions where applicable):
Challenges
BB&T has grown at a rapid pace since its merger of equals with Southern National Corporation in 1995, and BB&T’s business has become more dynamic and complex in recent years. Consequently, management has annually evaluated and, as necessary, adjusted the Corporation’s business strategy in the context of the current operating environment. During this process, management considers the current financial condition and performance of the Company and its expectations for future economic activity, both on a national and local market scale. The achievement of BB&T’s key strategic objectives and established long-term financial goals is subject to many uncertainties and challenges. In the opinion of management, the challenges that are most relevant and likely to have a near term impact on performance, are presented below:
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Competition
The financial services industry is highly competitive and dramatic change continues to occur in all aspects of the Company’s business. The ability of nonbank financial entities to provide services previously reserved for commercial banks has intensified competition. BB&T’s subsidiaries compete actively with national, regional and local financial services providers, including banks, thrifts, securities dealers, mortgage bankers, finance companies and insurance companies. Competition among providers of financial products and services continues to increase with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to consolidate, which affects competition by eliminating some regional and local institutions, while strengthening the franchises of acquirers. For additional information concerning markets, BB&T’s competitive position and business strategies, see “Market Area” and “General Business Development” below.
Market Area
BB&T’s primary market area consists of North and South Carolina, Virginia, Maryland, Georgia, eastern Tennessee, West Virginia, Kentucky, Florida and Washington, D.C. This area’s employment base is diverse and primarily consists of manufacturing, general services, agricultural, wholesale/retail trade, technology and financial services. BB&T believes its current market area is economically strong and will support consistent growth in assets and deposits in the future. Even so, management intends to continue expanding and diversifying the BB&T franchise, although at a slower pace than in recent years. Management strongly believes that BB&T’s community bank approach to providing client service is a competitive advantage that strengthens the Corporation’s ability to enter new markets and effectively provide financial products and services to businesses and individuals in these markets.
General Business Development
BB&T is a regional financial holding company. The core of its business and franchise was created by the merger-of-equals between BB&T and Southern National Corporation in 1995 and the acquisition of United Carolina Bancshares in 1997. BB&T has maintained a long-term focus on a strategy that includes expanding and diversifying the BB&T franchise in terms of revenues, profitability and asset size. Tangible evidence of this focus is the growth in average total assets, loans and deposits, which have increased over the last five years at compound annual rates of 11.1%, 11.3%, and 11.2%, respectively.
Merger Strategy
BB&T’s growth in business, profitability and market share over the past several years was enhanced significantly by mergers and acquisitions. Management made a strategic decision not to pursue bank or thrift acquisitions during 2004 or 2005, instead focusing on fully integrating recent mergers and improving internal growth. Management intends to resume strategic mergers and acquisitions, including bank and thrift acquisitions primarily within BB&T’s existing footprint, and, in fact, recently announced plans to acquire two banks. BB&T will continue to pursue economically advantageous acquisitions of insurance agencies, asset managers, consumer and commercial finance companies, and other strategic opportunities to grow existing businesses and potentially to expand into other related financial businesses. BB&T’s acquisition strategy is focused on three primary objectives:
BB&T consummated acquisitions of 53 community banks and thrifts, 77 insurance agencies and 28 nonbank financial services providers over the last fifteen years. In the long-term, BB&T expects to continue to take advantage of the consolidation in the financial services industry and expand and enhance its franchise through
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mergers and acquisitions. The consideration paid for these acquisitions may be in the form of cash, debt or BB&T stock. The amount of consideration paid to complete these transactions may be in excess of the book value of the underlying net assets acquired, which could have a dilutive effect on BB&T’s earnings. In addition, acquisitions often result in significant front-end charges against earnings; however, cost savings and revenue enhancements, especially incident to in-market bank and thrift acquisitions, are also typically anticipated.
Lending Activities
The primary goal of the BB&T lending function is to help clients achieve their financial goals by providing quality loan products that are fair to the client and profitable to the Corporation. Management believes that this purpose can best be accomplished by building strong, profitable client relationships over time, with BB&T becoming an important contributor to the prosperity and well-being of its clients. In addition to the importance placed on client knowledge and continuous involvement with clients, BB&T’s lending process incorporates the standards of a consistent company-wide credit culture and an in-depth local market knowledge. Furthermore, the Corporation employs strict underwriting criteria governing the degree of assumed risk and the diversity of the loan portfolio in terms of type, industry and geographical concentration. In this context, BB&T strives to meet the credit needs of businesses and consumers in its markets while pursuing a balanced strategy of loan profitability, loan growth and loan quality.
BB&T conducts the majority of its lending activities within the framework of the Corporation’s community bank operating model, with lending decisions made as close to the client as practicable.
The following table summarizes BB&T’s loan portfolio based on the regulatory classification of the portfolio, which focuses on the underlying loan collateral, and differs from internal classifications presented herein that focus on the primary purpose of the loan.
Table 2
Composition of Loan and Lease Portfolio
Commercial, financial and agricultural loans
Lease receivables
Real estate—construction and land development loans
Real estate—mortgage loans
Consumer loans
Total loans and leases held for investment
Loans held for sale
Total loans and leases
Less: unearned income
Net loans and leases
BB&T’s loan portfolio is approximately 50% commercial and 50% retail by design, and is divided into three major categories—commercial, consumer and mortgage. Loans from BB&T’s specialized lending segment, as discussed in Note 20, “Operating Segments” of the “Notes to Consolidated Financial Statements,” are included in the applicable categories. BB&T lends to a diverse customer base that is substantially located within the Corporation’s primary market area. At the same time, the loan portfolio is geographically dispersed throughout BB&T’s branch network to mitigate concentration risk arising from local and regional economic downturns.
The following discussion presents the principal types of lending conducted by BB&T and describes the underwriting procedures and overall risk management of BB&T’s lending function. The relative risk of each loan portfolio is presented in the “Asset Quality” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.
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Underwriting Approach
Recognizing that the loan portfolio is a primary source of profitability, proper loan underwriting is critical to BB&T’s long-term financial success. BB&T’s underwriting approach is designed to define acceptable combinations of specific risk-mitigating features that ensure credit relationships conform to BB&T’s risk philosophy. Provided below is a summary of the most significant underwriting criteria used to evaluate new loans and loan renewals:
Commercial Loan and Lease Portfolio
The commercial loan and lease portfolio represents the largest category of the Corporation’s total loan portfolio and is segmented as follows—business loans, generally defined as client relationships with total credit exposure above $1,000,000, small business loans, and leases. BB&T’s commercial lending program is generally targeted to serve small-to-middle market businesses with sales of $200 million or less. Traditionally, lending to small and mid-sized businesses has been among BB&T’s strongest markets.
Commercial loans are primarily originated through BB&T’s banking network. In accordance with the Corporation’s lending policy, each loan undergoes a detailed underwriting process, which incorporates BB&T’s underwriting approach, procedures and evaluations described above. In addition, the bank has adopted an internal maximum credit exposure lending limit of $220 million for a “best grade” credit, which is considerably below the Banks’ maximum legal lending limit. Commercial loans are typically priced with an interest rate tied to market indexes, such as the prime rate and the London Interbank Offered Rate (“LIBOR”). Commercial loans are individually monitored and reviewed for any possible deterioration in the ability of the client to repay the loan. Approximately 94% of BB&T’s commercial loans are secured by real estate, business equipment, inventories and other types of collateral.
BB&T provides commercial leasing services through BB&T Leasing Corp. (“Leasing”), a subsidiary of Branch Bank. Leasing provides three primary products: finance or capital leases, true leases (as defined under the Internal Revenue Code) and other operating leases for vehicles, rolling stock and tangible personal property. Leasing also provides lease-related services for small to medium-sized commercial customers. In addition to the services offered by Leasing, other BB&T subsidiaries provide leases to municipalities and invest in various types of leveraged lease transactions. Substantially all of BB&T’s leases are secured.
Consumer Loan Portfolio
BB&T offers a wide variety of consumer loan products. Various types of secured and unsecured loans are marketed to qualifying existing clients and to other creditworthy candidates in BB&T’s market area. These loans are relatively homogenous and no single loan is individually significant in terms of its size and potential risk of loss. Consumer loans are subject to the same rigorous lending policies and procedures as described above for commercial loans and are underwritten with note amounts and credit limits that ensure consistency with the Corporation’s risk philosophy. In addition to its normal underwriting due diligence, BB&T uses automated “scoring systems” to help underwrite the credit risk in its consumer portfolio.
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The consumer loan portfolio consists of three primary sub-portfolios—direct retail, revolving credit and sales finance. The direct retail category consists mainly of home equity loans and lines of credit, which are secured by residential real estate. It also includes installment loans and some unsecured lines of credit other than credit cards. The revolving credit category is comprised of the outstanding balances on credit cards and BB&T’s checking account overdraft protection product, Constant Credit. Such balances are generally unsecured and actively managed by BB&T Bankcard Corporation. Finally, the sales finance category primarily includes secured indirect installment loans to consumers for the purchase of automobiles. Such loans are originated through approved franchised and independent automobile dealers throughout the BB&T market area and, to a lesser degree, states outside BB&T’s market area. On a very limited basis, sales finance loans are also originated through qualified non-automotive dealers for the purchase of boats, recreational vehicles and other consumer equipment. Substantially all consumer loans, excluding the revolving credit portfolio, are secured.
Mortgage Loan Portfolio
BB&T is a large originator of residential mortgage loans, with originations in 2005 totaling $10.5 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. BB&T primarily originates conforming mortgage loans. These are loans that are underwritten in accordance with the underwriting standards set forth by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). They are generally collateralized by one-to-four-family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing.
Risks associated with the mortgage lending function include interest rate risk, which is mitigated through the sale of substantially all conforming fixed-rate loans in the secondary mortgage market and an effective mortgage servicing rights hedge process. Borrower risk is lessened through rigorous underwriting procedures and mortgage insurance. The right to service the loans and receive servicing income is generally retained when conforming loans are sold. Management believes that the retention of mortgage servicing is a primary relationship driver in retail banking and a vital part of management’s strategy to establish profitable long-term customer relationships and offer high quality client service. BB&T also purchases residential mortgage loans from correspondent originators. The loans purchased from third-party originators are subject to the same underwriting and risk-management criteria as loans originated internally.
The following table presents BB&T’s total loan portfolio based upon the primary purpose of the loan, as discussed herein, rather than upon regulatory reporting classifications:
Table 3
Composition of Loan and Lease Portfolio Based on Loan Purpose
Loans and leases, net of unearned income (1):
Commercial loans
Total commercial loans and leases
Sales finance
Revolving credit
Direct retail
Total consumer loans
Residential mortgage loans
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The following table reflects the scheduled maturities of commercial, financial and agricultural loans, as well as real estate construction loans:
Table 4
Selected Loan Maturities and Interest Sensitivity (1)
Fixed rate:
1 year or less (2)
1-5 years
After 5 years
Total
Variable rate:
Total loans and leases (3)
(3) The above table excludes:
(i) consumer loans
(ii) real estate mortgage loans
(iii) loans held for sale
(iv) lease receivables
Scheduled repayments are reported in the maturity category in which the payment is due. Determinations of maturities are based upon contract terms. BB&T’s credit policy typically does not permit automatic renewal of loans. At the scheduled maturity date (including balloon payment date), the customer generally must request a new loan to replace the matured loan and execute either a new note or note modification with rate, terms and conditions negotiated at that time.
Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments
The allowance for loan and lease losses is determined based on management’s best estimate of probable losses that are inherent in the portfolio at the balance sheet date. BB&T’s allowance is driven by existing conditions and observations, and reflects losses already incurred, even if not yet identifiable.
The Corporation determines the allowance based on an ongoing evaluation of the loan and lease portfolios. This evaluation is inherently subjective because it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Increases to the allowance are made by charges to the provision for credit losses, which is reflected on the Consolidated Statements of Income. Loans or leases deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance.
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In addition to the allowance for loan and lease losses, BB&T also estimates probable losses related to binding unfunded lending commitments. The methodology to determine such losses is inherently similar to the methodology utilized in calculating the allowance for commercial loans, adjusted for factors specific to binding commitments, including the probability of funding and exposure at funding. The reserve for unfunded lending commitments is included in accounts payable and other liabilities on the Consolidated Balance Sheets. Changes to the reserve for unfunded lending commitments are made by charges or credits to the provision for credit losses.
Reserve Policy and Methodology
The allowance for loan and lease losses consists of (1) a component for individual loan impairment recognized and measured pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” and (2) components of collective loan impairment recognized pursuant to SFAS No. 5, “Accounting for Contingencies,” including a component that is unallocated. BB&T maintains specific reserves for individually impaired loans pursuant to SFAS No. 114. A loan is impaired when, based on current information and events, it is probable that BB&T will be unable to collect all amounts due (interest as well as principal) according to the contractual terms of the loan agreement. On a quarterly basis, BB&T reviews all commercial lending relationships with outstanding debt of $2 million or more that have been classified as substandard or doubtful. Loans are considered impaired when the borrower does not have the cash flow capacity or willingness to service the debt according to contractual terms, or it does not appear reasonable to assume that the borrower will continue to pay according to the contractual agreement. The amount of impairment is based on the present value of expected cash flows discounted at the loan’s effective interest rate, and/or the value of collateral adjusted for any origination costs and nonrefundable fees that existed at the time of origination.
Reserves established pursuant to the provisions of SFAS No. 5 for collective loan impairment are primarily based on historical charge-off experience using a rolling twelve quarter annualized net charge-off rate. However, historical charge-off experience may be adjusted to reflect the effects of current conditions. BB&T considers information derived from its loan risk ratings; internal observable data related to trends within the loan and lease portfolios, including credit quality, concentrations, aging of the portfolio, growth and acquisitions; volatility adjustments to reflect changes in historical net charge-off rates and changes in probabilities of default; external observable data related to industry and general economic trends; and any significant, relevant changes to BB&T’s policies and procedures. Any adjustments to historical loss experience are based on one or more sets of observable data as described above and are directionally consistent with changes in the data from period to period, taking into account the interaction of components over time. The adjusted historical loss information is applied to pools of loans grouped according to similar risk characteristics to calculate components of the allowance. In the commercial lending portfolio, each loan is assigned a “risk grade” at origination by the account officer and the assigned risk grade is subsequently reviewed and finalized through BB&T’s established loan review committee process. Loans are assigned risk grades based on an assessment of conditions that affect the borrower’s ability to meet contractual obligations under the loan agreement. This process includes reviewing borrowers’ financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. The established risk management regimen includes a review of all credit relationships with total credit exposure of $1 million or more on an annual basis or at any point management becomes aware of information affecting the borrower’s ability to fulfill their obligations. In addition, for small business and commercial clients where total credit exposure is less than $1 million, BB&T has developed an automated loan review system to identify and proactively manage accounts with a higher risk of loss. The “score” produced by this automated system is updated monthly. All of the loan portfolios grouped in the retail lending and specialized lending categories typically employ scoring models to segment credits into groups with homogenous risk characteristics. Scoring models are validated on a periodic basis in order to ensure reliable default rate information. This information is employed to evaluate the levels of risk associated with new production as well as to assess any risk migration in the existing portfolio.
A portion of the Corporation’s allowance for loan and lease losses is not allocated to any specific category of loans. This unallocated portion of the allowance reflects management’s best estimate of the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion considered unallocated may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current economic conditions,
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industry or borrower concentrations and the status of merged institutions. The allocated and unallocated portions of the allowance are available to absorb losses in any loan or lease category. Management evaluates the adequacy of the allowance for loan and lease losses based on the combined total of the allocated and unallocated components.
While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance or to the reserving methodology may be necessary if economic conditions differ substantially from the assumptions used in making the valuations.
The following table presents an estimated allocation of the allowance for loan and lease losses at the end of each of the past five years. This table is presented based on the regulatory reporting classifications of the loans. Amounts applicable to years prior to 2002 reflect acquisitions accounted for as poolings of interests. This allocation of the allowance for loan and lease losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.
Table 5
Allocation of Allowance for Loan and Lease Losses by Category
Balances at end of period applicable to:
Commercial, financial and agricultural
Real estate:
Construction and land development
Mortgage
Total real estate
Consumer
Unallocated
Investment Activities
Investment securities represent a significant portion of BB&T’s assets. BB&T’s subsidiary banks invest in securities as allowable under bank regulations. These securities include obligations of the U.S. Treasury, U.S. government agencies, U.S. government sponsored entities, including mortgage-backed securities, bank eligible obligations of any state or political subdivision, bank eligible corporate obligations, including commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. BB&T’s bank subsidiaries may also deal in securities subject to the provisions of the Gramm-Leach-Bliley Act. Scott & Stringfellow, Inc., BB&T’s full-service brokerage and investment banking subsidiary, engages in the underwriting, trading and sales of equity and debt securities subject to the risk management policies of the Corporation.
BB&T’s investment activities are governed internally by a written, board-approved policy. The investment policy is carried out by the Corporation’s Asset / Liability Management Committee (“ALCO”), which meets regularly to review the economic environment and establish investment strategies. The ALCO also has much broader responsibilities, which are discussed in the “Market Risk Management” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.
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Investment strategies are established by ALCO based on the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of the Corporation. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits as prescribed by law and other borrowings; and (iii) to earn the maximum return on funds invested that is commensurate with meeting the requirements of (i) and (ii).
Funding Activities
Deposits are the primary source of funds for lending and investing activities, and their cost is the largest category of interest expense. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. Federal Home Loan Bank (“FHLB”) advances, other secured borrowings, Federal funds purchased and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. BB&T’s funding activities are monitored and governed through BB&T’s overall asset/liability management process, which is further discussed in the “Market Risk Management” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein. BB&T conducts its funding activities in compliance with all applicable laws and regulations. Following is a brief description of the various sources of funds used by BB&T. For further discussion relating to outstanding balances and balance fluctuations, refer to the “Deposits and Other Borrowings” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.
Deposits
Deposits are attracted principally from clients within BB&T’s branch network through the offering of a broad selection of deposit instruments to individuals and businesses, including noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money rate savings accounts, investor deposit accounts, certificates of deposit and individual retirement accounts. Deposit account terms vary with respect to the minimum balance required, the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (i) the interest rates offered by competitors, (ii) the anticipated amount and timing of funding needs, (iii) the availability and cost of alternative sources of funding, and (iv) the anticipated future economic conditions and interest rates. Client deposits are attractive sources of funding because of their stability and relative cost. Deposits are regarded as an important part of the overall client relationship and provide opportunities to cross-sell other BB&T services. In addition, BB&T gathers a portion of its deposit base through wholesale funding products, which include negotiable certificates of deposit and Eurodollar deposits through the use of a Cayman branch facility. At December 31, 2005, these sources of deposits represented approximately 12% of BB&T’s total deposits.
The following table provides information regarding the scheduled maturities of time deposits that are $100,000 and greater at December 31, 2005:
Table 6
Scheduled Maturities of Time Deposits $100,000 and Greater
(Dollars in thousands)
Three months or less
Over three through six months
Over six through twelve months
Over twelve months
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Borrowed Funds
BB&T’s ability to borrow funds from nondeposit sources provides additional flexibility in meeting the liquidity needs of the Company. Short-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term FHLB advances, and U.S. Treasury tax and loan depository note accounts. See Note 9 “Federal Funds Purchased, Securities Sold Under Agreements to Repurchase, and Short-Term Borrowed Funds” in the “Notes to Consolidated Financial Statements” herein for additional disclosures related to these types of borrowings.
BB&T also utilizes longer-term borrowings when management determines that the pricing and maturity options available through these sources create cost-effective options for funding asset growth and satisfying capital needs. BB&T’s long-term borrowings include long-term FHLB advances to the Banks, senior and subordinated debt issued by BB&T Corporation and Branch Bank, junior subordinated debt underlying trust preferred securities and capital leases. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for additional disclosures related to long-term borrowings.
Employees
At December 31, 2005, BB&T had approximately 27,700 full-time equivalent employees compared to approximately 26,100 full-time equivalent employees at December 31, 2004.
Properties
BB&T and its significant subsidiaries occupy headquarters offices that are either owned or operated under long-term leases. BB&T also owns free-standing operations centers, with its primary operations and information technology center located in Wilson, North Carolina. BB&T also owns or leases significant office space used as the Corporation’s headquarters in Winston-Salem, North Carolina. At December 31, 2005, BB&T’s subsidiary banks operated 1,404 branch offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. BB&T also operates numerous insurance agencies and other businesses that occupy facilities. Office locations are either owned or leased. Management believes that the premises occupied by BB&T and its subsidiaries are well-located and suitably equipped to serve as financial services facilities. See Note 6 “Premises and Equipment” in the “Notes to Consolidated Financial Statements” in this report for additional disclosures related to BB&T’s properties and other fixed assets.
Executive Officers of BB&T
The following table lists the members of BB&T’s executive management team as of December 31, 2005:
Name of Executive Officer
Title
John A. Allison, IV
Ricky K. Brown
W. Kendall Chalk
Barbara F. Duck
Robert E. Greene
Christopher L. Henson
Kelly S. King
Steven B. Wiggs
C. Leon Wilson
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Web Site Access to BB&T’s Filings with the Securities and Exchange Commission
All of BB&T’s electronic filings with the Securities and Exchange Commission (“SEC”), including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available at no cost on the Corporation’s web site, www.BBandT.com, through the Investor Relations link as soon as reasonably practicable after BB&T files such material with, or furnishes it to, the SEC. BB&T’s SEC filings are also available through the SEC’s web site at www.sec.gov.
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REGULATORY CONSIDERATIONS
As a bank holding company and a financial holding company under federal law, BB&T is subject to regulation under the Bank Holding Company Act of 1956, as amended, (the “BHCA”) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As state-chartered commercial banks, Branch Bank, BB&T-SC and BB&T-VA are subject to regulation, supervision and examination by state bank regulatory authorities in their respective home states. These authorities include the North Carolina Commissioner of Banks, in the case of Branch Bank, the South Carolina Commissioner of Banking, in the case of BB&T-SC, and the Virginia State Corporation Commission’s Bureau of Financial Institutions, in the case of BB&T-VA. In addition, BB&T Bankcard Corporation is a special-purpose Georgia bank, subject to regulation, supervision and examination by the Georgia Department of Banking and Finance. Branch Bank, BB&T-SC, BB&T-VA and BB&T Bankcard Corporation are collectively referred to herein as the “Banks.” Each of the Banks is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”). State and Federal law also govern the activities in which the Banks engage, the investments they make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks’ operations.
In addition to federal and state banking laws and regulations, BB&T and certain of its subsidiaries and affiliates, including those that engage in securities underwriting, dealing, brokerage, investment advisory activities and insurance activities, are subject to other federal and state laws and regulations, and supervision and examination by other state and federal regulatory agencies, including the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state insurance and securities regulators.
The earnings of BB&T’s subsidiaries, and therefore the earnings of BB&T, are affected by general economic conditions, management policies, changes in state and federal laws and regulations and actions of various regulatory authorities, including those referred to above. Proposals to change the laws and regulations to which BB&T is subject are frequently introduced at both the federal and state levels. The likelihood and timing of any such changes and the impact such changes might have on BB&T and its subsidiaries are impossible to determine with any certainty. The following description summarizes the significant state and federal laws to which BB&T and the Banks currently are subject. To the extent statutory or regulatory provisions are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions.
Financial Holding Company Regulation
Under current federal law, as amended by the Gramm-Leach-Bliley Act of 1999 (“GLBA”), a bank holding company, such as BB&T, may elect to become a financial holding company, which allows the holding company to offer customers virtually any type of service that is financial in nature or incidental thereto, including banking and activities closely related thereto, securities underwriting, insurance (both underwriting and agency) and merchant banking. In order to become and maintain its status as a financial holding company, the company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act of 1977 (“CRA”) rating. If the Federal Reserve determines that a financial holding company is not well-capitalized or well-managed, the company has a period of time to come into compliance, but during the period of noncompliance, the Federal Reserve can place any limitations on the financial holding company that it believes to be appropriate. Furthermore, if the Federal Reserve determines that a financial holding company has not maintained a satisfactory CRA rating, the company will not be able to commence any new financial activities or acquire a company that engages in such activities, although the company will still be allowed to engage in activities closely related to banking and make investments in the ordinary course of conducting merchant banking activities. BB&T became a financial holding company on June 14, 2000, and currently satisfies the requirements to maintain its status as a financial holding company.
Most of the financial activities that are permissible for financial holding companies are also permissible for a “financial subsidiary” of one or more of the Banks, except for insurance underwriting, insurance company portfolio investments, real estate investments and development, and merchant banking, which must be conducted in a financial holding company. In order for these financial activities to be engaged in by a financial subsidiary of a
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bank, federal law requires the parent bank (and its sister-bank affiliates) to be well- capitalized and well-managed; the aggregate consolidated assets of all of that bank’s financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion; the bank must have at least a satisfactory CRA rating; and if that bank is one of the 100 largest national banks, it must meet certain financial rating or other comparable requirements.
Current federal law also establishes a system of functional regulation under which the Federal Reserve Board is the umbrella regulator for bank holding companies, but bank holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. Certain specific activities, including traditional bank trust and fiduciary activities, may be conducted in the bank without the bank being deemed a “broker” or a “dealer” in securities for purposes of functional regulation. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain identifiable areas.
Acquisitions
BB&T complies with numerous laws related to its acquisition activity. Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. Current Federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Furthermore, a bank headquartered in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states have opted out of such interstate merger authority prior to such date, and subject to any state requirement that the target bank shall have been in existence and operating for a minimum period of time, not to exceed five years; and subject to certain deposit market-share limitations. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable Federal or state law.
Other Safety and Soundness Regulations
The Federal Reserve Board has enforcement powers over bank holding companies and their non-banking subsidiaries. The Federal Reserve Board has authority to prohibit activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative order or written agreement with a federal regulator. These powers may be exercised through the issuance of cease and desist orders, civil money penalties or other actions.
There also are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution is insolvent or is in danger of becoming insolvent. For example, under requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit financial resources to support such institutions in circumstances where it might not do so otherwise. In addition, the “cross-guarantee” provisions of Federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund (“SAIF”) or the Bank Insurance Fund (“BIF”) as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the SAIF or the BIF or both. The FDIC’s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institution.
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State banking regulators also have broad enforcement powers over the Banks, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator (with the approval of the Governor in the case of a North Carolina state bank) in order to conserve the assets of any such institution for the benefit of depositors and other creditors. The North Carolina Commissioner of Banks also has the authority to take possession of a North Carolina state bank in certain circumstances, including, among other things, when it appears that such bank has violated its charter or any applicable laws, is conducting its business in an unauthorized or unsafe manner, is in an unsafe or unsound condition to transact its business or has an impairment of its capital stock.
Payment of Dividends
BB&T is a legal entity separate and distinct from its subsidiaries. The majority of BB&T’s revenue is from dividends paid to BB&T by the Banks. The Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well-capitalized” under the prompt corrective action regulations summarized elsewhere in this section. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. North Carolina and Virginia laws state that, subject to certain capital requirements, the board of directors of a bank chartered under their laws may declare a dividend of as much of that bank’s undivided profits as the directors deem expedient. South Carolina allows for the payment of dividends by a state-chartered bank with the prior approval of the Commissioner of Banking. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. During the year ended December 31, 2005, the Banks declared $1.4 billion in dividends payable to BB&T. At December 31, 2005, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $3.2 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $880.7 million.
Capital
Each of the federal banking agencies, including the Federal Reserve Board and the FDIC, have issued substantially similar risk-based and leverage capital guidelines applicable to banking organizations they supervise, including bank holding companies and banks. Under the risk-based capital requirements, BB&T and the Banks are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common shareholders’ equity excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities; less nonqualifying intangible assets net of applicable deferred income taxes and certain nonfinancial equity investments. This is called “Tier 1 capital.” The remainder may consist of qualifying subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for credit losses. This is called “Tier 2 capital.” Tier 1 capital and Tier 2 capital combined are referred to as total regulatory capital.
The Federal Reserve requires bank holding companies that engage in trading activities to adjust their risk-based capital ratios to take into consideration market risks that may result from movements in market prices of covered trading positions in trading accounts, or from foreign exchange or commodity positions, whether or not in trading accounts, including changes in interest rates, equity prices, foreign exchange rates or commodity prices. Any capital required to be maintained under these provisions may consist of a new “Tier 3 capital” consisting of forms of short-term subordinated debt.
Each of the federal bank regulatory agencies, including the Federal Reserve, also has established minimum leverage capital requirements for banking organizations. These requirements provide that banking organizations that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and that have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total
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adjusted average assets of at least 3%. Institutions not meeting these criteria, as well as institutions with supervisory, financial or operational weaknesses, are expected to maintain a minimum Tier 1 capital to total adjusted average assets ratio equal to 100 to 200 basis points above that stated minimum. Holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve also continues to consider a “tangible Tier 1 capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activity.
In addition, both the Federal Reserve Board and the FDIC has adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by each agency in assessing an institution’s overall capital adequacy. The capital guidelines provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy. The agencies also require banks and bank holding companies to adjust their regulatory capital to take into consideration the risk associated with certain recourse obligations, direct credit subsidies, residual interest and other positions in securitized transactions that expose banking organizations to credit risk.
The ratios of Tier 1 capital, total capital to risk-adjusted assets, and leverage capital of BB&T and the Banks as of December 31, 2005, are shown in the following table.
Table 7
Capital Adequacy Ratios of BB&T Corporation and Principal Banking Subsidiaries
Risk-based capital ratios:
Tier 1 capital (1)
Total risk-based capital (2)
Tier 1 leverage ratio (3)
The federal banking agencies, including the Federal Reserve Board and the FDIC, are required to take “prompt corrective action” in respect of depository institutions and their bank holding companies that do not meet minimum capital requirements. The law establishes five capital categories for insured depository institutions for this purpose: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” To be considered “well-capitalized” under these standards, an institution must maintain a total risk-based capital ratio of 10% or greater; a Tier 1 risk-based capital ratio of 6% or greater; a leverage capital ratio of 5% or greater; and must not be subject to any order or written directive to meet and maintain a specific capital level for any capital measure. BB&T and each of the Banks are classified as “well-capitalized.” Federal law also requires the bank regulatory agencies to implement systems for “prompt corrective action” for institutions that fail to meet minimum capital requirements within the five capital categories, with progressively more severe restrictions on operations, management and capital distributions according to the category in which an institution is placed. Failure to meet capital requirements may also cause an institution to be directed to raise additional capital. Federal law also mandates that the agencies adopt safety
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and soundness standards relating generally to operations and management, asset quality and executive compensation, and authorizes administrative action against an institution that fails to meet such standards.
In addition to the “prompt corrective action” directives, failure to meet capital guidelines may subject a banking organization to a variety of other enforcement remedies, including additional substantial restrictions on its operations and activities, termination of deposit insurance by the FDIC and, under certain conditions, the appointment of a conservator or receiver.
Deposit Insurance Assessments
The deposits of the Banks are insured by the FDIC up to the limits set forth under applicable law. A majority of the deposits of the Banks are subject to the deposit insurance assessments of the BIF of the FDIC. However, a portion of the Banks’ deposits (relating to the acquisitions of various savings associations) are subject to assessments imposed by the SAIF of the FDIC. The assessments imposed in BIF-insured and SAIF-insured deposits have been equalized.
The FDIC imposes a risk-based deposit premium assessment system, based in part on an insured institution’s capital classification under the prompt corrective action provision, and whether the institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. The assessments are set forth in schedules issued by the FDIC that specify, at semi-annual intervals, target reserve ratios designed to maintain the reserve ratio of each of the funds at 1.25% of its estimated insured deposits. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of assessable deposits, depending on the institution’s capital position and other supervisory factors. In addition, both SAIF-insured and BIF-insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2005, the FDIC assessed BIF-insured and SAIF-insured deposits 1.32 basis points per $100 of deposits to cover those obligations. At December 31, 2005, BB&T’s assessment was limited to this 1.32 basis point obligation.
Consumer Protection Laws
In connection with their lending and leasing activities, the Banks are each subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and their respective state law counterparts.
Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
The CRA requires the Banks’ primary federal bank regulatory agency, in this case the FDIC, to assess the bank’s record in meeting the credit needs of the communities served by each Bank, including low- and moderate-income neighborhoods and persons. Institutions are assigned one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” This assessment is reviewed for any bank that applies to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. The CRA record of each subsidiary bank of a financial holding company, such as BB&T, also is assessed by the Federal Reserve in connection with any acquisition or merger application.
USA Patriot Act
The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such
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financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies, such as BB&T, with equity or debt securities registered under the Securities Exchange Act of 1934, as amended. In particular, the Sarbanes-Oxley Act established: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) certification responsibilities for the Chief Executive Officer and Chief Financial Officer with respect to the Company’s financial statements; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the federal securities laws.
Other Regulatory Matters
BB&T and its subsidiaries and affiliates are subject to numerous examinations by federal and state banking regulators, as well as the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state insurance and securities regulators. BB&T and its subsidiaries have from time to time received requests for information from regulatory authorities in various states, including state insurance commissions and state attorneys general, securities regulators and other regulatory authorities, concerning their business practices. Such requests are considered incidental to the normal conduct of business.
Corporate Governance
Information with respect to BB&T’s corporate governance policies and principles is presented on BB&T’s web site, www.BBandT.com, and includes:
BB&T intends to disclose any substantive amendments or waivers to the Code of Ethics for Directors or Senior Financial Officers on our web site atwww.BBandT.com/Investor.
NYSE Certification
The annual certification of BB&T’s Chief Executive Officer required to be furnished to the New York Stock Exchange pursuant to Section 303A.12(a) of the NYSE Listed Company Manual was previously filed with the New York Stock Exchange on May 26, 2005.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion and analysis of the consolidated financial condition and consolidated results of operations of BB&T Corporation and subsidiaries (“BB&T” or the “Corporation”) for each of the three years in the period ended December 31, 2005, and related financial information, are presented in conjunction with the consolidated financial statements and related notes to assist in the evaluation of BB&T’s 2005 performance.
Reclassifications
In certain circumstances, reclassifications have been made to prior period information to conform to the 2005 presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income.
Mergers and Acquisitions Completed During 2005
During 2005, BB&T acquired a number of nonbank financial services companies and insurance agencies, all of which were immaterial in relation to the consolidated results of BB&T. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for further information regarding mergers and acquisitions.
Pending Mergers
On December 15, 2005, BB&T announced plans to acquire Main Street Banks, Inc. (“Main Street”), based in Atlanta, Georgia. At the time of announcement, Main Street had $2.5 billion in assets and operated 24 full-service banking offices in the Atlanta and Athens, Georgia metro areas. Shareholders of Main Street will receive .6602 shares of BB&T stock in exchange for each share of Main Street common stock held. The transaction, which is subject to shareholder and regulatory approval, is expected to be completed in the second quarter of 2006.
On January 12, 2006, BB&T announced plans to acquire First Citizens Bancorp (“First Citizens”), a bank holding company headquartered in Cleveland, Tennessee. First Citizens is the parent company to three community banks and operated 19 full-service branches at the time of the announcement. As of September 30, 2005, First Citizens had $686 million in assets. Shareholders of First Citizens, which is a privately held company, may elect to receive cash, subject to certain limitations, or 1.30 shares of BB&T stock for each share of First Citizen common stock held. The merger, which is subject to regulatory and shareholder approval, is expected to be completed in the second quarter of 2006.
Critical Accounting Policies
The accounting and reporting policies of BB&T Corporation and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. BB&T’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses. Different assumptions in the application of these policies could result in material changes in BB&T’s consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting and reporting policies include BB&T’s accounting for the allowance for loan and lease losses and reserve for unfunded lending commitments, valuation of mortgage servicing rights, intangible assets and other purchase accounting related adjustments associated with mergers and acquisitions, costs and benefit obligations associated with BB&T’s pension and postretirement benefit plans, and income taxes. Understanding BB&T’s accounting policies is fundamental to understanding BB&T’s consolidated financial position and consolidated results of operations. Accordingly, BB&T’s significant accounting policies and changes in accounting principles and effects of new accounting pronouncements are discussed in detail in Note 1 in the “Notes to Consolidated Financial Statements.”
The following is a summary of BB&T’s critical accounting policies that are highly dependent on estimates, assumptions and judgments. These critical accounting policies are reviewed with the Audit Committee of BB&T’s Corporate Board of Directors on a periodic basis.
It is the policy of BB&T to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that equals management’s best estimate of probable credit losses that are inherent in the portfolio at the balance sheet date. Estimates for loan and lease losses are determined by analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, plans for problem loan and lease administration, the results of regulatory examinations, and changes in the size, composition and risk assessment of the loan and lease portfolio. Also included in management’s estimates for loan and lease losses are considerations with respect to the impact of current economic events, the outcomes of which are uncertain. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which BB&T conducts business. The methodology used to determine an estimate for the reserve for unfunded lending commitments is inherently similar to the methodology utilized in calculating the allowance for loans and leases adjusted for factors specific to binding commitments, including the probability of funding and exposure at the time of funding. A detailed discussion of the methodology used in determining the allowance for loan and lease losses and the reserve for unfunded lending commitments is included in the “Overview and Description of Business—Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments.”
Valuation of Mortgage Servicing Rights
BB&T has a significant mortgage loan servicing portfolio and related mortgage servicing rights. Mortgage servicing rights represent the present value of the future net servicing fees from servicing mortgage loans acquired or originated by BB&T. The methodology used to determine the fair value of mortgage servicing rights is subjective and requires the development of a number of assumptions, including anticipated prepayments of loan principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining interest rates, the value of mortgage servicing assets declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. BB&T amortizes mortgage servicing rights over the estimated period that servicing income is expected to be received based on projections of the amount and timing of estimated future cash flows. The amount and timing of servicing asset amortization is updated based on actual results and updated projections. Please refer to Note 8 “Loan Servicing” in the “Notes to Consolidated Financial Statements” for quantitative disclosures reflecting the effect that changes in management’s assumptions would have on the fair value of mortgage servicing rights.
Intangible Assets
BB&T’s growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. BB&T’s mergers and acquisitions are accounted for using the purchase method of accounting. Under the purchase method, BB&T is required to record the assets acquired, including identified intangible assets and liabilities assumed at their fair value, which often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. The amortization of identified intangible assets is based upon the estimated economic benefits to be received, which is also subjective. These estimates also include the establishment of various accruals and allowances based on planned facility dispositions and employee severance considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in goodwill, which is subject to ongoing periodic impairment tests based on the fair value of net assets acquired compared to the carrying value of goodwill. Please refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for a description of BB&T’s impairment testing process. The major assumptions used in the impairment testing process include the estimated future cash flows of each business unit and discount rates. Discount rates are unique to each business unit and are based upon the cost of capital specific to the industry in which the business unit operates. Management has evaluated the effect of lowering the estimated future cash flows or increasing the discount rate for each business unit by 10% and determined that no impairment of goodwill would have been recognized under this evaluation.
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Pension and Postretirement Benefit Obligations
BB&T offers various pension plans and postretirement benefit plans to employees. The calculation of the obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and assumptions used in the determination of future values of plan assets and liabilities are subject to management judgment and may differ significantly if different assumptions are used. The discount rate assumption used to measure the postretirement benefit obligations is set by reference to published high-quality bond indices, as well as certain hypothetical spot-rate yield curves. These yield curves were constructed from the underlying bond price and yield data collected as of the plan’s measurement date and are represented by a series of annualized, individual discount rates with durations ranging from six months to thirty years. Each discount rate in the curve was derived from an equal weighting of the double A or higher bond universe, apportioned into distinct maturity groups. For durations where no bond maturities were available, the discount rates for these maturities were extrapolated based on historical relationships from observable data in similar markets. These indices and hypothetical curves give only an indication of the appropriate discount rate because the cash flows of the bonds comprising the indices and curves do not match the projected benefit payment stream of the plan precisely. For this reason, we also consider the individual characteristics of the plan, such as projected cash flow patterns and payment durations, when setting the discount rate. Please refer to Note 13 “Benefit Plans” in the “Notes to Consolidated Financial Statements” for disclosures related to BB&T’s benefit plans, including quantitative disclosures reflecting the impact that changes in certain assumptions would have on service and interest costs and benefit obligations.
Income Taxes
The calculation of BB&T’s income tax provision is complex and requires the use of estimates and judgments. As part of the Company’s analysis and implementation of business strategies, consideration is given to the tax laws and regulations that apply to the specific facts and circumstances for any transaction under evaluation. This analysis includes the amount and timing of the realization of income tax liabilities or benefits. Management closely monitors tax developments in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments utilized in determining the income tax provision and records adjustments as necessary.
Analysis of Financial Condition
A summary of the more significant fluctuations in balance sheet accounts is presented below.
For the year ended December 31, 2005, BB&T’s average assets totaled $104.6 billion, an increase of $8.3 billion, or 8.7%, compared to the 2004 average of $96.3 billion, primarily reflecting growth in average loans and leases and investment securities. Average loans and leases for 2005 were up $5.4 billion, or 8.2%, from 2004 and average investment securities increased $2.2 billion, or 12.3% compared to 2004. The primary components of the growth in average loans and leases were commercial loans and leases, which increased $2.9 billion, or 8.7%; consumer loans, which increased $1.6 billion, or 7.9%; and mortgage loans, which increased $934.1 million, or 7.5%. Total earning assets averaged $92.7 billion in 2005, an increase of $7.8 billion, or 9.1%, compared to 2004. These averages and growth rates include the effects of acquisitions.
BB&T’s average deposits totaled $70.3 billion, reflecting growth of $5.5 billion, or 8.5%, compared to 2004. The categories of deposits with the highest growth rates were: certificates of deposit and other time deposits, which increased $2.9 billion, or 10.9%; noninterest-bearing deposits, which increased $1.2 billion, or 10.2%; and money rate savings, which increased $1.4 billion, or 6.2%.
Shorter-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances. Average shorter-term borrowings totaled $7.4 billion for the year ended December 31, 2005, an increase of $795.4 million, or 12.1% from the 2004 average. BB&T has also utilized long-term debt for a significant portion of its funding needs. Long-term debt includes FHLB advances, other secured borrowings by the Banks and senior and subordinated debt issued by the Corporation and Branch Bank. Average long-term debt totaled $12.0 billion for the year ended December 31, 2005, up $1.1 billion, or 9.9%, compared to 2004.
The compound annual rate of growth in average total assets for the five-year period ended December 31, 2005, was 11.1%. Over the same five-year period, average loans and leases increased at a compound annual rate of
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11.3%, average securities increased at a compound annual rate of 6.1%, and average deposits grew at a compound annual rate of 11.2%. All balance sheet growth rates referred to include the effect of acquisitions accounted for as purchases, as well as internal growth.
For more detailed discussions concerning the causes of these fluctuations, please refer to the sections that follow.
Securities
The securities portfolio provides earnings and liquidity, and is managed as part of the overall asset and liability management process to optimize net interest income and reduce exposure to interest rate risk. Management has historically emphasized investments with duration of five years or less to provide flexibility in managing the balance sheet in changing interest rate environments. Total securities increased 6.9% in 2005, to a total of $20.5 billion at the end of the year. The quality of the investment portfolio continues to be strong with 55.0% of the total portfolio’s fair market value at December 31, 2005 comprised of U.S. Treasury securities and U.S. government-sponsored entity obligations, excluding mortgage-backed securities. The combined duration of the U.S. Treasury and U.S. government-sponsored entity portfolios was 3.41 years and 3.23 years at December 31, 2005 and 2004, respectively. Mortgage-backed securities composed 32.3% of the total investment portfolio at year-end 2005. The duration of the mortgage-backed securities was 3.18 years at December 31, 2005 compared to 2.78 years at December 31, 2004. The duration of the available-for-sale portfolio at December 31, 2005 was 3.26 years compared to 3.13 years at December 31, 2004.
The following table provides information regarding the composition of BB&T’s securities portfolio for the years presented:
Table 8
Composition of Securities Portfolio
Trading securities (at estimated fair value):
Securities held to maturity (at amortized cost):
U.S. Treasury securities
Total securities held to maturity
Securities available for sale (at estimated fair value):
U.S. government-sponsored entity securities
States and political subdivisions
Mortgage-backed securities
Equity and other securities
Total securities available for sale
Total securities
At December 31, 2005, trading securities reflected on BB&T’s consolidated balance sheet totaled $706.5 million compared to $334.3 million at December 31, 2004. Approximately two-thirds of the trading portfolio at December 31, 2005, was held by BB&T’s full-service brokerage subsidiary as a normal part of its operations and, as a result, is subject to significant fluctuations based on market conditions, which affect the timing of purchases and sales of securities. Market valuation gains and losses in the trading portfolio are reflected in current earnings.
Securities available for sale totaled $19.8 billion at year-end 2005 and are carried at estimated fair value. Securities available for sale at year-end 2004 totaled $18.8 billion. Unrealized market valuation gains and losses on securities classified as available for sale are recorded as a separate component of shareholders’ equity, net of deferred income taxes. The available-for-sale portfolio is primarily composed of investments in U.S. government-
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sponsored entity securities and mortgage-backed securities, which together composed 89.8% of the portfolio. This portfolio also contains investments in U.S. Treasury securities, which represented less than 1% of the December 31, 2005 balance, obligations of states and municipalities, which represented 3.4% of the available-for-sale portfolio, and equity and other securities, which made up 6.2% of the available-for-sale portfolio.
The $944.8 million increase in securities available for sale was the result of a combination of factors, including management’s decision to increase its securities portfolio to offset variances in projected loan growth during the early part of 2005, the reinvestment of cash flows from securities that matured in 2004 that were not reinvested until 2005 due to prevailing market conditions at the time the securities matured and the securitization of approximately $210 million in mortgage loans that were held in BB&T’s loan portfolio and subsequently transferred to the securities portfolio. During the year ended December 31, 2005, BB&T sold $1.3 billion of available-for-sale securities and realized net gains totaling $113 thousand.
The following table presents BB&T’s securities portfolio at December 31, 2005, segregated by major category with ranges of maturities and average yields disclosed.
Table 9
Within one year
One to five years
Five to ten years
After ten years
Total securities (5)
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The available-for-sale portfolio comprised 96.6% of total securities at December 31, 2005. Management believes that the high concentration of securities in the available-for-sale portfolio allows flexibility in the day-to-day management of the overall investment portfolio, consistent with the objective of optimizing profitability and mitigating interest rate risk.
The market value of the available-for-sale portfolio at year-end 2005 was $533.2 million lower than the amortized cost of these securities. At December 31, 2005, BB&T’s available-for-sale portfolio had net unrealized losses, net of deferred income taxes, of $337.6 million, which is reported as a component of shareholders’ equity. At December 31, 2004, the available-for-sale portfolio had net unrealized losses of $87.5 million, net of deferred income taxes.
On December 31, 2005, BB&T held certain investment securities having continuous unrealized loss positions for more than 12 months totaling $479.1 million. Substantially all of these investments were in U.S. government-sponsored entity securities, which are primarily comprised of debentures and mortgage-backed securities issued by the Federal Farm Credit Bureau, the Federal Home Loan Bank System, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These agencies are rated AAA and the unrealized losses are the result of increases in market interest rates rather than the credit quality of the issuers. Furthermore, in excess of 85% of the total value of these securities is within 5% of their amortized cost at December 31, 2005. BB&T has the ability and intent to retain these securities for a period of time sufficient to recover all unrealized losses. Accordingly, BB&T has not recognized any other-than-temporary impairment in connection with these securities.
The fully taxable equivalent (“FTE”) yield on the total securities portfolio was 4.17% for the year ended December 31, 2005, compared to 4.05% for the prior year. The increase in FTE yield resulted principally from the changes in the overall composition of the securities portfolio with a larger concentration of higher-yielding mortgage-backed securities. The yield on U.S. Treasuries and U.S. government sponsored-entity securities decreased from 3.88% in 2004 to 3.84% in 2005, while the yield on mortgage-backed securities increased from 4.52% to 4.72% and the FTE yield on state and municipal securities increased from 6.51% last year to 6.73% in the current year.
Loans and Leases
Management emphasizes commercial lending to small and medium-sized businesses, consumer lending and mortgage lending with an overall goal of maximizing the profitability of the loan portfolio while maintaining strong asset quality. The various categories of loan products offered by BB&T are discussed under “Lending Activities” in the “Overview and Description of Business” section herein. BB&T is a full-service lender with approximately one-half of its loan portfolio comprised of loans to businesses and one-half comprised of loans to individual consumers. Average commercial loans, including lease receivables, comprise 50.2% of the loan portfolio, compared to 50.0% in 2004. Average consumer loans, which include sales finance, revolving credit and direct retail, comprise 31.0% of average loans, compared to 31.1% in 2004. Average mortgage loans represented the remaining 18.8% of average total loans for 2005, compared to 18.9% a year ago.
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BB&T’s loan portfolio, excluding loans held for sale, increased $6.8 billion, or 10.1%, as compared to 2004. Average total loans and leases for 2005 increased $5.4 billion, or 8.2%, compared to 2004. In addition to strong internal loan growth, the average loan increase was aided by the addition of loans held by Republic Bancshares, Inc. (“Republic”), which was acquired on April 14, 2004, and had loans of $1.7 billion. Average loan growth was reduced by the securitization of $210 million and $1.0 billion of residential mortgage loans during the fourth quarter of 2005 and the third quarter of 2004, respectively. The resulting mortgage-backed securities were transferred to the available-for-sale securities portfolio. The securitization in the third quarter of 2004 was undertaken to rebalance the loan portfolio, which had grown significantly as a result of strong mortgage loan originations over the prior two years and the retention of approximately $3.6 billion in fixed-rate mortgage loans during the second-half of 2003. The securitization completed during 2005 was to provide additional collateral-eligible assets needed to satisfy client demands.
Average commercial loans and leases increased $2.9 billion, or 8.7%, in 2005 as compared to 2004 and the pace of growth in this portfolio continued to improve throughout 2005 as a result of improving general economic conditions across BB&T’s footprint. Average consumer loans increased $1.6 billion, or 7.9%, as compared to 2004, which was comprised of increases in direct retail loans of 10.0%, sales finance loans of 3.7% and revolving credit loans of 6.0%. The pace of growth in the consumer loan portfolio slowed somewhat in 2005, especially direct retail loans, due to higher interest rates causing a slowdown in demand for home equity loan products. Sales finance loans produced positive trends, as two of BB&T’s primary competitors faced significant challenges in the latter part of 2005 and BB&T was able to capitalize on its position as the leading bank lender of sales finance loans in most of its markets. Average mortgage loans increased $934.1 million, or 7.5%, compared to 2004. Management views mortgage loans as excellent long-term investments due to their lower credit risk, liquidity characteristics and current favorable spreads versus U.S. Treasury securities, and believes originating and servicing mortgage loans is an integral part of BB&T’s relationship-based credit culture. The growth in the portfolio of mortgage loans in 2005 was reduced by the securitizations previously discussed. BB&T is a large originator of residential mortgage loans, with 2005 originations of $10.5 billion. To improve the overall yield of the loan portfolio and to mitigate interest rate risk, BB&T sells most of its fixed-rate mortgage loans in the secondary market. At December 31, 2005, BB&T was servicing $25.8 billion in residential mortgages owned by third parties and $15.3 billion of mortgage loans owned by BB&T, including $781.1 million classified as securities available for sale.
The average annualized FTE yields on commercial, consumer and mortgage loans for 2005 were 6.58%, 7.31% and 5.44%, respectively, resulting in a yield for the total loan portfolio of 6.59%. The FTE yields on commercial, consumer and mortgage loans for 2004 were 5.41%, 6.79% and 5.55%, respectively, resulting in a yield for the total loan portfolio of 5.87%. The 72 basis point increase in the average yield on loans resulted primarily from an increase in rates on commercial loans as variable-rate loans were repriced and fixed-rate loans with lower yields were replaced with higher-yielding loans and leases. During the second half of 2004, the Federal Reserve started to steadily increase the intended Federal funds rate in response to a pick up in economic activity. As a result of the Federal Reserve Board’s actions, the prime rate, which is the basis for pricing many commercial and consumer loans, was 7.25% at year-end 2005, compared to 5.25% at year-end 2004 and 4.00% during the first half of 2004. Therefore, as loans gradually reprice at higher rates or mature and are replaced with higher-yielding loans, the annualized yield of the loan portfolio is expected to increase. Evidence of this trend is visible from the changes in the quarterly annualized interest yield of the loan portfolio, which improved from 6.25% in the first quarter of 2005 to 6.90% during the fourth quarter of 2005. The rise in short-term interest rates was not matched by a similar rise in long-term interest rates. Therefore, mortgage rates, which are influenced by long-term interest rates in the marketplace, remained relatively unchanged compared to last year. As a result, the overall yield on mortgage loans declined slightly for 2005 compared to 2004, as older higher-yielding mortgage loans, which matured or were refinanced, were replaced with lower-yielding mortgage loans.
Asset Quality and Credit Risk Management
BB&T utilizes the following general practices to manage credit risk:
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BB&T’s lending strategy, which focuses on relationship-based lending within our markets and smaller individual loan balances, continues to produce excellent credit quality. As measured by relative levels of nonperforming assets and net charge-offs, BB&T’s asset quality has remained significantly better than published industry averages.
Asset Quality
The following table summarizes asset quality information for BB&T for the past five years.
Table 10
Nonaccrual loans and leases
Restructured loans
Foreclosed property
Nonperforming assets
Loans 90 days or more past due and still accruing
Asset Quality Ratios: (1)
Nonaccrual and restructured loans and leases as a percentage of loans and leases
Nonperforming assets as a percentage of:
Total assets
Loans and leases plus foreclosed property
Net charge-offs as a percentage of average loans and leases
Allowance for loan and lease losses as a percentage of loans and leases
Allowance for loan and lease losses as a percentage of loans and leases held for investment
Ratio of allowance for loan and leases to:
Net charge-offs
Nonaccrual and restructured loans and leases
During 2005, BB&T’s credit quality continued to improve. The improving economic conditions combined with BB&T’s careful loan underwriting process and active monitoring of past due loans resulted in a reduction in total nonperforming assets and relative levels of nonperforming assets and net charge-offs. This is third consecutive year in which BB&T has experienced improvement in these asset quality ratios.
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The following table summarizes nonperforming assets and past due loans by loan type for the past three years.
Table 11
Summary of Nonperforming Assets and Past Due Loans
Commercial loans and leases
Total nonaccrual loans and leases
Foreclosed real estate
Other foreclosed assets
Total nonperforming assets
Nonaccrual loans and leases as a percentage of total loans and leases
Total nonaccrual loans and leases as a percentage of loans and leases
Loans 90 days or more past due and still accruing interest
Total loans 90 days or more past due and still accruing interest
Total loans 90 days or more past due and still accruing interest as a percentage of total loans and leases
The allowance for loan and lease losses and the reserve for unfunded lending commitments compose BB&T’s allowance for credit losses. The allowance for credit losses totaled $829.8 million at December 31, 2005, a slight increase compared to $828.3 million at the end of 2004. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.10% at December 31, 2005, compared to 1.18% at year-end 2004. As a percentage of loans held for investment, the ratio of the allowance for loan and lease losses to total loans and leases was 1.11% at December 31, 2005 compared to 1.19% at the end of last year. BB&T’s strong credit history, combined with improvements in BB&T’s relative levels of net charge-offs and nonperforming assets, led to the reduction in the
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allowance as a percentage of outstanding loans and leases for a fourth consecutive year. Please refer to Note 5 “Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments” in the “Notes to Consolidated Financial Statements” for additional disclosures.
Information relevant to BB&T’s allowance for loan and lease losses for the last five years is presented in the following table. The table is presented using regulatory classifications.
Table 12
Analysis of Allowance for Credit Losses
Balance, beginning of period
Charge-offs:
Real estate
Total charge-offs
Recoveries:
Total recoveries
Provision charged to expense
Allowance for loans (sold) acquired, net
Balance, end of period
Average loans and leases (1)
Net charge-offs as a percentage of average loans and leases (1)
Deposits and Other Borrowings
Client deposits generated through the BB&T branch network are the largest source of funds used to support asset growth. Total deposits at December 31, 2005, were $74.3 billion, an increase of $6.6 billion, or 9.7%, compared to year-end 2004. The increase in deposits during 2005 was driven by a $4.4 billion, or 15.8% increase in certificates of deposit (“CDs”) and other time deposits, a $1.2 billion, or 10.0% increase in noninterest-bearing deposits, and a $1.1 billion, or 4.8% increase in money-rate savings accounts. For the year ended December 31, 2005, total deposits averaged $70.3 billion, an increase of $5.5 billion, or 8.5%, compared to 2004. The increase in average deposits was the result of a $2.9 billion, or 10.9% increase in average CDs and other time deposits, a $1.4 billion, or 6.2% increase in average money rate savings accounts, and a $1.2 billion, or 10.2% increase in noninterest-bearing deposits. The overall increase in average deposits included the impact of the acquisition of Republic during the second quarter of 2004, which added deposits of $2.5 billion.
CDs and other time deposits represent the largest component of BB&T’s deposits and composed 41.7% of total average deposits for 2005, compared to 40.8% at year-end 2004. Average money-rate savings accounts are the second largest source and comprised 33.1% of total average deposits for 2005 compared to 33.8% for 2004. The
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remainder of the portfolio is comprised of noninterest-bearing deposits and savings and interest-checking accounts, which comprised 18.3% and 7.0%, respectively, of total average deposits in the current year, compared to 18.0% and 7.4%, respectively, for last year. The increase in the percentage of CDs and other time deposits to total deposits during 2005 was primarily a result of the Corporation decreasing its reliance on federal funds purchased and securities sold under repurchase agreements, and instead relying to a greater degree on wholesale deposit products. The decision to use wholesale deposit products was primarily due to more attractive pricing of these types of funding sources. During the fourth quarter of 2005, the growth in CDs and other time deposits was generated by retail CDs in BB&T’s branch network, while wholesale funding products declined compared to the third quarter, as management emphasized retail CDs.
The average rate paid on interest-bearing deposits increased to 2.18% during 2005, from 1.37% in 2004. This increase resulted primarily from the steady interest rate increases by the Federal Reserve which began during the second half of 2004 and resulted in BB&T increasing its rates on its interest-bearing deposit products. The average rates paid on the various categories of interest-bearing deposits also increased as follows: other time deposits, including individual retirement accounts and certificates of deposit, increased to 3.07% in the current year from 2.11% in 2004; money rate savings accounts increased to 1.42% in the current year from .74% in 2004; interest checking increased to .80% in 2005 from .33% in 2004; and savings deposits increased to .22% in 2005 from .17% in 2004.
BB&T also uses various types of shorter-term borrowings in meeting funding needs. While client deposits remain the primary source for funding loan originations, management uses shorter-term borrowings as a supplementary funding source for loan growth. Shorter-term borrowings comprised 7.1% of total funding needs on average in 2005 as compared to 6.8% in 2004. See Note 9 “Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Short-Term Borrowed Funds” in the “Notes to Consolidated Financial Statements” herein for further disclosure. The types of shorter-term borrowings utilized by the Corporation include Federal funds purchased, which composed 17.1% of total shorter-term borrowings, and securities sold under repurchase agreements, which comprised 41.1% of shorter-term borrowings at year-end 2005. Master notes, U.S. Treasury tax and loan deposit notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances are also utilized to meet short-term funding needs. Shorter-term borrowings at the end of 2005 were $6.6 billion, relatively unchanged compared to year-end 2004. Average shorter-term borrowings totaled $7.4 billion during 2005 compared to $6.6 billion last year. The increase in average shorter-term borrowings was primarily to fund healthy loan growth during 2005; however, these funds were replaced with other funding sources later in the year resulting in the slight decline in the balance at December 31, 2005 compared to year-end 2004. The rates paid on average shorter-term borrowings increased from 1.37% in 2004 to 3.04% during 2005. The increase in the cost of shorter-term borrowings resulted from recent actions by the Federal Reserve Board, which increased the targeted Federal funds rate by 125 basis points during the second half of 2004 and 200 basis points during 2005. At December 31, 2005, the targeted federal funds rate was 4.25% as compared to its lowest level of 1.00% set in June 2003. The following table summarizes certain pertinent information for the past three years with respect to BB&T’s shorter-term borrowings:
Table 13
Federal Funds Purchased, Securities Sold Under
Agreements to Repurchase and Short-Term Borrowed Funds
Maximum outstanding at any month-end during the year
Balance outstanding at end of year
Average outstanding during the year
Average interest rate during the year
Average interest rate at end of year
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BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 11.4% of total funding needs on average during 2005 and 11.3% in 2004. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for further disclosure. Long-term debt at December 31, 2005 totaled $13.1 billion, an increase of $1.7 billion, or 14.9%, from year-end 2004. For the year ended December 31, 2005, average long-term debt increased $1.1 billion, or 9.9%, compared to the average for 2004. BB&T’s long-term debt consists primarily of FHLB advances, which composed 43.3% of total outstanding long-term debt at December 31, 2005, and subordinated notes of BB&T Corporation, which composed 25.5% of the year-end balance. FHLB advances are cost-effective long-term funding sources that provide BB&T with the flexibility to structure the debt in a manner that aids in the management of interest rate risk and liquidity. The remaining long-term debt consists of both secured and unsecured senior and subordinated borrowings by Branch Bank, junior subordinated debt to unconsolidated trusts issued by the Corporation, and capital leases. The average rate paid on long-term debt increased from 3.48% during 2004 to 4.22% during 2005 primarily because BB&T has issued floating rate instruments or elected to swap a portion of its fixed-rate long-term debt to floating rates.
The increase in long-term debt during 2005 was primarily the result of the issuance of $500 million of capital securities by BB&T Corporation and $1.25 billion of senior floating rate debt issued by Branch Bank during 2005. The proceeds from the capital securities offering are being used to fund repurchases of BB&T’s common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&T’s subsidiaries and for other general corporate purposes. The proceeds from the senior floating rate debt offerings are being used for general bank funding purposes.
During the second quarter of 2005, BB&T redeemed $89.0 million of trust preferred securities. These trust preferred securities were assumed by BB&T through various acquisitions. The average interest rate paid on such securities was approximately 8.5%, which was significantly higher than BB&T’s current borrowing rates. BB&T recorded a $2.9 million loss on early extinguishment of debt in connection with the redemption, which is reflected in BB&T’s Consolidated Statements of Income as a category of noninterest expenses.
On June 30, 2005, BB&T exchanged $350 million of subordinated notes maturing in 2025 and bearing an interest rate of 6.375% for $400 million aggregate principal amount of subordinated global notes maturing in 2017 and bearing an interest rate of 4.90%. This exchange was accounted for in accordance with Emerging Issues Task Force 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” (“EITF 96-19”). The transaction gave rise to substantially similar debt as defined by EITF 96-19 and, therefore, resulted in no immediate gain or loss. The financing costs relating to this exchange were deferred and will be amortized over the life of the $400 million subordinated global notes.
During 2004, Branch Bank issued $500 million of senior floating rate debt maturing in June 2007. The proceeds from the offering are being used for general bank funding purposes. On October 27, 2004, BB&T Corporation issued $600 million of subordinated global notes maturing in November 2019. The proceeds from this offering are being used to fund repurchases of BB&T’s common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&T’s subsidiaries and for other general corporate purposes.
Liquidity needs are a primary consideration in evaluating funding sources. BB&T’s strategy is to maintain funding flexibility in order that the Corporation may react rapidly to opportunities that may become available in the marketplace. BB&T will continue to focus on traditional core funding strategies, supplemented as needed by the types of borrowings discussed above. See “Liquidity” herein for additional discussion.
Analysis of Results of Operations
Consolidated net income for 2005 totaled $1.65 billion, which generated basic earnings per share of $3.02 and diluted earnings per share of $3.00. Net income for 2004 was $1.56 billion and net income for 2003 totaled $1.06 billion. Basic earnings per share were $2.82 in 2004 and $2.09 in 2003, while diluted earnings per share were $2.80 and $2.07 for 2004 and 2003, respectively.
Two important and commonly used measures of bank profitability are return on average assets (net income as a percentage of average total assets) and return on average shareholders’ equity (net income as a percentage of average common shareholders’ equity). BB&T’s returns on average assets were 1.58%, 1.62% and 1.25% for the years ended December 31, 2005, 2004 and 2003, respectively. The returns on average common shareholders’ equity were 14.95%, 14.71% and 11.97% for the last three years.
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Merger-Related and Restructuring Charges
Mergers and acquisitions have played an important role in the development of BB&T’s franchise. BB&T has been an active acquirer of financial institutions, insurance agencies and other nonbank fee income producing businesses for many years. However, in 2004, management elected not to announce any new bank or thrift acquisitions during 2004 and 2005, and instead focus on integrating recent acquisitions and improving internal growth. Refer to Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of mergers and acquisitions consummated during the three years ended December 31, 2005. As a result of these activities, the consolidated results of operations for the three year period covered by this discussion include the effects of merger-related and restructuring charges, as well as expenses and certain gains related to the consummation of the transactions.
Merger-related charges and expenses include personnel-related items such as staff relocation costs, severance benefits, early retirement packages and contract settlements. They also include furniture, equipment and occupancy costs related to department and branch consolidations as well as costs related to converting the data processing systems of acquired companies to BB&T’s automation platform. Merger-related charges also include professional fees, advertising and asset write-offs incurred in connection with the mergers.
During 2005, BB&T recorded net merger-related and restructuring credits, or gains of $10.7 million, which are reflected in BB&T’s Consolidated Statements of Income as a separate category of noninterest expenses. These amounts were primarily associated with the sale of duplicate facilities and the finalization of severance and other personnel-related liabilities in connection with the First Virginia Banks, Inc. (“First Virginia”) and Republic acquisitions on terms more beneficial than originally estimated.
During 2004, BB&T recorded merger-related and restructuring charges of $5.5 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of McGriff and Republic.
During 2003, BB&T recorded merger-related and restructuring charges of $89.8 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of Equitable Bank and First Virginia.
The following table presents the components of merger-related and restructuring charges included in noninterest expenses. This table includes changes to previously recorded merger-related accruals and period expenses for merger-related items that must be expensed as incurred. Items that are required to be expensed as incurred include certain expenses associated with systems conversions, data processing, training, and other costs.
Table 14
Summary of Merger-Related and Restructuring Charges
Severance and personnel-related charges
Occupancy and equipment charges
Systems conversions and related charges
Marketing and public relations
Asset write-offs, and other merger-related charges
Severance and personnel-related costs or credits include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination or reversals of previously estimated amounts, which typically occur in corporate support and data processing functions. BB&T did not have any job eliminations in connection with mergers during 2005. During 2004, BB&T estimated that 200 positions would be eliminated and receive severance in connection with the acquisition of Republic and 225 employees did, in fact, receive severance in 2004. Nine former employees
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continued to receive severance payments during 2005. During 2003, BB&T estimated that 1,918 positions would be eliminated and receive severance and 980 employees did, in fact, receive severance during 2003. Substantially all of the remaining positions involved employees who voluntarily resigned or were offered positions elsewhere within BB&T. These former employees did not receive severance. A total of 551 of the employees whose jobs were eliminated received severance payments during 2004.
Occupancy and equipment charges or credits represent merger-related costs or gains associated with lease terminations, obsolete equipment write-offs, and the sale of duplicate facilities and equipment. Credits may result when obsolete properties or equipment are sold for more than originally estimated. Systems conversions and related charges include expenses necessary to convert and combine the acquired branches and operations of merged companies. Marketing and public relations costs represent direct media advertising related to the acquisitions. The other merger-related charges are composed of asset and supply inventory write-offs, litigation accruals, and other similar charges.
In conjunction with the consummation of an acquisition and the completion of other requirements, BB&T typically accrues certain merger-related expenses related to estimated severance and other personnel costs, costs to terminate lease contracts, costs related to the disposal of duplicate facilities and equipment, costs to terminate data processing contracts and other costs associated with an acquisition. The following tables present a summary of activity with respect to BB&T’s merger and restructuring accruals related to the mergers listed above, with the more significant merger (First Virginia) presented separately. These tables include costs reflected as expenses, as presented in the table above, and certain accruals recorded through purchase accounting adjustments.
Merger-
related andrestructuringcharges
Other merger-related charges
The remaining accruals at December 31, 2005, for First Virginia primarily relate severance payments for certain executive officers and costs to exit certain leases and to dispose of excess facilities and equipment. These liabilities will be utilized in the future because they relate to specific contracts or legal obligations that expire in later years, or they relate to the disposal of duplicate facilities and equipment, which may take longer to complete.
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Activity with respect to the merger and restructuring accruals for all other mergers, which are discussed above, is presented in the accompanying table:
The liabilities for severance and personnel-related costs relate to severance liabilities that will be paid out based on such factors as expected termination dates, the provisions of employment contracts and the terms of BB&T’s severance plans. The remaining occupancy and equipment accruals relate to costs to exit certain leases and to dispose of excess facilities and equipment. Such liabilities will be utilized upon termination of the various leases and sale of duplicate property. The other merger-related liabilities relate to litigation and other similar charges.
In general, a major portion of accrued costs are utilized in conjunction with or immediately following the systems conversion, when most of the duplicate positions are eliminated and the terminated employees begin to receive severance. Other accruals are utilized over time based on the sale, closing or disposal of duplicate facilities or equipment or the expiration of lease contracts. Merger accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at December 31, 2005 are expected to be utilized during 2006, unless they relate to specific contracts that expire in later years.
Net Interest Income
Net interest income is BB&T’s primary source of revenue. Net interest income is influenced by a number of factors, including the volume, mix and maturity of interest-earning assets and interest-bearing liabilities and the interest rates earned and paid thereon. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by the net interest margin. The accompanying table presents the dollar amount of changes in interest income and interest expense, and distinguishes between the changes related to increases or decreases in average outstanding balances of interest-earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Changes attributable to both volume and rate have been allocated proportionately.
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Table 15
FTE Net Interest Income and Rate / Volume Analysis
For the Years Ended December 31, 2005, 2004 and 2003
Increase(Decrease)
Assets
Securities, at amortized cost (1):
U.S. government-sponsored entity securities (6)
Other securities
Trading securities
Other earning assets (2)
Loans and leases, net of unearned income (1)(3)(4)(5)
Total earning assets
Non-earning assets
Liabilities and Shareholders’ Equity
Interest-bearing deposits:
Savings and interest checking
Money rate savings
Other time deposits
Total interest-bearing deposits
Federal funds purchased, securities sold under repurchase agreements and short-term borrowed funds
Long-term debt
Total interest-bearing liabilities
Noninterest-bearing deposits
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
Average interest rate spread
Net interest margin
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For 2005, net interest income on an FTE-adjusted basis totaled $3.6 billion, compared with $3.4 billion in 2004 and $3.1 billion in 2003. The 5.2% increase in net interest income during 2005 resulted because the benefit from strong earning asset growth more than offset the adverse impact of the steady increase in short-term rates, which caused funding costs to increase faster than interest on earning assets.
The FTE-adjusted net interest margin is the primary measure used in evaluating the gross profit margin from the portfolios of earning assets. The FTE-adjusted net interest margin was 3.89% in 2005, 4.04% in 2004 and 4.06% in 2003. The average yield on interest earning assets increased 58 basis points compared to the average yield during 2004, while the average cost of funds over the same time period increased 88 basis points. The faster increase in the cost of funds compared to interest-earning assets is primarily a result of a delay in the repricing of earning assets compared to interest-bearing liabilities. While many of BB&T’s liabilities reprice in a short period of time after an increase in rates, there is typically a delay of between three and eighteen months before BB&T’s assets will be repriced. Therefore, once interest rates stabilize BB&T will continue to benefit from repricing of earning-assets and should not experience a similar rise in its cost of funding. In addition to the lag effect described above, the margin was also negatively affected by a flattening yield curve during 2005. Financial services companies, like BB&T, borrow money from clients and pay short-term rates, and invest assets in longer-term maturities, which generally produce an interest spread. During 2005, while short-term rates were rising in response to the Federal Reserve Boards actions, there was not a similar increase in longer-term rates. BB&T’s net interest margin was also negatively impacted by a reduction in benefits from interest-rate swaps when compared to 2004. BB&T’s management expects that interest rates will stabilize during 2006 and, given a return to a more traditional yield curve, BB&T’s net interest margin will also stabilize.
Provision for Credit Losses
A provision for credit losses is charged against earnings in order to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that reflects management’s best estimate of probable losses inherent in the credit portfolios at the balance sheet date. The amount of the provision is based on continuing assessments of nonperforming and “watch list” loans and associated unfunded credit commitments, analytical reviews of loss experience in relation to outstanding loans and funded credit commitments, loan charge-offs, nonperforming asset trends and management’s judgment with respect to current and expected economic conditions and their impact on the loan portfolio and outstanding unfunded credit commitments. The methodology used is described in the “Overview and Description of Business” section under the heading “Allowance for Loan and Lease Losses and Reserve for Unfunded Credit Commitments.” The provision for credit losses recorded by BB&T in 2005 was $217.3 million, compared with $249.3 million in 2004 and $247.6 million in 2003.
The provision for credit losses decreased 12.8% during 2005 while the total loan and lease portfolio increased 10.1% compared to the balance outstanding at the end of 2004. Net charge-offs were .30% of average loans and leases for 2005 compared to .36% of average loans during 2004. The allowance for loan and lease losses was 1.10% of loans and leases outstanding and was 3.60x total nonaccrual and restructured loans and leases at year-end 2005, compared to 1.18% and 2.99x, respectively, at December 31, 2004. The small increase from 2003 and the decrease compared with 2004 in the provision for credit losses reflects these improving credit quality trends and growth in the credit portfolios. Management expects these positive asset quality trends to stabilize in 2006.
Noninterest Income
Noninterest income has become, and will continue to be, a significant contributor to BB&T’s financial success. Noninterest income includes service charges on deposit accounts, trust revenue, mortgage banking income, investment banking and brokerage fees and commissions, insurance commissions, gains and losses on securities transactions and other commissions and fees derived from other activities. Noninterest income as a percentage of total revenues has steadily increased in recent years, totaling 39.1% for 2005 due to BB&T’s emphasis on growing and expanding its fee-based businesses. Fee-based service revenues lessen BB&T’s dependence on traditional spread-based interest income and are a relatively stable revenue source during periods of changing interest rates.
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The following table provides a breakdown of BB&T’s noninterest income:
Table 16
2005v.
2004
2004v.
2003
Service charges on deposits
Mortgage banking income
Trust income
Insurance commissions
Securities gains, net
Bankcard fees and merchant discounts
Investment banking and brokerage fees and commissions
Other nondeposit fees and commissions
Income from bank-owned life insurance
Other noninterest income
Total noninterest income
The 9.7% growth in noninterest income was the result of increased revenues from insurance commissions, trust income, bankcard fees and merchant discounts, service charges on deposit accounts, investment banking brokerage fees and commissions and other nondeposit fees and commissions. These increases were partially offset by a decline in gains from sales of securities and mortgage banking income. The 16.0% growth in noninterest income for 2004 was led by increased revenues from BB&T’s insurance operations as well as growth in income from service charges on deposit accounts, bankcard fees and merchant discounts, and other nondeposit fees and commissions. These increases were partially offset by a significant decline in gains from sales of securities. The major categories of noninterest income and fluctuations in these amounts are discussed in the following paragraphs. These fluctuations reflect the impact of acquisitions.
Service charges on deposit accounts represent BB&T’s second largest category of noninterest revenue. During 2005, BB&T experienced a 3.7% increase in revenue from service charges on deposit accounts compared to 2004. The primary reasons for the increase were higher revenues from overdraft items due to pricing increases and changes in fee structure, which increased revenues $40.1 million compared to 2004. This increase was partially offset by declines in commercial account analysis fees as a result of higher earnings credits and a reduction in monthly account service fees on certain personal and business services, which reduced revenues $8.0 million and $10.7 million, respectively, compared to last year. Management frequently monitors the pricing of various deposit products and services to ensure that BB&T remains competitive. During 2004, BB&T experienced a 19.6% increase in revenue from service charges on deposit accounts compared to 2003. The primary reasons for the increase were the purchases of Republic and First Virginia, improved collection of NSF and overdraft charges on commercial and personal accounts, and growth in commercial account analysis fees, which were $8.4 million, $60.8 million, and $11.8 million, respectively, more than in 2003. Additionally, the robust growth in noninterest bearing commercial and consumer deposit accounts during 2004 led to a higher level of transaction activity and related service fees, which offset the effect of the introduction of new lower-fee deposit products during 2003 and 2004 in response to intense price competition within BB&T’s markets.
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Income from mortgage banking activities includes gains and losses from the sale of mortgage loans, revenue from servicing mortgage loans, valuation adjustments for mortgage servicing rights, mortgage servicing rights-related derivative gains/losses and amortization related to mortgage servicing rights. Mortgage banking income totaled $103.8 million in 2005, $110.1 million in 2004 and $109.4 million in 2003. The following table provides a breakdown of the various components of mortgage banking income and related statistical information:
Table 17
Mortgage Banking Income and Related Statistical Information
As of/ For the Years
Ended December 31,
Mortgage Banking Income
Residential mortgage production revenues
Residential mortgage servicing revenues
Commercial mortgage banking revenues
Amortization of mortgage servicing rights
Mortgage servicing rights valuation recaptures (impairment)
Mortgage servicing rights derivative hedge (losses) gain
Net
Total mortgage banking income
NM—notmeaningful
Mortgage Banking Statistical Information
Residential mortgage originations
Residential mortgage loans serviced for others
Residential mortgage loan sales
10 Year Treasury Note Rate at period end
Change in 10 Year Treasury Note Rate during period
Commercial mortgage originations
Commercial mortgage loans serviced for others
The 5.7% decline in mortgage banking income was primarily a result of a decrease in the net impact of the valuation adjustment for mortgage servicing rights and related derivatives, which declined $15.7 million, or 62.4% compared to 2004. During 2005, BB&T recorded $86.0 million of recapture for the valuation of mortgage servicing rights as compared to $8.5 million in 2004. BB&T enters into a variety of derivative financial instruments to mitigate the risk associated with the valuation of mortgage servicing rights and has in the past used other economic risk management strategies, including the use of trading securities. During 2005 and 2004, BB&T recorded (losses)/gains related to its derivative financial instruments and other risk management strategies of $(76.5 million) and $16.7 million, respectively. In addition, mortgage production revenues declined 5.8% due to a lower volume of residential mortgage loan sales in 2005 compared to 2004. While residential mortgage originations increased from $10.0 billion in 2004 to $10.5 billion in 2005, a higher percentage of the 2005 originations were adjustable-rate mortgages, which BB&T typically retains in its loan portfolio. Commercial mortgage banking revenues, which are generated by BB&T’s subsidiary, Laureate Capital LLC (“Laureate”), increased 26.9%, or $5.8 million, due to a higher volume of loan originations. Laureate also increased its presence during 2005 with the acquisition of two firms specializing in commercial mortgage banking. Overall, mortgage banking income in 2004 was relatively unchanged compared to 2003; however, the components of income fluctuated as higher mortgage interest rates resulted in lower refinance activity and, consequently, less mortgage production revenue, but resulted in a recapture of the valuation allowance offsetting mortgage servicing rights. This is in contrast to 2003 when refinance activity resulting from very low mortgage rates produced record levels of mortgage production and related revenues, but also resulted in a large impairment in the value of BB&T’s
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mortgage servicing rights. The mortgage servicing rights impairment which resulted in 2003 was largely offset by securities gains, which were utilized by BB&T as an economic risk management strategy prior to BB&T adopting a strategy that is dependent upon derivative financial instruments.
Revenues from BB&T’s extensive insurance agency/brokerage operations were the largest source of noninterest income during 2005 and 2004. Internal growth, combined with the expansion of BB&T’s insurance agency network through acquisitions during the last two years, resulted in growth of 15.4% in 2005 and 56.4% in 2004. Commission income from CRC Insurance Services (“CRC”), BB&T’s wholly owned wholesale insurance broker, contributed approximately $31.3 million in growth for the current year, while BB&T Insurance Services, Inc. and McGriff contributed an additional $18.9 million and $16.4 million of growth, respectively, compared to 2004. These increases were in property and casualty insurance commissions, which increased $66.6 million compared to 2004. Employee benefits commissions increased $15.7 million compared to 2004 and insurance fees and charges increased $14.5 million. The increase in commission income during 2004 was primarily related to the acquisition of McGriff, which contributed approximately $152.0 million of the $223.2 million increase. In addition, revenues from CRC contributed $47.4 million in growth in 2004 compared to 2003.
Revenue from corporate and personal trust services increased by $21.2 million, or 17.7%, in 2005 compared to 2004. Trust revenues are based on the types of services provided as well as the overall value of the assets managed, which is affected by stock market conditions. The increase in trust service income in 2005 was primarily a result of the acquisition of Sterling Capital Management LLC (“Sterling”), which contributed approximately $15.2 million in growth in the current year. In addition, administrative fees from proprietary mutual funds increased $5.2 million in 2005 compared to 2004. The increase in trust revenues during 2004 was primarily due to the acquisition of First Virginia, which added $2.2 billion in assets under management at the beginning of the third quarter of 2003 and to increases in proprietary mutual fund management fees. The increase in assets under management from First Virginia was offset by the loss of $2.4 billion in trust assets from the North Carolina state employees’ 401 (k) plan, which transferred to a successor trustee at the end of the quarter. The timing of these transfers had a net positive impact on 2004 trust income compared to 2003. The value of trust assets under management, including custodial accounts, increased during each of the last three years and was $32.9 billion, $28.4 billion and $27.2 billion at December 31, 2005, 2004 and 2003, respectively. The increase in assets under management during 2005 was primarily a result of the acquisition of Sterling, which added approximately $8 billion in assets. This increase was partially offset by a discontinuation of custodial responsibilities for approximately $4.5 billion of the assets of certain BB&T proprietary funds. The change in custodial responsibilities resulted in greater efficiencies for the shareholders of the BB&T Funds.
Net gains on sales of securities were $113 thousand in 2005 compared to $6.1 million in 2004. Net gains from sales of securities declined by 95.1% during 2004. During 2004, BB&T shifted to a risk management strategy related to mortgage servicing rights and mortgage banking operations entirely dependant on derivatives. During the period of declining interest rates that existed in 2003, BB&T utilized the increases in the value of the available-for-sale securities portfolio as an economic hedge against the decline in the carrying value of BB&T’s mortgage servicing rights. The net securities gains taken in 2003 were used to offset the net writedowns in the value of mortgage servicing rights.
Investment banking and brokerage fees and commissions increased $24.9 million in 2005 compared to 2004 and $17.4 million in 2004 compared to 2003. These increases resulted primarily from growth in investment banking and retail brokerage revenues at BB&T’s full-service brokerage and investment banking subsidiary, Scott & Stringfellow. The primary contributor to the 2005 increase was the acquisition of Windsor Group, LLC by Scott and Stringfellow. The 2004 increase was a result of higher demand for investment services at Scott & Stringfellow due to the continued expansion of a new product line and an improving economic environment, which resulted in increased revenues of $10.2 million during 2004 compared to 2003. The majority of the remaining $7.2 million increase in investment banking and brokerage fees and commissions in 2004 compared to 2003 were related to BB&T Investment Services, Inc., and caused by higher investment services revenues from BB&T’s newer markets through the increase in the number of investment counselors in those markets. In addition, production levels from BB&T’s existing investment counselors also increased during 2004.
Other nondeposit fees and commissions, including bankcard fees and merchant discounts increased $50.7 million, or 15.9%, during 2005 compared to 2004. The principal drivers of the increase were check card interchange fees, bankcard fees and merchant discounts and debit card network interchange fees, which
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increased $16.1 million, $10.0 million, $9.4 million, respectively, compared to 2004. In addition, fees from money orders and official checks increased $8.2 million compared to 2004. The primary sources of the 2004 increase compared to 2003 were bankcard fees and merchant discounts, check card interchange fees, debit card network interchange fees, business check card interchange fees, and check card foreign ATM fees, which increased $18.2 million, $13.2 million, $4.0 million, $4.2 million, and $4.6 million, respectively, compared to 2003. In addition, the acquisitions of Republic and First Virginia contributed to the revenue growth.
BB&T has purchased life insurance coverage on certain of its officers for whom it has an insurable interest. Income from bank-owned life insurance increased slightly compared to 2004 primarily due to an increase in death proceeds on certain policies, which were partially offset by a decline in the market yields used to credit interest income to such policies. The 6.9% decline in 2003 was a result of declining market yields. BB&T has not purchased any additional contracts under this program since mid-year 2002.
Other income increased by 8.5%, or $5.6 million in 2005 compared to 2004. The increase during 2005 was primarily due to higher income from limited partnership investments, which increased $7.2 million compared to last year. In addition, trading income at Scott & Stringfellow increased $6.9 million compared to last year due to increased activity in the trading portfolio. This increase was offset by decreases related to derivative valuations and ineffectiveness of hedging derivatives, and lower income from various financial assets isolated for the purpose of providing post-employee benefits of $4.5 million and $2.8 million, respectively, during 2005 as compared to 2004. During 2004, other income increased by 88.0% primarily due to a $12.7 million fair value
adjustment related to miscellaneous investments made by a small business investment company and higher income from investments in limited partnerships, which were up $6.2 million. Another contributing factor was growth in revenues from check sales, which increased $5.6 million, primarily due to the acquisitions of First Virginia and Republic.
The ability to generate significant amounts of noninterest revenue in the future will be very important to the continued financial success of BB&T. Through its subsidiaries, BB&T will continue to focus on asset management, mortgage banking, trust, insurance, investment banking and brokerage services, as well as other fee-producing products and services. BB&T plans to continue to pursue acquisitions of additional insurance agencies and asset management companies, as well as explore strategic acquisitions of other nonbank entities as a means of expanding fee-based revenues. Also, among BB&T’s principal strategies following the acquisition of a financial institution is the cross-sell of noninterest income generating products and services to the acquired institution’s client base.
Noninterest Expense
Noninterest expense totaled $3.2 billion in 2005, $2.9 billion in 2004 and $3.0 billion in 2003. Certain significant items principally stemming from mergers and acquisitions were recorded as noninterest expenses during 2005, 2004 and 2003. In 2005, $10.7 million in pretax merger-related credits were recorded, in 2004 there was $5.5 million in merger-related charges, and in 2003, $89.8 million of merger-related charges were recognized. Additional disclosures related to these merger-related charges are presented in “Merger-Related and Restructuring Charges.” Noninterest expenses for 2005 also include a $44.0 million pre-tax one-time, non-cash adjustment that was recorded to account for escalating lease payments and the amortization of leasehold improvements. In addition, noninterest expense for 2003 includes a loss from the early termination of FHLB advances in the amount of $384.9 million, which was part of a balance sheet restructuring that management undertook to enhance future earnings, reduce interest rate risk and exposure to market volatility, improve the net interest margin and re-align the securities portfolio.
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The table below shows the components of noninterest expense and the discussion that follows explains the composition of certain categories and the factors that caused them to change in 2005 and 2004.
Table 18
Salaries and wages
Pension and other employee benefits
Total personnel expenses
Net occupancy expense on bank premises
Furniture and equipment expense
Total occupancy and equipment expenses
Regulatory charges
Foreclosed property expense
Amortization of intangibles
Software
Telephone
Advertising and public relations
Travel and transportation
Professional services
Supplies
Loan processing expenses
Deposit related expense
Merger-related and restructuring charges
Loss on early extinguishment of debt
Other noninterest expenses
Total noninterest expense
NM—not meaningful
The 9.3% increase in total noninterest expense during 2005 compared to 2004 was primarily due to increased personnel costs, the one-time lease adjustment noted above, and increased advertising and professional services. The 4.9% decrease in total noninterest expense during 2004 compared to 2003 was primarily caused by the combination of lower merger-related charges and the losses on early termination of FHLB advances in 2003. No such losses were incurred in 2004. These comparative decreases were partially offset by additional noninterest expenses as a result of the acquisitions of Republic, McGriff and several other nonbank financial services companies during 2004, and the acquisition of First Virginia in July of 2003.
Total personnel expense is the largest component of noninterest expense and includes salaries and wages, as well as pension and other employee benefit costs. The 2005 increase of 9.4% resulted primarily from additional salaries and wages as a result of increased incentive compensation and increased staffing. Total salaries and wages expense increased $135.8 million in 2005 compared to 2004 as a result of higher insurance incentive compensation, investment banking incentive compensation, mortgage loan production incentive compensation and other annual performance compensation, which grew $33.9 million, $19.2 million, $8.2 million and $19.3 million, respectively, compared to 2004. In addition, other compensation costs increased $54.5 million, primarily due to increased costs associated with additional staffing. The 6.0% increase in pension and other employee benefit costs was also affected by the additional salaries and wages expense, which caused increases in social security taxes and defined contribution plan expenses, of $8.7 million and $3.5 million, respectively, compared to 2004. In addition, pension expense increased $2.4 million and health care expenses increased $5.7 million compared to 2004. These increases were offset by a $12.4 million reduction in the cost of retiree health care due to a change in the level of subsidy for post-retirement medical benefits, which was made effective during 2004. The 2004 increase of
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12.9% resulted primarily from additional personnel expenses associated with the First Virginia, McGriff and Republic mergers. The 14.0% increase in salaries and wages was primarily attributable to the above mentioned mergers, as well as higher insurance incentive compensation, investment banking incentive compensation, and other annual performance compensation, which grew $28.3 million, $12.2 million, and $16.3 million, respectively, compared to 2003. These increases were partially offset by lower mortgage loan production incentive compensation, which decreased $34.2 million compared to last year due to significantly lower mortgage loan production in 2004. The 8.1% increase in pension and other employee benefit costs was also affected by the above mergers, which caused increases in all categories of benefit expenses compared to 2003. Additional disclosures relating to BB&T’s benefit plans can be found in Note 13 “Benefit Plans” in the “Notes to Consolidated Financial Statements.”
Net occupancy and equipment expense increased by $56.0 million, or 13.5% in 2005. The increase is primarily the result of the $44.0 million one-time lease adjustment previously mentioned. In addition, rent expense on building and premises, depreciation and amortization expense and building maintenance expense increased an additional $7.5 million, $3.0 million and $2.9 million, respectively, compared to 2004. During 2004, net occupancy and equipment expense increased 12.0%. Substantially all of the increase resulted from the acquisitions of Republic, McGriff and First Virginia, which collectively added approximately $37.1 million in occupancy and equipment expenses. This amount was comprised of higher rent on buildings and premises, furniture and equipment expenses, utilities expenses, and depreciation expenses, which increased by $16.1 million, $12.6 million, $4.4 million, and $4.0 million, respectively, compared to 2003. Additionally, building maintenance expenses and real estate taxes increased by $2.3 million and $2.7 million, respectively.
The increase in amortization expense associated with intangible assets in 2005 compared to 2004 was primarily due to the acquisitions of Windsor and Sterling, which added $4.5 million and $1.9 million, respectively in amortization expense in 2005 as compared to 2004. The increase during 2004 was primarily due to the acquisitions of First Virginia, McGriff and Republic, which added $21.7 million, $19.6 million and $6.5 million, respectively, in amortization expenses during 2004 compared to the prior year. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of completed mergers and acquisitions during the three year period ended December 31, 2005.
Loan processing expenses were up $14.0 million, or 16.6% compared to 2004. This increase was primarily driven by higher expenses on retail loans and home equity lines of credit and retail bankcard expenses, which increased $5.9 million and $7.8 million, respectively, compared to 2004. The 2004 increase of $5.4 million compared to 2003 was also primarily driven by higher expenses on retail loans and home equity lines of credit, merchant expenses and retail bankcard expenses, which increased $3.0 million, $3.3 million, and $1.2 million, respectively, compared to 2003. However, this increase was partially offset by declines of $1.2 million and $1.1 million in mortgage loan processing and sales finance expenses, respectively, as a result of the lower volume of such loans in 2004.
Other noninterest expenses, including professional services, increased $54.6 million, or 8.4%, compared to 2004, which reflected an increase of $33.7 million, or 5.4% compared to 2003. The 2005 increase was primarily the result of higher advertising expenses, professional fees, and software expenses. The majority of the 2004 increase resulted from higher taxes and license expenses, insurance claims expenses, employee travel, and higher net losses from the disposition of fixed assets and the acquisitions of Republic, McGriff and First Virginia. Please refer to Table 18 for additional detail on fluctuations in other categories of noninterest expense.
The effective management of the Company’s noninterest operating costs is another key contributor to BB&T’s financial success, especially as BB&T becomes a larger and more diverse company. In 2004, management announced plans to implement cost savings and revenue enhancement initiatives with a goal to produce $175 million in combined annual cost savings and revenue enhancements. Implementation of the initiatives began in the fourth quarter of 2004. Management expected that approximately $60 million would be realized in 2005 pursuant to this effort. During 2005, management estimates that approximately $75 million of cost savings and revenue enhancements were achieved. Management anticipates that substantially all of the $175 million of annual benefits will be achieved in 2006 or in early 2007.
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Provision for Income Taxes
BB&T’s provision for income taxes totaled $813.0 million for 2005, an increase of $49.0 million, or 6.4%, compared to 2004. The provision for income taxes totaled $764.0 million in 2004 and $552.1 million in 2003. BB&T’s effective tax rates for the years ended 2005, 2004 and 2003 were 33.0%, 32.9% and 34.1%, respectively. The increased provision for income taxes in 2005 was the result of higher pretax income. The higher provision in 2004 compared to 2003 was due to higher pretax income during the year, which was offset by a decrease in the effective tax rate compared to 2003 attributable to the effects of adjustments related to deferred income taxes associated with BB&T’s leasing operations, which are discussed below. A reconciliation of the effective tax rate to the statutory tax rate is included in Note 12 “Income Taxes” in the “Notes to Consolidated Financial Statements” herein.
BB&T has extended credit to, and invested in, the obligations of states and municipalities and their agencies, and has made other investments and loans that produce tax-exempt income. The income generated from these investments together with certain other transactions that have favorable tax treatment have reduced BB&T’s overall effective tax rate from the statutory rate in 2005, 2004 and 2003. These transactions include entering into option contracts transferring future management of residual interests of certain leveraged leases to a wholly-owned foreign subsidiary for which BB&T intends to permanently reinvest the earnings.
BB&T continually monitors and evaluates the potential impact of current events and circumstances on the estimates and assumptions used in the analysis of its income tax positions and, accordingly, BB&T’s effective tax rate may fluctuate in the future. On a periodic basis, BB&T evaluates its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of current Internal Revenue Service (“IRS”) examinations of BB&T’s tax returns, recent positions taken by the IRS on similar transactions, if any, and the overall tax environment in relation to tax-advantaged transactions. In 2003, BB&T determined that it was appropriate to defer recognition of benefits from the option contracts described above until such benefits were realized for income tax purposes and recorded adjustments to reflect that determination.
In the normal course of business, BB&T is subject to examinations from various tax authorities. These examinations may alter the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. During 2003, the IRS concluded its examination of BB&T’s federal income tax returns for the years ended December 31, 1996, 1997 and 1998. Following its examination, the IRS issued a Revenue Agent Report assessing taxes and interest in the amount of $59.3 million related to BB&T’s income tax treatment of certain leveraged lease transactions which were entered into during the years under examination. The assessment, which was paid by BB&T during 2003, did not significantly affect BB&T’s consolidated results of operations in 2003 as it related primarily to differences in the timing of recognizing income and deductions for income tax purposes for which deferred taxes had been previously provided. Management continues to believe that BB&T’s treatment of these leveraged leases was appropriate and in compliance with the tax law and regulations applicable for the years examined. BB&T filed a refund request for the taxes and interest related to this matter which was denied by the IRS during the second quarter of 2004. Early in the fourth quarter of 2004, BB&T filed a lawsuit in the United States District Court for the Middle District of North Carolina to pursue a refund of $3.3 million in taxes plus interest assessed by the IRS related to a leveraged lease transaction entered into during 1997. While management expects that this litigation will not be resolved for one to two years, management believes that there will be no material impact on the results of operations or the financial condition of BB&T, regardless of the outcome of this litigation. Management continues to evaluate its alternatives with regard to the remaining amounts paid, which are related to BB&T’s tax treatment of leveraged lease transactions for the year ended December 31, 1998.
Market Risk Management
The effective management of market risk is essential to achieving BB&T’s strategic financial objectives. As a financial institution, BB&T’s most significant market risk exposure is interest rate risk; however, market risk also includes product liquidity risk, price risk and volatility risk. The primary objective of interest rate risk management is to minimize any adverse effect that changes in interest rates have on net interest income. This is accomplished through active management of asset and liability portfolios with a focus on the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The goal of
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these activities is the development of appropriate maturity and repricing opportunities in BB&T’s portfolios of assets and liabilities that will produce consistent net interest income during periods of changing interest rates. BB&T’s ALCO monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes under various interest rate scenarios.
The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The ALCO meets regularly to review BB&T’s interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards.
BB&T utilizes a variety of financial instruments to manage various financial risks. These instruments, commonly referred to as derivatives, primarily consist of interest rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. BB&T uses derivatives primarily to manage the economic risk related to business loans, federal funds purchased, long-term debt, mortgage servicing rights, mortgage banking operations, and institutional certificates of deposit. BB&T’s derivatives resulted in an increase in net interest income of $52.0 million, $155.4 million and $124.2 million in 2005, 2004 and 2003, respectively.
Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. On December 31, 2005, BB&T had derivative financial instruments outstanding with notional amounts totaling $23.7 billion. The estimated fair value of open contracts used for risk management purposes at December 31, 2005 had net unrealized losses of $10.6 million.
See Note 18 “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements” herein for additional disclosures.
Impact of Inflation and Changing Interest Rates
The majority of BB&T’s assets and liabilities are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Fluctuations in interest rates and actions of the Board of Governors of the Federal Reserve System (“FRB”) to regulate the availability and cost of credit have a greater effect on a financial institution’s profitability than do the effects of higher costs for goods and services. Through its balance sheet management function, which is monitored by the ALCO, management believes that BB&T is positioned to respond to changing needs for liquidity, changes in interest rates and inflationary trends.
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BB&T’s interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions at December 31, 2005, and is not necessarily indicative of positions on other dates. The carrying amounts of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. The table does not reflect the impact of hedging strategies.
Table 19
Interest Rate Sensitivity Gap Analysis
Securities and other interest-earning assets (1)
Federal funds sold and securities purchased under resale agreements or similar arrangements
Loans and leases (2)
Savings and interest checking (3)
Money rate savings (3)
Management uses Interest Sensitivity Simulation Analysis (“Simulation”) to measure the sensitivity of projected earnings to changes in interest rates. Simulation takes into account the current contractual agreements that BB&T has made with its customers on deposits, borrowings, loans, investments and any commitments to enter into those transactions. Management monitors BB&T’s interest sensitivity by means of a computer model that incorporates current volumes, average rates earned and paid, and scheduled maturities and payments of asset and liability portfolios, together with multiple scenarios of projected prepayments, repricing opportunities and anticipated volume growth. Using this information, the model projects earnings based on projected portfolio balances under multiple interest rate scenarios. This level of detail is needed to simulate the effect that changes in interest rates and portfolio balances may have on the earnings of BB&T. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better illustration of the sensitivity of earnings to changes in interest rates than other analyses such as static or dynamic gap.
The asset/liability management process requires a number of key assumptions. Management determines the most likely outlook for the economy and interest rates by analyzing external factors, including published economic projections and data, the effects of likely monetary and fiscal policies as well as any enacted or prospective regulatory changes. BB&T’s current and prospective liquidity position, current balance sheet
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volumes and projected growth, accessibility of funds for short-term needs and capital maintenance are also considered. This data is combined with various interest rate scenarios to provide management with information necessary to analyze interest sensitivity and to aid in the development of strategies to reach performance goals.
The following table shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next twelve months under the “most likely” interest rate scenario incorporated into the Interest Sensitivity Simulation computer model. Key assumptions in the preparation of the table include prepayment speeds on mortgage-related assets, cash flows and maturities of derivative financial instruments, changes in market conditions, loan volumes and pricing, deposit sensitivity, customer preferences, and capital plans. The resulting change in net interest income reflects the level of sensitivity that net interest income has in relation to changing interest rates.
Table 20
Interest Sensitivity Simulation Analysis
Interest Rate Scenario
Annualized Hypothetical
Percentage Change in
Linear
Change in
Prime Rate
December 31,
2005
3.00%
1.50
No Change
(1.50)
(2.25)
(3.00)
NA = BB&T’s model typically calculates interest rate scenarios for both an increase and decrease of 1.50% and 3.00% change in rates. However, during 2004 a decrease of 3.00% in rates would have resulted in a negative federal funds rate and therefore an alternative scenario was modeled.
Management has established parameters for asset/liability management, which prescribe a maximum negative impact on interest sensitive income of 3% for the next twelve months for a linear change of 150 basis points for six months followed by a flat interest rate scenario for the remaining six month period, and a maximum negative impact of 6% for a linear change of 300 basis points over 12 months. It is management’s ongoing objective to effectively manage the impact of changes in interest rates and minimize any negative effects on earnings.
Liquidity
Liquidity represents BB&T’s continuing ability to meet funding needs, primarily deposit withdrawals, timely repayment of borrowings and other liabilities, and funding of loan commitments. In addition to the level of liquid assets, such as trading securities and securities available for sale, many other factors affect the ability to meet liquidity needs, including access to a variety of funding sources, maintaining borrowing capacity in national money markets, growing core deposits, the repayment of loans and the capability to securitize or package loans for sale.
The purpose of BB&T Corporation (the “Parent Company”) is to serve as the capital financing vehicle for the operating subsidiaries. The assets of the Parent Company consist primarily of cash on deposit with subsidiary banks, equity investments in subsidiaries, advances to subsidiaries, accounts receivable from subsidiaries, and other miscellaneous assets. The principal obligations of the Parent Company are principal and interest on master notes, long-term debt, and redeemable capital securities. The main sources of funds for the Parent Company are dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from issuance of long-term debt and master notes. The primary uses of funds by the Parent Company are for the retirement of common stock, investments in subsidiaries, advances to subsidiaries, dividend payments to shareholders, and interest and principal payments due on long-term debt and master notes.
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The primary source of funds used for Parent Company cash requirements has been dividends declared from the Banks, which totaled $1.4 billion during 2005, and net proceeds from the issuance of long-term debt, which totaled $415.9 million in 2005. Funds raised through master note agreements with commercial clients are placed on deposit with bank subsidiaries primarily for their use in meeting short-term funding needs and, to a lesser extent, to support the short-term temporary cash needs of the Parent Company. At December 31, 2005 and 2004, master note balances totaled $1.1 billion and $910.2 million, respectively.
During 2005, BB&T filed a universal shelf registration statement with the Securities and Exchange Commission to provide for the issuance of up to $2.5 billion of securities, which could include unsecured debt securities, shares of common stock, shares of preferred stock, depositary shares representing fractional interest in preferred stock, stock purchase contracts, stock purchase units, warrants to purchase debt securities, preferred stock or common stock, or units consisting of a combination of these securities. In addition, the universal shelf registration statement provided for the issuance of capital securities issued by BB&T Capital Trust I. During 2005, BB&T issued $500 million of capital securities under this registration statement, leaving $2.0 billion available for issuance under this universal shelf registration statement.
The Parent Company had six issues of subordinated notes outstanding at December 31, 2005 and 2004 totaling $3.3 billion and $3.4 billion, respectively. Please refer to Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” for additional information with respect to these subordinated notes.
BB&T’s subsidiary banks have several major sources of funding to meet their liquidity requirements, including access to capital markets through issuance of senior or subordinated bank notes and institutional certificates of deposit, access to the FHLB system, dealer repurchase agreements and repurchase agreements with commercial clients, participation in the Treasury, Tax and Loan and Special Direct Investment programs with the Federal Reserve, access to the overnight and term Federal funds markets, use of a Cayman branch facility, access to retail brokered certificates of deposit and a borrower in custody program with the Federal Reserve for the discount window.
Management believes current sources of liquidity are adequate to meet BB&T’s current requirements and plans for continued growth. See Note 6 “Premises and Equipment,” Note 10 “Long-Term Debt” and Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements” for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations.
Contractual Obligations, Commitments, Contingent Liabilities, Off-Balance Sheet Arrangements, and Related Party Transactions
The following table presents, as of December 31, 2005, BB&T’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. Further discussion of the nature of each obligation is included in Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”
Table 21
Contractual Obligations and Other Commitments
Capital lease obligations (1)
Operating leases
Commitments to fund affordable
housing investments
Time deposits
Total contractual cash obligations
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BB&T’s significant commitments include certain investments in affordable housing and historic building rehabilitation projects throughout its market area. BB&T enters into such arrangements as a means of supporting local communities and recognizes tax credits relating to these investments. At December 31, 2005, BB&T’s investments in such projects totaled $277.6 million, which includes outstanding commitments of $172.4 million. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. The Banks typically provide financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. BB&T’s risk exposure relating to such commitments is generally limited to the amount of investments and commitments made. Please refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for further discussion of these investments in limited partnerships.
In addition, BB&T enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the Consolidated Balance Sheets with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December 31, 2005, do not represent the amounts that may ultimately be paid under these contracts. Further discussion of derivative instruments is included in Note 1 “Summary of Significant Accounting Policies” and Note 18 “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements.”
In the ordinary course of business, BB&T indemnifies its officers and directors to the fullest extent permitted by law against liabilities arising from litigation. BB&T also issues standard representation warranties in underwriting agreements, merger and acquisition agreements, loan sales, brokerage activities and other similar arrangements. Counterparties in many of these indemnifications provide similar indemnifications to BB&T. Although these agreements often do not specify limitations, BB&T has not been required to act on the guarantees and does not believe that any payments pursuant to them would materially change the financial condition or results of operations of BB&T.
Merger and acquisition agreements of businesses other than financial institutions occasionally include additional incentives to the acquired entities to offset the loss of future cash flows previously received through ownership positions. Typically, these incentives are based on the acquired entity’s contribution to BB&T’s earnings compared to agreed-upon amounts. When offered, these incentives are typically issued for terms of three to eight years. As certain provision of these agreements do not specify dollar limitations, it is not possible to quantify the maximum exposure resulting from these agreements.
In the normal course of business, BB&T is also a party to financial instruments to meet the financing needs of clients and to mitigate exposure to interest rate risk. Such financial instruments include commitments to extend credit and certain contractual agreements, including standby letters of credit and financial guarantee arrangements. Further discussion of these commitments is included in Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”
BB&T contracts with an independent third party for the disbursement of official checks. Under the terms of the agreement, BB&T acts as an agent for the third party in the issuance of official checks. Funds received from the buyers of official checks are transferred to the third party issuer to cover the checks when they are ultimately presented for payment. But for this arrangement with the third party, these funds would have remained at BB&T in the form of noninterest-bearing deposits. The official check program is contractually arranged to substantially limit BB&T’s exposure to loss, since the third party is required to invest the funds received and maintain an equal relationship between outstanding checks and the balances available to cover the checks. BB&T monitors this relationship through a reconciliation process. The third party has provided a letter of credit from another bank in favor of BB&T and has access to a revolving line of credit to further mitigate any risk that there would be inadequate funds to cover the outstanding balance of official checks sold. However, in the event that the third party failed to honor official checks BB&T had sold as its agent, it is likely that BB&T would choose to reimburse the purchasers, though not contractually obligated to do so. At December 31, 2005, the third party issuer had outstanding official checks that had been sold by BB&T totaling $510.9 million.
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BB&T’s significant commitments and obligations are summarized in the accompanying table. Not all of the commitments presented in the table will be utilized thus the actual cash requirements are likely to be significantly less than the amounts reported.
Table 22
Summary of Significant Commitments
Lines of credit
Commercial letters of credit
Standby letters of credit and financial guarantees written
Other commitments (1)
Total other commitments
Related Party Transactions
The Corporation may extend credit to certain officers and directors in the ordinary course of business. These loans are made under substantially the same terms as comparable third-party lending arrangements and are in compliance with applicable banking regulations.
The maintenance of appropriate levels of capital is a management priority and is monitored on an ongoing basis. BB&T’s principal goals related to capital are to provide an adequate return to shareholders while retaining a sufficient base from which to support future growth and to comply with all regulatory standards.
The capital of the subsidiaries is regularly monitored to determine if the levels that management believes are the most beneficial and efficient for their operations are maintained. Management intends to maintain capital at the Banks at levels that will result in the Banks being classified as “well-capitalized” for regulatory purposes. Further, it is management’s policy to maintain capital levels at the Banks that result in regulatory risk-based capital ratios that target a Tier 1 leverage ratio of approximately 7.0%. If the capital levels of the banking subsidiaries increase above these guidelines, excess capital may be transferred to the Parent Company, subject to regulatory and other operating considerations, in the form of special dividend payments.
Management also regularly monitors the capital position of BB&T on a consolidated basis. In this regard, management’s policy is to maintain capital at levels that will result in BB&T being classified as “well-capitalized” for regulatory purposes. Further, it is management’s intention to maintain consolidated capital levels that result in regulatory risk-based capital ratios that are in line with peers and to maintain a Tier 1 leverage ratio in the range of 7.0% to 8.0%. Payments of cash dividends to BB&T’s shareholders, which have generally been in the range of 40.0% to 50.0% of earnings over the last six years, and repurchases of common shares are the methods used to manage any excess capital generated. In addition, management closely monitors the Parent Company’s double leverage ratio (investments in subsidiaries as a percentage of shareholders’ equity) with the intention of maintaining the ratio below 125.0%. The active management of the subsidiaries’ equity capital, as described above, is the process utilized to manage this important driver of Parent Company liquidity and is a key element in the management of BB&T’s capital position.
Shareholders’ Equity
Shareholders’ equity totaled $11.1 billion at December 31, 2005, an increase of $254.6 million, or 2.3%, from year-end 2004. During 2005, BB&T issued 4.7 million shares in connection with business combinations, the exercise of stock options and other stock-based incentive plans, which increased shareholders’ equity by $130.2 million. Additionally, growth of $839.1 million in shareholders’ equity resulted from BB&T’s earnings retained
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after dividends to shareholders. This growth was partially offset by a decrease in accumulated other comprehensive income totaling $245.0 million during 2005, primarily related to an increase in unrealized losses on available-for-sale securities, and by the repurchase of 12.0 million shares of common stock at a cost of $486.5 million.
Capital Adequacy and Resources
Bank holding companies and their subsidiaries are subject to regulatory requirements with respect to risk-based capital adequacy. Capital adequacy is an important indicator of financial stability and performance. Risk-based capital ratios measure capital as a percentage of a combination of risk-weighted balance sheet and off-balance sheet risk. The risk-weighted values of both balance sheet and off-balance sheet items are determined in accordance with risk factors specified by Federal bank regulatory pronouncements.
Tier 1 capital is calculated as common shareholders’ equity, excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets, net of applicable deferred income taxes, and certain nonfinancial equity investments. Tier 1 capital is required to be at least 4% of risk-weighted assets, and total capital (the sum of Tier 1 capital, a qualifying portion of the allowance for loan and lease losses and qualifying subordinated debt) must be at least 8% of risk-weighted assets, with one half of the minimum consisting of Tier 1 capital.
In addition to the risk-based capital measures described above, regulators have also established minimum leverage capital requirements for banking organizations. This is the primary measure of capital adequacy used by management and is calculated by dividing period-end Tier 1 capital by average tangible assets for the most recent quarter. The minimum required Tier 1 leverage ratio ranges from 3% to 5% depending upon Federal bank regulatory agency evaluations of an organization’s overall safety and soundness. BB&T’s regulatory capital and ratios are set forth in the following table.
Table 23
Capital—Components and Ratios
Tier 1 capital
Tier 2 capital
Total regulatory capital
Tier 1 leverage ratio
Common Stock and Dividends
BB&T’s ability to pay dividends is primarily dependent on earnings from operations, the adequacy of capital and the availability of liquid assets for distribution. BB&T’s ability to generate liquid assets for distribution is dependent on the ability of the Banks to pay dividends to the Parent Company. The payment of cash dividends is an integral part of providing a competitive return on shareholders’ investments. The Corporation’s policy is to accomplish this while retaining sufficient capital to support future growth and to meet regulatory requirements. BB&T’s common dividend payout ratio, computed by dividing dividends paid per common share by basic earnings per common share, was 48.34% in 2005 as compared to 47.52% in 2004. BB&T’s annual cash dividends paid per common share increased 9.0% during 2005 to $1.46 per common share for the year, as compared to $1.34 per common share in 2004. This increase marked the 34th consecutive year that the Corporation’s annual cash dividend paid to shareholders has been increased. A discussion of dividend restrictions is included in Note 15 “Regulatory Requirements and Other Restrictions” in the “Notes to Consolidated Financial Statements” and in the “Regulatory Considerations” section.
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BB&T’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “BBT”. BB&T’s common stock was held by approximately 257,000 shareholders at December 31, 2005 compared to approximately 255,000 at December 31, 2004. The accompanying table, “Quarterly Summary of Market Prices and Dividends Paid on Common Stock,” sets forth the quarterly high and low trading prices and closing sales prices for BB&T’s common stock and the dividends paid per share of common stock for each of the last eight quarters.
Table 24
Quarterly Summary of Market Prices and Cash Dividends Paid on Common Stock
Cash
DividendsPaid
Quarter Ended:
March 31
June 30
September 30
December 31
Year
Share Repurchases
BB&T has periodically repurchased shares of its own common stock. During the years ended December 31, 2005, 2004 and 2003, BB&T repurchased 12.0 million shares, 11.3 million shares and 21.5 million shares of common stock, respectively. In accordance with North Carolina law, repurchased shares cannot be held as treasury stock, but revert to the status of authorized and unissued shares.
On August 26, 2003, BB&T’s Board of Directors granted authority for the repurchase of up to 50 million shares of BB&T’s common stock as needed for general corporate purposes. The plan remains in effect until all the authorized shares are repurchased unless modified by the Board of Directors.
The following table presents the common stock repurchases made by BB&T during the fourth quarter of 2005 and the remaining shares that may be repurchased under the August 26, 2003, Board authorization:
Share Repurchase Activity
Segment Results
BB&T’s operations are divided into seven reportable business segments: the Banking Network, Mortgage Banking, Trust Services, Insurance Services, Investment Banking and Brokerage, Specialized Lending, and Treasury. These operating segments have been identified based primarily on BB&T’s organizational structure. See Note 20 “Operating Segments”, in the “Notes to Consolidated Financial Statements” herein, for additional
disclosures related to BB&T’s operating segments, the internal accounting and reporting practices utilized to manage these segments and financial disclosures for these segments as required by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Fluctuations in noninterest income from external customers and noninterest expense incurred directly by the segments are more fully discussed in the “Noninterest Income” and “Noninterest Expense” sections of this discussion and analysis. Merger-related expenses in 2005, 2004 and 2003 and the loss on early extinguishment of debt incurred in 2003 are retained in the corporate office and are excluded from segment results as presented herein.
Banking Network
The Banking Network had strong internal loan and deposit growth during 2005, with total assets at year-end 2005 increasing 7.6% compared to 2004. The total Banking Network was composed of 1,404 banking offices at the end of 2005, down from 1,413 banking offices at December 31, 2004. Net interest income for the Banking Network totaled $3.5 billion, an increase of $443.1 million, or 14.3%, compared to 2004. Net interest income for 2004 amounted to $3.1 billion, an increase of $677.0 million, or 28.0%, compared to 2003. The increase in net interest income in 2005 is composed of a 19.8% increase in net interest income from external customers and a 3.0% increase in the net credit generated by the internal funds transfer pricing (“FTP”) system. The increase in net interest income from external customers is primarily due to strong growth in commercial and consumer loans. The increase in the FTP credit was largely due to strong deposit growth and increases in crediting rates on funding products.
The economic provision for loan and lease losses decreased $3.1 million, or 1.3%, from 2004 to 2005. The decrease was primarily due to lower net-charge-offs, which were partially offset by loan growth. The 2004 provision reflected an increase of $21.2 million, or 9.4%, compared to 2003, primarily as a result of increased loan growth and additional loans as a result of the acquisition of Republic.
Noninterest income produced from external customers in the Banking Network increased $73.0 million, or 8.9% during 2005, due primarily to growth in service charges on deposits and other nondeposit fees and commissions. Noninterest income allocated from other segments increased $33.7 million, or 9.2% due to higher intersegment revenue related to wealth management, insurance and investment banking referrals compared to 2004. Comparing 2004 to 2003, noninterest income from external customers increased $115.4 million, or 16.4%, and intersegment noninterest income decreased $83.9 million, or 18.6%. Noninterest expenses incurred within the Banking Network were up slightly, increasing 1.4% in 2005 compared with 2004 because of the integration of past acquisitions and resulting cost savings, while noninterest expenses allocated to the Banking Network increased $74.0 million, or 13.5%, which resulted from growth within the segment. Comparing 2004 to 2003, noninterest expenses were flat and noninterest expenses allocated to the Banking Network increased $54.1 million, or 10.9%.
The provision for income taxes allocated to the Banking Network increased $154.9 million, or 21.2%, primarily due to an increase in pretax income, as well as an increase in the effective tax rate compared to 2004. The 2004 provision for income taxes increased $247.8 million, or 51.2%, compared to 2003, also due to increases in pretax income and the effective tax rate.
Total identifiable assets for the Banking Network increased $3.9 billion, or 7.6%, to a total of $56.0 billion, compared to 2004, which reflected an increase of $4.6 billion, or 9.6%, compared to 2003. The increase in 2005 was largely due to internal growth, while the 2004 increase was primarily due to the acquisition of Republic.
Mortgage Banking
BB&T’s mortgage originations totaled $10.5 billion in 2005, up 5.7% from the 2004 mortgage origination volume. BB&T’s residential mortgage servicing portfolio, which includes portfolio loans on BB&T’s balance sheet and loans serviced for third parties, totaled $41.1 billion at year-end 2005 compared to $37.9 billion at December 31, 2004.
Net interest income for the Mortgage Banking segment totaled $248.3 million, down $84.0 million, or 25.3%, compared to 2004 primarily as a result of higher funding costs associated with higher rates and the flattening of the yield curve. Net interest income for 2004 reflected a decrease of $51.3 million, or 13.4%, compared with 2003, largely due to the same factors.
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The economic provision for loan and lease losses increased $.7 million from 2004 to 2005. The increase in 2004 compared to 2003 was $1.9 million, which was primarily as a result of BB&T’s decision to retain, rather than sell, an additional $3.6 billion of mortgage loans during 2003 and 2004. In so doing, BB&T recorded additional provisions for loan losses related to these retained mortgage loans.
Noninterest income in the Mortgage Banking segment decreased $5.6 million, or 4.7% compared to 2004 primarily due to fluctuations in the valuation of mortgage servicing rights. From 2003 to 2004, noninterest income decreased $45.2 million, or 27.7%, due to a substantial decrease in residential mortgage production revenues. Noninterest expenses incurred within the Mortgage Banking segment increased $3.9 million, or 8.3%, primarily as a result of increased personnel costs compared to 2004, while noninterest expenses allocated to Mortgage Banking increased $16.2 million, or 83.9%. Comparing 2004 to 2003, noninterest expenses incurred by the Mortgage Banking segment decreased $9.3 million, or 16.6% due to lower mortgage loan incentive compensation, while intersegment noninterest expenses increased $7.7 million, or 65.7%.
The provision for income taxes allocated to the Mortgage Banking segment decreased $36.0 million, or 29.1%, due to lower pretax income compared to 2004. For 2004, the provision for income taxes decreased $21.9 million, or 15.0%, compared to 2003, also due to lower pretax income and an increase in the effective tax rate.
Total identifiable assets for the Mortgage Banking segment increased $2.2 billion, or 17.8%, from 2004 to 2005, and $213.5 million, or 1.7%, from 2003 to 2004, reflecting a higher percentage of adjustable rate mortgage originations in 2005, which are retained in the mortgage loan portfolio.
Trust Services
Net interest income for the Trust Services segment totaled $4.9 million, a decrease of $1.1 million, or 18.9%, compared to 2004. This decrease is composed of a 22.3% increase in net interest expense paid to external customers combined with a 6.6% decrease in the net credit for funds as calculated by BB&T’s internal FTP system. Net interest income in 2004, which totaled $6.1 million, was $17.0 million, or 73.7% less than the income recorded in 2003. The change in 2004 compared to 2003 was largely due to a decrease in deposits attributable to the trust services segments.
Noninterest income in the Trust Services segment totaled $157.6 million, an increase of $27.3 million, or 21.0% during 2005. Noninterest income amounted to $130.3 million in 2004, an increase of $14.3 million, or 12.3%, compared to 2003. The revenue increase in 2005 was primarily due to the acquisition of Sterling Capital and increases in mutual fund administration fees. Noninterest expenses incurred by Trust Services increased $28.7 million, or 28.7%, while noninterest expenses allocated to Trust Services increased $7.8 million. The increases in noninterest expenses in 2005 were largely due to the acquisition of Sterling Capital, including amortization of the related intangible assets. For 2004, noninterest expense incurred by Trust Services increased $9.3 million, or 10.3%, while expenses allocated to the Trust Services segment increased $1.0 million from 2003.
The provision for income taxes allocated to Trust Services decreased $3.0 million, or 33.2%, due to lower pretax income compared to 2004. Comparing 2004 and 2003, the provision for income taxes decreased $3.1 million, or 25.5%, also due to lower pretax income offset by a higher effective tax rate compared to 2003. Total identifiable segment assets for Trust Services increased 103.7% to a total of $213.4 million at December 31, 2005, compared to 2004, and increased 25.3% from 2003 to 2004, primarily due to the acquisition of Sterling Capital in 2005 and the acquisitions of financial institutions with trust assets in 2004.
Insurance Services
Noninterest income produced by the Insurance Services segment totaled $689.3 million during 2005, an increase of $85.9 million, or 14.2%, compared to 2004. During 2004, noninterest income amounted to $603.4 million, an increase of $230.4 million, or 61.8%, compared to 2003. Internal growth combined with the expansion of BB&T’s insurance agency network and insurance brokerage operations through acquisitions during the last two years were responsible for this strong growth. For 2005, noninterest expenses incurred within the Insurance Services segment increased $90.0 million, or 19.0% from 2004, while noninterest expenses allocated to the segment in 2005 increased $9.2 million, or 47.9%. For 2004, noninterest expenses incurred within Insurance Services increased $186.9 million, or 65.1% from 2003, while allocated corporate expenses increased $4.2 million from 2003. The overall increase in noninterest expenses within the Insurance Services segment principally resulted from the continued expansion of the BB&T insurance agency network and resulting additional allocated expenses.
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The provision for income taxes allocated to Insurance Services decreased $3.7 million, or 8.2% in 2005 compared to 2004, primarily as a result of a decrease in pretax income. During 2004, the provision for income taxes allocated to Insurance Services increased $17.1 million, or 60.7%, consistent with the growth in pretax income compared to 2003. Total identifiable segment assets for Insurance Services increased 15.1% to a total of $2.1 billion in 2005, following a 92.4% increase in 2004. These increases are primarily due to the acquisition of insurance agencies, the largest of which was the acquisition of McGriff in 2004.
Specialized Lending
BB&T’s Specialized Lending segment continued to expand during 2005 compared to 2004 and 2003. Net interest income from external customers totaled $301.2 million, up $22.5 million, or 8.1%, compared to 2004. Net interest income from external customers in 2004 amounted to $278.7 million, an increase of $54.0 million, or 24.0%, compared with 2003. These increases were caused by broader diversification among the specialty finance alternatives offered to clients by the business units comprising the Specialized Lending segment. Also, loans in Specialized Lending produce higher yields than the overall portfolio, creating these increases in net interest income. In addition, interest-earning assets have grown more rapidly in this segment than in the Banking Network, with average loans growing 24.4% in 2005 compared to 2004.
The economic provision for loan and lease losses totaled $102.5 million in 2005, an increase of $10.6 million, or 11.6%, compared to 2004. The economic provision for loan and lease losses amounted to $91.9 million for 2004, an increase of $4.2 million, or 4.8%, compared to 2003. Due to the generally higher credit risk profiles of the clients of Specialized Lending, loss rates are expected to be higher than conventional bank lending. Loss rates are also affected by shifts in the portfolio mix of the underlying subsidiaries. The growth in this segment has required additional provisions for loan and leases losses.
Noninterest income produced by the Specialized Lending segment totaled $58.5 million in 2005, an increase of $17.8 million, or 43.7% compared to 2004, which reflected a decrease of $4.4 million, or 9.7%, compared to 2003. The 2004 increase was primarily due to increases in changes in the mix of product offerings and associated fees. For 2005, noninterest expenses incurred within the Specialized Lending segment increased $13.3 million, or 10.6% compared to 2004 and allocated corporate expenses increased $2.5 million, or 16.9% from 2004 to 2005. Comparing 2004 and 2003, noninterest expenses incurred within the Specialized Lending segment increased $15.5 million, or 14.0%, and allocated corporate expenses increased $6.0 million. The increases in noninterest expenses incurred within the Specialized Lending segment increased due to a combination of growth from acquisitions and internal growth.
The provision for income taxes allocated to the Specialized Lending segment increased $6.5 million, or 26.2%, primarily due to the combination of a higher effective tax rate and higher pretax income in 2005. For 2004, the provision for income taxes increased $5.6 million, or 29.3%, compared to 2003 due to higher pretax income, which was partially offset by a lower effective tax rate.
Total identifiable assets for the Specialized Lending segment increased $597.6 million, or 24.8%, from 2004 to 2005, and $458.2 million, or 23.5%, from 2003 to 2004, due to acquisitions and internal growth during the last two years.
Investment Banking and Brokerage
Net interest income for the Investment Banking and Brokerage segment totaled $9.0 million, an increase of $1.2 million compared to 2004. Net interest income in 2004 amounted to $7.8 million, an increase of $1.0 million compared to 2003. The increases in net interest income are primarily a result of an increase in trading securities and market conditions. Noninterest income during 2005 totaled $312.1 million, an increase of $37.2 million, or 13.5% compared to 2004. For 2004, noninterest income amounted to $274.9 million, an increase of $22.1 million, or 8.7% compared to 2003. The increase during 2005 was primarily due to the acquisition of Windsor Group LLC. Noninterest expenses incurred within the Investment Banking and Brokerage segment totaled $276.7 million in 2005, an increase of $38.2 million compared to 2004, primarily as a result of higher incentive compensation. Comparing 2004 and 2003, noninterest expenses incurred by the Investment Banking and Brokerage segment increased $22.6 million, and allocated corporate expenses increased $5.0 million.
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The provision for income taxes allocated to the Investment Banking and Brokerage segment decreased $.5 million during 2005 compared to 2004, which in turn was $1.7 million lower than 2003. These fluctuations were consistent with the fluctuations in pretax income in both 2005 and 2004. Total identifiable assets for the Investment Banking and Brokerage segment increased to a total of $1.3 billion at December 31, 2005, compared to $885.3 million at year-end 2004.
Treasury
Net interest income for the Treasury segment totaled $40.0 million in 2005, a decrease of $183.9 million, or 82.1%, compared to 2004. For 2004, net interest income amounted to $223.9 million, a decrease of $51.8 million, or 18.8% compared with 2003. These decreases were principally due to the increase in short-term interest rates, which increased the cost of funding. The increase in funding costs was partially offset by an increase in interest income due to growth in the investment portfolio. Noninterest income decreased $3.7 million during 2005, and, for 2004, noninterest income decreased $139.5 million. The decrease in 2004 was primarily due to substantial decreases in gains on sales of securities. Noninterest expenses incurred within the Treasury segment increased 3.1% in 2005 compared to 2004. For 2004, noninterest expenses within the Treasury segment decreased slightly, and allocated corporate expenses decreased $.5 million.
The provision for income taxes allocated to the Treasury segment during 2005 decreased $61.7 million due to lower pretax income and a change in the effective tax rate. In 2004, the provision for income taxes decreased $48.6 million, primarily due to lower pretax income. Total identifiable assets for the Treasury segment increased $1.6 billion, or 8.5% during 2005 to a total of $20.1 billion. For 2004, total identifiable segment assets for the Treasury segment decreased $1.8 billion or 8.7%.
Fourth Quarter Results
Net income for the fourth quarter of 2005 was $429.6 million, compared to $416.9 million for the comparable period of 2004. On a per share basis, diluted net income for the fourth quarter of 2005 was $.78 compared to $.75 for the same period a year ago. Annualized returns on average assets and average shareholders’ equity were 1.58% and 15.32%, respectively, for the fourth quarter of 2005, compared to 1.68% and 15.21%, respectively, for the fourth quarter of 2004.
Net interest income amounted to $899.7 million for the fourth quarter of 2005, an increase of 6.3% compared to $846.0 million for the same period of 2004. Noninterest income totaled $619.0 million for the fourth quarter of 2005, up 12.9% from $548.2 million earned during the fourth quarter of 2004. BB&T’s noninterest expense for the fourth quarter of 2005 totaled $818.0 million, up 15.1% from the $710.8 million recorded in the fourth quarter of 2004.
The fourth quarter 2005 provision for credit losses increased 6.4% to $69.3 million, compared to $65.2 million for the fourth quarter of 2004. The fluctuation in the quarterly provision is a reflection of actual credit losses experienced during each quarter as well as management’s judgment as to the adequacy of the allowance for loan and lease losses and reserve for unfunded lending commitments at the end of each quarter.
The fourth quarter 2005 provision for income taxes totaled $201.8 million, a slight increase compared to $201.3 million for the same period of 2004.
The accompanying table, “Quarterly Financial Summary—Unaudited,” presents condensed information relating to quarterly periods in the years ended December 31, 2005 and 2004.
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Table 25
Quarterly Financial Summary—Unaudited
Third
Quarter
First
Net interest income
Provision for credit losses
Securities (losses) gains, net
Noninterest expense
Provision for income taxes
Net income
Basic earnings per share
Diluted earnings per share
Securities, at amortized cost
Loans and leases (1)
Federal funds purchased, securities sold under repurchase agreements and short-term debt
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SIX YEAR FINANCIAL SUMMARY AND SELECTED RATIOS
(Dollars in thousands, except per share data)
Five Year
Compound
GrowthRate
Interest income
Interest expense
Net interest income after provision credit losses
Noninterest income
Income before income taxes and cumulative effect of change in accounting principle
Income before cumulative effect of change in accounting principle
Cumulative effect of change in accounting principle
Average shares outstanding (000’s):
Basic
Diluted
Cash dividends paid per share
Book value per share
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SIX YEAR FINANCIAL SUMMARY AND SELECTED RATIOS—Continued
Other assets
Rate of return on:
Average total assets
Average shareholders’ equity
Dividend payout
Average equity to average assets
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CONTROLS AND PROCEDURES
Management’s Report on Internal Control Over Financial Reporting
Management of BB&T is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (the Exchange Act)). The Corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. BB&T’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that in reasonable detail, accurately and fairly reflect the transactions and disposition of the Corporation’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with the authorizations of BB&T’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material impact on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Management of the Corporation, under the supervision and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the internal control over financial reporting based on the framework in “Internal Control – Integrated Framework” promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the “COSO” criteria. Based on this evaluation under the “COSO” criteria, management concluded that the internal control over financial reporting was effective as of December 31, 2005.
As of the end of the period covered by this report, the management of the Corporation, under the supervision and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) of the Exchange Act, as amended. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective in enabling the Corporation to record, process, summarize and report, in a timely manner, the information that the Corporation is required to disclose in its Exchange Act reports.
There was no change in the Corporation’s internal control over financial reporting that occurred during the fourth quarter that has materially affected or is likely to materially affect, the Corporation’s internal control over financial reporting.
Management’s assessment of the effectiveness of the internal control structure over financial reporting, as of December 31, 2005, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included on page 67, which expresses unqualified opinions on management’s assessment and on the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005.
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of BB&T Corporation:
We have completed integrated audits of BB&T Corporation’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on these audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of BB&T Corporation and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing on page 66, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Charlotte, North Carolina
March 10, 2006
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BB&T CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
Cash and due from banks
Interest-bearing deposits with banks
Trading securities at fair value
Securities available for sale at fair value
Securities held to maturity at amortized cost (fair value $125 at December 31, 2004)
Loans and leases, net of unearned income
Allowance for loan and lease losses
Loans and leases, net
Premises and equipment, net of accumulated depreciation
Goodwill
Core deposit and other intangible assets
Deposits:
Certificates of deposit and other time deposits
Total deposits
Accounts payable and other liabilities
Total liabilities
Commitments and contingencies (Notes 6 and 14)
Shareholders’ equity:
Preferred stock, $5 par, 5,000,000 shares authorized, none issued or outstanding at December 31, 2005 or at December 31, 2004
Common stock, $5 par, 1,000,000,000 shares authorized; 543,102,080 issued and outstanding at December 31, 2005 and 550,406,287 issued and outstanding at December 31, 2004
Additional paid-in capital
Retained earnings
Unvested restricted stock
Accumulated other comprehensive income (loss), net of deferred income taxes of $(207,319) at December 31, 2005 and $(66,662) at December 31, 2004
Total shareholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
Interest and fees on loans and leases
Interest and dividends on securities:
Taxable interest income
Tax-exempt interest income
Dividends
Interest on short-term investments
Total interest income
Interest on deposits
Interest on federal funds purchased, securities sold under repurchase agreements and short-term borrowed funds
Interest on long-term debt
Total interest expense
Net Interest Income After Provision for Credit Losses
Other income
Personnel expense
Occupancy and equipment expense
Merger-related and restructuring (gains) charges
Other expenses
Income before income taxes
Net Income
Cash dividends paid
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Comprehensive income:
Unrealized holding gains (losses) arising during the period on securities available for sale, net of tax of $(153,933)
Less: reclassification adjustment for losses (gains) on securities available for sale included in net income, net of tax of $(46,907)
Change in unrealized gains (losses) on securities, net of tax
Change in unrecognized gain (loss) on cash flow hedge, net of tax of $5,788
Total comprehensive income
Common stock issued:
In purchase acquisitions
In connection with stock option exercises and other employee benefits, net of cancellations
Redemption of common stock
Cash dividends declared on common stock, $1.25 per share
Other, net
Unrealized holding gains (losses) arising during the period on securities available for sale, net of tax of $(55,843)
Less: reclassification adjustment for losses (gains) on securities available for sale included in net income, net of tax of $(2,382)
Change in unrecognized gain (loss) on cash flow hedge, net of tax of $(19,822)
Change in minimum pension liability, net of tax of $(1,625)
Cash dividends declared on common stock, $1.37 per share
Add (Deduct):
Unrealized holding gains (losses) arising during the period on securities available for sale, net of tax of $(143,776)
Reclassification adjustment for losses (gains) on securities available for sale included in net income, net of tax of $159
Change in unrecognized gain (loss) on cash flow hedge, net of tax of $4,532
Change in minimum pension liability, net of tax of $(1,572)
Cash dividends declared on common stock, $1.49 per share
CONSOLIDATED STATEMENTS OF CASH FLOWS
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Amortization of purchase accounting mark-to-market adjustments, net
Discount accretion and premium amortization on long-term debt, net
Discount accretion and premium amortization on securities, net
Net (increase) decrease in trading account securities
Gain on sales of securities, net
Gain on sales of loans and mortgage loan servicing rights, net
(Gain) loss on disposals of premises and equipment, net
Proceeds from sales of loans held for sale
Purchases of loans held for sale
Origination of loans held for sale, net of principal collected
Tax benefit from exercise of stock options
(Increase) decrease in other assets, net
Increase in accounts payable and other liabilities, net
Net cash provided by operating activities
Proceeds from sales of securities available for sale
Proceeds from maturities, calls and paydowns of securities available for sale
Purchases of securities available for sale
Proceeds from maturities, calls and paydowns of securities held to maturity
Purchases of securities held to maturity
Leases made to customers
Principal collected on leases
Loan originations, net of principal collected
Purchases of loans
Net cash (paid) acquired in business combinations
Purchases and originations of mortgage servicing rights
Proceeds from disposals of premises and equipment
Purchases of premises and equipment
Proceeds from sales of foreclosed property or other real estate held for sale
Net cash (used in) provided by investing activities
Net increase (decrease) in deposits
Net (decrease) increase in federal funds purchased, securities sold under repurchase agreements and short-term borrowed funds
Proceeds from issuance of long-term debt
Repayment of long-term debt
Net proceeds from common stock issued
Cash dividends paid on common stock
Net cash provided by (used in) financing activities
Cash paid during the year for:
Interest
Income taxes
Noncash investing and financing activities:
Transfer of securities available for sale to trading securities
Transfer of loans to foreclosed property
Transfer of fixed assets to other real estate owned
Securitization of mortgage loans
Common stock issued in business combinations
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
NOTE 1. Summary of Significant Accounting Policies
BB&T Corporation (“BB&T”, the “Company” or “Parent Company”) is a financial holding company organized under the laws of North Carolina. Branch Banking and Trust Company (“Branch Bank”); Branch Banking and Trust Company of South Carolina (“BB&T-SC”); Branch Banking and Trust Company of Virginia (“BB&T-VA”), (collectively, the “Banks”), comprise BB&T’s principal direct banking subsidiaries. BB&T also conducts operations through its nonbank subsidiaries.
The accounting and reporting policies of BB&T Corporation and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The following is a summary of BB&T’s more significant accounting policies.
Nature of Operations
BB&T is a financial holding company headquartered in Winston-Salem, North Carolina. BB&T conducts its operations primarily through its subsidiary banks, which have branches in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Florida, Alabama, Indiana and Washington, D.C. BB&T’s subsidiary banks provide a wide range of banking services to individuals and businesses. BB&T’s subsidiary banks offer a variety of loans to businesses and consumers. Such loans are made primarily to individuals residing in the market areas described above or to businesses located within BB&T’s geographic footprint. BB&T’s subsidiary banks also market a wide range of deposit services to individuals and businesses. BB&T’s subsidiary banks offer, either directly, or through their subsidiaries, lease financing to businesses and municipal governments; factoring; discount brokerage services, annuities and mutual funds; life insurance, property and casualty insurance, health insurance and commercial general liability insurance on an agency basis and through a wholesale insurance brokerage operation; insurance premium financing; permanent financing arrangements for commercial real estate; loan servicing for third-party investors; direct consumer finance loans to individuals; and trust services. The direct nonbank subsidiaries of BB&T provide a variety of financial services including automobile lending, equipment financing, full-service securities brokerage, payroll processing, asset management and capital markets services.
Principles of Consolidation
The consolidated financial statements of BB&T include the accounts of BB&T Corporation and those subsidiaries that are majority-owned by BB&T and over which BB&T exercises control. In consolidation, all significant intercompany accounts and transactions are eliminated. The results of operations of companies acquired are included only from the dates of acquisition. All material wholly-owned and majority-owned subsidiaries are consolidated unless accounting principles generally accepted in the United States of America require otherwise.
BB&T evaluates variable interests in entities for which voting interests are not an effective means of identifying controlling financial interests. Variable interests are those in which the value of the interest changes with the fair value of the net assets of the entity exclusive of variable interests. If the results of the evaluation indicate the existence of a primary beneficiary and the entity does not effectively disperse risks among the parties involved, that primary beneficiary is required to consolidate the entity. Likewise, if the evaluation indicates that the requirements for consolidation are not met and the entity has previously been consolidated, then the entity would be deconsolidated.
BB&T has variable interests in certain entities that were not required to be consolidated, including affordable housing partnership interests, historic tax credit partnerships, other partnership interests and trusts that have issued capital securities.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
BB&T generally accounts for unconsolidated partnership investments using the equity method of accounting. In addition to affordable housing partnerships, which represent the majority of unconsolidated investments in variable interest entities, BB&T also has investments and future funding commitments to venture capital and other entities. The maximum potential exposure to losses relative to investments in variable interest entities is generally limited to the sum of the outstanding balance, future funding commitments and any related loans to the entity. Loans to these entities are underwritten in substantially the same manner as are other loans and are generally secured.
BB&T has investments in certain entities for which BB&T does not have controlling interest. For these investments, the Company records its interest using the equity method with its portion of income or loss being recorded in other noninterest income on the Consolidated Statements of Income. BB&T periodically evaluates these investments for impairment.
In certain instances, amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the current year presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses and the reserve for unfunded lending commitments, valuation of mortgage servicing rights, valuation of goodwill, intangible assets and other purchase accounting related adjustments, benefit plan obligations and expenses, and tax assets, liabilities and expense.
Business Combinations
BB&T accounts for all business combinations using the purchase method of accounting. Under this method of accounting, the accounts of an acquired entity are included with the acquirer’s accounts as of the date of acquisition with any excess of purchase price over the fair value of the net assets acquired (including identifiable intangibles) capitalized as goodwill. BB&T typically provides an allocation period not to exceed one year to finalize the purchase price allocations related to its business combinations. Management currently does not anticipate material adjustments to the assigned values of the assets and liabilities of acquired companies.
To consummate an acquisition, BB&T typically issues common stock and / or pays cash, depending on the terms of the merger agreement. The value of common shares issued in connection with purchase business combinations is determined based on the market price of the securities issued over a reasonable period of time, not to exceed three days before and three days after the measurement date.
In connection with mergers and acquisitions, BB&T typically issues options to purchase shares of its common stock in exchange for options outstanding at the acquired entities at the time the merger is completed. To the extent vested, the options are considered to be part of the purchase price paid. There is no change in the aggregate intrinsic value of the options issued compared to the intrinsic value of the options held immediately before the exchange, nor does the ratio of the exercise price per option to the market value per share change.
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, interest-bearing deposits with banks, Federal funds sold and securities purchased under resale agreements or similar arrangements. Cash and cash equivalents have maturities of three months or less. Accordingly, the carrying amount of such instruments is considered a reasonable estimate of fair value.
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At date of purchase, BB&T classifies investment securities as held to maturity, available for sale or trading. Interest income and dividends on securities are recognized in interest income on an accrual basis. Premiums and discounts on debt securities are amortized as an adjustment to yield using the interest method.
Debt securities acquired with both the intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost.
Debt securities, which may be sold to meet liquidity needs arising from unanticipated deposit and loan fluctuations, changes in regulatory capital requirements, or unforeseen changes in market conditions, are classified as available for sale. Equity securities classified as available for sale are primarily comprised of stock issued by the Federal Home Loan Bank of Atlanta and are carried at cost, which approximates fair value. All other securities available for sale are reported at estimated fair value, with unrealized gains and losses reported as accumulated other comprehensive income or loss, net of deferred income taxes, in the shareholders’ equity section of the Consolidated Balance Sheets. Gains or losses realized from the sale of securities available for sale are determined by specific identification and are included in noninterest income.
BB&T evaluates each held to maturity and available for sale security in a loss position for other than temporary impairment. In its evaluation BB&T considers such factors as the length of time and the extent to which the market value has been below cost, the financial condition of the issuer, and BB&T’s ability and intent to hold the security to an expected recovery in market value. Unrealized losses for other than temporary impairment on debt and equity securities are recognized in current period earnings.
Trading account securities, which include both debt and equity securities, are reported at fair value. Unrealized market value adjustments, fees, and realized gains or losses from trading account activities (determined by specific identification) are included in noninterest income. Interest income on trading account securities is included in interest and dividends from securities.
Loans Held for Sale
Loans held for sale, which are composed of mortgage and consumer loans, are reported at the lower of cost or market value on an aggregate loan portfolio basis. Gains or losses realized on the sales of loans are recognized at the time of sale and are determined by the difference between the net sales proceeds and the carrying value of the loans sold including any deferred origination fees and costs, adjusted for any servicing asset or liability retained. Gains and losses on sales of mortgage loans are included in mortgage banking income. Gains or losses on sales of consumer loans are included in other noninterest income.
Loans and leases that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized fees and costs on originated loans and unamortized premiums or discounts on purchased loans. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using methods which approximate the interest method. Discounts and premiums are amortized or accreted to interest income over the estimated life of the loans using methods that approximate the interest method. Commercial loans and substantially all installment loans accrue interest on the unpaid balance of the loans.
Lease receivables consist primarily of investments in leveraged lease transactions and direct financing leases on rolling stock, equipment and real property. Direct financing lease receivables are stated at the total amount of future minimum lease payments receivable plus estimated residual values and initial direct costs, less unearned income. Leveraged leases are also carried net of non-recourse debt. Income is recognized over the lives of the
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lease contracts using the interest method. BB&T also enters into operating leases as lessor. Operating lease equipment is carried at cost less accumulated depreciation and is depreciated to the estimated residual value using the straight-line method over the lesser of the lease term or projected economic life of the equipment. BB&T estimates the residual value at the inception of each lease. In addition, BB&T reviews residual values at least annually, and monitors the residual realizations at the end of the lease term. If the review of the estimated residual values indicates potential impairment and this decline is other than temporary, such impairment is recognized in current period earnings. Estimated residual values are evaluated using information that includes both internal and external appraisals and historical residual realization experience.
BB&T classifies loans and leases past due when the payment of principal and interest based upon contractual terms is greater than 30 days delinquent.
Nonperforming Assets
Nonperforming assets include loans and leases on which interest is not being accrued and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of customers’ loan defaults. Loans and leases are generally placed on nonaccrual status when concern exists that principal or interest is not fully collectible, or when principal or interest becomes 90 days past due, whichever occurs first. Certain loans past due 90 days or more may remain on accrual status if management determines that it does not have concern over the collectibility of principal and interest. Generally, when loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction to the remaining principal balance as long as concern exists as to the ultimate collection of the principal. Loans and leases are removed from nonaccrual status when they become current as to both principal and interest and concern no longer exists as to the collectibility of principal and interest.
Assets acquired as a result of foreclosure are carried at the lower of cost or net realizable value. Net realizable value equals fair value less estimated selling costs. Cost is determined based on the sum of unpaid principal, accrued but unpaid interest if not required to be reversed and acquisition costs associated with the loan. Any excess of cost over net realizable value at the time of foreclosure is charged to the allowance for loan and lease losses. Generally, such properties are valued periodically and if the carrying value is greater than the net realizable value, a valuation reserve is established with a charge to noninterest expense. Routine maintenance costs, declines in market value and net losses on disposal are included in other noninterest expense.
The allowance for loan and lease losses and reserve for unfunded lending commitments are management’s best estimate of probable credit losses that are inherent in the loan and lease portfolios and off-balance sheet lending commitments at the balance sheet date. The Company determines the allowance for loan and lease losses and the reserve for unfunded lending commitments based on an ongoing evaluation. This evaluation is inherently subjective because it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates are susceptible to significant change. Increases to the allowance for loan and lease losses and the reserve for unfunded lending commitments are made by charges to the provision for credit losses, which is reflected in the Consolidated Statements of Income. Loans or lease balances deemed to be uncollectible are charged off against the allowance for loan and lease losses. Recoveries of amounts previously charged-off are credited to the allowance for loan and lease losses.
The allowance for loan and lease losses is the accumulation of various components that are calculated based on various methodologies. BB&T’s allowance for loan and lease losses consists of (1) a component for individual loan impairment recognized and measured pursuant to SFAS No. 114 and (2) components of collective loan impairment recognized pursuant to SFAS No. 5.
BB&T maintains specific reserves for individually impaired loans pursuant to SFAS No. 114. A loan is impaired when, based on current information and events, it is probable that BB&T will be unable to collect all
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amounts due (interest as well as principal) according to the contractual terms of the loan agreement. Specific reserves are determined on a loan by loan basis based on management’s best estimate of BB&T’s exposure, given the current payment status of the loan, the present value of expected payments and the value of any underlying collateral.
Management’s estimate of the SFAS No. 5 component of the allowance for loan and lease losses is based on one or more sets of observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation is principally based on historical charge-off experience, but also includes information derived from BB&T’s credit ratings systems; internal observable data related to trends within the loan and lease portfolios, including credit quality, geographic, borrower and industry concentrations, aging of the portfolio, growth and loan portfolios of acquired companies; volatility adjustments to reflect changes in historical net charge-off rates and changes in probabilities of default; external observable data related to industry and general economic trends; and any significant, relevant changes to policies or procedures.
The methodology used to determine the reserve for unfunded lending commitments is inherently similar to that used to determine the SFAS No. 5 component of the allowance for loan and lease losses described above, adjusted for factors specific to binding commitments, including the probability of funding and exposure at default.
While management uses the best information available to establish the allowance for loan and lease losses and the reserve for unfunded lending commitments, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in performing the valuations or, if required by regulators, based upon information available to them at the time of their examinations.
Premises and Equipment
Premises, equipment, capital leases and leasehold improvements are stated at cost less accumulated depreciation or amortization. Land is stated at cost. In addition, purchased software and costs of computer software developed for internal use are capitalized provided certain criteria are met. Depreciation and amortization are computed principally using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line basis over the lesser of the lease terms, including certain renewals which were deemed probable at lease inception, or the estimated useful lives of the improvements. Capitalized leases are amortized by the same methods as premises and equipment over the estimated useful lives or lease terms, whichever is less. Obligations under capital leases are amortized using the interest method to allocate payments between principal reduction and interest expense. Rent expense and rental income on operating leases is recorded using the straight-line method over the appropriate lease terms.
Securities Sold Under Repurchase Agreements
Securities sold under repurchase agreements have maturities ranging from 1 day to 24 months. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the borrowing. The terms of repurchase agreements may require BB&T to provide additional collateral if the fair value of the securities underlying the borrowings declines during the term of the agreement.
The provision for income taxes is based upon income before taxes for financial statement purposes, adjusted for nontaxable income and nondeductible expenses. Deferred income taxes have been provided when different accounting methods have been used in determining income for income tax purposes and for financial reporting purposes. Deferred tax assets and liabilities are recognized based on future tax consequences attributable to differences arising from the financial statement carrying values of assets and liabilities and their tax bases. In the event of changes in the tax laws, deferred tax assets and liabilities are adjusted in the period of the enactment of those changes, with the cumulative effects included in the current year’s income tax provision.
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Derivative Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest rate swaps, caps, floors, collars, financial forwards and futures contracts, swaptions, when-issued securities, foreign exchange contracts and options written and purchased. BB&T uses derivatives primarily to manage economic risk related to securities, business loans, mortgage servicing rights and mortgage banking operations, Federal funds purchased, other time deposits, long-term debt and institutional certificates of deposit. BB&T also uses derivatives to facilitate transactions on behalf of its clients. The fair value of derivatives in a gain or loss position is included in other assets or liabilities, respectively, in the Consolidated Balance Sheets.
BB&T classifies its derivative financial instruments as either (1) a hedge of an exposure to changes in the fair value of a recorded asset or liability (“fair value hedge”), (2) a hedge of an exposure to changes in the cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”), or (3) derivatives not designated as hedges. Changes in the fair value of derivatives not designated as hedges are recognized in current period earnings.
BB&T uses a combination of the short-cut method and the long-haul method to assess hedge effectiveness. The short-cut method is primarily used for fair value hedges of long-term debt. This method allows for the assumption of zero hedge ineffectiveness if a set of strict criteria are met at the inception of the derivative. As permitted under the short-cut method, no further assessment of hedge effectiveness is performed for these transactions. For hedges that use the long-haul method to assess hedge effectiveness, BB&T documents, both at inception and over the life of the hedge, at least quarterly, its analysis of actual and expected hedge effectiveness. This analysis includes techniques such as regression analysis and hypothetical derivatives under method 2 of DIG Issue G7 to demonstrate that the hedge has been, and is expected to be, highly effective in off-setting corresponding changes in the fair value or cash flows of the hedged item. For cash flow hedges involving interest rate caps and collars, this analysis also includes consideration of the criteria under the response to question 2 of DIG Issue G20. For a qualifying fair value hedge, changes in the value of the derivatives that have been highly effective as hedges are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged. For a qualifying cash flow hedge, the portion of changes in the fair value of the derivatives that have been highly effective are recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings. For qualifying cash flow hedges involving interest rate caps and collars, the initial fair value of the premium paid is allocated and recognized in the same future period that the hedged forecasted transaction impacts earnings.
For either fair value hedges or cash flow hedges, ineffectiveness may be recognized in noninterest income to the extent that changes in the value of the derivative instruments do not perfectly offset changes in the value of the hedged items. If the hedge ceases to be highly effective, BB&T discontinues hedge accounting and recognizes the changes in fair value in current period earnings. If a derivative that qualifies as a fair value or cash flow hedge is terminated or the designation removed, the realized or then unrealized gain or loss is recognized into income over the original hedge period (fair value hedge) or period in which the hedged item affects earnings (cash flow hedge). Immediate recognition in earnings is required upon sale or extinguishment of the hedged item (fair value hedge) or if it is probable that the hedged cash flows will not occur (cash flow hedge).
Derivatives used to manage economic risk not designated as hedges primarily represent economic risk management instruments of mortgage servicing rights and mortgage banking operations, with gains or losses included in mortgage banking income. In connection with its mortgage banking activities, BB&T enters into loan commitments to fund residential mortgage loans at specified rates and for specified periods of time. To the extent that BB&T’s interest rate lock commitments relate to loans that will be held for sale upon funding, they are also accounted for as derivatives, with gains or losses included in mortgage banking income. Gains and losses on other derivatives used to manage economic risk are primarily included in other income.
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Per Share Data
Basic net income per common share is computed by dividing net income applicable to common shares by the weighted average number of shares of common stock outstanding during the years presented. Diluted net income per common share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and other potentially dilutive securities outstanding.
Goodwill and Other Intangible Assets
Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as purchases. BB&T allocates goodwill to the business that receives significant benefits from the acquisition. In accordance with provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized over an estimated useful life, but rather is tested at least annually for impairment. BB&T performs its impairment testing in the fourth quarter of each year and more frequently if circumstances exist that indicate a probable reduction in the fair value of the business below its carrying value. BB&T measures impairment using multiple methodologies, which include the present value of estimated future cash flows and comparisons of each business unit’s performance to the values of companies of similar industry and size. The analysis is based upon available information regarding expected future cash flows and discount rates. Discount rates are based upon the cost of capital specific to the industry. If the carrying value of the business exceeds the discounted fair value of the business, a second analysis is performed to measure the fair value of all assets and liabilities. If, based on the second analysis, it is determined that the fair value of the assets and liabilities of the business is less than the carrying value, BB&T would recognize impairment for the excess of carrying value over fair value.
Core deposit and other intangible assets include premiums paid for acquisitions of core deposits (core deposit intangibles) and other identifiable intangible assets. Intangible assets other than goodwill, which are determined to have finite lives, are amortized based upon the estimated economic benefits received.
Loan Securitizations
BB&T securitizes most of its fixed-rate conforming mortgage loans, converts them into mortgage-backed securities issued primarily through the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”), and sells the resulting securities to third party investors. BB&T records loan securitizations as a sale when the transferred loans are legally isolated from its creditors and the other accounting criteria for a sale are met. Gains or losses recorded on loan securitizations depend in part on the net carrying amount of the loans sold, which is allocated between the loans sold and retained interests based on their relative fair values at the date of sale. BB&T generally retains the mortgage servicing on loans sold. Since quoted market prices are not typically available, BB&T estimates the fair value of these retained interests using modeling techniques to determine the net present value of expected future cash flows. Such models incorporate management’s best estimates of key variables, such as prepayment speeds and discount rates appropriate for the risks involved. Gains and losses incurred on loans sold to third party investors are included in mortgage banking income on the Consolidated Statements of Income.
BB&T also periodically securitizes mortgage loans that it intends to hold for the foreseeable future and transfers the resulting securities to the securities available for sale portfolio. This is generally accomplished by exchanging the loans for mortgage-backed securities issued primarily by Freddie Mac. Since the transfers are not considered a sale, no gain or loss is recorded in conjunction with these transactions.
Mortgage Servicing Rights
The carrying value of mortgage servicing rights is included as other assets in the Consolidated Balance Sheets. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing revenue. The amortization is adjusted prospectively in response to changes in estimated projections of future cash flows. BB&T periodically assesses mortgage servicing rights for impairment based on the fair value of those rights. Impairment is evaluated by strata, which are based on predominant risk characteristics, such as product,
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note rate and other terms. To the extent the carrying value of the servicing rights exceeds the fair value by strata, impairment is recognized through a valuation allowance established through a charge to mortgage banking income. The valuation allowance may be adjusted in the future as the value of the mortgage servicing rights increases or decreases. Mortgage servicing rights and any related valuation allowance are also periodically evaluated to determine whether any portion of the valuation allowance represents other than temporary impairment. Any reduction of mortgage servicing rights and related valuation allowance pursuant to this evaluation has no impact on the results of operations other than a reduction of future amortization of mortgage servicing rights. Revenues from originating, marketing and servicing mortgage loans as well as valuation adjustments related to capitalized mortgage servicing rights are included in mortgage banking income on the Consolidated Statements of Income.
Stock-Based Compensation
BB&T maintains various stock-based compensation plans. These plans provide for the granting of stock options (incentive and nonqualified), stock appreciation rights, restricted stock, restricted stock units, performance units and performance shares to selected BB&T employees and directors. All of BB&T’s stock-based compensation plans, except for plans assumed in connection with the First Virginia Banks, Inc. merger, have been presented to, and approved by BB&T’s shareholders. As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), BB&T currently accounts for share-based payments to employees using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations. Since the option price equaled the market price on the date of the grant for options awarded by BB&T, compensation cost has not been recognized for any of the periods presented, except with respect to restricted stock awards and awards that have been modified.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be expensed based on their fair values.
BB&T adopted SFAS No. 123(R) on January 1, 2006, using the modified-prospective method, which requires the recognition of compensation costs beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.
The adoption of the fair value method in SFAS No. 123(R) will have an impact on BB&T’s result of operations, although it will have no impact on BB&T’s overall financial position. The impact of adoption of SFAS No. 123(R) on BB&T’s result of operations cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, as of December 31, 2005 BB&T had $61.6 million, after-tax, of stock compensation expense for unvested awards that will be recognized as compensation expense over a weighted average life of approximately two years. Additionally, BB&T’s stock option grants contain a provision that accelerates vesting of options for holders that retire and have met retirement eligibility requirements. Currently, as part of the pro forma disclosures required by SFAS No. 123, BB&T reports a pro forma expense for the unrecognized compensation cost in the period that the accelerated vesting occurs. However, upon adoption of SFAS No. 123(R), BB&T will recognize compensation expense based on retirement eligibility dates for all share-based awards granted after the adoption of SFAS No. 123(R) that contain an accelerated vesting provision. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While BB&T cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amounts of operating cash flows recognized for such tax deductions during 2005, 2004 and 2003 were $16.0 million, $15.6 million and $13.0 million, respectively.
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The following table presents BB&T’s net income, basic earnings per share and diluted earnings per share as reported, and pro forma net income and pro forma earnings per share assuming compensation cost for BB&T’s stock option plans had been determined based on the fair value at the grant dates for awards under those plans granted after December 31, 1994, consistent with the method prescribed by SFAS No. 123.
(Dollars in thousands,
except per share data)
Net income:
Net income as reported
Add: Stock-based compensation expense included in reported net income, net of tax
Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of tax
Pro forma net income
Basic EPS:
As reported
Pro Forma
Diluted EPS:
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2005, 2004 and 2003, respectively:
Assumptions:
Risk-free interest rate
Dividend Yield
Volatility factor
Weighted average expected life
Fair value of options per share
Changes in Accounting Principles and Effects of New Accounting Pronouncements
In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans purchased by BB&T or acquired in business combinations. SOP 03-3 does not apply to loans originated by BB&T. BB&T adopted the provisions of SOP 03-3 effective January 1, 2005. The initial implementation had no effect on BB&T’s consolidated financial position or consolidated results of operations, but affects BB&T’s accounting for impaired loans purchased or acquired in business combinations.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29” (“SFAS No. 153”). SFAS No. 153 requires that exchanges of nonmonetary assets be accounted for at fair value unless the exchange lacks commercial substance. A nonmonetary exchange has commercial substance when the future cash flows of an entity are expected to change significantly as a result of
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the exchange. SFAS No. 153 also eliminates a provision in APB Opinion No. 29 that exempted nonmonetary exchanges of similar productive assets from fair value accounting. SFAS No. 153 was adopted for nonmonetary asset exchanges occurring after June 30, 2005. The adoption of SFAS No. 153 did not materially affect BB&T’s consolidated financial position or consolidated results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” (“SFAS No. 154”), which requires retrospective application for reporting a voluntary change in accounting principle, unless it is impracticable to do so. SFAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and also addresses the reporting of a correction of error by restating previously issued financial statements. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Management does not believe the adoption of SFAS No. 154 will have a material effect on the Company’s results of operations or financial position.
In July 2005, the FASB issued Proposed FASB Staff Position (“FSP”) FAS 13-a “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease”, which proposes to amend SFAS No. 13, “Accounting for Leases.” The proposed FSP would require recalculations of leveraged leases for changes that affect the timing of cash flows, even if the total amount of cash flows is not affected. If the FSP is finalized as currently proposed, it would require a one-time non-cash charge to be recorded as a cumulative effect of a change in accounting principle. The amount of the charge related to the previously recognized lease income, if any, would then be recognized into income over the remaining lives of the respective leases. While BB&T has entered into leveraged lease transactions in prior years that may require recalculations, any impact on BB&T’s consolidated financial position or consolidated results of operations cannot currently be predicted with certainty, because the final timing and provisions of the proposal have yet to be determined.
In July 2005, the FASB issued a Proposed Interpretation of SFAS No. 109 “Accounting for Income Taxes” entitled “Accounting for Uncertain Tax Positions”. The proposed Interpretation would clarify the criteria under which tax benefits could be recognized under SFAS No. 109. If the proposed Interpretation is finalized as currently proposed it would require a one-time non-cash charge to be recorded as a cumulative effect of a change in accounting principle. While BB&T is currently evaluating the potential impact of this proposed Interpretation, any impact on BB&T’s consolidated financial position or consolidated results of operations cannot currently be predicted with certainty, because the final timing and provisions of the proposal have yet to be determined.
In November, 2005, the FASB issued FSP FAS 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP provides additional guidance on when an investment in a debt or equity security becomes impaired and when the impairment is considered other than temporary and recognized as a loss in earnings. The guidance also requires certain disclosures for unrealized losses that have not been recognized as other-than-temporary impairments. This FSP was effective for reporting periods beginning after December 15, 2005. The adoption of this FSP will not materially affect BB&T’s consolidated financial position or consolidated results of operations.
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NOTE 2. Business Combinations
The following table presents summary information with respect to mergers and acquisitions of financial institutions and other significant financial services companies completed during 2004 and 2003. There have been no significant mergers completed during 2005.
Summary of Completed Mergers and Acquisitions
Date of Acquisition
Acquired Institution
Headquarters
Total Assets
IntangiblesRecorded
PurchaseConsideration
BB&TCommonSharesIssued toCompleteTransaction
April 14, 2004
February 1, 2004
July 1, 2003
March 14, 2003
Insurance and Other NonBank Acquisitions
During 2005, BB&T acquired five insurance businesses and four nonbank financial services companies, including the acquisition of a 70% ownership interest in Sterling Capital Management LLC, an investment management services company based in Charlotte, North Carolina. In conjunction with these transactions, BB&T issued approximately 1.2 million shares of common stock and paid approximately $136.4 million in cash. Approximately $104.4 million in goodwill and $85.2 million of identifiable intangible assets were recorded in connection with these transactions. BB&T acquired eight insurance agencies and three nonbank financial services companies during 2004. In conjunction with these transactions, BB&T issued approximately 1.4 million shares of common stock and paid approximately $74.2 million in cash. Approximately $49.7 million in goodwill and $34.8 million of identifiable intangible assets were recorded in connection with these transactions. During 2003, BB&T acquired six insurance agencies. In conjunction with these transactions, BB&T issued approximately 1.7 million shares of common stock and paid approximately $1.0 million in cash. Approximately $42.3 million in goodwill and $30.9 million of identifiable intangible assets were recorded in connection with these transactions.
In connection with the acquisitions completed during 2005, BB&T offered additional incentives to the acquired companies to offset the loss of future cash flows previously received through ownership positions. These amounts will be charged to goodwill based on the terms of the agreement. The amounts payable under these agreements is $24.8 million and $84.2 million for acquisitions completed during 2005 and 2004, respectively.
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BB&T has incurred certain expenses in connection with business combinations. The following table presents the components of merger-related and restructuring charges included in noninterest expenses. This table includes increases to previously recorded merger-related accruals and period expenses for merger-related items that must be expensed as incurred. Items that are required to be expensed as incurred include certain expenses associated with systems conversions, data processing, training, and other costs.
Asset write-offs and other merger-related charges
Severance and personnel-related costs or credits include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination or reversals of previously estimated amounts, which typically occur in corporate support and data processing functions. Occupancy and equipment charges or credits represent merger-related costs or gains associated with lease terminations, obsolete equipment write-offs, and the sale of duplicate facilities and equipment. Credits may result when obsolete properties or equipment are sold for more than originally estimated. Systems conversions and related charges include expenses necessary to convert and combine the acquired branches and operations of merged companies. Marketing and public relations costs represent direct media advertising related to the acquisitions. The other merger-related charges are composed of asset and supply inventory write-offs, litigation accruals, and other similar charges.
In conjunction with the consummation of an acquisition and completion of other requirements, BB&T typically accrues certain merger-related expenses related to estimated severance and other-personnel related costs, lease terminations, disposal of duplicate facilities and equipment, termination of data processing contracts and other costs associated with the acquisition. The costs related to the acquired entity are accrued in accordance with the guidance in EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination”, and generally recorded as adjustments to the purchase price unless they are required to be expensed as incurred. The costs related to existing BB&T facilities and personnel are recorded in accordance with the guidance in SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS 112, “Employers’ Accounting for Postemployment Benefits”, as appropriate, and reflected as merger-related and restructuring charges on the Consolidated Statements of Income.
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The following tables present a summary of BB&T’s merger accrual activity for 2005 and 2004. The amounts presented as “Accrued at Acquisition” represent the estimated costs accrued in accordance with EITF 95-3 and recorded as adjustments to the purchase price of an acquisition. The amounts presented as “merger-related and restructuring charges” represent estimated costs that are incurred in connection with acquisitions, changes to estimates of previously accrued costs, and period expenses incidental to a business combination that must be expensed as incurred, such as expenses related to systems conversion, data processing, training, and other costs. The amounts presented as “utilized” represent the amounts paid in connection with merger-related accruals. The amounts presented as “purchase price adjustments” represent changes to estimates of previously accrued amounts and were recorded as adjustments to goodwill.
Balance
January 1,
Accrued at
acquisition
Merger-related
and
restructuring
charges
Purchase Price
Adjustments
The liabilities for severance and personnel-related costs will be paid out based on such factors as expected termination dates, the provisions of employment contracts and the terms of BB&T’s severance plans. The remaining occupancy and equipment accruals relate to costs to exit certain leases and to dispose of excess facilities and equipment. Such liabilities will be utilized upon termination of the various leases and sale of duplicate property. The other merger-related liabilities relate to litigation and other similar charges.
Severance and personnel-related costs or credits include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination or reversals of previously estimated amounts, which typically occur in corporate support and data processing functions. BB&T did not have any job eliminations in connection with mergers during 2005. During 2004, BB&T estimated that 200 positions would be eliminated and receive severance in connection with
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The following tables provide a summary of BB&T’s merger accrual activity, by acquisition, for 2005 and 2004:
First Citizens Corporation
First Liberty Financial Corporation
Premier Bancshares, Inc.
Hardwick Holding Company
First Banking Company of Southeast Georgia
One Valley Bancorp, Inc.
BankFirst Corporation
FCNB Corp.
FirstSpartan Financial Corp.
Century South Banks, Inc.
Virginia Capital Bancshares, Inc.
F&M National Corporation
Community First Banking Company
MidAmerica Bancorp
Area Bancshares Corporation
Equitable Bank
First Virginia Banks, Inc.
Republic Bancshares, Inc.
Nonbank subsidiaries
Other adjustments
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During 2004, BB&T recorded $17.0 million in adjustments to its merger related accruals that were reductions to goodwill, net of deferred taxes. Of this amount, $16.7 million were related to the acquisition of First Virginia and included $14.1 million of favorable settlements of information technology contracts as a result of leveraging existing relationships with vendors.
NOTE 3. Securities
The amortized costs and approximate fair values of securities held to maturity and available for sale were as follows:
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Accumulated other comprehensive income at December 31, 2005 and 2004 included $337.6 million and $87.5 million, respectively, of net after-tax unrealized losses relating to securities available for sale.
At December 31, 2005 and 2004, securities with carrying value of approximately $9.5 billion and $8.7 billion were pledged to secure municipal deposits, securities sold under agreements to repurchase, other borrowings, and for other purposes as required or permitted by law.
BB&T had certain investments in marketable debt securities and mortgage-backed securities from the Fannie Mae and Freddie Mac that exceeded ten percent of shareholders’ equity at December 31, 2005. Those investments had market values of $3.5 billion and $3.9 billion, respectively, at December 31, 2005. In addition, these investments had total amortized costs of $3.6 billion and $4.0 billion, respectively, at December 31, 2005. Trading securities totaling $706.5 million at December 31, 2005 and $334.3 million at December 31, 2004 are excluded from the accompanying tables.
Equity securities include investments in stock issued by the FHLB of Atlanta. At December 31, 2005 and 2004, BB&T held $343.7 million of investments in FHLB stock.
Proceeds from sales of securities available for sale during 2005, 2004 and 2003 were $1.3 billion, $2.3 billion and $12.3 billion, respectively. Gross gains of $12.9 million, $13.7 million and $180.4 million and gross losses of $12.8 million, $7.6 million and $54.1 million were realized on those sales in 2005, 2004 and 2003, respectively.
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The amortized cost and estimated fair value of the debt securities portfolio at December 31, 2005, by contractual maturity, are shown in the accompanying table. The expected life of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted average contractual maturities of underlying collateral.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total debt securities
Total equity securities
The following tables reflect the gross unrealized losses and fair value of BB&T’s investments at December 31, 2005 and 2004, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
Total temporarily impaired securities
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NOTE 4. Loans and Leases
Loans and leases, net of unearned income:
Total loans and leases (1)(2)
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The investment in lease receivables, net of unearned income, was $3.2 billion and $2.9 billion at December 31, 2005 and 2004, respectively. These balances included $1.6 billion investments in leveraged leases as follows:
Rentals receivable (net of principal and interest on nonrecourse debt and head lease obligation)
Unearned income
Investment in leveraged leases, net of unearned income
Deferred taxes arising from leveraged leases
Net investment in leveraged leases
BB&T had $54.1 billion in loans secured by real estate at December 31, 2005. However, these loans were not concentrated in any specific market or geographic area other than the Banks’ primary markets. Certain loans have been pledged as collateral for all outstanding Federal Home Loan Bank Advances at December 31, 2005 and 2004.
The following table sets forth certain information regarding BB&T’s impaired loans:
Total recorded investment—impaired loans
Total recorded investment with no related valuation allowance
Total recorded investment with related valuation allowance
Allowance for loan and lease losses assigned to impaired loans
Net carrying value—impaired loans
Average impaired loans for the years ended December 31, 2005, 2004, and 2003 totaled $53.7 million, $81.8 million and $181.2 million, respectively. The amount of interest that has been recognized as income on impaired loans for any of the last three years has not been significant.
NOTE 5. Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments
An analysis of the allowance for credit losses for each of the past three years is presented in the following table:
Beginning Balance
Allowance for acquired (sold) loans, net
Loans and leases charged-off
Recoveries of previous charge-offs
Net loans and leases charged-off
Ending Balance
The allowance for credit losses consists of the allowance for loan and lease losses, which is presented on the Consolidated Balance Sheets, and the reserve for unfunded lending commitments, which is included in other liabilities on the Consolidated Balance Sheets. At December 31, 2005, 2004 and 2003, the allowance for loan and lease losses totaled $825.3 million, $804.9 million and $784.9 million, respectively. The reserve for unfunded
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lending commitments totaled $4.5 million, $23.4 million and $8.5 million at December 31, 2005, 2004 and 2003, respectively.
At December 31, 2005, 2004 and 2003, loans and leases not currently accruing interest totaled $228.9 million, $268.6 million and $350.4 million, respectively. Loans 90 days or more past due and still accruing interest totaled $103.4 million, $100.2 million and $116.8 million at December 31, 2005, 2004 and 2003, respectively. The gross additional interest income that would have been earned if the loans and leases classified as nonaccrual had performed in accordance with the original terms was approximately $15.4 million, $17.8 million and $19.5 million in 2005, 2004 and 2003, respectively. Foreclosed property totaled $70.7 million, $88.9 million and $96.1 million at December 31, 2005, 2004 and 2003, respectively.
NOTE 6. Premises and Equipment
A summary of premises and equipment is presented in the accompanying table:
Land and land improvements
Buildings and building improvements
Furniture and equipment
Leasehold improvements
Construction in progress
Capitalized leases on premises and equipment
Less—accumulated depreciation and amortization
Net premises and equipment
Useful lives for premises and equipment are as follows: buildings and building improvements—40 years; furniture and equipment—5 to 10 years; leasehold improvements—estimated useful life or lease term, including certain renewals which were deemed probable at lease inception, whichever is less; and capitalized leases on premises and equipment—estimated useful life or remaining term of tenant lease, whichever is less. Certain properties are pledged to secure mortgage indebtedness totaling $1.7 million at December 31, 2005 and 2004.
BB&T has noncancelable leases covering certain premises and equipment. Many of the leases have one or more renewal options, generally for periods of two to five years. Total rent expense applicable to operating leases was $151.2 million, $109.4 million and $114.0 million for 2005, 2004 and 2003, respectively. Rental income from owned properties and subleases was $9.4 million, $10.4 million and $9.3 million for 2005, 2004 and 2003, respectively. Future minimum lease payments for operating and capitalized leases for years subsequent to 2005 are as follows:
Years ended December 31:
2006
2007
2008
2009
2010
2011 and later
Total minimum lease payments
Less—amount representing interest
Present value of net minimum payments on capitalized leases
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NOTE 7. Goodwill and Other Intangible Assets
The changes in the carrying amounts of goodwill attributable to each of BB&T’s operating segments for the years ended December 31, 2005 and 2004 are as follows:
Balance, January 1, 2004
Acquired goodwill, net
Adjustments to goodwill
Balance December 31, 2004
Balance, December 31, 2005
The adjustments to goodwill recorded during 2005 include $23.2 million of contingent consideration paid to acquired companies subsequent to the date of acquisition based on the terms of the purchase agreements and $3.1 million related to the accounting for property and equipment leases of acquired companies. The adjustments to goodwill in 2004 primarily reflect reallocations of purchase price subsequent to the dates of acquisition.
The following table presents the gross carrying amounts and accumulated amortization for BB&T’s identifiable intangible assets subject to amortization at the dates presented:
Identifiable intangible assets
Core deposit intangibles
Other (1)
Totals
During the years ended December 31, 2005, 2004 and 2003, BB&T incurred $112.3 million, $106.3 million and $55.7 million, respectively, in pretax amortization expenses associated with core deposit intangibles and other intangible assets. At December 31, 2005, the weighted-average remaining life of core deposit intangibles and other identifiable intangibles was 10.43 years and 11.10 years, respectively.
The following table presents estimated amortization expense for each of the next five years.
For the Year Ended December 31:
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NOTE 8. Loan Servicing
The following is an analysis of BB&T’s mortgage servicing rights arising from BB&T’s residential mortgage operations and commercial mortgage banking activities included in other assets in the Consolidated Balance Sheets:
For the Years Ended December 31,
Balance, January 1,
Amount capitalized
Acquired in purchase acquisitions
Amortization expense
Other than temporary impairment
Change in valuation allowance
Balance, December 31,
Following is an analysis of the aggregate changes in the valuation allowance for mortgage servicing rights in 2005, 2004 and 2003:
Valuation Allowance for
Provision for impairment
Provision recapture and other reductions
The unpaid principal balances of BB&T’s total residential mortgage servicing portfolio were $41.1 billion, $37.8 billion and $36.6 billion at December 31, 2005, 2004 and 2003, respectively. The unpaid principal balances of residential mortgage loans serviced for others were $25.8 billion, $24.5 billion and $24.9 billion at December 31, 2005, 2004 and 2003, respectively. Mortgage loans serviced for others are not included in loans on the accompanying Consolidated Balance Sheets.
During 2005, 2004 and 2003, BB&T sold residential mortgage loans with unpaid principal balances of $4.8 billion, $5.3 billion and $13.1 billion, respectively, and recognized pretax gains of $33.7 million, $36.2 million and $133.2 million, respectively, which were recorded in noninterest income as a component of mortgage banking income. BB&T retained the related mortgage servicing rights and receives servicing fees. At December 31, 2005 and 2004, the approximate weighted average servicing fee was .35% of the outstanding balance of the residential mortgage loans. The weighted average coupon interest rate on the portfolio of mortgage loans serviced for others was 5.83% and 5.86% at December 31, 2005 and 2004, respectively.
At December 31, 2005, BB&T had $275.8 million of residential mortgage loans sold with limited recourse liability. In the event of nonperformance by the borrower, BB&T has maximum recourse exposure of approximately $82.7 million on these mortgage loans.
BB&T also arranges and services commercial real estate mortgages through Laureate Capital, the commercial mortgage banking subsidiary of Branch Bank. During the years ended December 31, 2005, 2004 and 2003, Laureate Capital originated $2.0 billion, $1.6 billion and $1.7 billion, respectively, of commercial real estate mortgages, all of which were arranged for third party investors and serviced by Laureate Capital. Laureate
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Capital’s exposure to credit risk or interest rate risk as a result of these loans is minimal. As of December 31, 2005, 2004 and 2003, Laureate Capital’s portfolio of commercial real estate mortgages serviced for others totaled $8.1 billion, $6.7 billion and $6.9 billion, respectively. Commercial real estate mortgage loans serviced for others are not included in loans on the accompanying Consolidated Balance Sheets. Mortgage servicing rights related to commercial mortgage loans totaled $20.1 million, $14.3 million and $14.8 million at December 31, 2005, 2004 and 2003, respectively.
BB&T uses assumptions and estimates in determining the fair value of capitalized mortgage servicing rights. These assumptions include prepayment speeds, net charge-off experience and discount rates commensurate with the risks involved and comparable to assumptions used by market participants to value and bid servicing rights available for sale in the market. At December 31, 2005, the sensitivity of the current fair value of the residential mortgage servicing rights to immediate 10% and 20% adverse changes in key economic assumptions are included in the accompanying table, which excludes commercial mortgage servicing rights.
Fair Value of Residential Mortgage Servicing Rights
Weighted Average Life
Prepayment Speed
Effect on fair value of a 10% increase
Effect on fair value of a 20% increase
Expected Credit Losses
Weighted Average Discount Rate
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the mortgage servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the effect of the change.
The Company also has securitized residential mortgage loans and retained the resulting securities available for sale. As of December 31, 2005, the fair value of the securities available for sale still owned by BB&T was $769.2 million and the remaining unpaid principal balance of the underlying loans totaled $781.1 million. Based on the performance of the underlying loans and general liquidity of the securities, the Company’s recovery of the cost basis in the securities has not been significantly impacted by changes in interest rates, prepayment speeds or credit losses.
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The following table includes a summary of mortgage loans managed or securitized and related delinquencies and net charge-offs.
Mortgage Loans Managed or Securitized (1)
Less: Loans Securitized and Transferred to Securities Available for Sale
Less: Loans Held for Sale
Less: Mortgage Loans Sold with Recourse
Mortgage Loans Held for Investment
Mortgage Loans on Nonaccrual Status
Mortgage Loans 90 Days Past Due and Still Accruing Interest
Mortgage Loan Net Charge-offs
Federal funds purchased, securities sold under agreements to repurchase and short-term borrowed funds are summarized as follows:
Federal funds purchased
Securities sold under agreements to repurchase
Master notes
U.S. Treasury tax and loan deposit notes payable
Other short-term borrowed funds
Federal funds purchased represent unsecured borrowings from other banks and generally mature daily. Securities sold under agreements to repurchase are borrowings collateralized by securities of the U.S. government or its agencies and have maturities ranging from one day to 24 months. U.S. Treasury tax and loan deposit notes payable are payable to the U.S. Treasury upon demand or for periods of less than one month. Master notes are unsecured, non-negotiable obligations of BB&T Corporation (variable rate commercial paper) that mature in less than one year.
A summary of selected data related to Federal funds purchased, securities sold under agreements to repurchase and short-term borrowed funds follows:
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NOTE 10. Long-Term Debt
Long-term debt is summarized as follows:
7.25% Subordinated Notes Due 2007
6.375% Subordinated Notes Due 2025 (1)
6.50% Subordinated Notes Due 2011 (2,4)
4.75% Subordinated Notes Due 2012 (2,4)
5.20% Subordinated Notes Due 2015 (2,4)
4.90% Subordinated Notes Due 2017 (2,4)
5.25% Subordinated Notes Due 2019 (2,4)
Floating Rate Secured Borrowings Due 2007 (6)
Floating Rate Senior Notes Due 2007
Floating Rate Senior Notes Due 2008
4.875% Subordinated Notes Due 2013 (2,4)
Varying maturities to 2025 with a weighted average cost of 5.25%
Varying maturities to 2028 with interest rates from 8.90% to 15.78%
Junior Subordinated Debt to Unconsolidated Trusts (3)
Other Long-Term Debt
Hedging (Losses) Gains
Total Long-Term Debt
Excluding the capitalized leases set forth in Note 6, future debt maturities total $270.8 million, $3.2 billion, $504.2 million, $18.9 million and $252.0 million for the next five years. The maturities for 2011 and later years total $8.8 billion.
On June 30, 2005, BB&T exchanged $350 million of subordinated notes maturing in 2025 and bearing an interest rate of 6.375% for $400 million aggregate principal amount of subordinated global notes maturing in 2017 and bearing an interest rate of 4.90%. This exchange was accounted for in accordance with Emerging Issues Task Force 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” (“EITF 96-19”). The
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transaction gave rise to substantially similar debt as defined by EITF 96-19 and; therefore resulted in no immediate gain or loss. The loss and financing costs relating to this exchange were deferred and will be amortized over the life of the $400 million subordinated global note offering.
Junior Subordinated Debt to Unconsolidated Trusts
In July, 1997, Mason-Dixon Capital Trust (“MDCT”) issued $20 million of 10.07% Preferred Securities. MDCT, a statutory business trust created under the laws of the State of Delaware, was formed by Mason-Dixon Bancshares, Inc., (“Mason-Dixon”) for the sole purpose of issuing the Preferred Securities and investing the proceeds thereof in 10.07% Junior Subordinated Debentures issued by Mason-Dixon. Mason Dixon, which merged into BB&T on July 14, 1999, entered into agreements which, taken collectively, fully, irrevocably and unconditionally guarantee, on a subordinated basis, all of MDCT’s obligations under the Preferred Securities. MDCT’s sole asset is the Junior Subordinated Debentures issued by Mason-Dixon and assumed by BB&T, which mature June 15, 2027, but are subject to early mandatory redemption in whole under certain limited circumstances and are callable in whole or part anytime after June 15, 2007. The Preferred Securities of MDCT, are subject to mandatory redemption in whole on June 15, 2027, or such earlier date in the event the Junior Subordinated Debentures are redeemed by BB&T pursuant to one of the prescribed limited circumstances or pursuant to the call provisions.
In November, 1997, MainStreet Capital Trust I (“MSCT I”) issued $50 million of 8.90% Trust Securities. MSCT I, a statutory business trust created under the laws of the State of Delaware, was formed by MainStreet Financial Corporation, (“MainStreet”) for the sole purpose of issuing the Trust Securities and investing the proceeds thereof in 8.90% Junior Subordinated Debentures issued by MainStreet. MainStreet, which merged into BB&T on March 5, 1999, entered into agreements which, taken collectively, fully, irrevocably and unconditionally guarantee, on a subordinated basis, all of MSCT I’s obligations under the Trust Securities. MSCT I’s sole asset is the Junior Subordinated Debentures issued by MainStreet and assumed by BB&T, which mature December 1, 2027, but are subject to early mandatory redemption in whole under certain limited circumstances and are callable in whole or part anytime after December 1, 2007. The Trust Securities of MSCT I are subject to mandatory redemption in whole on December 1, 2027, or such earlier date in the event the Junior Subordinated Debentures are redeemed by BB&T pursuant to one of the prescribed limited circumstances or pursuant to the call provisions. One Valley Bancorp, Inc., which merged into BB&T Corporation on July 6, 2000 and a subsidiary of Mason-Dixon Bancshares, Inc, which merged into BB&T on July 14, 1999, each owned $2 million of the Trust Securities issued by MSCT I.
In November, 1997, Premier Capital Trust I (“PCT I”) issued $28.75 million of 9.00% Preferred Securities. PCT I, a statutory business trust created under the laws of the State of Delaware, was formed by Premier Bancshares, Inc., (“Premier”) for the purpose of issuing the Preferred Securities and investing the proceeds thereof in 9.00% Junior Subordinated Debentures issued by Premier. Premier, which merged into BB&T on January 13, 2000, entered into agreements which, taken collectively, fully, irrevocably and unconditionally guarantee, on a subordinated basis, all of PCT I’s obligations under the Preferred Securities. PCT I’s sole asset is the Junior Subordinated Debentures issued by Premier and assumed by BB&T, which mature December 31, 2027, but are subject to early mandatory redemption in whole under certain limited circumstances and are callable in whole or part anytime after December 31, 2007. The Preferred Securities of PCT I, are subject to mandatory redemption in whole on December 31, 2027, or such earlier date in the event the Junior Subordinated Debentures are redeemed by BB&T pursuant to one of the prescribed limited circumstances or pursuant to the call provisions.
In August 2005, BB&T Capital Trust I (“BBTCT”) issued $500 million of 5.85% Capital Securities. BBTCT, a statutory business trust created under the laws of the State of Delaware, was formed by BB&T for the sole purpose of issuing the Capital Securities and investing the proceeds thereof in 5.85% Junior Subordinated Debentures issued by BB&T. BB&T is the sole owner of the common securities of BBTCT and has made guarantees which, taken collectively, fully, irrevocably, and unconditionally guarantee, on a subordinated basis,
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all of BBTCT’s obligations under the Trust and Capital Securities. BBTCT’s sole asset is the Junior Subordinated Debentures issued by BB&T, which mature August 18, 2035, but are subject to early redemption (i) in whole or in part at any time at the option of BB&T pursuant to the optional redemption provisions of such security, or (ii) in whole, but not in part, under certain prescribed limited circumstances. The Capital Securities of BBTCT are subject to mandatory redemption in whole or in part, upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption.
NOTE 11. Shareholders’ Equity
The authorized capital stock of BB&T consists of 1,000,000,000 shares of common stock, $5 par value, and 5,000,000 shares of preferred stock, $5 par value. At December 31, 2005, 543,102,080 shares of common stock and no shares of preferred stock were issued and outstanding.
Stock Option Plans
At December 31, 2005, BB&T had options and restricted shares outstanding from the following stock-based compensation plans: the 2004 Stock Incentive Plan, the 1995 Omnibus Stock Incentive Plan (“Omnibus Plan”), and the Non-Employee Directors’ Stock Option Plan (“Directors’ Plan”), which are described below. All plans generally allow for accelerated vesting of options or restricted shares for holders that retire and have met retirement eligibility requirements. BB&T’s shareholders have approved all plans that award incentive stock options, non-qualified stock options, shares of restricted stock, performance shares and stock appreciation rights with the exception of plans assumed from acquired companies. As of December 31, 2005, the 2004 Stock Incentive Plan is the only plan that has shares available for future grants.
BB&T’s 2004 Stock Incentive Plan is intended to assist the Corporation in recruiting and retaining employees, directors and independent contractors and to associate the interests of eligible participants with those of BB&T and its shareholders. At December 31, 2005 there were 2.1 million nonqualified stock options and 260 thousand restricted shares outstanding under this plan. The options outstanding under the plan generally vest ratably over five years and have a ten-year term. At December 31, 2005, there were 22.6 million shares remaining available to grant under this plan.
BB&T’s Omnibus Plan was intended to allow BB&T to recruit and retain employees with ability and initiative and to associate the employees’ interests with those of BB&T and its shareholders. At December 31, 2005, 8.2 million qualified stock options at prices ranging from $9.42 to $48.01 and 23.4 million non-qualified stock options at prices ranging from $8.90 to $53.10 were outstanding. The stock options generally vest over 3 to 5 years and have a 10-year term.
The Directors’ Plan was intended to provide incentives to non-employee directors to remain on the Board of Directors and share in the profitability of BB&T. In 2005, the plan was amended and no future grants will be awarded in connection with this plan. At December 31, 2005, options to purchase 697 thousand shares of common stock at prices ranging from $11.04 to $31.80 were outstanding pursuant to the Directors’ Plan.
BB&T also has option plans outstanding as the result of assuming the plans of acquired companies. At December 31, 2005, there were 433 thousand stock options outstanding in connection with these plans, with option prices ranging from $16.53 to $29.54.
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A summary of the status of the Company’s stock incentive plans at December 31, 2005, 2004 and 2003 reflecting changes during the years then ended is presented below:
Outstanding at beginning of year
Issued in purchase transactions
Granted
Exercised
Forfeited or Expired
Outstanding at end of year
Exercisable at year-end
The following table summarizes information about the Company’s stock awards outstanding at December 31, 2005:
Options/Restricted Shares
Exercisable
Range of
Exercise Prices
Weighted-Average
RemainingContractual Life
Exercise Price
$ — to $ —
0.01 to 10.00
10.01 to 15.00
15.01 to 25.00
25.01 to 35.00
35.01 to 45.00
45.01 to 53.10
During the years ended December 31, 2005, 2004 and 2003, BB&T repurchased 12.0 million shares, 11.3 million shares and 21.5 million shares of common stock, respectively. At December 31, 2005, BB&T was authorized to repurchase 23.4 million shares under the August 26, 2003, Board of Directors’ authorization.
Note 12. Income Taxes
The provision for income taxes was comprised of the following:
Current expense (benefit):
Federal
State
Foreign
Total current expense
Deferred expense:
Total deferred expense
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The income tax provisions in the above table do not include the effects of income tax deductions resulting from exercises of stock options, which amounted to $16.0 million, $15.6 million and $13.0 million in 2005, 2004 and 2003, respectively, and were recorded as increases to shareholders’ equity. The foreign income tax expense is related to income generated on assets controlled by a foreign subsidiary of Branch Bank.
The reasons for the difference between the provision for income taxes and the amount computed by applying the statutory Federal income tax rate to income before income taxes were as follows:
Federal income taxes at statutory rate of 35%
Increase (decrease) in provision for income taxes as a result of:
Tax-exempt income from securities, loans and leases, net of related non-deductible interest expense
Tax-exempt life insurance income
Option contracts on leveraged leases
State income taxes, net of Federal tax benefit
Effective income tax rate
BB&T has entered into certain transactions that have favorable tax treatment. These transactions include loans and investments that produce tax-exempt income, reducing BB&T’s effective tax rate from the statutory rate. On a periodic basis, BB&T evaluates its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. In this regard, during 2003 BB&T determined that it was appropriate to defer recognition of benefits from option contracts transferring responsibility for management of future residuals in certain leveraged lease investments to a foreign subsidiary until such benefits were realized for income tax purposes and recorded adjustments to reflect that determination.
The tax effects of temporary differences that gave rise to significant portions of the net deferred tax assets (liabilities) included in other liabilities in the “Consolidated Balance Sheets” were:
Deferred compensation
Unrealized (gain)/loss on securities available for sale
Other
Total deferred tax assets
Lease financing
Prepaid pension plan expense
Loan servicing rights
Unamortized FHLB loan prepayment fees
Total deferred tax liabilities
Net deferred tax liabilities
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Securities transactions resulted in income tax expense (benefit) of $(159 thousand), $2.4 million, and $46.9 million related to securities gains for the years ended December 31, 2005, 2004 and 2003, respectively.
In the normal course of business, BB&T is subject to examinations from various tax authorities. These examinations may alter the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. During 2003, the IRS concluded its examination of BB&T’s federal income tax returns for the years ended December 31, 1996, 1997 and 1998. Following its examination, the IRS issued a Revenue Agent Report assessing taxes and interest in the amount of $59.3 million related to BB&T’s income tax treatment of certain leveraged lease transactions which were entered into during the years under examination. The assessment, which was paid by BB&T during 2003, did not affect BB&T’s consolidated results of operations in 2003 as it related primarily to differences in the timing of recognizing income and deductions for income tax purposes for which deferred taxes had been previously provided. Management continues to believe that BB&T’s treatment of these leveraged leases was appropriate and in compliance with existing tax laws and regulations for the years examined. BB&T filed a refund request for the taxes and interest related to this matter which was denied by the IRS during the second quarter of 2004. In the fourth quarter of 2004, BB&T filed a lawsuit in the United States District Court for the Middle District of North Carolina to pursue a refund of $3.3 million in taxes plus interest assessed by the IRS related to one of these leveraged lease transactions entered into during 1997. While management expects that this litigation will not be resolved for one to two years, management believes that there will be no material impact on the consolidated results of operations or the consolidated financial position of BB&T, regardless of the outcome of this litigation. Management continues to evaluate its alternatives with regard to the remaining amounts paid, which are related to BB&T’s tax treatment of leveraged lease transactions for the year ended December 31, 1998.
NOTE 13. Benefit Plans
BB&T provides various benefit plans to substantially all employees, including employees of acquired entities. Employees of acquired entities generally participate in existing BB&T plans after consummation of the business combinations. The plans of acquired institutions are typically merged into the BB&T plans after consummation of the mergers, and, under these circumstances, credit is usually given to these employees for years of service at the acquired institution for vesting and eligibility purposes.
The following table summarizes expenses (income) relating to employee retirement plans:
Defined benefit plans
Defined contribution and ESOP plans
Postretirement benefit plans
Total expense related to benefit plans
Defined Benefit Retirement Plans
BB&T provides a defined benefit retirement plan qualified under the Internal Revenue Code that covers substantially all employees. Benefits are based on years of service, age at retirement and the employee’s compensation during the five highest consecutive years of earnings within the last ten years of employment.
In addition, supplemental retirement benefits are provided to certain key officers under supplemental defined benefit executive retirement plans, which are not qualified under the Internal Revenue Code. Although technically unfunded plans, a Rabbi Trust and insurance policies on the lives of the certain covered employees partially finance future benefits.
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The following are the significant actuarial assumptions that were used to determine net periodic pension costs:
Weighted average assumed discount rate
Weighted average expected long-term rate of return on plan assets
Assumed rate of annual compensation increases
The weighted average expected long-term rate of return on plan assets represents the average rate of return expected to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, BB&T considers long-term compound annualized returns of historical market data for each asset category, as well as historical actual returns on the Company’s plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted average expected long-term rate of return for the plan based on target asset allocations contained in BB&T’s Investment Policy Statement.
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Financial data relative to the defined benefit pension plans is summarized in the following tables for the years indicated. The data is calculated using an actuarial measurement date of December 31.
Net Periodic Pension Cost
Service cost
Interest cost
Estimated return on plan assets
Net amortization and other
Net periodic pension cost
The following are the significant actuarial assumptions that were used to determine benefit obligations:
Actuarial Assumptions
Qualified
Pension Plan
Nonqualified
Pension Plans
Change in Projected Benefit Obligation
Projected benefit obligation, January 1,
Actuarial (gain) loss
Benefits paid
Change in plan provisions
Plans of acquired entities (1)
Projected benefit obligation, December 31,
Change in Plan Assets
Fair value of plan assets, January 1,
Actual return on plan assets
Employer contributions
Fair value of plan assets, December 31,
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Net Amount Recognized
Funded status
Unrecognized prior service cost
Unrecognized net loss (gain)
Net amount recognized
Reconciliation of Net Pension Asset (Liability)
Prepaid pension cost, January 1,
Contributions
Purchase accounting recognition
Prepaid (accrued) pension cost, December 31,
The accumulated benefit obligation for the qualified plans totaled $874.8 million and $822.7 million at December 31, 2005 and 2004, respectively. For the nonqualified plans, the accumulated benefit obligation totaled $92.1 million and $87.4 million at December 31, 2005 and 2004, respectively. BB&T had recorded a minimum pension liability of $8.4 million and $4.6 million in connection with its nonqualified plans at December 31, 2005 and 2004, respectively and had recorded $5.2 million and $3.0 million, net of tax, as accumulated other comprehensive income for this minimum pension liability, at December 31, 2005 and 2004, respectively.
Employer contributions to the qualified pension plan are in amounts between the minimum required for funding standard accounts and the maximum amount deductible for federal income tax purposes. Management is not required to make a contribution to the qualified pension plan during 2006; however, management elected to make a discretionary contribution of $80 million in the first quarter of 2006, and may make additional contributions in 2006 if determined appropriate. For the nonqualified plans the employer contributions are based on benefit payments. The following table reflects the estimated benefit payments reflecting expected future service for the next five years and for the years 2011 through 2015:
Estimated Benefit Payments
2011-2015
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The allocation of plan assets for the defined benefit pension plans, by asset category, is as follows at December 31, 2005 and 2004.
Allocation of Plan Assets
Equity securities
Debt securities
Cash equivalents
The plan assets included 964 thousand shares valued at $40.4 million and 936 thousand shares valued at $39.4 million of BB&T common stock at December 31, 2005 and 2004, respectively.
BB&T’s primary total return objective for plan assets is, over a full market cycle, to exceed the rate of inflation by at least 4% per year and to compare favorably to a universe of peer portfolios comprised of a similar group of investments. The plan assets have a long-term, indefinite time horizon that runs concurrent with the average life expectancy of the participants. As such, the Plan can assume a time horizon that extends well beyond a full market cycle, and can assume an above-average level of risk, as measured by the standard deviation of annual return. It is expected, however, that both professional investment management and sufficient portfolio diversification will smooth volatility and help to generate a reasonable consistency of return. The investments are broadly diversified among economic sector, industry, quality and size in order to reduce risk and to produce incremental return. Within approved guidelines and restrictions, investment managers have wide discretion over the timing and selection of individual investments.
The target asset allocations for the plan assets include a range of 40% to 80% for equity securities, 20% to 60% for debt securities, with any remainder to be held in cash equivalents. Equities are expected to be maintained at a risk level approximately equivalent to that of the equity market as a whole, with investments generally restricted to high-quality, marketable securities of corporations with minimum market capitalization of $100 million that are actively traded. No single major industry may represent more than 25% of the total market value of the plan, and no single security may represent more than 10% of the total market value. Investments in debt securities are intended to provide both diversification and a predictable and dependent source of income, and may include appropriately-liquid preferred stocks, corporate debt securities and obligations of the U.S. Government and its agencies or mutual funds investment in these types of securities. Investments in a single issuer, other than the U.S. Government, may not exceed 5% of the total market value of the plan assets. No more than 15% of the corporate debt securities in the debt securities portfolio may be rated below investment grade. Cash equivalent investments may include the highest quality commercial paper, repurchase agreements, Treasury Bills, certificates of deposit and money market funds to provide income and liquidity for expense payments.
Postretirement Benefits Other than Pension
BB&T provides certain postretirement benefits. These benefits provide covered employees a subsidy for purchasing health care and life insurance. During 2004, BB&T changed its postretirement benefit to eliminate the subsidy for those employees retiring after December 31, 2004. BB&T also reduced the subsidy paid to employees who retired on or before December 31, 2004, were age 55 years or older, and had at least ten years of service. For those employees, the subsidy is based upon years of service of the employee at the time of retirement. The effect of the change in subsidy has been accounted for as a plan amendment and reduced the projected benefit obligation by $95.5 million, which is being amortized as a reduction of benefit costs over approximately 17 years. Employer contributions to the plan are based on benefit payments.
The estimated benefit payments for other postretirement benefits are $3.5 million, $3.2 million, $2.9 million, $2.7 million and $2.5 million for the next five years and $6.4 million for the years 2011 through 2015.
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The following are the significant actuarial assumptions that were used to determine postretirement benefit plans other than pension costs and obligations:
Medical trend rate—initial year
Medical trend rate—ultimate
The following tables set forth the components of the retiree benefit plan and the amounts recognized in the consolidated financial statements at December 31, 2005, 2004 and 2003 using a measurement date for actuarial calculations as of December 31. Because of the change in subsidy to the plan effective in 2004, management does not believe that any subsidy that may be provided by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 would be material. Therefore, no subsidy has been included in the actuarial calculation.
Net Periodic Postretirement Benefit (Income) Cost:
Amortization and other
Total (income) expense
Plan participants’ contributions
Actuarial loss (gain)
Plan amendments
Years Ended
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Unrecognized net actuarial (gain) loss
Reconciliation of Postretirement Benefit
Accrued postretirement benefit, January 1,
Net periodic postretirement benefit income (cost)
Adjustment for additional claims
Accrued postretirement benefit, December 31,
The following table provides the impact that changes in the assumed health care trend rate would have on the net periodic cost of the postretirement plan and the accumulated benefit obligation. Because of the change in subsidy to the plan in 2004 and the demographics of the plan, the effects of changing the assumed health care trend rate produces the opposite effect that would be expected if this was an ongoing plan.
Impact of a 1% change in assumed health care cost on:
Service and interest costs
Accumulated postretirement benefit obligation
Defined Contribution Plans
BB&T offers a 401(k) Savings Plan and other defined contribution plans that permit employees with more than 90 days of service to contribute from 1% to 25% of their compensation. For full-time employees who are 21 years of age or older with one year or more of service, BB&T makes matching contributions of up to 6% of the employee’s compensation. BB&T’s contribution to the 401(k) Savings Plan and nonqualified defined contribution plans totaled $56.9 million, $53.4 million and $45.7 million for the years ended December 31, 2005, 2004 and 2003, respectively. BB&T also offers defined contribution plans to certain employees of subsidiaries who do not participate in the 401(k) Savings Plan.
There are various other employment contracts, deferred compensation arrangements and covenants not to compete with selected members of management and certain retirees.
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Note 14. Commitments and Contingencies
BB&T utilizes a variety of financial instruments to meet the financing needs of clients and to reduce exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees, interest rate caps, floors and collars, interest rate swaps, swaptions, when-issued securities, options written and forward and futures contracts. BB&T also has commitments to fund certain affordable housing investments and contingent liabilities of certain sold loans. The following table presents the contractual or notional amount of these instruments:
Financial instruments whose contract amounts represent credit risk:
Commitments to extend, originate or purchase credit
Financial instruments whose notional or contract amounts exceed the amount of credit risk:
Derivative financial instruments
Commitments to fund low income housing investments
Mortgage loans sold with recourse
Commitments to extend, originate or purchase credit are primarily lines of credit to businesses and consumers and have specified rates and maturity dates. Many of these commitments also have adverse change clauses, which allow BB&T to cancel the commitment due to deterioration in the borrowers’ creditworthiness.
Standby letters of credit and financial guarantees written are unconditional commitments issued by BB&T to guarantee the performance of a customer to a third party. As of December 31, 2005, BB&T had issued $2.7 billion in such guarantees. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper issuance, bond financing and similar transactions. The credit risk involved in the issuance of these guarantees is essentially the same as that involved in extending loans to clients and as such, the instruments are collateralized when necessary.
Commercial letters of credit are short-term commitments issued primarily to facilitate trade finance activities for clients and are generally collateralized by the goods being shipped to the client.
In the ordinary course of business, BB&T indemnifies its officers and directors to the fullest extent permitted by law against liabilities arising from pending litigation. BB&T also issues standard representation warranties in underwriting agreements, merger and acquisition agreements, loan sales, brokerage activities and other similar arrangements. Counterparties in many of these indemnifications provide similar indemnifications to BB&T. Although these agreements often do not specify limitations, BB&T has not been required to act on the guarantees and does not believe that any payments pursuant to them would materially change the financial condition or results of operations of the company.
Merger and acquisition agreements of businesses other than financial institutions occasionally include additional incentives to the acquired entities to offset the loss of future cash flows previously received through ownership positions. Typically, these incentives are based on the acquired entity’s contribution to BB&T’s earnings compared to agreed-upon amounts. When offered, these incentives are typically issued for terms of three to eight years. As certain provisions of these agreements do not specify dollar limitations, it is not possible to quantify the maximum exposure resulting from these agreements.
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Forward commitments to sell mortgage loans and mortgage-backed securities are contracts for delayed delivery of securities in which BB&T agrees to make delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities’ values and interest rates.
BB&T invests in certain affordable housing and historic building rehabilitation projects throughout its market area as a means of supporting local communities, and receives tax credits related to these investments. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. BB&T’s Banks typically provide financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. BB&T’s outstanding commitments to fund affordable housing investments totaled $172.4 million and $215.2 million at December 31, 2005 and 2004, respectively.
Legal Proceedings
The nature of the business of BB&T’s banking and other subsidiaries ordinarily results in a certain amount of litigation. The subsidiaries of BB&T are involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Based on information currently available, advice of counsel, available insurance coverage and established reserves, BB&T’s management believes that the liabilities, if any, arising from these proceedings will not have a materially adverse effect on the consolidated financial position, consolidated results of operations or consolidated cash flows of BB&T. However, in the event of unexpected future developments, it is possible that the ultimate resolution of these matters, if unfavorable, may be material to BB&T’s consolidated financial position, consolidated results of operations or consolidated cash flows.
NOTE 15. Regulatory Requirements and Other Restrictions
BB&T’s Banks are required by the Board of Governors of the Federal Reserve System to maintain reserve balances in the form of vault cash or deposits with the Federal Reserve Bank based on specified percentages of certain deposit types, subject to various adjustments. At December 31, 2005, the net reserve requirement amounted to $422.9 million.
BB&T’s Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well-capitalized” under the prompt corrective action regulations. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. At December 31, 2005, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $3.2 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $880.7 million.
BB&T is subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on BB&T’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of BB&T’s assets, liabilities and certain off-balance-sheet items calculated pursuant to regulatory directives. BB&T’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. BB&T is in full compliance with these requirements. Banking regulations also identify five capital categories for insured depository institutions: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 2005 and 2004, BB&T and each of the Banks were classified as “well capitalized”.
Quantitative measures established by regulation to ensure capital adequacy require BB&T to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average tangible assets (leverage ratio).
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The following table provides summary information regarding regulatory capital for BB&T and its significant banking subsidiaries as of December 31, 2005 and 2004:
Minimum
Requirement
CapitalRequirement
BB&T
Branch Bank
BB&T—SC
BB&T—VA
As an approved seller/servicer, one of our Banks is required to maintain minimum levels of shareholders’ equity, as specified by various agencies, including the United States Department of Housing and Urban Development, Government National Mortgage Association, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association. At December 31, 2005 and 2004, this subsidiary’s equity was above all required levels.
At December 31, 2005 and 2004, BB&T’s broker/dealer subsidiaries had restricted cash deposits totaling $85.2 million and $122.2 million, respectively. These deposits relate to monies held for the exclusive benefit of clients.
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NOTE 16. Parent Company Financial Statements
Parent Company
Condensed Balance Sheets
Interest-bearing bank balances
Investment in banking subsidiaries
Investment in other subsidiaries
Total investments in subsidiaries
Advances to / receivables from banking subsidiaries
Advances to / receivables from other subsidiaries
Premises and equipment
Short-term borrowed funds
Short-term borrowed funds due to subsidiaries
Dividends payable
Long-term debt due to subsidiaries
Condensed Income Statements
Dividends from banking subsidiaries
Dividends from other subsidiaries
Interest and other income from subsidiaries
Other income (loss)
Total income
Total expenses
Income before income taxes and equity in undistributed earnings of subsidiaries
Income tax benefit
Income before equity in undistributed earnings of subsidiaries
Equity in undistributed earnings of subsidiaries in excess of (less than) dividends from subsidiaries
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Condensed Statements of Cash Flows
Equity in earnings of subsidiaries (in excess of) less than dividends from subsidiaries
Depreciation of premises and equipment
Amortization of unearned compensation
Discount accretion and premium amortization
(Gain) loss on sales of securities
Decrease (increase) in other assets
Increase (decrease) in accounts payable and accrued liabilities
Investment in subsidiaries
Advances to subsidiaries
Proceeds from repayment of advances to subsidiaries
Net cash paid in purchase accounting transactions
Net increase in long-term debt
Net increase (decrease) in short-term borrowed funds
Net (decrease) increase in advances from subsidiaries
Net cash used in financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Year
Cash and Cash Equivalents at End of Year
NOTE 17. Disclosures about Fair Value of Financial Instruments
A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity.
Estimates of the fair value of BB&T’s financial instruments are presented in the accompanying tables. Fair value estimates are made at a point in time, based on relevant market data and information about the financial instrument. Fair values should be calculated based on the value of one trading unit without regard to any
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premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, estimated transaction costs that may result from bulk sales or the relationship between various financial instruments. No readily available market exists for a significant portion of BB&T’s financial instruments. Fair value estimates for these instruments are based on judgments regarding current economic conditions, currency and interest rate risk characteristics, loss experience and other factors. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision. Therefore, the calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. In addition, changes in assumptions could significantly affect these fair value estimates.
The following methods and assumptions were used by BB&T in estimating the fair value of its financial instruments:
Cash and cash equivalents: For these short-term instruments, the carrying amounts are a reasonable estimate of fair values.
Securities: Fair values for securities are based on quoted market prices, if available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities.
Loans receivable and loans held for sale: The fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and credit quality. The carrying amounts of accrued interest approximate fair values. The fair values of loans held for sale, which are primarily residential mortgage loans, are based on quoted market prices and the projected value of the net servicing fees.
Deposit liabilities: The fair values for demand deposits, interest-checking accounts, savings accounts and certain money market accounts are, by definition, equal to the amount payable on demand at the reporting date, i.e., their carrying amounts. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to aggregate expected maturities.
Federal funds purchased, securities sold under repurchase agreements and short-term borrowed funds: The carrying amounts of Federal funds purchased, borrowings under repurchase agreements and short-term borrowed funds approximate their fair values.
Long-term debt: The fair values of long-term debt are estimated based on quoted market prices for the instrument if available, or for similar instruments if not available, or by using discounted cash flow analyses, based on BB&T’s current incremental borrowing rates for similar types of instruments.
Derivative financial instruments: The fair values of derivative financial instruments are determined based on external pricing sources and dealer quotes. The fair value of most interest rate lock commitments, which are related to residential mortgage loan commitments, are based on quoted market prices adjusted for commitments that BB&T does not expect to fund, excluding any value attributable to the net servicing fee.
Contractual commitments: The fair values of commitments are estimated using the fees charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair values also consider the difference between current levels of interest rates and the committed rates. The fair values of guarantees and letters of credit are estimated based on the counterparties’ creditworthiness and average default rates for loan products with similar risks. The fair values of commitments to fund affordable housing investments are estimated using the net present value of future commitments.
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The following is a summary of the carrying amounts and fair values of BB&T’s financial assets and liabilities:
Cash and cash equivalents
Securities available for sale
Securities held to maturity
Derivative assets
Loans (1)
Leases
Derivative liabilities
Capitalized leases
NA—not applicable.
The following is a summary of the notional or contractual amounts and fair values of BB&T’s off-balance sheet financial instruments and other commitments:
Contractual commitments:
Standby and commercial letters of credit and financial guarantees written
Commitments to fund affordable housing investments
N/A—not applicable.
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NOTE 18. Derivative Financial Instruments
The following tables set forth certain information concerning BB&T’s derivative financial instruments at December 31, 2005 and 2004:
Receive fixed swaps
Pay fixed swaps
Forward starting receive fixed swaps
Forward starting pay fixed swaps
Caps, floors and collars
Foreign exchange contracts
Futures contracts
Interest rate lock commitments
Forward commitments
Swaptions
When-issued securities
Options on contracts purchased
Options on contracts sold
Commercial mortgage index swap
BB&T’s receive fixed swaps had weighted average receive rates of 4.74% and 4.61% and weighted average pay rates of 4.28% and 2.63% at December 31, 2005 and 2004, respectively. In addition, BB&T’s pay fixed swaps had weighted average receive rates of 4.29% and 2.40% and weighted average pay rates of 3.97% and 3.37% at December 31, 2005 and 2004, respectively.
The following tables disclose data with respect to BB&T’s derivative financial instrument classifications and hedging relationships:
Derivative Classifications and Hedging Relationships
Notional
Amount
Derivatives Designated as Cash Flow Hedges:
Hedging business loans
Hedging institutional certificates of deposit, other time deposits and federal funds purchased
Hedging medium term bank notes
Derivatives Designated as Fair Value Hedges:
Hedging long-term debt
Derivatives Not Designated as Hedges
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At December 31, 2005 and 2004, BB&T had designated notional values of $3.4 billion and $3.0 billion, respectively, of derivatives as fair value hedges. At December 31, 2005, fair value hedges reflected a net unrealized loss of approximately $26.1 million, with instruments in a gain position reflecting a fair value of $32.1 million recorded in other assets and instruments in a loss position with a fair value of $58.2 million recorded in other liabilities. At December 31, 2004, derivatives designated as fair value hedges reflected a net unrealized gain of $62.6 million, composed of instruments in a gain position with a fair value of $72.5 million and instruments in a loss position with a fair value of $9.9 million. The impact on earnings during 2005 resulting from fair value hedge ineffectiveness was a loss of $2.1 million. There was no impact on earnings during 2004 or 2003 resulting from fair value hedge ineffectiveness.
At December 31, 2005 and 2004, BB&T had designated derivatives with notional values of $4.3 billion and $7.0 billion, respectively, as cash flow hedges. The instruments had a net estimated fair value of $8.0 million and $(3.4 million) at December 31, 2005 and 2004, respectively. The effect on earnings resulting from the ineffectiveness of cash flow hedges was not material for 2005, 2004 or 2003.
Accumulated other comprehensive income includes $13.5 million and $20.7 million of net after-tax unrecognized losses attributable to cash flow hedges at December 31, 2005 and 2004, respectively. The estimated net amount of the unrecognized losses reflected in accumulated other comprehensive income at December 31, 2005 that is expected to be reclassified into earnings within the next 12 months is $4.1 million. During 2005, 2004 and 2003, BB&T reclassified into earnings from other comprehensive income after-tax net gains of $2.6 million, $42.2 million and $42.5 million, respectively.
Accumulated other comprehensive income included $22.1 million and $8.0 million in unrecognized after-tax losses on interest rate swaps and collars hedging variable interest payments on business loans at December 31, 2005 and 2004, respectively. These amounts included unrecognized after-tax losses on previously terminated and de-designated swaps of $10.6 million and $4.8 million at December 31, 2005 and 2004, respectively. In addition, accumulated other comprehensive income included $8.6 million in net unrecognized gains and $12.7 million in net unrecognized losses on interest rate swaps and caps hedging variable interest payments on federal funds purchased, institutional certificates of deposit, other time deposits and medium term bank notes at December 31, 2005 and 2004, respectively. These amounts included unrecognized after-tax losses of $7.5 million and $13.6 million on interest rate caps at December 31, 2005 and 2004, respectively. BB&T’s floating rate business loans, federal funds purchased, institutional certificates of deposit, other time deposits and medium term bank notes expose it to variability in cash flows for interest payments. The risk management objective for these assets and liabilities is to hedge the variability in the interest payments. This objective is met by entering into interest rate swaps, and interest rate collars and caps. Interest rate collars and caps fix the interest payments when interest rates on the hedged item exceed predetermined rates.
All of BB&T’s cash flow hedges are hedging exposure to variability in future cash flows for forecasted transactions related to the payment of variable interest on then existing financial instruments. The maximum length of time over which BB&T is hedging its exposure to the variability in future cash flows for forecasted transactions related to variable interest payments on existing financial instruments is 4.8 years.
BB&T also held $16.0 billion and $10.5 billion in notional value of derivatives not designated as hedges at December 31, 2005 and 2004, respectively. At December 31, 2005 and 2004, these instruments were in a net gain position with a net estimated fair value of $7.5 million and $14.1 million, respectively. Changes in the fair value of these derivatives are reflected in current period earnings. Derivatives not designated as a hedge in the notional amounts of $11.3 billion and $8.5 billion have been entered into as risk management instruments for mortgage servicing rights and mortgage banking operations at December 31, 2005 and 2004, respectively. For mortgage loans originated for sale, BB&T is exposed to changes in market rates and conditions subsequent to the interest rate lock and funding date. BB&T’s economic hedge strategy related to its interest rate lock commitment derivatives and loans held for sale includes utilizing mortgage-based derivatives such as forward commitments and options in order to mitigate market risk. At December 31, 2005 and 2004, respectively, BB&T held derivatives not designated as hedges with notional amounts totaling $2.9 billion and $2.0 billion that have been
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entered into to facilitate transactions on behalf of BB&T’s clients. BB&T also held derivatives not designated as hedges with notional amounts totaling $1.8 billion at December 31, 2005, as risk management instruments primarily related to securities.
Credit risk related to derivatives arises when amounts receivable from a counterparty exceed those payable. Because the notional amount of the instruments only serves as a basis for calculating amounts receivable or payable, the risk of loss with any counterparty is limited to a small fraction of the notional amount. BB&T’s maximum loss related to credit risk is equal to the gross fair value of its derivative instruments. BB&T deals only with national market makers with strong credit ratings in its derivatives activities. BB&T further controls the risk of loss by subjecting counterparties to credit reviews and approvals similar to those used in making loans and other extensions of credit. In addition, counterparties are required to provide cash collateral to BB&T when their unsecured loss positions exceed certain negotiated limits. As of December 31, 2005 and 2004, BB&T had received cash collateral of approximately $2.9 million and $46.5 million, respectively. All of the derivative contracts to which BB&T is a party settle monthly, quarterly or semiannually. Further, BB&T has netting agreements with the dealers with which it does business. Because of these factors, BB&T’s credit risk exposure related to derivatives contracts at December 31, 2005 and 2004 was not material.
Note 19. Computation of Earnings Per Share
The basic and diluted earnings per share calculations are presented in the following table:
Weighted average number of common shares outstanding during period
Add:
Effect of dilutive outstanding options
Weighted average number of common shares, as adjusted
For the years ended December 31, 2005, 2004 and 2003, respectively, options to purchase an additional 99 thousand, 180 thousand and 10.1 million shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.
NOTE 20. Operating Segments
BB&T’s operations are divided into seven reportable business segments: the Banking Network, Mortgage Banking, Trust Services, Insurance Services, Specialized Lending, Investment Banking and Brokerage, and Treasury. These operating segments have been identified based on BB&T’s organizational structure. The
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segments require unique technology and marketing strategies and offer different products and services. While BB&T is managed as an integrated organization, individual executive managers are held accountable for the operations of these business segments.
BB&T measures and presents information for internal reporting purposes in a variety of different ways. Information for BB&T’s reportable segments is available based on organizational structure, product offerings and customer relationships. The internal reporting system presently utilized by management in the planning and measuring of operating activities, as well as the system to which most managers are held accountable, is based on organizational structure.
BB&T emphasizes revenue growth by focusing on client service, sales effectiveness and relationship management. The segment results contained herein are presented based on internal management accounting policies that were designed to support these strategic objectives. Unlike financial accounting, there is no comprehensive authoritative body of guidance for management accounting equivalent to generally accepted accounting principles. The performance of the segments is not comparable with BB&T’s consolidated results or with similar information presented by any other financial institution. Additionally, because of the interrelationships of the various segments, the information presented is not indicative of how the segments would perform if they operated as independent entities.
The management accounting process uses various estimates and allocation methodologies to measure the performance of the operating segments. To determine financial performance for each segment, BB&T allocates capital, funding charges and credits, an economic provision for loan and lease losses, certain noninterest expenses and income tax provisions to each segment, as applicable. Also, to promote revenue growth and provide a basis for employee incentives, certain revenues of Mortgage Banking, Trust Services, Insurance Services, Specialized Lending, and the Investment Banking and Brokerage segments are reflected in the individual segment results and also allocated to the Banking Network. This double counting of revenue is reflected in intersegment noninterest revenues and eliminated to arrive at consolidated results. Allocation methodologies are subject to periodic adjustment as the internal management accounting system is revised and business or product lines within the segments change. Also, because the development and application of these methodologies is a dynamic process, the financial results presented may be periodically revised.
BB&T’s overall objective is to maximize shareholder value by optimizing return on equity and managing risk. Allocations of capital and the economic provision for loan and lease losses are designed to address this objective. Capital is assigned to each segment on an economic basis, using management’s assessment of the inherent risks associated with the segment. Economic capital allocations are made to cover the following risk categories: credit risk, funding risk, interest rate risk, option risk, basis risk, market risk and operational risk. Each segment is evaluated based on a risk-adjusted return on capital. Capital assignments are not equivalent to regulatory capital guidelines and the total amount assigned to all segments typically varies from total consolidated shareholders’ equity. Unallocated capital is retained in the Treasury segment.
The economic provision for loan and lease losses is also allocated to the relevant segments based on management’s assessment of the segments’ risks as described above. Unlike the provision for loan and lease losses recorded pursuant to generally accepted accounting principles, the economic provision adjusts for the impact of expected credit losses over the effective lives of the related loans and leases. Any unallocated provision for loan and lease losses is retained in the corporate office.
BB&T allocates expenses to the reportable segments based on various methodologies, including volume and amount of loans and deposits, amount of total assets and liabilities and the volume of full-time equivalent employees serviced. A portion of corporate overhead expense is not allocated, but is retained in corporate accounts reflected as other expenses in the accompanying tables. Income taxes are allocated to the various segments using effective tax rates.
BB&T utilizes a funds transfer pricing (“FTP”) system to eliminate the effect of interest rate risk from the segments’ net interest income because such risk is centrally managed within the Treasury segment. The FTP
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system credits or charges the segments with the economic value or cost of the funds the segments create or use. The FTP system provides a funds credit for sources of funds and a funds charge for the use of funds by each segment. The net FTP credit or charge is reflected as net intersegment interest income (expense) in the accompanying tables.
BB&T’s Banking Network serves individual and business clients by offering a variety of loan and deposit products and other financial services. The Banking Network is primarily responsible for serving client relationships, and, therefore, is credited with revenue from the Mortgage Banking, Trust Services, Insurance Services, Investment Banking and Brokerage, Specialized Lending and other segments, which is reflected in intersegment noninterest income. Amortization and depreciation expense that has been allocated to the segment totaled $82.7 million, $83.7 million and $84.7 million for 2005, 2004 and 2003, respectively.
The Mortgage Banking segment retains and services mortgage loans originated by the Banking Network as well as those purchased from various correspondent originators. Mortgage loan products include fixed- and adjustable-rate government and conventional loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. Fixed-rate mortgage loans are typically sold to government agencies with servicing rights retained by BB&T, while adjustable-rate loans are typically held in the portfolio. The Mortgage Banking segment earns interest on loans held in the warehouse and portfolio, fee income from the origination and servicing of mortgage loans and recognizes gains or losses from the sale of mortgage loans. The Banking Network receives an interoffice credit for the origination of loans and servicing rights, with the corresponding charge remaining in the corporate office, which is reflected as part of other net income in the accompanying tables reconciling segment results to consolidated results. Amortization and depreciation expense that has been allocated to the segment totaled $1.4 million, $1.1 million and $2.2 million for 2005, 2004 and 2003, respectively.
BB&T’s Trust Services segment provides personal trust administration, estate planning, investment counseling, wealth management, asset management, employee benefits services, and corporate trust services to individuals, corporations, institutions, foundations and government entities. The Banking Network receives an interoffice credit for trust fees on referred accounts, with the corresponding charge remaining in the corporate office, which is reflected as part of other net income in the accompanying tables reconciling segment results to consolidated results. Amortization and depreciation expense that has been allocated to the segment totaled $6.9 million, $4.5 million and $3.8 million for 2005, 2004 and 2003, respectively.
BB&T operates the 6th largest insurance agency/brokerage network in the nation. BB&T Insurance Services provides property and casualty, life and health insurance to businesses and individuals. It also provides small business and corporate products, such as workers compensation and professional liability, as well as surety coverage and title insurance. The Banking Network receives credit for insurance commissions on referred accounts, with the corresponding charge retained in the corporate office, which is reflected as part of other net income in the accompanying tables reconciling segment results to consolidated results. Amortization and depreciation expense that has been allocated to the segment totaled $49.7 million, $43.2 million and $15.1 million for 2005, 2004 and 2003, respectively.
BB&T’s Specialized Lending segment consists of six wholly owned subsidiaries that provide specialty finance alternatives to consumers and businesses including: dealer-based financing of equipment for both small
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businesses and consumers, commercial fleet vehicle and equipment leasing, direct consumer finance, insurance premium finance, nonconforming mortgage lending, indirect sub-prime automobile finance, and full-service commercial mortgage banking. Bank clients as well as non-bank clients within and outside BB&T’s primary geographic market area are served by these companies. The Banking Network receives credit for referrals to these companies with the corresponding charge retained in the corporate office, which is reflected as part of other net income in the accompanying tables reconciling segment results to consolidated results. Amortization and depreciation expense that has been allocated to the segment totaled $13.7 million, $11.8 million and $10.7 million for 2005, 2004 and 2003, respectively.
BB&T’s Investment Banking and Brokerage segment offers clients investment alternatives, including discount brokerage services, equities, fixed-rate and variable-rate annuities, mutual funds and governmental and municipal bonds through BB&T Investment Services, Inc., a subsidiary of Branch Bank. The Investment Banking and Brokerage segment includes Scott & Stringfellow, Inc., a full-service brokerage and investment banking firm headquartered in Richmond, Virginia. Scott & Stringfellow provides services in retail brokerage, equity and debt underwriting, investment advice, corporate finance and equity research and facilitates the origination, trading and distribution of fixed-income securities and equity products in both the public and private capital markets. Scott & Stringfellow also has a public finance department that provides investment banking services, financial advisory services and municipal bond financing to a variety of regional taxable and tax-exempt issuers. The Banking Network is credited for investment service revenues on referred accounts, with the corresponding charge retained in the corporate office, which is reflected as part of other net income in the accompanying tables reconciling segment results to consolidated results. Amortization and depreciation expense that has been allocated to the segment totaled $7.2 million, $2.4 million and $2.4 million for 2005, 2004 and 2003, respectively.
BB&T’s Treasury segment is responsible for the management of the securities portfolios, overall balance sheet funding and liquidity, and overall management of interest rate risk. Amortization and depreciation expense that has been allocated to the segment totaled $.1 million, $.2 million and $.2 million for 2005, 2004 and 2003, respectively.
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The following tables present selected financial information for BB&T’s reportable business segments for the years ended December 31, 2005, 2004 and 2003:
BB&T Corporation
Reportable Segments
Net interest income (expense)
Net intersegment interest income (expense)
Economic provision for loan and lease losses
Intersegment noninterest income
Allocated corporate expenses
Segment net income
Identifiable segment assets (period end)
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For the Years Ended December 31, 2005, 2004 and 2003—continued
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Net interest income from segments
Other net interest income (expense) (1)
Elimination of management accounting practices (2)
Elimination of other interest income and expense (3)
Consolidated net interest income
Net income from segments
Other net income (loss) (1)
Elimination of other income and expense (3)
Consolidated net income
Total assets from segments
Other, net (1,3)
Consolidated total assets
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of March 10, 2006:
(Registrant)
By:
/s/ John A. Allison, IV
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated as of March 10, 2006.
Senior Executive Vice President and
Chief Financial Officer
Edward D. Vest
Executive Vice President and Corporate Controller
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A Majority of the Directors of the Registrant are included.
Jennifer S. Banner
Director
Anna R. Cablik
Nelle R. Chilton
Ronald E. Deal
Tom D. Efird
Barry J. Fitzpatrick
L. Vincent Hackley, PhD.
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EXHIBIT INDEX
Description
Location
Agreement and Plan of Reorganization dated as of July 29, 1994 and amended and restated as of October 22, 1994 between the Registrant and BB&T Financial Corporation.
Incorporated herein by reference to Annex I of Form S-4 Registration Statement No. 33-56437.
Plan of Merger as of July 29, 1994 as amended and restated on October 22, 1994 between the Registrant and BB&T Financial Corporation.
Incorporated herein by reference to Annex II of Form S-4 Registration Statement No. 33-56437.
Agreement and Plan of Reorganization dated as of January 20, 2003 between the Registrant and First Virginia Banks, Inc.
Incorporated herein by reference to Appendix A of Form S-4 Registration Statement No. 333-103832.
Amended and Restated Articles of Incorporation of the Registrant, as amended.
Incorporated herein by reference to Exhibit 3(i) of the Annual Report on Form 10-K, filed March 7, 2005.
Bylaws of the Registrant, as amended.
Incorporated herein by reference to Exhibit 4.2 of Form S-3 Registration Statement No. 333-126592.
Amended and Restated Articles of Incorporation of the Registrant related to Junior Participating Preferred Stock.
Incorporated herein by reference to Article IV of Exhibit 3(i).
Subordinated Indenture (including Form of Subordinated Debt Security) between the Registrant and U.S. Bank National Association (as successor in interest to State Street Bank and Trust Company), as trustee, dated as of May 24, 1996.
Incorporated herein by reference to Exhibit 4(d) of Form S-3 Registration Statement No. 333-02899.
Senior Indenture (including form of Senior Debt Security) between Registrant and U.S. Bank National Association (as successor in interest to State Street Bank and Trust Company), as trustee, dated as of May 24, 1996
Incorporated herein by reference to Exhibit 4(c) of Form S-3 Registration Statement No. 333-02899.
First Supplemental Indenture between the Registrant and U.S. Bank National Association, Trustee, dated as of December 23, 2003.
Incorporated herein by reference to Exhibit 4 of the Current Report on Form 8-K, filed December 23, 2003.
Second Supplemental Indenture between the Registrant and U.S. Bank National Association, Trustee, dated as of September 24, 2004.
Incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K, filed September 27, 2004.
BB&T Corporation Non-Employee Directors’ Deferred Compensation and Stock Option Plan (amended and restated November 1, 2001).
Incorporated herein by reference to Exhibit 10(v) of the Annual Report on Form 10-K, filed March 15, 2002.
2001 Declaration of Amendment to BB&T Corporation Non-Employee Directors’ Deferred Compensation and Stock Option Plan.
Incorporated herein by reference to Exhibit 10(y) of the Annual Report on Form 10-K, filed March 15, 2002.
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2004 Declaration of Amendment to BB&T Corporation Non-Employee Directors’ Deferred Compensation and Stock Option Plan.
Incorporated herein by reference to Exhibit 10(c) of the Annual Report on Form 10-K, filed March 7, 2005.
2005 Declaration of Amendment to BB&T Corporation Non-Employee Directors’ Deferred Compensation and Stock Option Plan.
Incorporated herein by reference to Exhibit 10(e) of the Current Report on Form 8-K, filed February 28, 2005.
2005 Declaration of Amendment No. 2 to BB&T Corporation Non-Employee Directors’ Deferred Compensation and Stock Option Plan.
Incorporated herein by reference to Exhibit 10(f) of the Current Report on Form 8-K, filed February 24, 2006.
Summary of Terms of Annual Non-Employee Director Option Grant Program.
Incorporated herein by reference to Exhibit 10(a) of the Current Report on Form 8-K, filed February 24, 2006.
BB&T Corporation 1995 Omnibus Stock Incentive Plan (as amended and restated through February 25, 2003).
Incorporated herein by reference to Exhibit 99 of Form S-8 Registration Statement No. 333-116502.
Form of Employee Nonqualified Stock Option Agreement for the BB&T Corporation 1995 Omnibus Stock Incentive Plan, as amended and restated.
Incorporated herein by reference to Exhibit 10(b) of the Current Report on Form 8-K, filed February 28, 2005.
BB&T Corporation 2004 Stock Incentive Plan.
Incorporated herein by reference to Exhibit 99 of Form S-8 Registration Statement No. 333-116488.
Form of Non-Employee Director Nonqualified Stock Option Agreement for the BB&T Corporation 2004 Stock Incentive Plan.
Incorporated herein by reference to Exhibit 10(b) of the Current Report on Form 8-K, filed February 24, 2006.
Form of Employee Nonqualified Stock Option Agreement for the BB&T Corporation 2004 Stock Incentive Plan.
Incorporated herein by reference to Exhibit 10(c) of the Current Report on Form 8-K, filed February 24, 2006.
Form of Restricted Stock Unit Agreement for the Company’s 2004 Stock Incentive Plan.
Incorporated herein by reference to Exhibit 10(d) of the Current Report on Form 8-K, filed February 24, 2006.
Form of Restricted Stock Unit Agreement (Performance Vesting Component) for the Company’s 2004 Stock Incentive Plan.
Incorporated herein by reference to Exhibit 10(e) of the Current Report on Form 8-K, filed February 24, 2006.
BB&T Corporation Amended and Restated 1996 Short-term Incentive Plan.
Incorporated herein by reference to Exhibit 10(q) of the Annual Report on Form 10-K, filed on March 16, 2001.
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Southern National Deferred Compensation Plan for Key Executives including amendments.
Incorporated herein by reference to Exhibit 10(l) of the Annual Report on Form 10-K, filed March 7, 2005.
Southern National Supplemental Executive Retirement Plan including amendments.
Incorporated herein by reference to Exhibit 10(m) of the Annual Report on Form 10-K, filed March 7, 2005.
Southern National Non-Qualified Defined Benefit Plan and amendments.
Incorporated herein by reference to Exhibit 10(l) of the Annual Report on Form 10-K, filed March 8, 2004.
BB&T Corporation Non-Qualified Defined Contribution Plan (amended and restated November 1, 2001).
Incorporated herein by reference to Exhibit 10(p) of the Annual Report on Form 10-K, filed March 15, 2002.
BB&T Corporation Supplemental Defined Contribution Plan for Highly Compensated Employees (amended and restated effective November 1, 2001).
Incorporated herein by Reference to Exhibit 10 (n) of the Annual Report on Form 10-K, filed March 15, 2002.
BB&T Corporation Non-Qualified Deferred Compensation Trust (amended and restated effective November 1, 2001).
Incorporated herein by reference to Exhibit 10(x) of the Annual Report on Form 10-K, filed March 15, 2002.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and John A. Allison, IV.
Incorporated herein by reference to Exhibit 10(z) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and W. Kendall Chalk.
Incorporated herein by reference to Exhibit 10(aa) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and Robert E. Greene.
Incorporated by reference to Exhibit 10(ab) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and Kelly S. King.
Incorporated herein by reference to Exhibit 10 (ad) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
2004 Amendments to Amended and Restated Employment Agreement, effective July 1, 2004, by and among the Registrant, Branch Banking and Trust Co. and Kelly S. King.
Incorporated herein by reference to Exhibit 99.3 of the Current Report on Form 8-K, filed November 1, 2004.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and C. Leon Wilson, III.
Incorporated herein by reference to Exhibit 10(ag) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
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Employment Agreement, dated October 29, 2004, by and among the Registrant, Branch Banking and Trust Co. and Christopher L. Henson.
Incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K, filed November 1, 2004.
Employment Agreement, dated October 29, 2004, by and among the Registrant, Branch Banking and Trust Co. and Ricky K. Brown.
Incorporated herein by reference to Exhibit 99.2 of the Current Report on Form 8-K, filed November 1, 2004.
Employment Agreement, dated November 10, 2003, by and among the Registrant, Branch Banking and Trust Co. and Barbara F. Duck.
Incorporated herein by reference to Exhibit 10(af) of the Annual Report on Form 10-K, filed March 8, 2004.
Employment Agreement, dated November 10, 2003, by and among the Registrant, Branch Banking and Trust Co. and Steven B. Wiggs.
Incorporated herein by reference to Exhibit 10(ag) of the Annual Report on Form 10-K, filed March 8, 2004.
Amended and Restated Employment Agreement by and among the Registrant, Branch Banking and Trust Co. and Scott E. Reed.
Incorporated herein by reference to Exhibit 10 (ae) of the Quarterly Report on Form 10-Q, filed May 13, 2002.
Death Benefit Only Plan, Dated April 23, 1990, by and between Branch Banking and Trust Company (as successor to Southern National Bank of North Carolina) and L. Glenn Orr, Jr.
Incorporated herein by
reference to Registration Statement No. 33-33984.
Settlement and Non-Compete Agreement, dated February 28, 1995, by and between the Registrant and L. Glenn Orr, Jr.
Incorporated herein by reference to Exhibit 10(b) of Form S-4 Registration Statement No. 33-56437.
Settlement and Noncompetition Agreement, dated July 1, 1997, by and between the Registrant and E. Rhone Sasser.
Incorporated herein by reference to Exhibit 10(af) of the Annual Report on Form 10-K, filed March 7, 2005.
Employment Agreement, dated February 6, 2000, by and between the Registrant and J. Holmes Morrison.
Incorporated herein by reference to Exhibit 10(s) of the Annual Report on Form 10-K, filed on March 16, 2001.
Employment Agreement, dated January 20, 2003, by and between Branch Banking and Trust Co. of Virginia and Barry F. Fitzpatrick.
Incorporated herein by reference to Exhibit 10(ae) of the Annual Report on Form 10-K, filed March 8, 2004.
Special Pay Agreement, dated January 20, 2003, by and between First Virginia Banks, Inc. and Barry J. Fitzpatrick.
Incorporated herein by reference to Exhibit 10(ah) of the Annual Report on Form 10-K, filed March 8, 2004.
First Virginia Banks, Inc. 1983 Directors’ Deferred Compensation Plan; First Virginia Banks, Inc. 1986 Directors’ Deferred Compensation Plan (and amendments thereto).
Incorporated herein by reference to Exhibit 10(ai) of the Annual Report on Form 10-K, filed March 8, 2004.
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First Virginia Banks, Inc. Key Employee Salary Reduction Deferred Compensation Plan; First Virginia Banks, Inc. 1986 Key Employee Salary Reduction Deferred Compensation Plan.
Incorporated herein by reference to Exhibit 10(aj) of the Annual Report on Form 10-K, filed March 8, 2004.
Statement re computation of earnings per share.
Filed herewith as Note 19 to the Financial Statements.
Statement re computation of ratios.
Filed herewith.
Subsidiaries of the Registrant.
Proxy Statement for the 2006 Annual Meeting of Shareholders.
Future filing incorporated herein by reference pursuant to General Instruction G(3).
Consent of Independent Registered Public Accounting Firm.
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15(d)-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15(d)-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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