UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended: September 30, 2013
Commission file number: 1-10853
BB&T CORPORATION
(Exact name of registrant as specified in its charter)
(I.R.S. Employer
Identification No.)
Winston-Salem, North Carolina
(Address of Principal Executive Offices)
(336) 733-2000
(Registrant’s Telephone Number, Including Area Code)
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 [X] No [ ]
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
At September 30, 2013, 704,924,992 shares of the Registrant’s common stock, $5 par value, were outstanding.
Glossary of Defined Terms
The following terms may be used throughout this Report, including the consolidated financial statements and related notes.
The accompanying notes are an integral part of these consolidated financial statements.
NOTE 1. Basis of Presentation
See the Glossary of Defined Terms at the beginning of this Report for terms used throughout the consolidated financial statements and related notes of this Form 10-Q.
General
These consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations and cash flow activity required in accordance with GAAP. In the opinion of management, all normal recurring adjustments necessary for a fair statement of the consolidated financial position and consolidated results of operations have been made. The year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by GAAP. The information contained in the financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2012 and the Quarterly Reports on Form 10-Q for the periods ended March 31, 2013 and June 30, 2013 should be referred to in connection with these unaudited interim consolidated financial statements.
Reclassifications
Certain amounts reported in prior periods’ consolidated financial statements have been reclassified to conform to the current presentation. Such reclassifications had no effect on previously reported cash flows, shareholders’ equity or net income.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with GAAP 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 include the determination of the ACL, determination of fair value for financial instruments, valuation of goodwill, intangible assets and other purchase accounting related adjustments, benefit plan obligations and expenses, and tax assets, liabilities and expense.
Changes in Accounting Principles and Effects of New Accounting Pronouncements
In June 2013, the FASB issued new guidance related to Investment Companies. The new guidance amends the criteria for an entity to qualify as an investment company and requires an investment company to measure all of its investments at fair value. This guidance is effective for interim and annual reporting periods beginning after December 15, 2013. The adoption of this guidance is not expected to be material to the consolidated financial position, results of operations or cash flows.
Effective January 1, 2013, the Company adopted new guidance impacting the presentation of certain items on the Balance Sheet. The new guidance requires an entity to disclose both gross and net information about derivatives, repurchase agreements and securities borrowing and lending transactions that have a right of setoff or are subject to an enforceable master netting arrangement or similar agreement. The adoption of this guidance did not impact the consolidated financial position, results of operations or cash flows. The new disclosures required by this guidance for derivatives are included in Note 14 to these consolidated financial statements. The adoption of this guidance did not impact our disclosures of repurchase agreements and securities borrowing and lending transactions as the balances and volume of transactions are not material.
Effective January 1, 2013, the Company adopted new guidance on Business Combinations. The new guidance clarifies that when a reporting entity recognizes an indemnification asset as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity should account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the lesser of the contractual term of the indemnification agreement or the remaining life of the indemnified assets. BB&T has previously accounted for its indemnification asset in accordance with this guidance; accordingly, the adoption of this guidance had no impact on the consolidated financial position, results of operations or cash flows.
Effective January 1, 2013, the Company adopted new guidance impactingComprehensive Income that requires a reporting entity to present significant amounts reclassified out of AOCI by the respective line items of net income. The adoption of this guidance did not impact the consolidated financial position, results of operations or cash flows. The new disclosures required by this guidance are included in Note 9 to these consolidated financial statements.
NOTE 2. Securities
As of September 30, 2013 and December 31, 2012, the fair value of covered securities included $1.1 billion and $1.3 billion, respectively, of non-agency MBS and $315 million and $326 million, respectively, of municipal securities.
As of September 30, 2013 and December 31, 2012, securities with carrying values of approximately $18.5 billion and $19.0 billion, respectively, were pledged to secure municipal deposits, securities sold under agreements to repurchase, other borrowings, and for other purposes as required or permitted by law.
Certain investments in marketable debt securities and MBS issued by FNMA and FHLMC exceeded ten percent of shareholders’ equity at September 30, 2013. The FNMA investments had total amortized cost and fair value of $13.5 billion and $13.1 billion, respectively. The FHLMC investments had total amortized cost and fair value of $7.2 billion and $7.1 billion, respectively.
The following table reflects changes in credit losses on securities with OTTI (excluding covered), which were primarily non-agency MBS, where a portion of the unrealized loss was recognized in OCI. OTTI of $4 million related to covered securities during 2012 is not reflected in this table.
The amortized cost and estimated fair value of the securities portfolio by contractual maturity are shown in the following table. The expected life of MBS may differ from contractual maturities because borrowers have the right to prepay the underlying mortgage loans with or without prepayment penalties.
Periodic reviews are conducted to identify and evaluate each investment with an unrealized loss for OTTI. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in AOCI for AFS securities.
Cash flow modeling is used to evaluate non-agency MBS in an unrealized loss position for potential credit impairment. These models give consideration to long-term macroeconomic factors applied to current security default rates, prepayment rates and recovery rates and security-level performance. At September 30, 2013, three non-agency MBS were below investment grade and had unrealized losses, none of which were significant.
At September 30, 2013, $71 million of unrealized loss on municipal securities was the result of fair value hedge basis adjustments that are a component of amortized cost. Municipal securities in an unrealized loss position are evaluated for credit impairment through a qualitative analysis of issuer performance and the primary source of repayment. The evaluation of municipal securities indicated there were no credit losses evident.
NOTE 3. Loans and ACL
The following tables include modifications made to existing TDRs, as well as new modifications that are considered TDRs. Balances represent the recorded investment as of the end of the period in which the modification was made. Rate modifications include TDRs made with below market interest rates that also include modifications of loan structures.
The following table summarizes the pre-default balance for modifications that experienced a payment default that had been classified as TDRs during the previous 12 months. Payment default is defined as movement of the TDR to nonaccrual status, foreclosure or charge-off, whichever occurs first.
NOTE 4. Goodwill and Other Intangible Assets
There have been no goodwill impairments recorded to date.
NOTE 5. Loan Servicing
Residential Mortgage Banking Activities
The following tables summarize residential mortgage banking activities for the periods presented:
Gains on residential mortgage loan sales, including marking LHFS to fair value and the impact of interest rate lock commitments, are recorded in noninterest income as a component of mortgage banking income. For certain of these transactions, the loan servicing rights were retained, including the related MSRs and on-going servicing fees.
Payments made to date for recourse exposure on residential mortgage loans sold with recourse liability have been immaterial.
BB&T also issues standard representations and warranties related to mortgage loan sales to GSEs. Although these agreements often do not specify limitations, management does not believe that any payments related to these warranties would materially change the financial condition or results of operations of BB&T.
Residential MSRs are recorded on the Consolidated Balance Sheets at fair value with changes in fair value recorded as a component of mortgage banking income in the Consolidated Statements of Income. Various derivative instruments are used to mitigate the income statement effect of changes in fair value due to changes in valuation inputs and assumptions of its residential MSRs.
During 2013, the prepayment speed assumptions were updated as actual observed prepayment speeds were slower, primarily as a result of rising interest rates. These valuation increases were partially offset by realization of servicing cash flows as well as higher servicing costs due to regulatory requirements and updates to OAS due to market changes in required rates of return.
The sensitivity of the fair value of the residential MSRs to adverse changes in key economic assumptions is included in the accompanying table:
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 the above table, the effect of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another, which may magnify or counteract the effect of the change.
Commercial Mortgage Banking Activities
CRE mortgage loans serviced for others are not included in loans and leases on the accompanying Consolidated Balance Sheets. The following table summarizes commercial mortgage banking activities for the periods presented:
NOTE 6. Deposits
NOTE 7. Long-Term Debt
The subordinated notes qualify under the risk-based capital guidelines as Tier 2 supplementary capital, subject to certain limitations. The Branch Bank floating-rate subordinated notes are based on LIBOR, but the majority of the cash flows have been swapped to a fixed rate, with an effective rate paid of 3.25% at September 30, 2013. Certain of the FHLB advances have been swapped to floating rates from fixed rates or from fixed rates to floating rates, with a weighted average rate paid of 3.62% and a weighted average maturity of 6.6 years at September 30, 2013.
NOTE 8. Shareholders’ Equity
Equity-Based Plans
At September 30, 2013, BB&T had options, restricted stock and restricted stock units outstanding from the following equity-based compensation plans: the 2012 Plan, the 2004 Plan, the Omnibus Plan, and the Directors’ Plan. BB&T’s shareholders have approved all equity-based compensation plans. As of September 30, 2013, the 2012 Plan is the only plan that has shares available for future grants. The 2012 and 2004 Plans allow for accelerated vesting of awards for holders who retire and have met all retirement eligibility requirements and in connection with certain other events.
The fair value of each option award on the date of grant is measured using the Black-Scholes option-pricing model.
NOTE 9. AOCI
NOTE 10. Income Taxes
The effective tax rates for the three months and nine months ended September 30, 2013 were higher than the corresponding periods of 2012 primarily due to adjustments for uncertain tax positions as described below.
In February 2010, BB&T received an IRS statutory notice of deficiency for tax years 2002-2007 asserting a liability for taxes, penalties and interest of approximately $892 million related to the disallowance of foreign tax credits and other deductions claimed by a subsidiary in connection with a financing transaction. BB&T paid the disputed tax, penalties and interest in March 2010 and filed a lawsuit seeking a refund in the U.S. Court of Federal Claims. On February 11, 2013, the U.S. Tax Court issued an adverse opinion in a case between the Bank of New York Mellon Corporation and the IRS involving a transaction with a structure similar to BB&T’s financing transaction. BB&T recognized an expense of $281 million in the first quarter of 2013 as a result of its consideration of this adverse decision. On September 20, 2013, the U.S. Court of Federal Claims issued an adverse opinion in BB&T’s case. BB&T continues to believe that its tax treatment of the transaction was correct; however, as a result of the ruling and tax matters related to other current tax examinations, BB&T recorded a $235 million income tax adjustment in the third quarter of 2013. Combined with previously-recorded tax reserves, the exposure for the financing transaction is fully reserved.
On September 23, 2013, the U.S. Tax Court modified its February 11, 2013 decision in part by allowing a portion of the disputed tax attributes, which partially reduced Bank of New York Mellon’s tax liability. On October 17, 2013, in a third case involving a transaction with a structure similar to BB&T’s financing transaction, the federal district court in Massachusetts
ruled in favor of Santander Holdings USA, Inc. on their motion for partial summary judgment relating to a significant issue. It is unclear whether further proceedings will be necessary to resolve that case. With respect to its own case, BB&T is considering its procedural options for responding to the court’s ruling, including appeal. Depending on the procedural course of action BB&T chooses to pursue and the ultimate outcome of any such future action in connection with its case, as well as the current IRS examination, it is reasonably possible that changes in the amount of unrecognized tax benefits could result in a benefit of up to $750 million during the next twelve months. The ultimate resolution of this matter may take longer.
NOTE 11. Benefit Plans
BB&T makes contributions to the qualified pension plan in amounts between the minimum required for funding and the maximum amount deductible for federal income tax purposes. Discretionary contributions of $345 million were made during the nine months ended September 30, 2013.
NOTE 12. Commitments and Contingencies
Letters of credit and financial guarantees written are unconditional commitments to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper issuance, bond financing and similar transactions, the majority of which are to tax exempt entities. 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.
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. Branch Bank typically provides financing during the construction and development of the properties; however, permanent
financing is generally obtained from independent third parties upon completion of a project. Tax credits are subject to recapture by taxing authorities based on compliance features required to be met at the project level. The maximum potential exposure to losses relative to these investments is generally limited to the sum of the carrying amount of the investment, tax credits subject to recapture 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.
Legal Proceedings
The nature of the business of BB&T’s banking and other subsidiaries ordinarily results in a certain amount of claims, litigation, investigations and legal and administrative cases and proceedings, all of which are considered incidental to the normal conduct of business. BB&T believes it has meritorious defenses to the claims asserted against it in its currently outstanding legal proceedings and, with respect to such legal proceedings, intends to continue to defend itself vigorously, litigating or settling cases according to management’s judgment as to what is in the best interests of BB&T and its shareholders.
On at least a quarterly basis, liabilities and contingencies in connection with outstanding legal proceedings are assessed utilizing the latest information available. For those matters where it is probable that BB&T will incur a loss and the amount of the loss can be reasonably estimated, a liability is recorded in the consolidated financial statements. These legal reserves may be increased or decreased to reflect any relevant developments on at least a quarterly basis. For other matters, where a loss is not probable or the amount of the loss is not estimable, legal reserves are not accrued. While the outcome of legal proceedings is inherently uncertain, based on information currently available, advice of counsel and available insurance coverage, management believes that its established legal reserves are adequate and the liabilities arising from legal proceedings will not have a material adverse effect on the consolidated financial position, consolidated results of operations or consolidated cash flows. However, in the event of unexpected future developments, it is possible that the ultimate resolution of these matters, if unfavorable, may be material to the consolidated financial position, consolidated results of operations or consolidated cash flows.
NOTE 13. Fair Value Disclosures
Various assets and liabilities are carried at fair value based on applicable accounting standards, including prime residential mortgage and commercial mortgage loans originated as LHFS. Accounting standards define fair value as the exchange price that would be received on the measurement date to sell an asset or the price paid to transfer a liability in the principal or most advantageous market available to the entity in an orderly transaction between market participants, with a three level valuation input hierarchy.
The following discussion focuses on the valuation techniques and significant inputs for Level 2 and Level 3 assets and liabilities.
A third-party pricing service is generally utilized in determining the fair value of its securities portfolio. Fair value measurements are derived from market-based pricing matrices that were developed using observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads and broker quotes. As described by security type below, additional inputs may be used, or some inputs may not be applicable. In the event that market observable data was not available, which would generally occur due to the lack of an active market for a given security, the valuation of the security would be subjective and may involve substantial judgment by management.
Trading securities: Trading securities are composed of various types of debt and equity securities, but the majority consists of debt securities issued by the U.S. Treasury, GSEs, or states and political subdivisions. The valuation techniques used for these investments are more fully discussed below.
GSE securities and MBS issued by GSE: GSE pass-through securities are valued using market-based pricing matrices that are based on observable inputs including benchmark TBA security pricing and yield curves that were estimated based on U.S. Treasury yields and certain floating rate indices. The pricing matrices for these securities may also give consideration to pool-specific data supplied directly by the GSE. GSE CMOs are valued using market-based pricing matrices that are based on observable inputs including offers, bids, reported trades, dealer quotes and market research reports, the characteristics of a specific tranche, market convention prepayment speeds and benchmark yield curves as described above.
States and political subdivisions: These securities are valued using market-based pricing matrices that are based on observable inputs including MSRB reported trades, issuer spreads, material event notices and benchmark yield curves.
Non-agency MBS: Pricing matrices for these securities are based on observable inputs including offers, bids, reported trades, dealer quotes and market research reports, the characteristics of a specific tranche, market convention prepayment speeds and benchmark yield curves as described above.
Other securities: These securities consist primarily of mutual funds and corporate bonds. These securities are valued based on a review of quoted market prices for assets as well as through the various other inputs discussed previously.
Covered securities: Covered securities are covered by FDIC loss sharing agreements and consist of re-remic non-agency MBS, municipal securities and non-agency MBS. Covered state and political subdivision securities and certain non-agency MBS are valued in a manner similar to the approach described above for these asset classes. The re-remic non-agency MBS, which are categorized as Level 3, were valued based on broker dealer quotes that reflected certain unobservable market inputs. Sensitivity to changes in the fair value of covered securities is significantly offset by changes in BB&T’s indemnification asset from the FDIC.
LHFS: Certain mortgage loans are originated to be sold to investors, which are carried at fair value. The fair value is primarily based on quoted market prices for securities backed by similar types of loans. The changes in fair value of these assets are largely driven by changes in interest rates subsequent to loan funding and changes in the fair value of servicing associated with the mortgage LHFS.
Residential MSRs: The fair value of residential MSRs is estimated using an OAS valuation model to project MSR cash flows over multiple interest rate scenarios, which are then discounted at risk-adjusted rates. The OAS model considers portfolio characteristics, contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenue, costs to service and other economic factors. Fair value estimates and assumptions are compared to industry surveys, recent market activity, actual portfolio experience and, when available, other observable market data.
Derivative assets and liabilities: The fair values of derivatives are determined based on quoted market prices and internal pricing models that are primarily sensitive to market observable data. The fair values of interest rate lock commitments, which are related to mortgage loan commitments and are categorized as Level 3, are based on quoted market prices adjusted for commitments that are not expected to fund and include the value attributable to the net servicing fees.
Private equity and similar investments: Private equity and similar investments are measured at fair value based on the investment’s net asset value. In many cases there are no observable market values for these investments and therefore management must estimate the fair value based on a comparison of the operating performance of the company to multiples in the marketplace for similar entities. This analysis requires significant judgment and actual values in a sale could differ materially from those estimated.
Short-term borrowings: Short-term borrowings represent debt securities sold short that are entered into as a hedging strategy for the purposes of supporting institutional and retail client trading activities.
BB&T’s policy is to recognize transfers in and transfers out of Levels 1, 2 and 3 as of the end of a reporting period. During the first nine months of 2013 and 2012, there were no transfers of securities between levels in the fair value hierarchy.
The majority of private equity and similar investments are in SBIC qualified funds, which primarily focus on equity and subordinated debt investments in privately-held middle market companies. The majority of these investments are not redeemable and distributions are received as the underlying assets of the funds liquidate. The timing of distributions, which are expected to occur on various dates through 2025, is uncertain and dependent on various events such as recapitalizations, refinance transactions and ownership changes among others. Excluding the investment of future funds, these investments have an estimated weighted average remaining life of approximately three years; however, the timing and amount of distributions may vary significantly. As of September 30, 2013, restrictions on the ability to sell the investments include, but are not limited to, consent of a majority member or general partner approval for transfer of ownership. These investments are spread over numerous privately-held middle market companies, and thus the sensitivity to a change in fair value for any
single investment is limited. The significant unobservable inputs for these investments are EBITDA multiples that ranged from 2x to 10x, with a weighted average of 7x, at September 30, 2013.
Excluding government guaranteed, there were no LHFS that were nonaccrual or 90 days or more past due and still accruing interest.
Additionally, accounting standards require the disclosure of the estimated fair value of financial instruments that are not recorded at fair value. 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. For the financial instruments not recorded at fair value, estimates of fair value are based on relevant market data and information about the instrument and are based on the value of one trading unit without regard to any premium or discount that may result from concentrations of ownership, 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 financial instruments. Fair value estimates for these instruments are based on 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 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 in estimating the fair value of these financial instruments.
Cash and cash equivalents and segregated cash due from banks: For these short-term instruments, the carrying amounts are a reasonable estimate of fair values.
HTM securities: The fair values of HTM securities are based on a market approach using observable inputs such as benchmark yields and securities, TBA prices, reported trades, issuer spreads, current bids and offers, monthly payment information and collateral performance.
Loans receivable: The fair values for loans are estimated using discounted cash flow analyses, applying interest rates currently being offered for loans with similar terms and credit quality, which are deemed to be indicative of orderly transactions in the current market. For commercial loans and leases, discount rates may be adjusted to address additional credit risk on lower risk grade instruments. For residential mortgage and other consumer loans, internal prepayment risk models are used to adjust contractual cash flows. Loans are aggregated into pools of similar terms and credit quality and discounted using a LIBOR based rate. The carrying amounts of accrued interest approximate fair values.
FDIC loss share receivable: The fair value of the FDIC loss share receivable is estimated using discounted cash flow analyses, applying a risk free interest rate that is adjusted for the uncertainty in the timing and amount of these cash flows. The expected cash flows to/from the FDIC related to loans were estimated using the same assumptions that were used in determining the accounting values for the related loans. The expected cash flows to/from the FDIC related to securities are based upon the fair value of the related securities and the payment that would be required if the securities were sold for that amount. The FDIC loss share agreements are not transferrable and, accordingly, there is no market for this receivable.
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. Fair values for CDs are estimated using a discounted cash flow calculation that applies current interest rates to aggregate expected maturities. In addition, nonfinancial instruments such as core deposit intangibles are not recorded at fair value. BB&T has developed long-term relationships with its customers through its deposit base and, in the opinion of management, these items add significant value to BB&T.
Short-term borrowings: The carrying amounts of Federal funds purchased, borrowings under repurchase agreements and other 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 current incremental borrowing rates for similar types of instruments.
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. These respective fair value measurements are categorized within Level 3 of the fair value hierarchy.
NOTE 14. Derivative Financial Instruments
Assets and liabilities related to derivatives are presented on a gross basis in the Consolidated Balance Sheets. Derivatives in a gain position are recorded as Other assets, derivatives in a loss position are recorded as Other liabilities and cash collateral posted is reported as Restricted cash. Derivatives with dealer counterparties are governed by the terms of ISDA master netting agreements and Credit Support Annexes. The ISDA Agreement allows counterparties to offset trades in a gain against trades in a loss to determine net exposure and allows for the right of setoff in the event of either a default or an additional termination event. Credit Support Annexes govern the terms of daily collateral posting practices. Collateral practices mitigate the potential loss impact to affected parties by requiring liquid collateral to be posted on a scheduled basis to secure the aggregate net unsecured exposure. In addition to collateral, the right of setoff allows counterparties to offset derivative values transacted with a defaulting party with certain other contractual receivables from or obligations due to the defaulting party in determining the net termination amount. No portion of the change in fair value of the derivatives has been excluded from effectiveness testing. The ineffective portion was immaterial for all periods presented.
Derivatives Credit Risk – Dealer Counterparties
Credit risk related to derivatives arises when amounts receivable from a counterparty exceed those payable to the same counterparty. The risk of loss is addressed by subjecting dealer counterparties to credit reviews and approvals similar to those used in making loans or other extensions of credit and by requiring collateral. Dealer counterparties operate under agreements to provide cash and/or liquid collateral when unsecured loss positions exceed negotiated limits.
Derivative contracts with dealer counterparties settle on a monthly, quarterly or semiannual basis, with daily movement of collateral between counterparties required within established netting agreements. BB&T only transacts with dealer counterparties that are national market makers with strong credit ratings.
Derivatives Credit Risk – Central Clearing Parties
Certain derivatives are cleared through central clearing parties that require initial margin collateral, as well as additional collateral for trades in a net loss position. Initial margin collateral requirements are established by central clearing parties on varying bases, with such amounts generally designed to offset the risk of non-payment. Initial margin is generally calculated by applying the maximum loss experienced in value over a specified time horizon to the portfolio of existing trades. The central clearing party used for TBA transactions does not post variation margin to the bank.
NOTE 15. Computation of EPS
NOTE 16. Operating Segments
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BB&T is a financial holding company organized under the laws of North Carolina. BB&T conducts operations through its principal bank subsidiary, Branch Bank, and its nonbank subsidiaries.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, regarding the financial condition, results of operations, business plans and the future performance of BB&T that 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. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “projects,” “may,” “will,” “should,” “could,” and other similar expressions are intended to identify these forward-looking statements. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. Such factors include, but are not limited to, the following:
These and other risk factors are more fully described in this report and in BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012 under the sections entitled “Item 1A. Risk Factors” and from time to time, in other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date
of this report. Actual results may differ materially from those expressed in or implied by any forward-looking statements. Except to the extent required by applicable law or regulation, BB&T undertakes no obligation to revise or update publicly any forward-looking statements for any reason.
Regulatory Considerations
BB&T and its subsidiaries and affiliates are subject to numerous examinations by federal and state banking regulators, as well as the SEC, FINRA, 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. Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012 for additional disclosures with respect to laws and regulations affecting BB&T.
Basel III
On July 2, 2013, the FRB approved final rules that established a new comprehensive capital framework for U.S. banking organizations. These rules established a more conservative definition of capital, including the elimination of trust-preferred securities for certain institutions. The rules also revised the calculation of risk-weighted assets and the minimum capital thresholds. Based on June 30, 2013 financial information, BB&T would be considered a Standardized Approach banking organization and must comply with the new requirements beginning on January 1, 2015. Institutions with greater than $250 billion in assets or $10 billion in foreign assets would be considered an Advanced Approach banking organization, which requires a more conservative calculation of risk-weighted assets, with a compliance date of January 1, 2014. Among other requirements, the minimum required common equity Tier 1 ratio, including the capital conservation buffer, will gradually increase from 4.5% on January 1, 2015 to 7.0% on January 1, 2019.
For BB&T, the final rules eased the requirements for determining risk-weighted assets when compared to the previously proposed requirements. Specifically, more conservative risk-weighting of certain residential mortgage loans and the requirement to recognize in capital the value of unrecognized gains and losses in AFS securities were not retained.
Dodd-Frank Act
A U.S. Federal District Court judge recently ruled against the debit card interchange fee limits imposed by the FRB as a result of the Dodd-Frank Act, resulting in the potential for further reductions to these caps. If upheld, the revised limits are expected to reduce annual revenue by approximately $80 million to $110 million.
Critical Accounting Policies
The accounting and reporting policies of BB&T are in accordance with GAAP and conform to the accounting and reporting guidelines prescribed by bank regulatory authorities. 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 the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting and reporting policies include accounting for the ACL, determining fair value of financial instruments, intangible assets, costs and benefit obligations associated with pension and postretirement benefit plans, and income taxes. Understanding BB&T’s accounting policies is fundamental to understanding the consolidated financial position and consolidated results of operations. Accordingly, the critical accounting policies are discussed in detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012. 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” in BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012. There have been no changes to the significant accounting policies during 2013. Additional disclosures regarding the effects of new accounting pronouncements are included in Note 1 “Basis of Presentation” included herein.
Executive Summary
Consolidated net income available to common shareholders for the third quarter of 2013 was $268 million, down 42.9%, compared to $469 million earned during the same period in 2012. On a diluted per common share basis, earnings for the third quarter of 2013 were $0.37, down 43.9% compared to $0.66 for the same period in 2012. BB&T’s results of operations for the third quarter of 2013 produced an annualized return on average assets of 0.68% and an annualized return on average common shareholders’ equity of 5.44% compared to prior year ratios of 1.10% and 9.94%, respectively.
As previously announced, financial results for the third quarter of 2013 were negatively impacted by a ruling issued by the U.S. Court of Federal Claims on September 20, 2013 regarding the IRS’s disallowance of tax deductions and foreign tax credits taken in connection with a financing transaction entered into by BB&T in 2002. Based on the court’s decision and an evaluation of other tax-related matters, a $235 million adjustment for uncertain income tax positions was recognized. Excluding the impact of this adjustment, diluted EPS was $0.70 for the third quarter of 2013, and the adjusted results of operations for the third quarter of 2013 produced an annualized return on average assets of 1.20% and an annualized return on average common shareholders’ equity of 10.22%. See non-GAAP Information on page 80.
Total revenues were $2.4 billion for the third quarter of 2013, down $124 million compared to the third quarter of 2012. The decrease in total revenues included a $66 million decrease in taxable-equivalent net interest income and a $58 million decrease in noninterest income. The decrease in taxable-equivalent net interest income reflects an $82 million decrease in interest income primarily driven by lower yields on new loans and securities and covered loan run-off, partially offset by a $16 million decrease in funding costs compared to the same quarter of the prior year. NIM was 3.68%, down 26 basis points compared to the third quarter of 2012.
The decrease in noninterest income reflects declines in mortgage banking and other income totaling $94 million and $22 million, respectively. These decreases were partially offset by a $22 million increase in insurance income and a $16 million improvement in FDIC loss share income. The decrease in mortgage banking income was driven by a reduction in margins due to competition. The decrease in other income includes $14 million of increased net losses on affordable housing investments and $8 million in lower income related to assets for certain post-employment benefits, which is offset in personnel expense. The increase in insurance income is primarily attributable to improved market conditions compared to the prior year, and the improvement in FDIC loss share income primarily reflects lower negative accretion as the indemnification asset continues to decline.
The provision for credit losses, excluding covered loans, declined $154 million, or 63.1%, compared to the third quarter of 2012, as improved credit quality resulted in lower provision expense. Net charge-offs, excluding covered loans, for the third quarter of 2013 were $161 million lower than the third quarter of 2012, a decline of 53.1%. The reserve release was $52 million for the third quarter of 2013 compared to $59 million in the same quarter of the prior year.
Noninterest expense was $1.5 billion for the third quarter of 2013, a decrease of $58 million, or 3.8%, compared to the third quarter of 2012. Foreclosed property expense declined $40 million, reflecting lower write-downs, losses and carrying costs associated with a lower level of foreclosed property. Merger-related and restructuring charges decreased $39 million compared to the third quarter of 2012, primarily due to merger charges associated with the BankAtlantic acquisition recognized during the earlier period. Lower mortgage repurchase expense in the current period drove a $15 million decrease in loan-related expense compared to the earlier quarter. These declines in noninterest expense were partially offset by increases in professional services and occupancy and equipment expense totaling $24 million and $11 million, respectively. The increase in professional services included a $16 million increase in professional services related to certain systems and process-related enhancements, while the increase in occupancy and equipment expense reflects increased IT equipment expense and other rent adjustments recognized during the current quarter.
The provision for income taxes was $450 million for the third quarter of 2013, compared to $177 million for the third quarter of 2012. The effective tax rate for the third quarter of 2013 was 59.3%, compared to 26.3% for the prior year’s third quarter. The increase in the effective tax rate was primarily due to the $235 million adjustment for uncertain income tax positions described previously. Excluding the impact of this adjustment, the effective tax rate for the third quarter of 2013 was 28.3%, compared to 26.3% in the same quarter of the prior year. The increase in the adjusted effective income tax rate resulted from deferred income tax expense recorded in the third quarter of 2013 related to a reduction in the North Carolina state income tax rate as BB&T is in a net deferred tax asset position, and a higher level of pre-tax earnings relative to permanent tax differences in 2013 compared to 2012.
NPAs, excluding covered foreclosed real estate, decreased $114 million compared to June 30, 2013, and $374 million compared to December 31, 2012. The decrease in NPAs over the nine months ended September 30, 2013 reflects a $350 million reduction in NPLs and a $24 million decline in foreclosed property. At September 30, 2013, NPAs represented 0.65% of total assets, excluding covered assets, which is its lowest level since 2007.
Average loans held for investment for the third quarter of 2013 totaled $115.1 billion, up $876 million, or 3.0%, compared to the second quarter of 2013. The increase in average loans held for investment was driven by strong growth in the other lending subsidiaries and sales finance portfolios, along with steady growth in the direct retail lending portfolio.
Average deposits for the third quarter of 2013 decreased $2.0 billion, or 6.2% on an annualized basis, compared to the prior quarter. Deposit mix continued to improve during the quarter as average noninterest-bearing deposits grew $658 million, while average certificates and other deposits decreased $2.5 billion. The cost of interest-bearing deposits was 0.31% for the third quarter of 2013, a decrease of one basis point from the second quarter and 11 basis points compared to the same period of 2012.
Total shareholders’ equity increased $871 million compared to December 31, 2012, which reflects net proceeds of $487 million from the issuance of Tier 1 qualifying non-cumulative perpetual preferred stock in the second quarter, and net income of $1.1 billion offset by common and preferred dividends totaling $485 million and $80 million, respectively. These increases were partially offset by a $301 million change in AOCI, which primarily reflects a decrease in unrealized net gains on available for sale securities totaling $493 million, and a $165 million decrease in unrealized net losses on cash flow hedges, both of which relate to the increase in certain interest rates during the nine months ended September 30, 2013.
The Tier 1 common ratio, Tier 1 risk-based capital and total risk-based capital ratios were 9.4%, 11.3% and 13.9% at September 30, 2013, respectively. These risk-based capital ratios remain well above regulatory standards for well-capitalized banks. As of September 30, 2013, measures of tangible capital were not required by the regulators and, therefore, were considered non-GAAP measures. Refer to the section titled “Capital Adequacy and Resources” herein for a discussion of how BB&T calculates and uses these measures in the evaluation of the Company and adjustments made to certain regulatory capital ratios previously presented.
On October 11, 2013, BB&T sold a consumer lending subsidiary with approximately $500 million in loans. The gain on the sale is estimated at $25 - 30 million, which is subject to customary post-closing adjustments. In connection with this sale, BB&T expects to incur conversion costs of up to $5 million.
Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012, for additional information with respect to BB&T’s recent accomplishments and significant challenges.
Analysis Of Results Of Operations
The following table sets forth selected financial ratios for the last five calendar quarters.
Consolidated net income available to common shareholders for the first nine months of 2013 totaled $1.0 billion, compared to $1.4 billion earned during the corresponding period of the prior year. Financial results for the first nine months of 2013 were negatively impacted by adjustments to the provision for income taxes totaling $516 million that were recorded in connection with the previously described court decision and an evaluation of other tax-related matters. On a diluted per common share basis, earnings for the first nine months of 2013 were $1.44 ($2.16 excluding the tax adjustment) compared to $1.99 earned during the first nine months of 2012. BB&T’s results of operations for the first nine months of 2013 produced an annualized return on average assets of 0.84% (1.22% adjusted) and an annualized return on average common shareholders’ equity of 7.10% (10.55% adjusted), compared to prior year returns of 1.12% and 10.30%, respectively. See Non-GAAP Information on page 80.
Net Interest Income and NIM
Third Quarter 2013 compared to Third Quarter 2012
Net interest income on a FTE basis was $1.5 billion for the third quarter of 2013, a decrease of 4.3% compared to the same period in 2012. The decrease in net interest income was driven by an $82 million decrease in interest income, partially offset by a $16 million decrease in funding costs compared to the same quarter of the prior year. For the three months ended September 30, 2013, average earning assets increased $3.1 billion, or 2.0%, compared to the same period of 2012, while average interest-bearing liabilities decreased $4.1 billion, or 3.3%. The NIM was 3.68% for the third quarter of 2013, compared to 3.94% for the same period of 2012. The 26 basis point decline in the NIM was primarily driven by lower yields on new loans and securities, and covered loan run-off, partially offset by lower funding costs.
The annualized FTE yield on the average securities portfolio for the third quarter of 2013 was 2.56%, which was eight basis points lower than the annualized yield earned during the third quarter of 2012, driven by a decline in the benefit of higher-yielding covered securities.
The annualized FTE yield for the total loan portfolio for the third quarter of 2013 was 4.82%, compared to 5.23% in the third quarter of 2012. The decrease in the FTE yield on the total loan portfolio was primarily due to covered loan run-off and lower yields on new loans due to the continued low interest rate environment.
The annualized cost of interest-bearing deposits for the third quarter of 2013 was 0.31%, compared to 0.42% for the same period in the prior year, reflecting management’s ability to lower rates on all categories of interest-bearing deposit products.
For the third quarter of 2013, the average annualized FTE rate paid on short-term borrowings was 0.13% compared to 0.25% during the third quarter of 2012. The average annualized rate paid on long-term debt for the third quarter of 2013 was 3.05%, compared to 2.64% for the same period in 2012. The increase in the average rate paid on long-term debt reflects the impact of $26 million in accelerated amortization of deferred hedge gains and issuance costs in the third quarter of 2012 resulting from the redemption of the Company’s trust preferred securities.
Management expects NIM to decrease by five to ten basis points in the fourth quarter of 2013 as a result of lower rates on new earning assets, the runoff of covered loans, tighter retail credit spreads, and the sale of a subsidiary with loans totaling approximately $500 million. These negative factors are expected to be partially offset by lower funding costs and anticipated favorable funding and asset mix changes.
Nine Months of 2013 compared to Nine Months of 2012
Net interest income on a FTE basis was $4.4 billion for the nine months ended September 30, 2013, a decrease of $128 million, or 2.8%, compared to the same period in 2012. The decrease in net interest income reflects a $252 million decrease in interest income, which was partially offset by a $124 million decline in funding costs. For the nine months ended September 30, 2013, average earning assets increased $4.7 billion, or 3.1%, compared to the same period of 2012, while average interest-bearing liabilities decreased $3.6 billion, or 2.9%. The NIM was 3.71% for the nine months ended September 30, 2013, compared to 3.94% for the same period of 2012. The 23 basis point decrease in the NIM was due to lower yields on new loans and runoff of covered assets, partially offset by lower funding costs.
The annualized FTE yield on the average securities portfolio for the nine months ended September 30, 2013 was 2.51%, a decrease of 15 basis points compared to the annualized yield earned during the same period of 2012, which primarily reflects a change in the mix of the securities portfolio driven by continued runoff of higher yielding securities.
The annualized FTE yield for the total loan portfolio for the nine months ended September 30, 2013 was 4.92% compared to 5.41% in the corresponding period of 2012. The decrease in the FTE yield on the total loan portfolio was primarily due to lower yields on new loans due to the low interest-rate environment and the runoff of covered loans.
The average annualized cost of interest-bearing deposits for the nine months ended September 30, 2013 was 0.33% compared to 0.45% for the same period in the prior year, reflecting management’s ability to lower rates on all categories of interest-bearing deposit products.
For the nine months ended September 30, 2013, the average annualized FTE rate paid on short-term borrowings was 0.16%, a 10 basis point decline from the rate paid for the same period of 2012. The average annualized rate paid on long-term debt for the nine months of 2013 was 3.17% compared to 2.95% for the same period in 2012. The increase in the average rate paid on long-term debt is due to the prior period positive impact of accelerated amortization from certain derivatives that were unwound in a gain position.
The following tables set forth the major components of net interest income and the related annualized yields and rates for the three and nine months ended September 30, 2013 compared to the same periods in 2012, as well as the variances between the periods caused by changes in interest rates versus changes in volumes. Changes attributable to the mix of assets and liabilities have been allocated proportionally between the changes due to rate and the changes due to volume.
FDIC Loss Share Receivable and the Net Revenue Impact from Covered Assets
The following tables provide information related to the FDIC loss share receivable and the net revenue related to covered loans and securities as a result of the Colonial acquisition. The tables exclude amounts related to other assets acquired and liabilities assumed in the acquisition.
Interest income on covered loans and securities for the third quarter of 2013 decreased $75 million compared to the third quarter of 2012, primarily due to decreased interest income on covered loans of $69 million, reflecting lower average covered loan balances and a lower yield. The yield on covered loans for the third quarter of 2013 was 16.78% compared to 18.21% in 2012. The decline in yield is primarily the result of changes in the remaining loan mix. Interest income on covered securities in the current quarter was $6 million lower than the third quarter of 2012 primarily due to duration adjustments in each quarter.
FDIC loss share income, net was a negative $74 million for the third quarter of 2013, a $16 million improvement compared to the third quarter of 2012, which primarily reflects lower negative accretion as the FDIC indemnification asset attributable to covered loans continues to decline.
Interest income for the nine months ended September 30, 2013 on covered loans and securities decreased $252 million compared to the nine months ended September 30, 2012. The decrease was primarily due to average loan balances, which were 33.2% lower for the nine-months of 2013 compared to 2012. The yield on covered loans for the nine months ended September 30, 2013 was 17.10%, compared to 18.89% in the corresponding period of 2012. At September 30, 2013, the accretable yield balance on these loans was $565 million. Accretable yield represents the excess of future cash flows above the current net carrying amount of loans and will be recognized into income over the remaining life of the covered and acquired loans.
The provision for covered loans was $16 million for the nine months ended September 30, 2013, compared to $17 million for the same period of the prior year.
FDIC loss share income, net was a negative $218 million for the nine months ended September 30, 2013, compared to a negative $221 million for the corresponding period of the prior year.
Provision for Credit Losses
The provision for credit losses totaled $92 million (including a $2 million provision for covered loans) for the third quarter of 2013, compared to $244 million (with no provision for covered loans) for the third quarter of 2012. The decrease in the overall provision for credit losses was driven by provision decreases related to the commercial and industrial, residential mortgage, and direct retail lending portfolios. The improvement in the commercial and industrial portfolio reflects improving loss frequency factors and credit metrics. The decrease in the provision for credit losses related to the residential mortgage and direct retail lending portfolios primarily reflects improved delinquency rates and loss severity factors.
Net charge-offs, excluding covered loans, were $161 million lower than the third quarter of 2012. This decrease in net charge-offs was broad-based in nature, with significant declines in net charge-offs related to the commercial and industrial, CRE – other and CRE – residential ADC, direct retail lending and residential mortgage portfolios. Net charge-offs were 0.48% of average loans and leases on an annualized basis (0.49% excluding covered loans) for the third quarter of 2013, compared to 1.05% of average loans and leases (1.08% excluding covered loans) for the same period in 2012. Management expects that net charge-offs will be at the lower end of the normalized range for net charge-offs (which ranges from 55 to 75 basis points) with some potential for outperformance over time. Net charge-offs during the fourth quarter may reflect normal consumer seasonality.
The provision for credit losses totaled $532 million (including $16 million for covered loans) for the nine months ended September 30, 2013, compared to $805 million (including $17 million for covered loans) for the same period of 2012. The improvement in the provision for credit losses was driven by decreases in the provision related to the direct retail lending and commercial and industrial portfolios totaling $191 million and $166 million, respectively. The decrease in the direct retail lending provision reflects improvements in credit metrics and economic factors considered in the allowance estimation process, as well as improvement in loss frequency and estimated losses related to TDRs. The decrease in the provision related to the commercial and industrial portfolio primarily reflects improvement in credit metrics and economic factors. The improvements in the provision for credit losses described above were partially offset by increases in certain other loan portfolios, which primarily reflect a normalization of loss frequency estimates.
Net charge-offs, excluding covered loans, for the nine months ended September 30, 2013 were $333 million lower than the comparable period of the prior year. The decrease in net charge-offs was broad based, with significant reductions in the CRE – residential ADC, CRE – other, commercial and industrial and direct retail lending portfolios totaling $102 million, $99 million, $58 million and $53 million, respectively. Net charge-offs for the other lending subsidiaries portfolio increased modestly when compared to the prior comparable period. Net charge-offs were 0.74% of average loans and leases on an annualized basis (or 0.73% excluding covered loans) for the nine months ended September 30, 2013 compared to 1.18% of average loans and leases (or 1.19% excluding covered loans) for the same period in 2012.
Noninterest Income
Noninterest income was $905 million for the third quarter of 2013, a decrease of $58 million, or 6.0%, compared to the earlier quarter. The decrease in noninterest income was driven by decreases in mortgage banking and other income. These decreases were partially offset by an increase in insurance income, an improvement in FDIC loss share income, and an increase in service charges on deposits.
Mortgage banking income was $94 million lower than the earlier quarter, which primarily reflects reductions in margins driven by increased competition. Other income declined $22 million compared to the earlier quarter, primarily the result of a $14 million increase in net losses on affordable housing investments and $8 million in lower income related to assets for certain post-employment benefits, which is offset in personnel expense. These decreases were partially offset by a $22 million increase in insurance income, which reflects improved market conditions compared to the earlier quarter, a $16 million improvement in FDIC loss share income, and a $10 million increase in service charges on deposits. The increase in services charges on deposits primarily reflects increased overdraft fees and a reclassification of certain fee waivers to checkcard fees and other income.
Other categories of noninterest income, including investment banking and brokerage fees and commissions, bankcard fees and merchant discounts, checkcard fees, trust and investment advisory revenues, income from bank-owned life insurance and securities gains (losses), totaled $285 million for the three months ended September 30, 2013, compared to $275 million for the same period of 2012.
Noninterest income for the nine months ended September 30, 2013 totaled $3.0 billion, compared to $2.8 billion for the same period in 2012, an increase of $152 million, or 5.4%. This improvement was primarily driven by increases in insurance income, securities gains (losses) and other income totaling $149 million, $58 million, and $21 million, respectively. In addition, bankcard fees and merchant discounts, checkcard fees, trust and investment advisory revenues, and investment banking and brokerage fees and commissions also reflect significant growth compared to the earlier period. These increases were partially offset by a decline in mortgage banking income compared to the same period of the prior year.
Insurance income, which is BB&T’s largest source of noninterest income, totaled $1.1 billion for the nine months ended September 30, 2013, an increase of $149 million, or 14.9%, compared to the corresponding period of 2012. This increase primarily reflects the impact of the acquisition of Crump Insurance on April 2, 2012, firming market conditions for insurance premiums, and a $13 million experience-based refund of reinsurance premiums that was received in the second quarter of 2013.
Net securities gains for the nine months ended September 30, 2013 totaled $46 million, compared to a net securities loss of $12 million in the corresponding period of the prior year. Other income for the nine months ended September 30, 2013 totaled $229 million, an increase of $21 million compared to the prior period. This increase was primarily driven by $16 million in higher income related to operating leases within the equipment finance leasing business and $7 million in higher income related to assets for certain post-employment benefits, which was offset by higher personnel expense.
Bankcard fees and merchant discounts increased $16 million, or 9.1%, and checkcard fees increased $13 million, or 9.6%, both driven by increased transaction volumes compared to the prior period. Trust and investment advisory revenues increased $11 million, or 8.0%, primarily due to a transfer of a product line that was previously included in investment banking and brokerage fees and commissions. Investment banking and brokerage fees and commissions for the nine months ended September 30, 2013 totaled $282 million, up $15 million, or 5.6%, compared to the corresponding period of the prior year, which primarily reflects higher retail investment commission income driven by an increase in assets under management, partially offset by the transfer of a product line to trust and investment advisory revenues.
Mortgage banking income totaled $465 million for the nine months ended September 30, 2013, a decrease of $144 million compared to the amount earned in the corresponding period of 2012. Primary drivers of this decrease include a $108 million decline in residential mortgage production revenues and a $50 million decrease in net mortgage servicing rights’ valuation adjustments.
Other categories of noninterest income, including service charges on deposits, income from bank-owned life insurance, and FDIC loss share income totaled $296 million during the nine months ended September 30, 2013, compared with $283 million for the same period of 2012.
Noninterest Expense
Noninterest expense was $1.5 billion for the third quarter of 2013, a decrease of $58 million, or 3.8%, compared to the earlier quarter. Primary drivers of the decline in noninterest expense include decreases in foreclosed property expense, merger-related and restructuring charges, and loan-related expense totaling $40 million, $39 million and $15 million, respectively. These declines in noninterest expense were partially offset by increases in professional services and occupancy and equipment expense totaling $24 million and $11 million, respectively.
The decrease in foreclosed property expense reflects lower write-downs, losses and carrying costs associated with a lower level of foreclosed property. The decrease in merger-related and restructuring charges primarily relates to merger charges associated with the BankAtlantic acquisition that were incurred during the earlier period. The decrease in loan-related expense was primarily driven by $28 million in expenses related to better identification of unrecoverable costs associated with investor-owned loans in the earlier quarter.
The increase in professional services included a $16 million increase in expenses related to certain systems and process-related enhancements and $8 million in higher legal fees, while the increase in occupancy and equipment expense reflects increased IT equipment expense and other rent adjustments recognized during the current quarter.
Personnel expense, the largest component of noninterest expense, totaled $805 million, an increase of $8 million compared to the third quarter of the prior year. The increase in personnel expense was primarily driven by a $22 million increase in salaries arising from normal salary increases and job class changes, partially offset by a $14 million decrease in incentives, equity-based compensation and fringe benefits.
Other categories of noninterest expenses, including regulatory charges, software expense, amortization of intangibles and other expense totaled $341 million for the current quarter compared to $348 million for the same period of 2012.
Noninterest expenses totaled $4.4 billion for the nine months ended September 30, 2013, an increase of $41 million, or 0.9%, over the same period a year ago. Primary drivers for the increase in noninterest expense include higher personnel, occupancy and equipment, professional services and other expense. These increases were partially offset by declines in foreclosed property expense, merger-related and restructuring charges, and loan-related expense.
Personnel expense was $2.5 billion for the nine months ended September 30, 2013, an increase of $164 million, or 7.1% from the earlier period. The acquisitions of Crump Insurance and BankAtlantic were the primary drivers for the increase in personnel expense. Other factors driving the increase include increased production based incentives and lower capitalized salaries as certain mortgage production that was directed to the held for investment portfolio in the prior year was directed to the held for sale portfolio in 2013.
Occupancy and equipment expense totaled $518 million for the nine months ended September 30, 2013, an increase of $40 million, or 8.4%. This increase largely relates to the Crump Insurance and BankAtlantic acquisitions. Professional services totaled $143 million for the nine months ended September 30, 2013, an increase of $33 million or 30.0%, compared to the prior year period. This increase was largely driven by systems and process-related enhancements as well as other project-related expenses. Other expense totaled $678 million for the nine months ended September 30, 2013, compared to $659 million for the prior year period. Primary drivers for this increase include higher project-related expenses, lower of cost or fair value adjustments on certain owned real estate, and increased depreciation expense related to assets used in the equipment finance leasing business. These increases were partially offset by a decrease in advertising and marketing expense and a loss on the sale of a leveraged lease that was recorded during the nine months ended September 30, 2012.
Foreclosed property expense for the nine months ended September 30, 2013 totaled $44 million, compared to $218 million for the same period in 2012, a decrease of $174 million, or 79.8%. Foreclosed property expense was lower due to fewer losses and write-downs, and lower maintenance costs due to a reduction in inventory compared to the prior year.
Merger-related and restructuring charges decreased $21 million compared to the prior period, primarily the result of merger-related charges associated with the acquisition of BankAtlantic on July 31, 2012. Loan-related expense totaled $191 million for the nine months ended September 30, 2013, a decrease of $19 million compared to the prior period. This decrease was primarily driven by improvements in mortgage repurchase expense. Regulatory charges totaled $110 million for the nine
months ended September 30, 2013, compared to $124 million for the same period in 2012, a decrease of $14 million, or 11.3%, which reflects improved credit quality that led to lower deposit insurance premiums.
Other categories of noninterest expenses, including software expense and amortization of intangibles totaled $195 million for the nine months ended September 30, 2013 compared to $182 million for the same period of 2012.
Provision for Income Taxes
The provision for income taxes was $450 million for the third quarter of 2013, compared to $177 million for the earlier quarter. This produced an effective tax rate for the third quarter of 59.3%, compared to 26.3% for the same quarter of the prior year. The increase in the effective tax rate was primarily due to the $235 million adjustment for uncertain income tax positions described previously. Excluding the impact of this adjustment, the effective tax rate for the third quarter was 28.3%. The increase in the adjusted effective tax rate primarily reflects deferred income tax expense related to a reduction in the North Carolina state income tax rate, as BB&T is in a net deferred tax asset position. The effective tax rate for the fourth quarter of 2013 is expected to be similar to the adjusted effective tax rate for the third quarter.
The provision for income taxes was $1.2 billion for the nine months ended September 30, 2013, an increase of $595 million compared to the same period of 2012. This increase reflects $516 million of adjustments for uncertain income tax positions that were recorded during the nine months ended September 30, 2013, primarily related to the previously described disallowance of tax deductions and foreign tax credits taken in connection with a financing transaction that occurred in 2002. BB&T’s effective income tax rate for the nine months ended September 30, 2013 was 50.2% (27.7% adjusted), compared to 27.4% for the prior year period. The increase in the adjusted effective tax rate primarily reflects higher levels of pre-tax earnings relative to permanent tax differences in 2013 compared to 2012.
Refer to Note 10 “Income Taxes” in the “Notes to Consolidated Financial Statements” for a discussion of uncertain tax positions and other tax matters.
Segment Results
See Note 16 “Operating Segments” in the “Notes to Consolidated Financial Statements” contained herein and BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012, for additional disclosures related to BB&T’s reportable business segments. Fluctuations in noninterest income and noninterest expense incurred directly by the segments are more fully discussed in the “Noninterest Income” and “Noninterest Expense” sections above. The following table reflects the net income (loss) for each segment:
Community Banking net income was $268 million in the third quarter of 2013, an increase of $23 million over the earlier quarter. The allocated provision for loan and lease losses decreased $47 million. The decrease in provision expense was primarily attributable to lower business and consumer loan charge-offs and improved credit trends in the CRE and direct retail loan portfolios. Noninterest income increased $30 million, primarily due to higher service charges on deposits, checkcard fees, bankcard fees, and merchant discounts. The $16 million decrease in noninterest expense was primarily attributable to lower foreclosed property expense. Segment net interest income decreased $41 million, primarily due to lower funding spreads on deposits, partially offset by improvements in deposit mix as a result of growth in noninterest-bearing deposits and a decrease in certificates of deposits.
Residential Mortgage Banking net income was $77 million in the third quarter of 2013, a decrease of $7 million from the earlier quarter. Noninterest income decreased $94 million, driven by lower gains on mortgage loan production and sales as higher interest rates during the quarter tightened pricing due to competitive factors. The allocated provision for loan and lease losses decreased $51 million, driven by improving delinquency rates, loss severity, and impairment estimates on loans classified as TDRs. Segment net interest income increased $14 million, which was driven by growth in average residential mortgage loans and higher credit spreads to funding costs when compared to the third quarter of 2012. Noninterest expense decreased $22 million, primarily due to lower mortgage repurchase expense.
Dealer Financial Services net income was $55 million in the third quarter of 2013, a decrease of $1 million from the earlier quarter. The allocated provision for loan and lease losses increased $4 million, primarily the result of growth in the loan portfolio. Segment net interest income increased $4 million, primarily due to wider credit spreads and loan growth in the Regional Acceptance Corporation portfolio. Dealer Financial Services grew average loans by 10.1% compared to the earlier quarter.
Specialized Lending net income was $83 million in the third quarter, an increase of $36 million over the earlier quarter. The allocated provision for loan and lease losses decreased $61 million, which primarily reflects the impact of adjustments to loss factors that were recorded in the prior period that resulted from more accelerated recognition of certain consumer loan charge-offs. The provision for income taxes increased $24 million, primarily due to higher pre-tax income and a higher proportion of tax-exempt income in the earlier quarter.
Insurance Services net income was $22 million in the third quarter of 2013, an increase of $6 million over the earlier quarter. Noninterest income growth of $23 million was driven by organic growth in wholesale and retail property and casualty insurance operations as market conditions improved and insurance pricing continued to firm. Higher noninterest income growth was offset by a $14 million increase in noninterest expense, primarily due to higher personnel and business referral expense.
Financial Services net income was $77 million in the third quarter, an increase of $4 million over the earlier quarter. The allocated provision for loan and lease losses decreased $15 million, primarily due to improved credit trends in the large corporate loan portfolio. Segment net interest income decreased $8 million, primarily due to lower funding spreads on deposits. Financial Services continues to generate significant loan growth, with Corporate Banking’s average loan balances increasing $1.3 billion or 22.0% over the earlier period, while BB&T Wealth’s average loan balances increased $276 million or 23.4%.
Other, Treasury & Corporate generated a net loss of $273 million, which reflects the impact of the previously described $235 million income tax adjustment for uncertain income tax positions. Excluding this adjustment, the net loss for the third quarter was $38 million. Segment net interest income decreased $34 million, primarily attributable to runoff in the covered loan portfolio. Noninterest income decreased $14 million, driven by a $14 million increase in net losses on affordable housing investments. Noninterest expense decreased $35 million, primarily attributable to merger-related expense associated with the BankAtlantic acquisition in the prior period.
Community Banking net income was $706 million for the nine months ended September 30, 2013, compared to $510 million in same period of the prior year. Segment net interest income decreased $106 million primarily as a result of lower funding spreads earned on deposits, partially offset by improvements in deposit mix as a result of growth in noninterest-bearing deposits, money market and savings deposits, and a decrease in certificates of deposits. The allocated provision for loan and lease losses decreased $298 million, reflecting a lower level of business and consumer loan charge-offs. Noninterest income increased $61 million primarily due to higher checkcard fees, bankcard fees, merchant discounts, and service charges on deposits. Noninterest expense decreased $71 million, primarily driven by lower foreclosed property and regulatory expense.
Residential Mortgage Banking net income was $258 million for the nine months ended September 30, 2013, compared to $282 million in the same period of the prior year. Segment net interest income increased $48 million which was driven by growth in average residential mortgage loans, as well as higher credit spreads to funding costs. The allocated provision for loan and lease losses decreased $21 million, primarily reflecting improving delinquency rates, loss severity and impairment estimates on loans classified as TDRs. Noninterest income decreased $139 million, driven by a decline in residential mortgage production revenues and a decrease in net mortgage servicing rights’ valuation adjustments. Noninterest expense decreased $41 million primarily due to lower foreclosed property expense and lower expense associated with mortgage repurchase reserves.
Dealer Financial Services net income was $154 million for the nine months ended September 30, 2013, compared to $178 million in the same period of the prior year. Segment net interest income increased $23 million, primarily the result of wider credit spreads related to lower funding costs and loan growth in the Regional Acceptance Corporation portfolio. Dealer Financial Services grew average loans for the nine months ended September 30, 2013 by 7.2% compared to the same period of the prior year. The allocated provision for loan and lease losses increased $59 million, primarily related to an increase in the allocated provision associated with the Regional Acceptance Corporation loan portfolio that resulted from a change in loan composition and the resulting estimated loan losses.
Specialized Lending net income was $204 million for the nine months ended September 30, 2013, compared to $171 million in the same period of the prior year. Segment net interest income grew $23 million, which benefitted from lower funding costs and strong loan growth in nearly all specialized lending businesses including 34.6% growth in average small ticket consumer finance loan balances, a 9.8% increase in the average commercial finance portfolio, and 8.1% growth in the average commercial insurance premium financing portfolio. The allocated provision for loan and lease losses decreased $32 million primarily due to a prior year adjustment to loss factors associated with the Lendmark Financial portfolio that resulted from an increase in the volume of TDRs and impaired loans. Noninterest expense increased $10 million, primarily due to higher depreciation on property held under operating leases in the equipment finance portfolio.
Insurance Services net income was $118 million for the nine months ended September 30, 2013, compared to $105 million in the same period of the prior year. Noninterest income was $153 million higher than the first nine months of 2012, which reflects the acquisition of Crump Insurance on April 2, 2012, firming market conditions for insurance premiums, organic growth in wholesale and retail property and casualty insurance operations and an experience-based refund of reinsurance premiums totaling $13 million that was received in the second quarter of 2013. Higher noninterest income growth was offset by a $122 million increase in noninterest expense, primarily the result of higher salary costs and performance-based incentives.
Financial Services net income was $218 million for the nine months ended September 30, 2013, compared to $202 million in the same period of the prior year. Average loan growth for the segment was 26.3% compared to the prior year. Segment net interest income decreased $7 million, primarily due to lower yields on loans. Noninterest income increased $6 million, driven by higher investment banking fees and commissions and trust and investment advisory revenues. Noninterest expense decreased $22 million, primarily due to an operating charge-off in the prior year.
Net income in Other, Treasury & Corporate can vary due to changing needs of the Corporation, including the size of the investment portfolio, the need for wholesale funding, and income received from derivatives used to hedge the balance sheet. Other, Treasury & Corporate generated a net loss of $517 million in the first nine months of 2013, compared to net income of $31 million in the same period of the prior year. The net loss was primarily the result of $516 million in adjustments for uncertain income tax positions previously described. Segment net interest income decreased $110 million primarily attributable to runoff in the covered loan portfolio. The $65 million increase in noninterest income was primarily driven by higher securities gains in the investment portfolio.
Analysis Of Financial Condition
Investment Activities
The total securities portfolio was $36.4 billion at September 30, 2013, a decrease of $2.3 billion, compared with December 31, 2012. As of September 30, 2013, the securities portfolio included $22.9 billion of AFS securities and $13.5 billion of HTM securities.
The effective duration of the securities portfolio increased to 5.2 years at September 30, 2013, compared to 2.8 years at December 31, 2012, primarily the result of an increase in interest rates during the nine months ended September 30, 2013. The duration of the securities portfolio excludes equity securities, auction rate securities and certain non-agency residential MBS that were acquired in the Colonial acquisition.
See Note 2 “Securities” in the “Notes to Consolidated Financial Statements” herein for additional disclosures related to BB&T’s evaluation of securities for OTTI.
Lending Activities
For the third quarter of 2013, average loans held for investment were $115.1 billion, a 3.0% annualized increase compared to $114.3 billion for the second quarter. The increase in average loans held for investment was driven by strong growth in the other lending subsidiaries and sales finance portfolios, along with steady growth in the direct retail lending portfolio. The growth in these portfolios was partially offset by continued runoff of the covered and CRE – residential ADC loan portfolios.
Excluding the impact of the fourth quarter 2013 sale of a consumer loan financing subsidiary with loans of approximately $500 million, average loan growth during the fourth quarter is expected to be modest.
Average other lending subsidiaries loans increased $611 million, reflecting strong growth in the small ticket consumer finance, insurance premium finance, and commercial mortgage lending portfolios totaling $296 million, $229 million, and $50 million, respectively. The growth in small ticket consumer finance business primarily reflects increased outdoor power equipment lending, while the increase in insurance premium finance reflects seasonality within that LOB. The increase in the commercial mortgage lending portfolio primarily reflects growth in interim first lien bridge loans to middle market real estate developers and investors. Growth in the average sales finance loan portfolio totaled $472 million based on the strength of demand in both the consumer and wholesale segments of the prime automobile lending market. The direct retail lending
portfolio increased $176 million compared to the prior quarter, primarily driven by strong growth in first lien closed end real estate loans early in the third quarter and continued growth in the small business and wealth sub-portfolios.
Average residential mortgage loans were essentially flat compared to the prior quarter, as expected runoff in the mortgage loan portfolio was offset by growth in adjustable-rate and construction-to-permanent loans during the quarter. The average covered and CRE – residential ADC loan portfolios declined 49.4% and 35.0% on an annualized basis, respectively, due to continued runoff of covered loans and weakness in the ADC market.
Average LHFS decreased $463 million, reflecting declines of $450 million in residential LHFS and $13 million in commercial LHFS. The decline in residential LHFS reflects declining loan origination volume, driven by rising interest rates and a related decrease in refinance activities.
Asset Quality
Asset quality continued to improve during the third quarter of 2013. NPAs, which includes foreclosed real estate, repossessions, NPLs and nonperforming TDRs, totaled $1.3 billion (or $1.2 billion excluding covered assets) at September 30, 2013, compared to $1.8 billion (or $1.5 billion excluding covered assets) at December 31, 2012. The 24.3% decrease in NPAs, excluding covered assets, was driven by a $350 million decrease in NPLs and a $24 million decline in foreclosed real estate and other foreclosed property. NPAs have decreased for 14 consecutive quarters and are at their lowest level since March 31, 2008. Refer to Table 7 for an analysis of the changes in NPAs during the nine months ended September 30, 2013. NPAs as a percentage of loans and leases plus foreclosed property were 1.10% at September 30, 2013 (or 1.00% excluding covered assets) compared with 1.51% (or 1.33% excluding covered assets) at December 31, 2012.
The current inventory of foreclosed real estate, excluding covered assets, totaled $85 million as of September 30, 2013. This includes land and lots, which totaled $16 million and had been held for approximately nine months on average. The remaining foreclosed real estate of $69 million, which is primarily single family residential and CRE, had an average holding period of four months.
Management expects NPAs to improve at a modest pace during the fourth quarter of 2013, assuming no significant economic deterioration during the quarter.
The following table presents the changes in NPAs, excluding covered foreclosed property, during the nine months ended September 30, 2013 and 2012:
Tables 8 and 9 summarize asset quality information for the last five quarters. As more fully described below, this information has been adjusted to exclude past due covered loans and certain mortgage loans guaranteed by the government:
Loans 90 days or more past due and still accruing interest, excluding government guaranteed loans and loans covered by FDIC loss share agreements, totaled $122 million at September 30, 2013, compared with $167 million at December 31, 2012, a decline of 26.9%. Loans 30-89 days past due, excluding government guaranteed loans and covered loans, totaled $923 million at September 30, 2013, which was a decline of $145 million, or 13.6%, compared with $1.1 billion at December 31, 2012.
Applicable ratios are annualized.
Potential problem loans include loans on nonaccrual status or past due as disclosed in Table 8. In addition, for its commercial portfolio segment, loans that are rated special mention or substandard performing are closely monitored by management as potential problem loans. Refer to Note 3 “Loans and ACL” in the “Notes to Consolidated Financial Statements” herein for additional disclosures related to these potential problem loans.
Certain residential mortgage loans have an initial period where the borrower is only required to pay the periodic interest. After the interest period, the loan will require the payment of both interest and principal over the remaining term. At September 30, 2013, approximately 7.7% of the outstanding balances of residential mortgage loans were in the interest-only phase, compared to 8.1% at December 31, 2012. Approximately 64.4% of the interest-only balances will begin amortizing within the next three years. Approximately 3.5% of interest-only loans are 30 days or more past due and still accruing and 1.8% are on nonaccrual status.
Home equity lines, which are a component of the direct retail portfolio, generally require the payment of interest only during the first 15 years after origination. After this initial period, the outstanding balance begins amortizing and requires the payment of both interest and principal. At September 30, 2013, approximately 66.1% of the outstanding balance of home equity lines was in the interest-only phase. Approximately 6.9% of these balances will begin amortizing at various dates through December 31, 2016. The delinquency rate of interest-only lines is similar to amortizing lines.
TDRs occur when a borrower is experiencing, or is expected to experience, financial difficulties in the near-term. As a result, BB&T will work with the borrower to prevent further difficulties, and ultimately to improve the likelihood of recovery on the loan. To facilitate this process, a concessionary modification that would not otherwise be considered may be granted resulting in classification of the loan as a TDR. Refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” in the Annual Report on Form 10-K for the year ended December 31, 2012 for additional policy information regarding TDRs.
Performing TDRs, excluding government guaranteed mortgage loans, totaled $1.3 billion at September 30, 2013, an increase of $15 million, or 1.1%, compared with December 31, 2012. Performing TDRs were fairly stable in most portfolios. The increase in performing TDRs was driven by a $79 million increase in the other lending subsidiaries portfolio, primarily related to payment extension activity in the Regional Acceptance Corporation portfolio. This increase was partially offset by decreases totaling $49 million and $12 million in the residential mortgage and direct retail lending portfolios, respectively. The following table provides a summary of performing TDR activity during the nine months ended September 30, 2013 and 2012:
Payments and payoffs represent cash received from borrowers in connection with scheduled principal payments, prepayments and payoffs of amounts outstanding at the maturity date of the loan. Transfers to nonperforming TDRs represent loans that no longer meet the requirements necessary to reflect the loan in accruing status and as a result are subsequently classified as a nonperforming TDR.
Allowance for Credit Losses
The ACL, which consists of the ALLL and the RUFC, totaled $1.9 billion at September 30, 2013, a decline of $118 million compared to December 31, 2012. The ALLL amounted to 1.59% of loans and leases held for investment at September 30, 2013 (1.51% excluding covered loans), compared to 1.76% (1.70% excluding covered loans) at year-end 2012. The decrease in the ALLL as a percentage of loans and leases reflects continued improvement in the credit quality of the loan portfolio. The percentage of the allowance for impaired loans to their recorded investment, excluding covered loans and government guaranteed loans, decreased from 15.8% at December 31, 2012 to 15.7% at September 30, 2013. The ratio of the ALLL to nonperforming loans held for investment, excluding covered loans, was 1.66x at September 30, 2013 compared to 1.37x at December 31, 2012.
BB&T monitors the performance of its home equity loans and lines secured by second liens similar to other consumer loans and utilizes assumptions specific to these loans in determining the necessary allowance. Notification is received when the first lien holder has initiated foreclosure proceedings against the borrower. When notified that the first lien holder is in the process of foreclosure, valuations are obtained to determine if any additional charge-offs or reserves are warranted. These valuations are updated at least annually thereafter.
BB&T has limited ability to monitor the delinquency status of the first lien unless the first lien is held or serviced by BB&T. As a result, using migration assumptions that are based on historical experience adjusted for current trends, the volume of second lien positions where the first lien is delinquent is estimated and the allowance is adjusted to reflect the increased risk of loss on these credits. Finally, additional reserves are provided on second lien positions for which the estimated combined current loan to value ratio exceeds 100%. As of September 30, 2013, BB&T held or serviced the first lien on 37% of its second lien positions.
Net charge-offs totaled $144 million for the third quarter of 2013 and amounted to 0.48% of average loans and leases (or 0.49% excluding covered loans), compared to $217 million, or 0.74% of average loans and leases (or 0.75% excluding covered loans), in the prior quarter. For the nine months ended September 30, 2013, net charge-offs were $650 million and amounted to 0.74% of average loans and leases (or 0.73% excluding covered loans), compared to $994 million, or 1.18% of average loans and leases (1.19% excluding covered loans), in the same period of 2012. Management expects that net charge-offs will be at the lower end of the normalized range for net charge-offs (which ranges from 55 to 75 basis points) in the fourth quarter of 2013, with some potential for outperformance over time. Net charge-offs during the fourth quarter may reflect normal consumer seasonality.
Charge-offs related to covered loans represent realized losses in certain acquired loan pools that exceed the amounts originally estimated at the acquisition date. This impairment, which is subject to the loss sharing agreements, was provided for in prior quarters and therefore the charge-offs have no impact on the Consolidated Statements of Income.
Refer to Note 3 “Loans and ACL” in the “Notes to Consolidated Financial Statements” for additional disclosures.
The following table presents an allocation of the allowance for loan and lease losses at September 30, 2013 and December 31, 2012. 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.
Information related to the ACL is presented in the following table:
Deposits
The following table presents the composition of average deposits for the last five quarters:
Average deposits for the third quarter decreased $2.0 billion, or 6.2% on an annualized basis, compared to the second quarter. Deposit mix continued to improve during the quarter as average noninterest-bearing deposits grew $658 million, while average certificates and other time deposits decreased $2.5 billion. Average noninterest-bearing deposits represented 26.8% of total average deposits for the third quarter compared to 25.8% for the prior quarter.
Growth in average noninterest-bearing deposits was driven by commercial accounts, which increased $811 million compared to the prior quarter. This increase was partially offset by a decline in noninterest-bearing deposits related to public funds and retail accounts that totaled $128 million and $33 million, respectively. Average interest-checking and money market and
savings accounts increased $86 million compared to the prior quarter, with $319 million in commercial account growth that was partially offset by decreases of $132 million and $101 million related to public funds and retail accounts, respectively. The decrease in average certificates and other time deposits was primarily driven by a $1.8 billion decline in non-client certificates of deposit. Average foreign office deposits decreased $307 million compared to the prior quarter as management obtained funding from other sources.
The cost of interest-bearing deposits was 0.31% for the third quarter, a decrease of one basis point compared to the prior quarter.
Management expects continued growth in noninterest-bearing deposits during the fourth quarter of 2013, along with lower interest-bearing deposit costs, resulting in the cost of deposits falling below 0.30% by year-end.
Borrowings
At September 30, 2013, short-term borrowings totaled $4.8 billion, an increase of $1.9 billion, compared to December 31, 2012. Long-term debt totaled $20.4 billion at September 30, 2013, an increase of $1.3 billion, or 6.7%, from the balance at December 31, 2012. The increase in long-term debt reflects the issuance of $1.0 billion of senior debt by the Parent Company and $1.6 billion of senior debt by Branch Bank. Taking swaps into consideration, the effective interest rates ranged from 0.58% to 1.11% at September 30, 2013. These issuances were partially offset by the maturity of $500 million in senior notes with an interest rate of 3.38%, the maturity of $222 million of subordinated notes with an interest rate of 4.875%, and a net decrease of $530 million in FHLB advances.
On October 28, 2013, Branch Bank issued $650 million of floating rate senior debt due in 2015.
Shareholders’ Equity
Total shareholders’ equity at September 30, 2013 was $22.1 billion, an increase of $871 million, or 4.1%, compared to December 31, 2012. This increase was driven by net income of $1.1 billion and net proceeds of $487 million from the issuance of Tier 1 qualifying Series G Non-Cumulative Perpetual Preferred Stock. These increases were partially offset by common and preferred dividends totaling $565 million and a $301 million increase in AOCI loss. The AOCI loss primarily reflects a decrease in unrealized net gains on AFS securities totaling $493 million, offset by a $165 million decrease in unrealized net losses on cash flow hedges, both of which relate to the increase in certain interest rates during the nine months ended September 30, 2013. BB&T’s book value per common share at September 30, 2013 was $27.59, compared to $27.21 at December 31, 2012.
Merger-Related and Restructuring Activities
At September 30, 2013 and December 31, 2012, merger-related and restructuring accruals totaled $17 million and $11 million, respectively. The increase is primarily due to optimization activities related to Community Banking initiated during the second quarter of 2013. Merger-related and restructuring accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at September 30, 2013 are expected to be utilized within one year, unless they relate to specific contracts that expire later.
Risk Management
Risk is inherent in the normal course of business activities. Risk decisions are made as closely as possible to where the risk occurs. Centrally, risk oversight is managed at the corporate level through oversight, policies and reporting. The principal types of inherent risk include regulatory, credit, liquidity, market, operational, reputation and strategic risks. Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012 for disclosures related to each of these risks under the section titled “Risk Management.”
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 in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in BB&T’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value. At BB&T, market risk management also includes the enterprise-wide IPV function.
Interest Rate Market Risk (Other than Trading)
BB&T actively manages market risk associated with 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 these activities is the development of appropriate maturity and repricing opportunities in BB&T’s portfolios of assets and liabilities that will produce reasonably consistent net interest income during periods of changing interest rates. 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 NIM and assure liquidity by coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. Among other things, this process gives consideration to prepayment trends related to securities, loans and leases and certain deposits that have no stated maturity. Prepayment assumptions are developed using a combination of market data and internal historical prepayment experience for residential mortgage-related loans and securities, and internal historical prepayment experience for client deposits with no stated maturity and loans that are not residential mortgage related. These assumptions are subject to monthly back-testing, and are adjusted as deemed necessary to reflect changes in interest rates relative to the reference rate of the underlying assets or liabilities. On a monthly basis, BB&T evaluates the accuracy of its interest rate forecast model, which includes an evaluation of its prepayment assumptions, to ensure that all significant assumptions inherent in the model appropriately reflect changes in the interest rate environment and related trends in prepayment activity. It is the responsibility of the MRLCC to determine and achieve the most appropriate volume and mix of earning assets and interest-bearing liabilities, as well as to ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The MRLCC also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The MRLCC 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 impacts on earnings and liquidity as a result of fluctuations in interest rates are within acceptable tolerance guidelines.
BB&T uses derivatives primarily to manage economic risk related to securities, commercial loans, MSRs, mortgage banking operations, long-term debt and other funding sources. BB&T also uses derivatives to facilitate transactions on behalf of its clients. As of September 30, 2013, BB&T had derivative financial instruments outstanding with notional amounts totaling $62.8 billion, with a net liability fair value of $160 million. See Note 14 “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements” herein for additional disclosures.
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 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 MRLCC, management believes that BB&T is positioned to respond to changing needs for liquidity, changes in interest rates and inflationary trends.
Management uses the Simulation to measure the sensitivity of projected earnings to changes in interest rates. The Simulation model projects net interest income and interest rate risk for a rolling two-year period of time. The Simulation takes into account the current contractual agreements that BB&T has made with its customers on deposits, borrowings, loans, investments and commitments to enter into those transactions. Furthermore, the Simulation considers the impact of expected customer behavior. Management monitors BB&T’s interest sensitivity by means of a model that incorporates the current volumes, average rates earned and paid, and scheduled maturities and payments of asset and liability portfolios, together with multiple scenarios that include 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 management believes that it provides a better illustration of the sensitivity of earnings to changes in interest rates than other analyses such as static or dynamic gap. In addition to the Simulation, BB&T uses EVE analysis to focus on projected changes in capital given potential changes in interest rates. This measure also allows BB&T to analyze interest rate risk that falls outside the analysis window contained in the Simulation model. The EVE model is a discounted cash flow of the portfolio of assets, liabilities, and derivative instruments. The difference in the present value of assets minus the present value of liabilities is defined as the economic value of equity.
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 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 the 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 assuming a gradual change in interest rates as described below. Key assumptions in the preparation of the table include prepayment speeds of mortgage-related and other assets, cash flows and maturities of derivative financial instruments, loan volumes and pricing, deposit sensitivity, customer preferences and capital plans. The resulting change in net interest income reflects the level of sensitivity that interest sensitive income has in relation to changing interest rates.
The MRLCC has established parameters related to interest sensitivity that prescribe a maximum negative impact on net interest income under different interest rate scenarios. In the event the results of the Simulation model fall outside the established parameters, management will make recommendations to the MRLCC on the most appropriate response given the current economic forecast. The following parameters and interest rate scenarios are considered BB&T’s primary measures of interest rate risk:
If a rate change of 200 basis points cannot be modeled due to a low level of rates, a proportional limit applies. Management currently only models a negative 25 basis point decline because larger declines would have resulted in a Federal funds rate of less than zero. In a situation such as this, the maximum negative impact on net interest income is adjusted on a proportional basis. Regardless of the proportional limit, the negative risk exposure limit will be the greater of 1% or the proportional limit.
Management has also established a maximum negative impact on net interest income of 4% for an immediate 100 basis points change in rates and 8% for an immediate 200 basis points change in rates. These “interest rate shock” limits are designed to create an outer band of acceptable risk based upon a significant and immediate change in rates.
Management must also consider how the balance sheet and interest rate risk position could be impacted by changes in balance sheet mix. Liquidity in the banking industry has been very strong during the current economic cycle. Much of this liquidity increase has been due to a significant increase in noninterest-bearing demand deposits. Consistent with the industry, Branch Bank has seen a significant increase in this funding source. The behavior of these deposits is one of the most important assumptions used in determining the interest rate risk position of BB&T. A loss of these deposits in the future would reduce the asset sensitivity of BB&T’s balance sheet as the company increases interest-bearing funds to offset the loss of this advantageous funding source.
Beta represents the correlation between overall market interest rates and the rates paid by BB&T on interest-bearing deposits. BB&T applies an average beta of approximately 80% to its managed rate deposits for determining its interest rate sensitivity. Managed rate deposits are high beta, premium money market and interest checking accounts, which attract significant client funds when needed to support balance sheet growth. BB&T regularly conducts sensitivity on other key variables to determine the impact they could have on the interest rate risk position. This allows BB&T to evaluate the likely impact on its balance sheet management strategies due to a more extreme variation in a key assumption than expected.
The following table shows the effect that the loss of demand deposits and an associated increase in managed rate deposits would have on BB&T’s interest-rate sensitivity position. For purposes of this analysis, BB&T modeled the incremental beta for the replacement of the lost demand deposits at 100%.
The following table shows the effect that the indicated changes in interest rates would have on EVE. Key assumptions in the preparation of the table include prepayment speeds of mortgage-related and other assets, cash flows and maturities of derivative financial instruments, loan volumes and pricing and deposit sensitivity. The resulting change in the EVE reflects the level of sensitivity that EVE has in relation to changing interest rates.
Market Risk from Trading Activities
BB&T also manages market risk from trading activities which consists of acting as a financial intermediary to provide its customers access to derivatives, foreign exchange and securities markets. Trading market risk is managed through the use of statistical and non-statistical risk measures and limits. BB&T utilizes a historical VaR methodology to measure and aggregate risks across its covered trading lines of business. This methodology uses two years of historical data to estimate economic outcomes for a one-day time horizon at a 99% confidence level. The average 99% one-day VaR and the maximum daily VaR for the three months ended September 30, 2013 were less than $1 million.
Contractual Obligations, Commitments, Contingent Liabilities, Off-Balance Sheet Arrangements and Related Party Transactions
Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012 for discussion with respect to BB&T’s quantitative and qualitative disclosures about its fixed and determinable contractual obligations. Additional disclosures about BB&T’s contractual obligations, commitments and derivative financial instruments are included in Note 12 “Commitments and Contingencies” and Note 13 “Fair Value Disclosures” in the “Notes to Consolidated Financial Statements.”
Liquidity
Liquidity represents BB&T’s continuing ability to meet funding needs, including deposit withdrawals, timely repayment of borrowings and other liabilities, and funding of loan commitments. In addition to the level of liquid assets, such as cash, cash equivalents and AFS securities, many other factors affect BB&T’s 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 ability to securitize or package loans for sale. BB&T monitors key liquidity metrics at both the Parent Company and Branch Bank.
Parent Company
The purpose of the Parent Company is to serve as the primary capital financing vehicle for the operating subsidiaries. The assets of the Parent Company consist primarily of cash on deposit with Branch Bank, 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 payments on long-term debt. The main sources of funds for the Parent Company are dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from the issuance of equity and long-term debt. The primary uses of funds by the Parent Company are for investments in subsidiaries, advances to subsidiaries, dividend payments to common and preferred shareholders, retirement of common stock and interest and principal payments due on long-term debt.
Liquidity at the Parent Company is more susceptible to market disruptions. BB&T prudently manages cash levels at the Parent Company to cover a minimum of one year of projected contractual cash outflows which includes unfunded external commitments, debt service, preferred dividends and scheduled debt maturities without the benefit of any new cash infusions. Generally, BB&T maintains a significant buffer above the projected one year of contractual cash outflows. In determining the buffer, BB&T considers cash for common dividends, unfunded commitments to affiliates, being a source of strength to its banking subsidiaries, and being able to withstand sustained market disruptions which may limit access to the credit markets. As of September 30, 2013 and December 31, 2012, the Parent Company had 30 months and 35 months, respectively, of cash on hand to satisfy projected contractual cash outflows as described above.
Branch Bank
Branch Bank has several major sources of funding to meet its liquidity requirements, including access to capital markets through issuance of senior or subordinated bank notes and institutional CDs, access to the FHLB system, dealer repurchase agreements and repurchase agreements with commercial clients, access to the overnight and term Federal funds markets, use of a Cayman branch facility, access to retail brokered CDs and a borrower in custody program with the FRB for the discount window. As of September 30, 2013, BB&T has approximately $54 billion of secured borrowing capacity, which represents approximately 326% of one year wholesale funding maturities.
BB&T also monitors the ability to meet customer demand for funds under both normal and stressed market conditions. In considering its liquidity position, management evaluates BB&T’s funding mix based on client core funding, client rate-sensitive funding and non-client rate-sensitive funding. In addition, management also evaluates exposure to rate-sensitive funding sources that mature in one year or less. Management also measures liquidity needs against 30 days of stressed cash outflows for Branch Bank. To ensure a strong liquidity position, management maintains a liquid asset buffer of cash on hand and highly liquid unpledged securities. The Company has established a policy that the liquid asset buffer would be a minimum of 5% of total assets, but intends to maintain the ratio well in excess of this level. As of September 30, 2013 and December 31, 2012, BB&T’s liquid asset buffer was 9.5% and 11.1%, respectively, of total assets.
The ability to raise funding at competitive prices is affected by the rating agencies’ views of the Parent Company’s and Branch Bank’s credit quality, liquidity, capital and earnings. Management meets with the rating agencies on a routine basis to discuss current outlooks.
BB&T and Branch Bank have Contingency Funding Plans designed to ensure that liquidity sources are sufficient to meet their ongoing obligations and commitments, particularly in the event of a liquidity contraction. These plans are designed to examine and quantify the organization’s liquidity under various “stress” scenarios. Additionally, the plans provide a framework for management and other critical personnel to follow in the event of a liquidity contraction or in anticipation of such an event. The plans address authority for activation and decision making, liquidity options and the responsibilities of key departments in the event of a liquidity contraction. The liquidity options available to management could include seeking secured funding, asset sales, and under the most extreme scenarios, curtailing new loan originations. Management believes current sources of liquidity are adequate to meet BB&T’s current requirements and plans for continued growth.
Capital Adequacy and Resources
The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. BB&T’s principal goals related to the maintenance of capital are to provide adequate capital to support BB&T’s risk profile consistent with the Board-approved risk appetite, provide financial flexibility to support future growth and client needs, comply with relevant laws, regulations, and supervisory guidance, achieve optimal credit ratings for BB&T and its subsidiaries and provide a competitive return to shareholders.
Management regularly monitors the capital position of BB&T on both a consolidated and bank level basis. In this regard, management’s overriding policy is to maintain capital at levels that are in excess of the operating capital guidelines, which are above the regulatory “well capitalized” levels. Management has recently implemented stressed capital ratio minimum guidelines to evaluate whether capital levels are sufficient to withstand the impact of plausible, severe economic downturns or bank-specific events. The following table presents the minimum capital ratios:
While nonrecurring events or management decisions may result in the Company temporarily falling below its operating minimum guidelines for one or more of these ratios, it is management’s intent through capital planning to return to these targeted operating minimums within a reasonable period of time. Such temporary decreases below the operating minimums shown above are not considered an infringement of BB&T’s overall capital policy provided the Company and Branch Bank remain “well-capitalized.”
On March 14, 2013, the FRB informed BB&T that it objected to certain elements of its capital plan. BB&T resubmitted its plan on June 11, 2013. On August 23, 2013, BB&T announced that the FRB did not object to the Company’s revised plan.
Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Tier 1 Common Equity, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.
BB&T’s common equity Tier 1 ratio under Basel III was approximately 9.0% at September 30, 2013 based on management’s interpretation of the final rules adopted by the FRB on July 2, 2013, which established a new comprehensive capital framework for U.S. banking organizations. The minimum required common equity Tier 1 ratio, including the capital conservation buffer, will gradually increase from 4.5% on January 1, 2015 to 7.0% on January 1, 2019.
Share Repurchase Activity
No shares were repurchased in connection with the 2006 Repurchase Plan during 2013.
Non-GAAP Information
Certain amounts have been presented that exclude the effect of the $281 million and $235 million adjustments for uncertain income tax positions that were recognized in the first quarter and third quarter of 2013, respectively. BB&T believes these adjusted measures are meaningful as excluding the adjustment increases the comparability of certain period-to-period results. The following table reconciles these adjusted measures to their corresponding GAAP amount.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to “Market Risk Management” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section herein.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, the management of the Company, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Refer to the “Commitments and Contingencies” and “Income Taxes” notes in the “Notes to Consolidated Financial Statements.”
ITEM 1A. RISK FACTORS
There have been no material changes to the risk factors disclosed in BB&T’s Annual Report on Form 10-K for the year ended December 31, 2012. In addition to the risk factors in BB&T’s Annual Report on Form 10-K, the following supplemental risk factor related to the implementation of a new ERP system should be carefully considered. Additional risks and uncertainties not currently known to BB&T or that management has deemed to be immaterial also may materially adversely affect BB&T’s business, financial condition, and/or operating results.
BB&T may not be able to successfully implement a new ERP system, which could adversely affect BB&T’s business operations and profitability.
BB&T is investing significant resources in an enterprise-wide initiative aimed at implementing an ERP financial platform, utilizing certain modules of SAP software. The ERP system is expected to be partially operational in 2014 and fully operational in 2015. The objective of the new ERP system is to modernize and consolidate many of BB&T’s existing systems that are currently used for a variety of functions throughout the Company, including both internal and external financial reporting. BB&T may not be able to successfully implement and integrate the new ERP system, which could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in BB&T stock, among others. In addition, a number of core business processes including, but not limited to, remitting amounts owed to vendors, could be affected. The implementation could extend past the expected timing and/or result in operating inefficiencies, which could increase the costs associated with the implementation.
Failure to implement part or all of the ERP system could result in impairment charges that adversely impact BB&T’s financial condition and results of operations and could result in significant costs to remediate or replace the defective components. In addition, BB&T may incur significant training, licensing, maintenance, consulting and amortization expenses during and after the implementation, and any such costs may continue for an extended period of time.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Refer to “Share Repurchase Activity” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section herein.
SIGNATURES
Pursuant to the requirements 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.
(Registrant)
Daryl N. Bible, Senior Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Cynthia B. Powell, Executive Vice President andCorporate Controller
(Principal Accounting Officer)
85