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: March 31, 2014
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 March 31, 2014, 718,496,658 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, 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 January 2014, the FASB issued new guidance related to Investments in Qualified Affordable Housing Projects. The new guidance allows an entity, provided certain criteria are met, to elect the proportional amortization method to account for these investments. The proportional amortization method allows an entity to amortize the initial cost of the investment in proportion to the amount of tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of the provision for income taxes. This guidance is effective for interim and annual reporting periods beginning after December 15, 2014. 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, 2014, the Company adopted new guidance related to Troubled Debt Restructurings. The new guidance clarifies the timing of when an in substance repossession or foreclosure of collateralized residential real property is deemed to have occurred. The guidance also requires disclosures related to the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The adoption of this guidance was not material to the consolidated financial position, results of operations or cash flows.
Effective January 1, 2014, the Company adopted 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. The adoption of this guidance was not material to the consolidated financial position, results of operations or cash flows.
NOTE 2. Securities
The fair value of covered securities included non-agency MBS of $1.0 billion and $1.1 billion as of March 31, 2014 and December 31, 2013, respectively, and states and political subdivisions securities of $314 million as of March 31, 2014 and December 31, 2013.
As of March 31, 2014 and December 31, 2013, securities with carrying values of approximately $9.1 billion and $11.9 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 March 31, 2014. The FNMA investments had total amortized cost and fair value of $12.8 billion and $12.4 billion, respectively. The FHLMC investments had total amortized cost and fair value of $6.0 billion and $5.8 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.
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.
The unrealized losses on GSE securities and MBS issued by GSE were the result of increases in market interest rates compared to the date the securities were acquired rather than the credit quality of the issuers or underlying loans.
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 March 31, 2014, there were no non-agency MBS in an unrealized loss position.
At March 31, 2014, $54 million of the unrealized loss on states and political subdivisions securities was the result of fair value hedge basis adjustments that are a component of amortized cost. States and political subdivisions 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 states and political subdivisions securities resulted in the OTTI recognized during the quarter ended March 31, 2014.
NOTE 3. Loans and ACL
During January 2014, approximately $8.3 billion of closed-end, first and second lien position residential mortgage loans were transferred from direct retail lending to residential mortgage to facilitate compliance with a series of new rules related to mortgage servicing associated with first and second lien position mortgages collateralized by real estate.
During March 2014, the CRE loan categories were realigned into CRE – income producing properties and CRE – construction and development in order to better reflect the nature of the underlying loans. Prior period data has been reclassified to conform to this new presentation.
Loans totaling $66.6 billion and $66.2 billion were pledged as collateral for borrowing capacity at the FHLB and FRB at March 31, 2014 and December 31, 2013, respectively. The collateral supports current advances and other activities, in addition to providing borrowing capacity subject to certain limitations. Unearned income and net deferred loan fees and costs totaled $234 million and $261 million at March 31, 2014 and December 31, 2013, respectively.
At March 31, 2014 and December 31, 2013, BB&T had $532 million and $531 million of mortgage loans collateralized by residential real estate that are in the process of foreclosure.
The following table summarizes the primary reason loan modifications were classified as TDRs and includes newly designated TDRs as well as modifications made to existing TDRs. Balances represent the recorded investment at the end of the quarter in which the modification was made. Rate modifications in this table 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. Loan Servicing
Residential Mortgage Banking Activities
The following tables summarize residential mortgage banking activities. Mortgage and home equity loans managed or securitized exclude loans serviced for others with no other continuing involvement.
Payments made to date for recourse exposure on residential mortgage loans sold with recourse liability have been immaterial.
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 5. Long-Term Debt
The effective rates above reflect the impact of cash flow and fair value hedges, as applicable. The subordinated notes qualify under the risk-based capital guidelines as Tier 2 supplementary capital, subject to certain limitations.
NOTE 6. Shareholders’ Equity
The weighted average assumptions used in the valuation of equity-based awards and the activity relating to options and RSUs during the period are presented in the following tables:
NOTE 7. AOCI
NOTE 8. Income Taxes
The effective tax rate for the three months ended March 31, 2014 was lower than the corresponding period of 2013 primarily due to adjustments for uncertain tax positions recorded during 2013 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. On September 20, 2013, the court denied BB&T’s refund claim. As a result, BB&T recorded tax adjustments of $281 million and $235 million during the quarters ended March 31, 2013 and September 30, 2013, respectively. BB&T has filed a Notice of Appeal to the U.S. Court of Appeals for the Federal Circuit. As of March 31, 2014, the exposure for this financing transaction is fully reserved. Depending on the outcome of the appeals process, as well as the current IRS examination, it is reasonably possible that changes in the amount of unrecognized tax benefits, penalties and interest could result in a benefit of up to $750 million during the next twelve months. The ultimate resolution of these matters may take longer.
NOTE 9. 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. A discretionary contribution of $110 million was made during the first quarter of 2014. There are no required contributions for the remainder of 2014, though BB&T may elect to make additional contributions.
NOTE 10. Commitments and Contingencies
Legal Proceedings
The nature of BB&T’s business 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 the 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 of BB&T.
NOTE 11. Fair Value Disclosures
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 tables present fair value information for assets and liabilities measured on a recurring basis:
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 the 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, primarily consisting 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.
U.S. Treasury securities: Treasury securities are valued using quoted prices in active over the counter markets.
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 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 those asset classes. The re-remic non-agency MBS, which are categorized as Level 3, are 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: Residential MSRs are valued using an OAS valuation model to project cash flows over multiple interest rate scenarios, which are then discounted at risk-adjusted rates. The 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 between fair value levels as of the end of a reporting period.
The majority of BB&T’s 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, BB&T estimates these investments have a weighted average remaining life of approximately three years; however, the timing and amount of distributions may vary significantly. As of March 31, 2014, restrictions on the ability to sell the investments include, but are not limited to, consent of a majority member or general partner’s approval for transfer of ownership. BB&T’s 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 4x to 10x, with a weighted average of 8x, at March 31, 2014.
Excluding government guaranteed, there were no LHFS that were nonaccrual or 90 days or more past due and still accruing interest.
For 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 BB&T’s 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 restricted cash: 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/payable: The fair values of the receivable and payable are 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 loss share agreements are not transferrable and, accordingly, there is no market for the receivable or payable.
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. BB&T has developed long-term relationships with its deposit customers, commonly referred to as core deposit intangibles, that have not been considered in the determination of the deposit liabilities’ fair value.
Short-term borrowings: The carrying amounts of short-term borrowings 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 12. Derivative Financial Instruments
Assets and liabilities related to derivatives are presented on a gross basis in the Consolidated Balance Sheets. The fair value of derivatives in a gain or loss position is included in other assets or liabilities, respectively, on the Consolidated Balance Sheets. Cash collateral posted for derivative instruments in a loss position 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 Master agreements allow 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 net derivative values with a defaulting party against 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 standings.
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 13. Computation of EPS
NOTE 14. Operating Segments
During January 2014, approximately $8.3 billion of closed-end, first and second lien position residential mortgage loans were transferred from Community Banking to Residential Mortgage Banking based on a change in how these loans are managed as a result of new qualified mortgage regulations. In connection with this transfer, $319 million of goodwill was transferred from Community Banking to Residential Mortgage Banking. The following tables have been revised to give retrospective effect to the transfer:
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, 2013 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 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 has 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, 2013 for additional disclosures with respect to laws and regulations affecting BB&T.
Dodd-Frank Act
The FRB has announced extensions for compliance with certain requirements of the Dodd-Frank Act that impact instruments held by BB&T. BB&T is currently evaluating the potential impact of these requirements on its financial condition and results of operations.
Interchange Fees
During March 2014, the D.C. Circuit Court of Appeals overturned the July 2013 lower court decision that ruled against the debit card interchange fee limits imposed by the FRB. Interchange fees, or “swipe fees,” are charges that merchants pay to card-issuing banks for processing electronic payment transactions. The case was remanded to the lower court for further proceedings on the FRB’s anti-exclusivity rule. The merchants may appeal the decision for rehearing before the D.C. Circuit Court of Appeals or petition the U.S. Supreme Court.
Foreign Account Tax Compliance Act and Conforming Regulations
In February 2014, The U.S. Treasury and IRS released the last substantial package of regulations necessary to implement the Foreign Account Tax Compliance Act. These regulations affect persons making certain U.S.-related payments to Foreign Financial Institutions and other foreign entities, as well as payments by Foreign Financial Institutions to other persons. In addition, these regulations revise certain existing provisions regarding tax withholding on certain U.S. source income paid to foreign persons, information reporting and backup withholding with respect to payments made to certain U.S. persons, portfolio interest paid to nonresident alien individuals and foreign corporations, and the associated requirements governing collection, refunds, and credits of amounts withheld under these rules.
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, 2013. 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, 2013. There have been no changes to the significant accounting policies during 2014. 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 first quarter of 2014 was $501 million, a 138.6% increase compared to $210 million earned during the same period in 2013. Net income available to common shareholders for the first quarter of 2014 was reduced by a $16 million adjustment ($0.02 impact to diluted earnings per share) that reflects the reallocation of certain partnership profit interests to non-controlling interest holders. Financial results for the first quarter of 2013 were negatively impacted by a $281 million adjustment to the provision for income taxes, which was driven by a U.S. Tax Court ruling on February 11, 2013 that had implications on positions BB&T had taken in a similar transaction that was the subject of litigation in the U.S. Court of Federal Claims.
On a diluted per common share basis, earnings for the first quarter of 2014 were $0.69, compared to $0.29 for the same period in 2013. Excluding the impact of the tax adjustment, diluted earnings per share for the first quarter of 2013 were $0.69. BB&T’s results of operations for the first quarter of 2014 produced an annualized return on average assets of 1.29%, an annualized return on average risk-weighted assets of 1.71%, and an annualized return on average common shareholders’ equity of 9.87%, compared to prior year ratios of 0.57% (1.20% adjusted), 0.76% (1.60% adjusted) and 4.44% (10.34% adjusted), respectively. See Non-GAAP Information on page 66.
Total revenues, which include taxable-equivalent net interest income and noninterest income, were $2.3 billion for the first quarter of 2014, down $166 million compared to the first quarter of 2013. The decrease in total revenues included a $76 million decrease in taxable-equivalent net interest income and a $90 million decrease in noninterest income. The decrease in taxable-equivalent net interest income reflects a $115 million decrease in interest income, which primarily reflects the continued runoff of higher yielding covered loans, the sale of a consumer lending subsidiary during the fourth quarter of 2013, and lower yields on new loans. The decrease in interest income was partially offset by a $39 million decrease in funding costs compared to the same quarter of the prior year. NIM was 3.52%, down 24 basis points compared to the first quarter of 2013.
The decrease in noninterest income reflects declines in mortgage banking income, FDIC loss share income and net securities gains (losses) totaling $106 million, $25 million and $21 million, respectively. These decreases were partially offset by a $62 million increase in insurance income. The decrease in mortgage banking income reflects a decline in the volume of residential mortgage loan production, tighter pricing and the retention of certain mortgage loans in the held-for-investment portfolio in the fourth quarter of 2013 through the first quarter of 2014. The decrease in FDIC loss share income primarily relates to a provision for covered loans offset recorded in the earlier quarter. Net securities gains for the first quarter of 2014 totaled $2 million compared to $23 million in the earlier quarter. Insurance income was $62 million higher than the earlier quarter, which reflects higher performance-based commission income, firming market conditions for insurance premiums and $23 million due to an improved process used to estimate commission income.
The provision for credit losses, excluding covered loans, declined $180 million, or 72.9%, compared to the first quarter of 2013, as improved credit quality resulted in lower provision expense. Net charge-offs, excluding covered loans, for the first quarter of 2014 were $119 million lower than the first quarter of 2013, a decline of 43.3%. Excluding the reserve for unfunded lending commitments and covered loans, the reserve release was $80 million for the first quarter of 2014, compared to $54 million in the earlier quarter.
Noninterest expense was $1.4 billion for the first quarter of 2014, a decrease of $11 million, or 0.8%, compared to the first quarter of 2013. This decline was primarily driven by a decrease in personnel expense totaling $35 million, which was largely the result of lower pension plan expense, driven by estimated returns on plan assets and lower amortization of net actuarial losses, and lower post-employment benefits expense, which is offset in other income. The decrease in noninterest expense also included declines in foreclosed property expense, regulatory charges, amortization of intangibles and professional services, which in the aggregate declined $22 million compared to the same quarter of the prior year. The overall decline in noninterest expense was partially offset by increases in other expense and loan-related expense of $22 million and $11 million, respectively. The increase in other expense includes higher project-related expenses, operating charge-offs and other related expenses, while the increase in loan-related expense primarily reflects higher expenses associated with certain investor-owned loans.
The provision for income taxes was $217 million for the first quarter of 2014, compared to $481 million for the first quarter of 2013. The effective tax rate for the first quarter of 2014 was 27.3%, compared to 65.3% for the prior year’s first quarter. The decrease in the effective tax rate primarily reflects the $281 million prior year adjustment to the income tax provision described previously.
NPAs, excluding covered foreclosed real estate, decreased $67 million compared to December 31, 2013, reflecting declines in NPLs and foreclosed property totaling $32 million and $35 million, respectively. Excluding covered assets, NPAs represented 0.54% of total assets as of March 31, 2014, which is the lowest percentage since 2007.
Average loans held for investment for the first quarter of 2014 totaled $115.1 billion, up $266 million, or 0.9% on an annualized basis, compared to the fourth quarter of 2013. This increase was driven by growth in the commercial and industrial, CRE – income producing properties and sales finance loan portfolios of $334 million, $262 million and $166 million, respectively. Growth in average loans held for investment was negatively impacted by continued runoff in the covered loan portfolio of $312 million, or 57.9% annualized, and a $212 million decrease in the other lending subsidiaries portfolio.
Average deposits for the first quarter of 2014 decreased $188 million compared to the fourth quarter of 2013. Deposit mix remained relatively stable, with average noninterest-bearing deposits increasing slightly to 28.2% of total average deposits for the first quarter of 2014, compared to 28.1% for the prior quarter. The cost of interest-bearing deposits was 0.27% for the first quarter of 2014, a decrease of one basis point from the prior quarter.
Total shareholders’ equity increased $747 million compared to December 31, 2013. This increase was primarily driven by net income of $578 million offset by common and preferred dividends totaling $163 million and $37 million, respectively. Other factors contributing to the increase in shareholders’ equity include $250 million in net activity related to equity awards and a $93 million net increase in AOCI, which primarily reflects a decrease in unrealized losses on AFS securities.
The Tier 1 common ratio, Tier 1 risk-based capital and total risk-based capital ratios were 10.2%, 12.1% and 14.6% at March 31, 2014, respectively. These risk-based capital ratios remain well above regulatory standards for well-capitalized banks. As of March 31, 2014, 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.
Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2013 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.
Net Interest Income and NIM
First Quarter 2014 compared to First Quarter 2013
Net interest income on a FTE basis was $1.4 billion for the first quarter of 2014, a decrease of 5.2% compared to the same period in 2013. The decrease in net interest income was driven by a $115 million decrease in interest income, partially offset by a $39 million decrease in funding costs compared to the same quarter of the prior year. For the three months ended March 31, 2014, average earning assets increased $1.7 billion, or 1.1%, compared to the same period of 2013, while average interest-bearing liabilities decreased $3.7 billion, or 3.1%. The NIM was 3.52% for the first quarter of 2014, compared to
3.76% for the same period of 2013. The 24 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 first quarter of 2014 was 2.48%, which was unchanged from the earlier period.
The annualized FTE yield for the total loan portfolio for the first quarter of 2014 was 4.58%, compared to 5.03% in the first quarter of 2013. The decrease in the FTE yield on the total loan portfolio was primarily due to continued runoff of higher yielding covered loans, the sale of a consumer lending subsidiary during the fourth quarter of 2013, and lower yields on new loans.
The annualized cost of interest-bearing deposits for the first quarter of 2014 was 0.27%, compared to 0.36% for the same period in the prior year, reflecting lower rates on all categories of interest-bearing deposit products.
For the first quarter of 2014, the average annualized FTE rate paid on short-term borrowings was 0.11% compared to 0.18% during the first quarter of 2013. The average annualized rate paid on long-term debt for the first quarter of 2014 was 2.49%, compared to 3.23% for the same period in 2013. This decrease was the result of lower rates on new debt issuances.
Management expects NIM to decrease by approximately ten basis points in the second quarter of 2014 with approximately half of the decline due to covered asset runoff. The other half of the decline is due to core margin changes as a result of lower earning asset yields driven by tighter credit spreads, partially offset by lower funding costs and favorable funding mix changes. Thereafter, the core margin is expected to be relatively stable for the remainder of the year.
The following table sets forth the major components of net interest income and the related annualized yields and rates for the three months ended March 31, 2014, compared to the same period in 2013, 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
In connection with the Colonial acquisition, Branch Bank entered into loss sharing agreements with the FDIC that outline the terms and conditions under which the FDIC will reimburse Branch Bank for a portion of the losses incurred on certain loans, OREO, certain investment securities and other assets. Refer to BB&T’s Annual Report on Form 10-K for the year ended December 31, 2013 for additional information regarding the loss sharing agreements. The following table presents the carrying amount of assets covered by each loss share agreement:
The loss sharing agreement applicable to commercial loans and other covered assets expires in the third quarter of 2014; however, Branch Bank must reimburse the FDIC for gains and recoveries, net of related expenses, through the third quarter of 2017. The following table provides information related to the carrying amount and fair value of the components of the FDIC loss share receivable (payable):
The decrease in the carrying amount attributable to covered loans was due to the receipt of cash from the FDIC and negative accretion due to the credit loss improvement, partially reduced by the offset to the provision for covered loans and the FDIC’s share of losses on foreclosed property. The change in the carrying amount attributable to covered securities was due to the offsets to the accretion of the discount and the amount of changes in unrealized gains of covered securities. The change in the carrying amount attributable to the aggregate loss calculation is primarily due to accretion of the expected payment, which is included in “Accretion due to credit loss improvement” below. The fair values were based upon a discounted cash flow methodology that was consistent with the acquisition date methodology. The fair value attributable to covered loans and the aggregate loss calculation changes over time due to the receipt of cash from the FDIC, updated credit loss assumptions and the passage of time. The fair value attributable to covered securities was based upon the timing and amount that would be payable to the FDIC should they settle at the current fair value at the conclusion of the loss share agreement.
The cumulative amount related to covered securities recognized through earnings resulted in a liability of $202 million as of March 31, 2014. Covered securities are classified as AFS and carried at fair market value, and the changes in unrealized gains/losses are offset by the applicable loss share percentage in AOCI, which resulted in a pre-tax liability of $366 million as of March 31, 2014. BB&T would only owe these amounts to the FDIC if BB&T were to sell these securities prior to the third quarter of 2017. BB&T does not currently intend to dispose of the covered securities.
Following the conclusion of the 10 year loss share period in 2019, should actual aggregate losses, excluding securities, be less than an amount determined in accordance with these agreements, BB&T will pay the FDIC a portion of the difference. As of March 31, 2014, BB&T projects that Branch Bank would owe the FDIC approximately $164 million under the aggregate loss calculation. This liability is expensed over time and BB&T has recognized total expense of approximately $113 million through March 31, 2014.
The following table provides information related to the income statement impact of covered loans and securities and the FDIC loss sharing receivable/payable. The table excludes all amounts related to other assets acquired and liabilities assumed in the acquisition.
Interest income on covered loans and securities for the first quarter of 2014 decreased $55 million compared to the first quarter of 2013, reflecting decreased interest income related to covered loans and securities totaling $49 million and $6 million, respectively. The decline in interest income relating to covered loans primarily reflects lower average covered loan balances. The yield on covered loans for the first quarter of 2014 was 18.65%, compared to 17.49% in the earlier quarter. The increase in yield primarily reflects the impact of the quarterly reassessment of expected future cash flows. The decrease in interest income on covered securities primarily reflects lower average covered security balances in the current quarter.
FDIC loss share income, net was a negative $84 million for the first quarter of 2014, $25 million worse than the first quarter of 2013, which primarily reflects the offset to the provision for covered loans recorded in the earlier quarter.
Provision for Credit Losses
The provision for credit losses, excluding covered loans, totaled $67 million for the first quarter of 2014, a decrease of $180 million compared to the provision for the first quarter of 2013. This decrease reflects improvement in loss frequencies related to the commercial and industrial and CRE – income producing properties portfolios, which resulted in provision decreases totaling $149 million and $19 million respectively. The provision for credit losses related to the other lending subsidiaries portfolio declined $21 million, primarily the result of updates to loss frequencies and overall credit quality improvement resulting from the sale of a consumer lending subsidiary during the fourth quarter of 2013. The provision related to the reserve for unfunded lending commitments reflected a net improvement of $35 million, which primarily reflects improvement in loss frequencies and credit quality. These decreases were partially offset by a $42 million increase in the provision for credit losses related to the CRE – construction and development portfolio, which primarily reflects a provision release in the earlier quarter.
Net charge-offs, excluding covered loans, were $119 million lower than the first quarter of 2013. This decrease in net charge-offs was broad-based in nature, with notable declines in net charge-offs related to the commercial and industrial, CRE –income producing properties, and direct retail lending portfolios that totaled $60 million, $25 million and $23 million, respectively. Net charge-offs in the other lending subsidiaries portfolio were $18 million higher than the earlier quarter as a result of a process change that resulted in accelerated recognition of charge-offs in the nonprime automobile lending portfolio. This increase is not indicative of a trend in the underlying portfolio.
Net charge-offs were 0.56% of average loans and leases on an annualized basis (0.55% excluding covered loans) for the first quarter of 2014, compared to 1.00% of average loans and leases (0.98% excluding covered loans) for the same period in 2013. Management expects that net charge-offs will be modestly below the normalized range for net charge-offs (which ranges from 50 to 70 basis points) for the next few quarters.
Noninterest Income
Noninterest income was $911 million for the first quarter of 2014, a decrease of $90 million, or 9.0%, compared to the earlier quarter. The decrease in noninterest income was driven by decreases in mortgage banking income, FDIC loss share income and net securities gains (losses) totaling $106 million, $25 million, and $21 million, respectively. These decreases were partially offset by a $62 million increase in insurance income.
The decrease in mortgage banking income reflects a decline in the volume of residential mortgage loan production, tighter pricing and the retention of certain mortgage loans in the held-for-investment loan portfolio in the fourth quarter of 2013 through the first quarter of 2014. The decrease in FDIC loss share income primarily relates to an offset for the provision for covered loans recorded in the earlier quarter. Net securities gains for the first quarter of 2014 totaled $2 million, compared to $23 million in the earlier quarter. Insurance income was $62 million higher than the earlier quarter, which reflects higher performance-based commission income, firming market conditions for insurance premiums and $23 million due to an improved process of estimating commission income.
Other categories of noninterest income, including service charges on deposits, investment banking and brokerage fees and commissions, bankcard fees and merchant discounts, trust and investment advisory revenues, checkcard fees, income from bank-owned life insurance, and other income totaled $492 million for the three months ended March 31, 2014, unchanged compared to the same period of 2013.
Noninterest Expense
Noninterest expense was $1.4 billion for the first quarter of 2014, a decrease of $11 million, or 0.8%, compared to the earlier quarter. This decline includes a $35 million decrease in personnel expense, which primarily reflects lower estimated qualified pension plan expense that was driven by lower amortization of net actuarial losses. The decline in noninterest expense also includes declines in foreclosed property expense, regulatory charges, amortization of intangibles and professional services that totaled $22 million in the aggregate.
These declines in noninterest expense were partially offset by increases in other expense and loan-related expense totaling $22 million and $11 million, respectively. The increase in other expense includes higher project-related expenses, operating charge-offs and other related expenses, while the increase in loan-related expense primarily reflects higher expenses associated with certain investor-owned loans.
Other categories of noninterest expenses, including occupancy and equipment, software and merger-related and restructuring charges totaled $227 million for the current quarter, compared to $214 million for the same period of 2013.
Management expects that positive operating leverage over the remainder of 2014 will drive the efficiency ratio lower.
Provision for Income Taxes
The provision for income taxes was $217 million for the first quarter of 2014, compared to $481 million for the earlier quarter. This produced an effective tax rate for the first quarter of 2014 of 27.3%, compared to 65.3% for the same quarter of the prior year. This decrease in the effective tax rate primarily reflects the $281 million prior year adjustment to the income tax provision described previously. The effective tax rate for the second quarter of 2014 is expected to be similar to the effective tax rate for the first quarter.
Segment Results
See Note 14 “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, 2013, 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.
During January 2014, approximately $8.3 billion of home equity loans and lines were transferred from Community Banking to Residential Mortgage Banking based on a change in how these loans are managed as a result of new qualified mortgage regulations. The following table has been revised to give retrospective effect to the transfer:
Community Banking net income was $217 million in the first quarter of 2014, an increase of $24 million over the earlier quarter. The allocated provision for loan and lease losses decreased $101 million driven by lower business and consumer loan charge-offs. The $31 million decrease in noninterest expense was primarily attributable to lower personnel, occupancy and equipment, and foreclosed property expense, partially offset by higher allocated service center and commercial loan pre-foreclosure expense. Segment net interest income decreased $52 million, primarily due to lower funding spreads on deposits, partially offset by improvements in deposit mix as a result of growth in noninterest-bearing and savings, and a decrease in certificates of deposit. Intersegment net referral fees decreased $28 million driven by lower mortgage banking referrals. The provision for income taxes increased $14 million, primarily due to higher pre-tax income.
Residential Mortgage Banking net income was $63 million in the first quarter of 2014, a decrease of $74 million from the earlier quarter. Noninterest income decreased $101 million driven by lower gains on residential mortgage loan production and sales as mortgage originations declined, pricing tightened due to competitive factors, and the correspondent network generated a more significant share of loan originations in the first quarter of 2014 compared to the earlier quarter. The decrease in noninterest income was also driven by a decrease in net MSR fair value gains. Segment net interest income decreased $20 million, primarily the result of lower average balances in the held-for-sale portfolio. The $8 million increase in noninterest expense was driven by higher expenses associated with the investor-owned servicing portfolio. The allocated provision for loan and lease losses decreased $13 million, which primarily reflects improved credit trends. The provision for income taxes decreased $46 million, primarily due to lower pre-tax income.
Dealer Financial Services net income was $35 million in the first quarter of 2014, a decrease of $5 million from the earlier quarter, primarily due to an increase in the allocated provision for loan and lease losses. The allocated provision for loan and lease losses increased $6 million, primarily due to a process change that resulted in accelerated recognition of charge-offs in the nonprime automobile lending portfolio. Segment net interest income was flat as loan growth was offset by lower funding spreads. Dealer Financial Services grew average loans by 12.3% compared to the earlier quarter.
Specialized Lending net income was $59 million in the first quarter of 2014, an increase of $9 million from the earlier quarter. Segment net interest income decreased $38 million compared to the earlier quarter, which primarily reflects the sale of a consumer lending subsidiary in the fourth quarter. The sale of this subsidiary had a beneficial impact on the allocated provision for loan and lease losses, which decreased $42 million. Noninterest expense decreased $13 million driven by lower personnel, loan processing, occupancy and equipment, and professional services expense. Small ticket consumer finance, equipment finance, governmental finance, and commercial mortgage businesses experienced strong growth compared to the earlier quarter.
Insurance Services net income was $75 million in the first quarter of 2014, an increase of $40 million over the first quarter of 2013. Insurance Service’s noninterest income was up $65 million, primarily due to higher performance-based commissions, increased commissions on certain new and renewal business and $23 million due to an improved process used to estimate commission income. Noninterest expense increased $15 million, primarily driven by higher salary, business referral, and insurance premium expense. The provision for income taxes increased $9 million, primarily due to higher pre-tax income.
Financial Services net income was $68 million in the first quarter of 2014, a decrease of $3 million from the earlier quarter. Segment net interest income decreased $9 million, primarily due to lower funding spreads on deposits. The allocated provision for loan and lease losses decreased $9 million, reflecting improved loss frequency in the large corporate loan portfolio. Financial Services continues to generate significant loan growth, with Corporate Banking’s average loan balances increasing $1.2 billion, or 17.9%, over the earlier period, while BB&T Wealth’s average loan balances increased $159 million, or 19.5%.
In the first quarter of 2014, Other, Treasury & Corporate generated net income of $61 million, an increase of $331 million over the earlier quarter. Earlier quarter results include a $281 million adjustment to the income tax provision as previously described. Excluding this adjustment, net income for the first quarter of 2013 was $11 million. The allocated provision for loan and lease losses decreased $53 million, primarily due to lower covered loan charge-offs and a decrease in the reserve for unfunded commitments attributable to improved loss frequency estimates. Segment net interest income increased $45 million, primarily due to higher interest income on the investment portfolio, lower corporate borrowing costs, and lower funding credits on deposits allocated to the Community Banking and Financial Services segments. Intersegment net referral fees increased $29 million as the result of lower shared mortgage banking referral income allocated to the Community Banking and Financial Services segments. Allocated corporate expenses decreased $35 million compared to the earlier quarter.
Analysis Of Financial Condition
Investment Activities
The total securities portfolio was $41.3 billion at March 31, 2014, an increase of $1.1 billion, compared with December 31, 2013. As of March 31, 2014, the securities portfolio included $20.5 billion of AFS securities (at fair value) and $20.8 billion of HTM securities (at amortized cost).
The effective duration of the securities portfolio decreased to 5.1 years at March 31, 2014, compared to 5.5 years at December 31, 2013, primarily the result of lower interest rates. 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
Average loans held for investment were $115.1 billion for the first quarter of 2014, a 0.9% increase compared to $114.8 billion for the fourth quarter of 2013.
Average residential mortgage loans increased $6.7 billion, and average direct retail lending loans decreased $6.6 billion, largely due to a transfer of approximately $8.3 billion of closed-end, first and second lien position, residential mortgage loans in January 2014. This transfer was completed in order to facilitate compliance with a series of new rules related to mortgage servicing associated with first and second lien position mortgages collateralized by real estate. Average loan balances for the first quarter of 2014 reflect the impact of this transfer from the date of the transfer through March 31, 2014.
During the first quarter of 2014, the CRE loan categories were realigned into CRE – income producing properties and CRE – construction and development in order to better reflect the nature of the underlying loans. Prior period data has been reclassified to conform to this new presentation.
The increase in average loans held for investment in the first quarter of 2014 compared to the prior quarter was driven by growth in the commercial and industrial, CRE – income producing properties and sales finance loan portfolios of $334 million, $262 million, and $166 million, respectively. Growth in average loans held for investment was negatively impacted by continued runoff in the covered loan portfolio of $312 million and a $212 million decrease in the other lending subsidiaries portfolio.
The increase in the commercial and industrial portfolio was largely driven by growth in middle market corporate lending. The average CRE – income producing properties portfolio increased $262 million, or 10.6% annualized compared to the prior quarter, reflecting growth in lending to multi-family residential and retail shopping center clients. The average CRE – construction and development portfolio increased 3.5% on an annualized basis compared to the prior quarter, based primarily on lending to single-family construction clients in certain geographical areas. The average sales finance portfolio increased $166 million, or 7.3% annualized, based on continued strength in the prime automobile lending market.
Average other lending subsidiaries loans decreased $212 million compared to the fourth quarter of 2013. This decline included a $205 million decrease in the insurance premium financing portfolio, which was primarily the result of seasonality in that line of business, a decrease of approximately $69 million that was largely attributable to the sale of a consumer lending subsidiary during the fourth quarter of 2013, and a $48 million decrease in the small ticket consumer finance portfolio. These declines were partially offset by a $109 million increase in the equipment finance portfolio.
Average LHFS for the first quarter of 2014 decreased $895 million compared to the prior quarter. This decrease reflects declines of $828 million and $67 million of residential LHFS and commercial LHFS, respectively. The decrease in residential LHFS reflects a continued decline in mortgage loan origination volume as well as the decision to retain certain originated mortgage loans.
Average loan growth for the second quarter of 2014 is expected to be in the range of 3% to 5% on an annualized basis compared to the first quarter of 2014.
Asset Quality
The following discussion excludes assets covered by FDIC loss sharing agreements that provide for reimbursement to BB&T for the majority of losses incurred on those assets. Covered loans, which are considered performing due to the application of the expected cash flows method, were $1.8 billion at March 31, 2014 and $2.0 billion at December 31, 2013. Covered foreclosed real estate totaled $98 million and $121 million at March 31, 2014 and December 31, 2013, respectively.
Asset quality continued to improve during the first quarter of 2014. NPAs, which include foreclosed real estate, repossessions, NPLs and nonperforming TDRs, totaled $1.0 billion at March 31, 2014, compared to $1.1 billion at December 31, 2013. The decrease in NPAs included declines in nonperforming loans and leases and foreclosed property of $32 million and $35 million, respectively. NPAs have decreased for 16 consecutive quarters and are at their lowest level since December 31, 2007. Refer to Table 8 for an analysis of the changes in NPAs during the three months ended March 31, 2014. NPAs as a percentage of loans and leases plus foreclosed property were 0.85% at March 31, 2014, compared with 0.91% at December 31, 2013.
Management expects NPAs to improve at a modest pace in the second quarter of 2014.
The following table presents the changes in NPAs during the three months ended March 31, 2014 and 2013:
Table 9 and Table 10 summarize asset quality information for the last five quarters. As more fully described below, the information has been adjusted to exclude past due covered loans and certain mortgage loans guaranteed by the government:
Applicable ratios are annualized.
Problem loans include loans on nonaccrual status or loans that are 90 days or more past due and still accruing as disclosed in Table 9. 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 March 31, 2014, approximately 5.4% of the outstanding balances of residential mortgage loans were in the interest-only phase, compared to 7.2% at December 31, 2013. Approximately 65.4% of the interest-only balances will begin amortizing within the next three years. Approximately 3.7% of interest-only loans are 30 days or more past due and still accruing and 2.4% 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 March 31, 2014, approximately 66% of the outstanding balances of home equity lines were in the interest-only phase. Approximately 9.7% of these balances will begin amortizing at various dates through December 31, 2017. 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 and a concession has been granted to the borrower. As a result, BB&T will work with the borrower to prevent further difficulties and ultimately 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, 2013 for additional policy information regarding TDRs.
Performing TDRs, excluding government guaranteed mortgage loans, totaled $1.3 billion at March 31, 2014, a decrease of $52 million, or 3.9%, compared with December 31, 2013. During the first quarter of 2014, approximately $94 million of performing TDRs were transferred from direct retail lending to residential mortgage in connection with the transfer of $8.3 billion in loans as previously described. Excluding the impact of this transfer, performing TDRs in the residential mortgage portfolio declined $43 million, largely due to the removal of TDRs due to sustained performance under the modified terms.
The following table provides a summary of performing TDR activity:
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.
ACL
The ACL, which consists of the ALLL and the RUFC, totaled $1.7 billion at March 31, 2014, a decline of $99 million compared to December 31, 2013. Excluding the reserve for unfunded lending commitments and covered loans, the reserve release was $80 million for the first quarter of 2014, compared to $67 million for the fourth quarter of 2013. Management expects future allowance releases, if any, to be lower as credit continues to improve.
The ALLL amounted to 1.41% of loans and leases held for investment at March 31, 2014 (1.34% excluding covered loans), compared to 1.49% (1.42% excluding covered loans) at year-end 2013. The decrease in the ALLL reflects continued improvement in expected loss factors related to most loan portfolios. The ratio of the ALLL to nonperforming loans held for investment, excluding covered loans, was 1.70x at March 31, 2014 compared to 1.73x at December 31, 2013.
Net charge-offs totaled $159 million for the first quarter of 2014, and amounted to 0.56% of average loans and leases (0.55% excluding covered loans), compared to $141 million, or 0.48% of average loans and leases (0.49% excluding covered loans), for the fourth quarter of 2013. The increase in net charge-offs resulted from a process change that resulted in accelerated recognition of charge-offs in the nonprime automobile lending portfolio, and is not indicative of a trend in the underlying portfolio.
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 ALLL at March 31, 2014 and December 31, 2013. This allocation of the ALLL 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 first quarter of 2014 decreased $188 million, or 0.6% on an annualized basis compared to the fourth quarter of 2013. The decrease in deposits reflects declines in interest checking and money market and savings accounts of $354 million and $531 million, respectively. These decreases were partially offset by an increase in certificates and other time deposits of $355 million and an increase in foreign office deposits of $297 million. Deposit mix remained relatively stable, with average noninterest-bearing deposits increasing slightly to 28.2% of total average deposits for the first quarter of 2014, compared to 28.1% for the fourth quarter of 2013.
Noninterest-bearing deposits increased $45 million compared to the fourth quarter of 2013, which reflects growth in retail and public funds accounts totaling $480 million and $295 million, respectively, partially offset by a decline in commercial account balances of $628 million.
The cost of interest-bearing deposits was 0.27% for the first quarter of 2014, a decrease of one basis point compared to the fourth quarter of 2013.
Management currently expects that deposit costs will be relatively flat compared to the current quarter, with some potential for a one or two basis point improvement in future quarters.
Borrowings
At March 31, 2014, short-term borrowings totaled $3.3 billion, a decrease of $853 million, or 20.6%, compared to December 31, 2013. Long-term debt totaled $23.4 billion at March 31, 2014, an increase of $1.9 billion, or 8.8%, from the balance at December 31, 2013. The increase in long-term debt during the current quarter is primarily due to the issuance of $2.4 billion of senior notes with maturity dates ranging from 2017 to 2021.
Shareholders’ Equity
Total shareholders’ equity at March 31, 2014 was $23.6 billion, an increase of $747 million compared to December 31, 2013. The increase in total shareholders’ equity was driven by earnings of $578 million, $250 million of net activity related to equity awards, and a $93 million net increase in AOCI. These increases were partially offset by common and preferred dividends totaling $163 million and $37 million, respectively. BB&T’s common equity per common share at March 31, 2014 was $29.03, compared to $28.52 at December 31, 2013.
Merger-Related and Restructuring Activities
At March 31, 2014 and December 31, 2013, merger-related and restructuring accruals totaled $26 million and $25 million, respectively. Merger-related and restructuring accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at March 31, 2014 are expected to be utilized within one year, unless they relate to specific contracts that expire later. As part of management's ongoing evaluation of the alignment of BB&T's cost structure with business needs, additional restructuring charges are expected to be incurred over the next several quarters.
Risk Management
BB&T has defined and established an enterprise-wide risk culture that places an emphasis on effective risk management through a strong tone at the top by the Board of Directors and Executive Management, accountability at all levels of the organization, an effective challenge environment and incentives to encourage strong risk management behavior. The risk culture promotes judicious risk-taking and discourages rampant revenue generation without consideration of corresponding risks. It is part of BB&T’s mission statement that risk is managed to optimize the long-term return to shareholders, while providing a safe and sound investment. Risk management begins with the LOBs, and as such, BB&T has established clear expectations for the LOBs in regards to the identification, monitoring, reporting and response to current and emerging risks. Centrally, risk oversight is managed at the corporate level through oversight, policies and reporting.
The Board of Directors and Executive Management established BB&T’s risk culture and promoted appropriate risk-taking behaviors. It is the responsibility of senior leadership to clearly communicate the organizational values that support the desired risk culture, recognize and reward behavior that reflects the defined risk culture and monitor and assess the current risk culture of BB&T. Regardless of financial gain or loss, employees are held accountable if they do not follow the established risk management policies and procedures. BB&T’s risk culture encourages transparency and open dialogue between all levels in the performance of bank functions, such as the development, marketing and implementation of a product or service. An effective challenge environment is reflected in BB&T’s decision-making processes.
The Chief Risk Officer leads the RMO, which designs, organizes and manages BB&T’s risk framework. The RMO is responsible for ensuring effective risk management oversight, measurement, monitoring, reporting and consistency. The RMO has direct access to the Board of Directors and Executive Management to communicate any risk issues (identified or emerging) as well as the performance of the risk management activities throughout the Company.
The principal types of inherent risk include compliance, 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, 2013 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 LOBs. 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, net income and capital 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 Simulation 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 and 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 March 31, 2014, BB&T had derivative financial instruments outstanding with notional amounts totaling $63.1 billion, with a net fair value of a loss of $67 million. See Note 12 “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 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. 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%.
If rates increased 200 basis points, BB&T could absorb the loss of $6.3 billion, or 17.3%, of noninterest bearing demand deposits and replace them with managed rate deposits with a beta of 100% before becoming neutral to interest rate changes.
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 LOBs. 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 March 31, 2014 and March 31, 2013 were each less than $1 million. Market risk disclosures under Basel II.5 are available in the Additional Disclosures section of the Investor Relations site on www.bbt.com/about.
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, 2013 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 10 “Commitments and Contingencies” and Note 11 “Fair Value Disclosures” in the “Notes to Consolidated Financial Statements.”
Liquidity
Liquidity represents the 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 the ability to meet liquidity needs, including access to a variety of funding sources, maintaining borrowing capacity in national money markets, growing core deposits, the repayment of loans and the ability to securitize or package loans for sale.
BB&T 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 March 31, 2014 and December 31, 2013, BB&T’s liquid asset buffer was 16.4% and 14.6%, respectively, of total assets.
In November 2013, the FDIC, FRB and OCC released a joint statement providing a notice of proposed rulemaking concerning the U.S. implementation of the Basel III liquidity coverage ratio rule. BB&T is currently evaluating the impact and is implementing balance sheet changes to support its compliance with the rule. These actions include changing the mix of the investment portfolio to include more GNMA and U.S. Treasury securities, which qualify as Level 1 under the rule, and changing its deposit mix to reduce public funds deposits and increase retail and commercial deposits. Based on management’s interpretation of the proposed rules that will be effective January 1, 2015, BB&T’s liquidity coverage ratio was approximately 87% at March 31, 2014, compared to the regulatory minimum of 80%.
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 primarily consist 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 requirements for common and preferred dividends, unfunded commitments to affiliates, being a source of strength to its banking subsidiaries and being able to withstand sustained market disruptions that could limit access to the capital markets. As of March 31, 2014 and December 31, 2013, the Parent Company had 35 months and 27 months, respectively, of cash on hand to satisfy projected contractual cash outflows as described above.
Branch Bank
BB&T carefully manages liquidity risk at Branch Bank. Branch Bank’s primary source of funding is customer deposits. Continued access to customer deposits is highly dependent on the confidence the public has in the stability of the bank and its ability to return funds to the client when requested. BB&T maintains a strong focus on its reputation in the market to ensure continued access to client deposits. BB&T integrates its risk appetite into its overall risk management framework to ensure the bank does not exceed its risk tolerance through its lending and other risk taking functions and thus risk becoming undercapitalized. BB&T believes that sufficient capital is paramount to maintaining the confidence of its depositors and other funds providers. BB&T has extensive capital management processes in place to ensure it maintains sufficient capital to absorb losses and maintain a highly capitalized position that will instill confidence in the bank and allow continued access to deposits and other funding sources. Branch Bank monitors many liquidity metrics at the bank including funding concentrations, diversification, maturity distribution, contingent funding needs and ability to meet liquidity requirements under times of stress.
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 March 31, 2014, BB&T has approximately $64.1 billion of secured borrowing capacity, which represents approximately 505% of one year wholesale funding maturities.
Capital
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 implemented stressed capital ratio minimum guidelines to evaluate whether capital ratios calculated with planned capital actions are likely to remain above minimums specified by the FRB for the annual CCAR. Breaches of stressed minimum guidelines prompt a review of the planned capital actions included in BB&T’s capital plan.
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.”
During March 2014, the FRB notified BB&T that it did not object to BB&T’s 2014 capital plan and related actions, which included a recommendation for a $0.01 per share increase in the quarterly common stock dividend to $0.24 per share to begin in the second quarter of 2014. BB&T’s board of directors subsequently approved this dividend increase. BB&T released the results of its year-end company-run stress test during March 2014.
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 Tier 1 common equity ratio was 10.2% at March 31, 2014 compared to 9.9% at December 31, 2013. The increase in regulatory capital was primarily the result of earnings in excess of dividends and the net impact of equity award activity during the first quarter of 2014.
Share Repurchase Activity
No shares were repurchased in connection with the 2006 Repurchase Plan during 2014.
Non-GAAP Information
Certain amounts have been presented that exclude the effect of the $281 million adjustment for an uncertain income tax position that was recognized in the first quarter of 2013. 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 amounts.
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, 2013. 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.
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)
71