Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 


 

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the fiscal year ended:

 

December 31, 2003

 

Commission File Number: 1-10853

 

BB&T CORPORATION

(Exact name of Registrant as specified in its Charter)

 

North Carolina   56-0939887
(State of Incorporation)   (I.R.S. Employer Identification No.)
200 West Second Street    
Winston-Salem, North Carolina   27101
(Address of principal executive offices)   (Zip Code)

 

(336) 733-2000

(Registrant’s telephone number, including area code)

 


 

Securities Registered Pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

Title of each class


 

Name of each exchange

on which registered


Common Stock, $5 par value

  New York Stock Exchange

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by references in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

Indicate by check mark whether the Registrant (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 is an accelerated filer (as defined in Rule 12b-2 of the Act). YES x  NO ¨

 

At December 31, 2003, the Corporation had 541,942,987 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation at December 31, 2003, was approximately $18.4 billion (based on the closing price of such stock as of the last trading day of the registrant’s most recently completed second fiscal quarter).

 

Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 27, 2004, are incorporated by reference in Part III of this report.

 


 



Table of Contents

CROSS REFERENCE INDEX

 

          Page

PART I

   Item 1   

Business

   4
     Item 2   

Properties

   16, 81
     Item 3   

Legal Proceedings

   99
     Item 4   

Submission of Matters to a Vote of Shareholders

    
         

None.

    

PART II

   Item 5    Market for the Registrant’s Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities    51
     Item 6   

Selected Financial Data

   55
     Item 7    Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
     Item 7A   

Quantitative and Qualitative Disclosures About Market Risk

   45
     Item 8   

Financial Statements and Supplementary Data

    
         

Consolidated Balance Sheets at December 31, 2003 and 2002

   60
          Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2003    61
          Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2003    62
          Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2003    63
          Notes to Consolidated Financial Statements    64
         

Report of Independent Auditors

   58
         

Quarterly Financial Summary for 2003 and 2002

   54
     Item 9    Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.    16
     Item 9A    Controls and Procedures    114

PART III

   Item 10    Directors and Executive Officers of the Registrant    *, 16
     Item 11    Executive Compensation    *
     Item 12    Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters    *
     Item 13    Certain Relationships and Related Transactions    *
     Item 14    Principal Accountant Fees and Services    *

PART IV

   Item 15    Exhibits, Financial Statement Schedules and Reports on Form 8-K    122

 

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    (a)    Financial Statements—See Listing in Item 8 above.     
    (b)    Current Reports on Form 8-K filed during the fourth quarter of 2003.
         

Type


  

Date Filed


  

Reporting Purpose


    
          Item 12    October 14, 2003    To announce BB&T’s third quarter 2003 earnings.     
          Item 9    November 12, 2003    To announce the signing of a definitive agreement to acquire McGriff, Seibels & Williams, Inc., of Birmingham, Alabama.     
          Item 5    November 19, 2003    To file BB&T’s calculation of earnings to fixed charges.     
          Item 9    December 2, 2003    To announce the signing of a definitive agreement to acquire Republic Bancshares, Inc., of St. Petersburg, Florida.     
          Item 5    December 11, 2003    To file certain information with respect to BB&T’s operating segments and Tier 2 regulatory capital, including financial statements.     
          Item 5    December 23, 2003    To file an underwriting agreement and Indenture Regarding Subordinated Securities.     
    (c)    Exhibits    122
    (d)    Financial Statement Schedules—None required.     
    *    The information required by Item 10 is incorporated herein by reference to the information that appears under the headings “Election of Directors”, “Corporate Governance Matters” and “Section 16(A) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders.
         The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation of Executive Officers”, “Retirement Plans” and “Compensation Committee Report on Executive Compensation” in the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders.
         The information required by Item 12 is incorporated herein by reference to the information that appears under the headings “Security Ownership” and “Section 16(A) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders.
         The information required by Item 13 is incorporated herein by reference to the information that appears under the headings “Compensation Committee Interlocks and Insider Participation” and “Transactions with Executive Officers and Directors” in the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders.
         The information required by Item 14 is incorporated herein by reference to the information that appears under the heading “Fees to Auditors” in the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders.

 

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OVERVIEW AND DESCRIPTION OF BUSINESS

 

General

 

BB&T Corporation (“BB&T”, “the Company” or “the Corporation”), headquartered in Winston-Salem, North Carolina, is a financial holding company providing a wide variety of banking and financial services. BB&T conducts its business operations primarily through its commercial banking subsidiaries, which have offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. In addition, BB&T offers various lending products, insurance and other financial services products nationwide through other subsidiaries.

 

BB&T’s principal commercial bank subsidiaries are Branch Banking and Trust Company (“Branch Bank”), Branch Banking and Trust Company of South Carolina (“BB&T-SC”) and Branch Banking and Trust Company of Virginia (“BB&T-VA”) collectively, the “Subsidiary Banks”. Branch Bank, BB&T’s largest subsidiary, was chartered in 1872 and is the oldest bank headquartered in North Carolina.

 

Forward-Looking Statements

 

This report contains forward-looking statements with respect to the financial condition, results of operations and business of BB&T. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of the management of BB&T, and on the information available to management at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce net interest margins and/or the volumes and values of loans made or held as well as the value of other financial assets held; (3) general economic or business conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduced demand for credit or other services; (4) legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which BB&T is engaged; (5) costs or difficulties related to the integration of the businesses of BB&T and its merger partners may be greater than expected; (6) expected cost savings associated with pending or recently completed mergers may not be fully realized or realized within the expected time frame; (7) deposit attrition, customer loss or revenue loss following pending or recently completed mergers may be greater than expected; (8) competitors of BB&T may have greater financial resources and develop products that enable such competitors to compete more successfully than BB&T; and (9) adverse changes may occur in the securities markets.

 

Principal Subsidiaries of BB&T Corporation

 

At December 31, 2003, the principal assets of BB&T included all of the issued and outstanding shares of common stock of:

 

  ·   Branch Banking and Trust Company, Winston-Salem, North Carolina;

 

  ·   Branch Banking and Trust Company of South Carolina, Greenville, South Carolina;

 

  ·   Branch Banking and Trust Company of Virginia, Richmond, Virginia;

 

  ·   Regional Acceptance Corporation, Greenville, North Carolina;

 

  ·   Scott & Stringfellow, Inc., Richmond, Virginia;

 

  ·   MidAmerica Gift Certificate Company, Louisville, Kentucky;

 

  ·   Sheffield Financial Corporation, Clemmons, North Carolina;

 

  ·   BB&T Factors Corporation, High Point, North Carolina; and

 

  ·   BB&T Bankcard Corporation, Columbus, Georgia

 

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Branch Bank’s principal operating subsidiaries include:

 

  ·   BB&T Leasing Corporation, based in Charlotte, North Carolina, which provides lease financing to commercial businesses and municipal governments;

 

  ·   BB&T Investment Services, Inc., located in Charlotte, North Carolina, which offers customers nondeposit investment alternatives, including discount brokerage services, fixed-rate and variable-rate annuities, mutual funds, and government and municipal bonds;

 

  ·   BB&T Insurance Services, Inc., headquartered in Raleigh, North Carolina, which was the 8th largest retail insurance broker in the country at December 31, 2003, and offers property and casualty, life, health, employee benefits, commercial general liability, surety, title, and other insurance products through its agency network;

 

  ·   Stanley, Hunt, DuPree & Rhine Inc., with dual headquarters in Greensboro, North Carolina and Greenville, South Carolina, which offers group medical plans, insurance and investment consulting, and actuarial services;

 

  ·   Prime Rate Premium Finance Corporation, Inc., located in Florence, South Carolina, which provides insurance premium financing primarily to customers in BB&T’s principal market area;

 

  ·   Laureate Capital, LLC, located in Charlotte, North Carolina, which specializes in arranging and servicing commercial mortgage loans;

 

  ·   Lendmark Financial Services, Inc., located in Conyers, Georgia, which offers alternative consumer and mortgage loans to clients unable to meet BB&T’s normal consumer and mortgage loan underwriting guidelines; and

 

  ·   CRC Insurance Services, Inc., based in Birmingham, Alabama, which is authorized to do business nationwide and was the 4th largest wholesale insurance broker in the country with 21 offices in 15 states at December 31, 2003.

 

BB&T-SC operated 94 banking offices at December 31, 2003 and is the third largest bank in South Carolina in terms of deposit market share.

 

BB&T-VA operated 427 banking offices at December 31, 2003 and is the second largest bank in Virginia in terms of deposit market share.

 

Scott & Stringfellow, Inc. (“Scott & Stringfellow”) is an investment banking and full-service brokerage firm located in Richmond, Virginia. At December 31, 2003, Scott & Stringfellow operated 23 full-service retail brokerage offices in Virginia, 12 in North Carolina, and 7 in South Carolina. Scott & Stringfellow specializes in the origination, trading and distribution of fixed-income securities and equity products in both the public and private capital markets. Scott & Stringfellow also has a public finance department that provides investment banking, financial advisory services and debt underwriting services to a variety of regional tax-exempt issuers. Scott & Stringfellow’s investment banking and corporate and public finance areas do business as BB&T Capital Markets.

 

The primary services offered by BB&T’s subsidiaries include:

 

  ·   small business lending

 

  ·   commercial middle market lending

 

  ·   real estate lending

 

  ·   retail lending

 

  ·   home equity lending

 

  ·   sales finance

 

  ·   mortgage lending

 

  ·   commercial mortgage

 

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  ·   leasing

 

  ·   asset management

 

  ·   agency insurance

 

  ·   wholesale insurance brokerage

 

  ·   institutional trust services

 

  ·   wealth management

 

  ·   investment brokerage services

 

  ·   capital markets services

 

  ·   factoring

 

  ·   asset-based lending

 

  ·   international banking services

 

  ·   cash management

 

  ·   electronic payment services

 

  ·   credit and debit card services

 

  ·   consumer finance

 

  ·   payroll processing

 

The following table reflects BB&T’s deposit market share and branch locations by state at December 31, 2003.

 

Table 1

BB&T Deposit Market Share and Branch Locations by State

December 31, 2003

 

    

% of

BB&T’s

Deposits


   

Deposit

Market

Share

Rank (2)


  

Number of

Branches


North Carolina (1)

   27 %   2nd    333

Virginia

   30     2nd    427

Georgia

   9     7th    114

Kentucky

   7     2nd    103

South Carolina

   7     3rd    94

West Virginia

   6     1st    84

Maryland

   8     6th    127

Tennessee

   2     9th    49

Florida

   2     23rd    18

Washington, D.C.

   2     5th    7

  (1)   Excludes home office deposits
  (2)   Source: SNL Financial

 

In addition to the markets described in the table above, BB&T operated two branches in Alabama and one branch in Indiana at December 31, 2003. After the completion of the pending acquisition of Republic Bancshares, Inc., BB&T will operate 89 branches in Florida. BB&T’s presence and deposit market share in other states listed in the table above will not change as a result of this pending acquisition.

 

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Executive Overview

 

Significant accomplishments

 

In the opinion of BB&T’s management, the Corporation’s most significant accomplishments during 2003 were as follows (amounts include the impact of acquisitions where applicable):

 

  ·   Average commercial loans and leases increased 7.3%

 

  ·   Average consumer loans increased 25.0%

 

  ·   Noninterest-bearing deposits increased 32.1%

 

  ·   Fee income increased 18.6%

 

  ·   Mortgage banking income increased 172.9%

 

  ·   Total mortgage originations reached a record $19.4 billion

 

  ·   Asset quality improved during the year

 

  ·   Households subscribing to 5 or more BB&T services grew to 26.5%

 

  ·   The number of customers using online banking services increased 60.7%

 

  ·   The merger with First Virginia, which was the largest acquisition in BB&T’s history, was announced, consummated and successfully converted to BB&T’s operating systems

 

  ·   The acquisition and systems conversion of Equitable Bank were successfully completed and the planned merger with Republic Bancshares, Inc., was announced

 

  ·   Several insurance agencies and a premium finance company were acquired during 2003

 

Challenges

 

BB&T has grown at a rapid pace since the merger of equals with Southern National Corporation in 1995, and BB&T’s business has become more dynamic and complex in recent years. Consequently, management has annually evaluated and, as necessary, adjusted the Corporation’s business strategy in the context of the current operating environment. During this process, management considers the current financial condition and performance of the bank and its expectations for future economic activity, both on a national and local market scale. The achievement of the bank’s strategic initiatives and established long-term financial goals is subject to many uncertainties and challenges. The challenges, which in the opinion of management, are most relevant and most likely to have a near-term effect on operations, are presented below:

 

  ·   Building revenue momentum

 

  ·   Improving efficiency

 

  ·   The economic environment in BB&T’s core markets

 

  ·   Costs associated with the current heightened regulatory environment

 

  ·   Dilution in earnings as a result of acquisitions

 

  ·   Volatility in the mortgage banking business

 

  ·   Improving competition from bank and nonbank providers

 

  ·   Intense price competition

 

Competition

 

The financial services industry is highly competitive and dramatic change continues to occur. BB&T’s subsidiaries compete actively with national, regional and local financial services providers, including banks, thrifts, securities dealers, mortgage bankers, finance companies and insurance companies. Competition among providers of financial products and services continues to increase with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to rapidly

 

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consolidate, which affects competition by eliminating some regional and local institutions, while strengthening the franchise of acquirers. For additional information concerning markets, BB&T’s competitive position and business strategies, see “Market Area” and “General Business Development” below.

 

Market Area

 

BB&T’s primary market area consists of North and South Carolina, Virginia, Maryland, Georgia, eastern Tennessee, West Virginia, Kentucky, Florida and Washington, D.C. The area’s employment base is diverse and primarily consists of manufacturing, general services, agricultural, wholesale/retail trade, technology and financial services. BB&T believes its current market area is economically strong and will support consistent growth in assets and deposits in the future. Even so, management intends to continue expanding and diversifying the BB&T franchise, although at a slower pace than in recent years. Management strongly believes that BB&T’s community bank approach to providing client service is a competitive advantage, which strengthens the Corporation’s ability to enter new markets and effectively provide financial products and services to businesses and individuals in these markets.

 

General Business Development

 

BB&T is a regional financial holding company. The core of its business and franchise was created by the merger-of-equals between BB&T and Southern National Corporation in 1995 and the acquisition of United Carolina Bancshares in 1997. BB&T has maintained a long-term focus on a strategy that includes expanding and diversifying the BB&T franchise both in terms of revenues, profitability and asset size. Tangible evidence of this focus is the growth in average total assets, loans and deposits, which have increased at compound annual rates of 10.7%, 11.1%, and 9.6%, respectively, over the last 5 years. A significant part of that growth has been the result of mergers and acquisitions.

 

Merger Strategy

 

BB&T’s growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. BB&T’s current acquisition strategy is focused on the following primary objectives:

 

  ·   to pursue acquisitions of banks and thrifts in the Carolinas, Virginia, Maryland, Washington D.C., Georgia, West Virginia, Tennessee, Kentucky, and Florida with assets of $250 million or more, while limiting annual asset growth from acquisitions to approximately 5% of BB&T’s consolidated total assets,

 

  ·   to acquire companies in niche markets that provide products or services that can be offered through the existing distribution system to BB&T’s current customer base, and

 

  ·   to consider strategic nonbank acquisitions in new markets that are economically feasible and provide positive long-term benefits.

 

BB&T has consummated acquisitions of 58 community banks and thrifts, 66 insurance agencies and 22 non-bank financial services providers over the last fifteen years. BB&T expects, in the long-term, to continue to take advantage of the consolidation in the financial services industry and expand and enhance its franchise through mergers and acquisitions. The consideration paid for these acquisitions may be in the form of cash, debt or BB&T stock. The amount of consideration paid to complete these transactions may be in excess of the fair value of the underlying net assets acquired, which could have a dilutive effect on BB&T’s earnings and / or book value per share. In addition, acquisitions often result in significant front-end charges against earnings; however, cost savings and revenue enhancements, especially incident to in-market bank and thrift acquisitions, are also typically anticipated.

 

Lending Activities

 

The primary goal of the BB&T lending function is to help clients achieve their financial goals by providing quality loan products that are fair to the customer and profitable to the Corporation. This purpose can best be accomplished by building strong, profitable client relationships over time, with BB&T becoming an important contributor to the prosperity and well being of its clients. In addition to the importance placed on customer knowledge and continuous involvement with clients, BB&T’s lending process incorporates the standards of a

 

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consistent company-wide credit culture and an in-depth local market knowledge. Furthermore, the Company employs strict underwriting criteria governing the degree of assumed risk and the diversity of the loan portfolio in terms of type, industry and geographic concentration. In this context, BB&T strives to meet the credit needs of businesses and consumers in its markets while pursuing balanced strategy of loan profitability, loan growth and loan quality.

 

BB&T conducts the majority of its lending activities within the framework of the Corporation’s community bank operating model, with lending decisions made as close to the client as practicable. Based on internal analyses, this approach has resulted in BB&T’s loan portfolio consistently outperforming the average of a group of BB&T’s peer banks in terms of asset quality, portfolio yield and rate of growth over the long term.

 

The following table summarizes BB&T’s loan portfolio based on the underlying collateral, rather than the primary purpose of the loan.

 

Table 2

Composition of Loan and Lease Portfolio

 

     December 31,

 
     2003

    2002

    2001

    2000

    1999

 
     (Dollars in thousands)  

Commercial, financial and agricultural loans

   $ 7,299,605     $ 7,061,493     $ 6,551,073     $ 6,555,578     $ 6,025,337  

Lease receivables

     5,129,488       5,156,307       5,012,110       4,453,598       2,606,002  

Real estate—construction and land development loans

     6,477,313       5,291,719       5,334,108       4,264,275       4,227,146  

Real estate—mortgage loans

     36,251,269       30,023,470       25,542,288       25,239,698       22,712,509  

Consumer loans

     9,049,916       6,412,563       5,965,010       5,891,059       5,091,840  
    


 


 


 


 


Total loans and leases held for investment

     64,207,591       53,945,552       48,404,589       46,404,208       40,662,834  

Loans held for sale

     725,459       2,377,707       1,907,416       906,244       390,338  
    


 


 


 


 


Total loans and leases

     64,933,050       56,323,259       50,312,005       47,310,452       41,053,172  

Less: unearned income

     (2,627,664 )     (2,805,246 )     (2,868,832 )     (2,483,377 )     (1,250,129 )
    


 


 


 


 


Net loans and leases

   $ 62,305,386     $ 53,518,013     $ 47,443,173     $ 44,827,075     $ 39,803,043  
    


 


 


 


 


 

BB&T’s loan portfolio is approximately 50% business and 50% retail, and is divided into three major categories—business, consumer and mortgage. Loans from BB&T’s specialized lending segment, as discussed in Note 20 of the “Notes to Consolidated Financial Statements” are included in the applicable categories. BB&T lends to a diverse customer base that is substantially located within the Company’s primary market area. At the same time, the loan portfolio is geographically dispersed throughout BB&T’s branch network to mitigate concentration risk arising from regional economic downturns.

 

The following discussion presents the principal types of lending conducted by BB&T and describes the underwriting procedures and overall risk management of BB&T’s lending function. The relative risk of each loan portfolio is presented in the “Asset Quality” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.

 

Underwriting Approach

 

Recognizing that the loan portfolio is a primary source of profitability, proper loan underwriting is critical to long-term financial success. BB&T’s underwriting approach is designed to define acceptable combinations of specific risk-mitigating features that ensure credit relationships conform to BB&T’s risk philosophy. Provided below is a summary of the most significant underwriting criteria used to evaluate new loans and loan renewals:

 

  ·   Cash flow and debt service coverage—cash flow adequacy is a necessary condition of creditworthiness, meaning that loans not clearly supported by a borrower’s cash flow must be justified by secondary repayment sources.

 

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  ·   Secondary sources of repayment—alternative repayment funds are a significant risk mitigating factor as long as they are liquid, can be easily accessed and provide adequate resources to supplement the primary cash flow source.

 

  ·   Value of any underlying collateral—loans are generally secured by the asset being financed. Because an analysis of the primary source of repayment is the most important factor, collateral, unless it is liquid, does not justify loans that cannot be serviced by the borrower’s normal cash flows.

 

  ·   Overall creditworthiness of the customer, taking into account the customer’s relationships, both past and current, with other lenders—our success depends on building lasting and mutually beneficial relationships with clients, which involves assessing their financial position and background.

 

  ·   Level of equity invested in the transaction—in general, borrowers are required to contribute or invest a portion of their own funds prior to any loan advances. Management believes that cash equity “commits” and makes a borrower a “risk taker”, and keeps the bank in a position of a lender rather than joint venture partner.

 

Business Loan and Lease Portfolio

 

The business loan and lease portfolio represents the largest category of the Company’s total loan portfolio and is segmented into three distinct components—commercial loans, defined as client relationships with total credit exposure above $500,000, small business loans, and leases. BB&T’s commercial lending program is generally targeted to serve small-to-middle market businesses with sales of $200 million or less. The bank does not extend credit to large national or out-of-market corporate customers unless they have a strong in-market presence or an existing relationship with BB&T and the requirements of loan quality and profitability can be met. Traditionally, lending to small and mid-sized businesses has been among BB&T’s strongest markets. For the sixth consecutive year, BB&T received recognition from the U.S. Small Business Administration as one of the top two “small business friendly” banks in the United States. Approximately 95% of the commercial loans are secured by real estate, business equipment, inventories, or other types of collateral.

 

Business loans are primarily originated through BB&T’s banking network. In accordance with the Corporation’s lending policy, each loan undergoes a detailed underwriting process, which incorporates BB&T’s underwriting approach, procedures and evaluations described above. In addition, BB&T has adopted an internal maximum credit exposure lending limit of $200 million for a “best grade” credit, which is considerably below the maximum legal lending limit of the Corporation. Commercial loans are typically priced with an interest rate tied to market indexes, such as the prime rate and the London Interbank Offered Rate (“LIBOR”). Business loans are individually monitored and reviewed for any possible deterioration in the ability of the client to repay the loan.

 

BB&T provides commercial leasing services through BB&T Leasing Corp. (“Leasing”), a subsidiary of Branch Bank. Leasing provides three primary products: finance or capital leases, true leases (as defined under the Internal Revenue Code) and other operating leases for vehicles, rolling stock and tangible personal property. Leasing also provides lease-related services for small to medium-sized commercial customers. In addition to the services offered by Leasing, other BB&T subsidiaries provide leases to municipalities and invest in various types of leveraged lease transactions. Approximately 100% of leases are secured.

 

Consumer Loan Portfolio

 

BB&T offers a wide variety of consumer loan products. Various types of secured and unsecured loans are marketed to qualifying, existing clients and to other creditworthy candidates in BB&T’s market area. These loans are relatively homogenous and no single loan is individually significant in terms of its size and potential risk of loss. Consumer loans are subject to the same rigorous lending policies and procedures as described above for commercial loans and are underwritten with note amounts and credit limits that ensure consistency with the Corporation’s policies. In addition to its normal underwriting due diligence, BB&T uses automated “scoring systems” to help underwrite the credit risk in its consumer portfolio.

 

The consumer loan portfolio consists of three primary sub-portfolios – direct retail, revolving credit and sales finance. The direct retail category consists mainly of home equity loans and lines of credit, which are secured by

 

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residential real estate. It also includes installment loans and some unsecured lines of credit other than credit cards. The revolving credit category is comprised of the outstanding balances on credit cards accounts and BB&T’s checking account overdraft protection product, Constant Credit. Such balances are generally unsecured and actively managed by BB&T Bankcard Corporation. Finally, the sales finance category includes primarily secured indirect installment loans to consumers for the purchase of automobiles. Such loans are originated through approved franchised and independent automobile dealers throughout the BB&T market area and limited adjoining states. On a very limited basis, sales finance loans are also originated through qualified non-automotive dealers for the purchase of boats, recreational vehicles and other consumer equipment. Approximately 96% of consumer loans are secured.

 

Mortgage Loan Portfolio

 

BB&T is a large originator of residential mortgage loans, with originations in 2003 totaling $19.4 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. BB&T primarily originates conforming mortgage loans. These are loans that are underwritten in accordance with the underwriting standards set forth by the government-sponsored entities, Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). They are generally collateralized by one-to-four-family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing.

 

Risks associated with the mortgage lending function include interest rate risk, which is mitigated through the sale of substantially all conforming fixed-rate loans in the secondary mortgage market, and default risk by the borrower, which is lessened through underwriting procedures and mortgage insurance. The right to service the loans and receive servicing income is generally retained when conforming loans are sold. Management believes that the retention of mortgage servicing is a primary relationship driver in retail banking and a vital part of management’s strategy to establish profitable long-term customer relationships and offer high quality client service. Branch Bank also purchases residential mortgage loans from more than 100 correspondent originators. The loans purchased from third-party originators are subject to the same underwriting and risk management criteria as loans originated internally.

 

The following table presents BB&T’s total loan portfolio based on the primary purpose of the loan, as discussed herein, rather than the underlying collateral:

 

Table 3

Composition of Loan and Lease Portfolio Based on Loan Purpose

 

     December 31,

     2003

   2002

   2001

   2000

   1999

     (Dollars in thousands)

Loans and leases, net of unearned income:

                                  

Business loans

   $ 28,656,274    $ 26,527,059    $ 23,640,081    $ 21,885,646    $ 18,884,501

Lease receivables

     2,679,478      2,527,173      2,319,061      2,100,965      1,508,396
    

  

  

  

  

Total business loans and leases

     31,335,752      29,054,232      25,959,142      23,986,611      20,392,897
    

  

  

  

  

Sales finance

     6,035,662      3,410,890      2,940,364      2,844,970      2,565,439

Revolving credit

     1,180,480      1,050,738      951,319      863,089      713,585

Direct retail

     12,130,101      9,400,230      8,273,829      8,336,368      7,526,163
    

  

  

  

  

Total consumer loans

     19,346,243      13,861,858      12,165,512      12,044,427      10,805,187
    

  

  

  

  

Residential mortgage loans (1)

     11,623,391      10,601,923      9,318,519      8,796,037      8,604,959
    

  

  

  

  

Total loans and leases (1)

   $ 62,305,386    $ 53,518,013    $ 47,443,173    $ 44,827,075    $ 39,803,043
    

  

  

  

  


(1)   Includes loans held for sale.

 

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The following table reflects the scheduled maturities of commercial, financial and agricultural loans, as well as construction loans:

 

Table 4

Selected Loan Maturities and Interest Sensitivity (1)

 

     December 31, 2003

    

Commercial,

Financial

and

Agricultural


  

Real Estate:

Construction


   Total

     (Dollars in thousands)

Fixed rate:

                    

1 year or less (2)

   $ 236,033    $ 272,539    $ 508,572

1-5 years

     678,462      468,698      1,147,160

After 5 years

     143,948      126,723      270,671
    

  

  

Total

     1,058,443      867,960      1,926,403
    

  

  

Variable rate:

                    

1 year or less (2)

     3,626,115      3,012,223      6,638,338

1-5 years

     2,234,336      2,120,335      4,354,671

After 5 years

     380,711      476,795      857,506
    

  

  

Total

     6,241,162      5,609,353      11,850,515
    

  

  

Total loans and leases (3)

   $ 7,299,605    $ 6,477,313    $ 13,776,918
    

  

  


(1)   Balances include unearned income.
(2)   Includes loans due on demand.

 

    

(Dollars in

thousands)


(3)    The above table excludes:     

(i)      consumer loans to individuals for household, family and other personal expenditures

   $ 9,049,916

(ii)     real estate mortgage loans

     36,251,269

(iii)    loans held for sale

     725,459

(iv)    lease receivables

     5,129,488
    

    Total

   $ 51,156,132
    

 

Scheduled repayments are reported in the maturity category in which the payment is due. Determinations of maturities are based upon contract terms. BB&T’s credit policy does not permit automatic renewals of loans. At the scheduled maturity date (including balloon payment date), the customer must request a new loan to replace the matured loan and execute a new note with rate, terms and conditions negotiated at that time.

 

Allowance for Loan and Lease Losses

 

The allowance is determined based on management’s best estimate of probable losses that are inherent in the portfolio at the balance sheet date. BB&T’s allowance is driven by existing conditions and observations and reflects losses already incurred, even if not yet identifiable.

 

The Company determines the allowance based on an ongoing evaluation of the loan and lease portfolios. This evaluation is inherently subjective because it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Increases to the allowance are made by charges to the provision for loan and lease losses, which is reflected on the Consolidated Statements of Income. Loans or leases deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance.

 

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Reserve Policy and Methodology

 

The allowance consists of (1) a component for individual loan impairment recognized and measured pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” and (2) components of collective loan impairment recognized pursuant to SFAS No. 5, “Accounting for Contingencies,” including a small component that is unallocated. BB&T maintains specific reserves for individually impaired loans pursuant to SFAS No. 114. A loan is impaired when, based on current information and events, it is probable that BB&T will be unable to collect all amounts due (interest as well as principal) according to the contractual terms of the loan agreement. On a quarterly basis, BB&T reviews all commercial lending relationships with outstanding debt of $2 million or more that have been classified as substandard or doubtful. Loans are considered impaired when the borrower does not have the capacity (cash flow) or willingness to service the debt according to contractual terms, or it does not appear reasonable to assume that the borrower will continue to pay according to contractual agreement. The amount of impairment is based on the present value of expected cash flows discounted at the loan’s effective interest rate, and the value of collateral adjusted for any origination costs and nonrefundable fees that existed at the time of origination.

 

Reserves established pursuant to the provisions of SFAS No. 5 for collective loan impairment are primarily based on historical charge-off experience using a rolling twelve quarter annualized net charge-off rate. However, historical charge-off experience may be adjusted to reflect the effects of current conditions. BB&T considers information derived from its loan ratings and models systems; internal observable data related to trends within the loan and lease portfolios, including credit quality, concentrations, aging of the portfolio, growth and acquisitions; external observable data related to industry and general economic trends; and any significant, relevant changes to BB&T’s policies and procedures. Any adjustments to historical loss experience are based on one or more sets of observable data as described above and are directionally consistent with changes in the data from period to period, taking into account the interaction of components over time. The adjusted historical loss information is applied to pools of loans grouped according to similar risk characteristics to calculate components of the allowance. In the commercial lending portfolio, each loan receives a “risk grade” at origination by the account officer and the assigned risk grade is subsequently reviewed and finalized through BB&T’s established loan review committee process. Loans are assigned risk grades based on an assessment of conditions that affect the borrower’s ability to meet contractual obligations under the loan agreement. That process includes reviewing borrowers’ financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. The established risk management regimen includes a review of all credit relationships with total credit exposure of $500,000 or more on an annual basis or at any point management becomes aware of information affecting the borrower’s ability to fulfill their obligations. In addition, for small business and commercial clients where total credit exposure is less than $1 million, BB&T has developed an automated loan review system to identify and proactively manage accounts with a higher risk of loss. The “score” produced by this automated system is updated monthly. All of the loan portfolios grouped in the retail lending and specialized lending categories typically employ scoring models to segment credits into groups with homogenous risk characteristics. Scoring models are validated on a periodic basis in order to ensure reliable default rate information. This information is employed to evaluate the levels of risk associated with new production as well as to understand any risk migration in the existing portfolio.

 

A portion of the Corporation’s allowance for loan and lease losses is not allocated to any specific category of loans. This unallocated portion of the allowance reflects management’s best estimate of the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion considered unallocated may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current economic conditions, industry or borrower concentrations and the status of merged institutions. The allocated and unallocated portions of the allowance are available to absorb losses in any loan or lease category. Management evaluates the adequacy of the allowance for loan and lease losses based on the combined total of the allocated and unallocated components.

 

While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance or to the reserving methodology may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments to original estimates,

 

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as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

 

The following table presents an allocation of the allowance for loan and lease losses at the end of each of the past five years. The allowance has been allocated by applying the methodologies described above to the loan portfolios based on the underlying collateral of the loans. Amounts applicable to years prior to 2002 reflect acquisitions accounted for as poolings of interests. This allocation of the allowance for loan and lease losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.

 

Table 5

Allocation of Allowance for Loan and Lease Losses by Category

 

    December 31,

 
    2003

    2002

    2001

    2000

    1999

 
    Amount

 

% Loans

in each

category


    Amount

 

% Loans

in each

category


    Amount

  % Loans
in each
category


    Amount

  % Loans
in each
category


    Amount

  % Loans
in each
category


 
    (Dollars in thousands)  

Balances at end of period applicable to:

                                                           

Commercial, financial and agricultural

  $ 142,293   11.2 %   $ 150,700   12.5 %   $ 133,238   13.0 %   $ 120,486   13.9 %   $ 99,424   14.7 %

Real estate:

                                                           

Construction and land development

    93,924   10.0       85,525   9.4       79,443   10.6       55,874   9.0       42,041   10.3  

Mortgage

    381,678   56.9       332,490   57.5       234,872   54.6       199,864   55.3       173,862   56.3  
   

 

 

 

 

 

 

 

 

 

Total real estate

    475,602   66.9       418,015   66.9       314,315   65.2       255,738   64.3       215,903   66.6  
   

 

 

 

 

 

 

 

 

 

Consumer

    79,765   13.9       64,209   11.4       54,668   11.9       49,575   12.5       60,255   12.4  

Lease receivables

    42,440   8.0       45,173   9.2       38,098   9.9       30,702   9.3       18,193   6.3  

Unallocated

    44,837   —         45,588   —         104,099   —         121,606   —         135,461   —    
   

 

 

 

 

 

 

 

 

 

Total

  $ 784,937   100.0 %   $ 723,685   100.0 %   $ 644,418   100.0 %   $ 578,107   100.0 %   $ 529,236   100.0 %
   

 

 

 

 

 

 

 

 

 

 

Investment Activities

 

Investment securities represent a significant portion of BB&T’s assets. BB&T’s subsidiary banks invest in securities as allowable under bank regulations. These securities include obligations of the U.S. Treasury, agencies of the U.S. government, including mortgage-backed securities, bank eligible obligations of any state or political subdivision, bank eligible corporate obligations, including commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. BB&T’s bank subsidiaries may also deal in securities subject to the provisions of the Gramm-Leach-Bliley Act. Scott & Stringfellow, Inc., BB&T’s full-service brokerage and investment banking subsidiary, engages in the underwriting, trading and sales of equity and debt securities subject to the risk management policies of the Corporation.

 

BB&T’s investment activities are governed internally by a written, board-approved policy. Investment policy is carried out by the Corporation’s Asset / Liability Management Committee (“ALCO”), which meets regularly to review the economic environment and establish investment strategies. The ALCO also has much broader responsibilities, which are discussed in “Market Risk Management”, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Investment strategies are established by the ALCO in consideration of the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of the Corporation. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits as prescribed by law and other borrowings; and (iii) to earn the maximum return on funds invested that is commensurate with meeting the requirements of (i) and (ii).

 

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Funding Activities

 

Deposits are the primary source of funds for lending and investing activities, and their cost is the largest category of interest expense. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. Federal Home Loan Bank (“FHLB”) advances, other secured borrowings, Federal funds purchased and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. BB&T’s funding activities are monitored and governed through BB&T’s overall asset/liability management process, which is further discussed in the “Market Risk Management” section in the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” herein. BB&T conducts its funding activities in compliance with all applicable laws and regulations. Following is a brief description of the various sources of funds used by BB&T. For further discussion relating to outstanding balances and balance fluctuations, refer to the “Deposits and Other Borrowings” section in the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” herein.

 

Deposits

 

Deposits are attracted principally from clients within BB&T’s branch network through the offering of a broad selection of deposit instruments to individuals and businesses, including noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money rate savings, investor deposit accounts, certificates of deposit and individual retirement accounts. Deposit account terms vary with respect to the minimum balance required, the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (i) the interest rates offered by competitors, (ii) anticipated amount and timing of funding needs, (iii) availability of and cost of alternative sources of funding, and (iv) anticipated future economic conditions and interest rates. Client deposits are attractive sources of liquidity because of their stability and relative cost. Deposits are regarded as an important part of the overall client relationship and provide opportunities to cross-sell other BB&T services.

 

The following table provides information regarding the scheduled maturities of time deposits that are $100,000 and greater at December 31, 2003:

 

Table 6

Scheduled Maturities of Time Deposits $100,000 and Greater

December 31, 2003

(Dollars in thousands)

 

Maturity Schedule

      

Less than three months

   $ 2,143,359

Three through six months

     1,142,521

Seven through twelve months

     1,137,122

Over twelve months

     2,211,037
    

Total

   $ 6,634,039
    

 

Borrowed Funds

 

BB&T’s ability to borrow funds from nondeposit sources provides additional flexibility in meeting the liquidity needs of customers and the bank. Short-term borrowed funds include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term FHLB advances, and U.S. Treasury tax and loan depository note accounts. See Note 9 in the “Notes to Consolidated Financial Statements”, herein, for additional disclosures related to short-term borrowed funds.

 

BB&T also utilizes longer-term borrowings when management determines that the pricing and maturity options available through these sources create cost-effective options for funding asset growth and satisfying capital needs. BB&T’s long-term borrowings include long-term FHLB advances to the Subsidiary Banks, subordinated debt issued by BB&T Corporation and Branch Bank, junior subordinated debt underlying trust preferred securities, mortgage indebtedness and capital leases. See Note 10 in the “Notes to Consolidated Financial Statements”, herein, for additional disclosures related to long-term borrowings.

 

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Employees

 

At December 31, 2003, BB&T had approximately 26,300 full-time equivalent employees compared to approximately 23,000 full-time equivalent employees at December 31, 2002.

 

Properties

 

BB&T and its significant subsidiaries occupy headquarters offices that are either owned or operated under long-term leases, and also own free-standing operations centers, with its primary operations and information technology center located in Wilson, North Carolina. BB&T also owns or leases significant office space used as the Corporation’s headquarters in Winston-Salem, North Carolina. At December 31, 2003, BB&T’s subsidiary banks operated 1,359 branch offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. BB&T also operates numerous insurance agencies and other businesses which occupy facilities. Office locations are variously owned or leased. Management believes that the premises occupied by BB&T and its subsidiaries are well-located and suitably equipped to serve as financial services facilities. See Note 6 “Premises and Equipment” in the “Notes to Consolidated Financial Statements” in this report for additional disclosures related to BB&T’s properties and other fixed assets.

 

Executive Officers of BB&T

 

BB&T’s Chairman and Chief Executive Officer is John A. Allison, IV. As of December 31, 2003, Mr. Allison is 55 and has 33 years of service with the Corporation. Henry G. Williamson, Jr., is BB&T’s Chief Operating Officer. Mr. Williamson is 56 and has 32 years of service with the Corporation. Kelly S. King is the President of BB&T Corporation and is the Senior Executive Vice President overseeing the Branch Network. Mr. King is 55 and has 32 years of service with the Corporation. W. Kendall Chalk is a Senior Executive Vice President and the Corporation’s Chief Credit Officer. Mr. Chalk is 58 and has served the Corporation for 29 years. Scott E. Reed is a Senior Executive Vice President and the Corporation’s Chief Financial Officer. Mr. Reed is 55 and has 32 years of service with the Corporation. Robert E. Greene is the President of Branch Banking and Trust Company and is the Senior Executive Vice President for Administrative Services for the Corporation. Mr. Greene is 53 and has served the Corporation for 31 years. C. Leon Wilson III is a Senior Executive Vice President and is the Corporation’s Operations Division Manager. Mr. Wilson is 48 and has served BB&T for 27 years. Barbara F. Duck is a Senior Executive Vice President and is the Manager of BB&T’s Production and Risk Management Group. Ms. Duck is 37 years old and has served BB&T for 16 years. Steven B. Wiggs is a Senior Executive Vice President and is the Director of BB&T’s Wealth Management Group. Mr. Wiggs is 45 years old and has served BB&T for 24 years.

 

Change in Independent Auditors

 

On March 19, 2002, the Corporation terminated the engagement of Arthur Andersen LLP as its independent auditors. Arthur Andersen LLP had served as the Corporation’s independent auditors for the fiscal year ended December 31, 2001. The decision to terminate the engagement of Arthur Andersen LLP was recommended by the Corporation’s Audit Committee and approved by its Board of Directors.

 

PricewaterhouseCoopers LLP has served as independent auditors for BB&T since March 19, 2002. BB&T has had no disagreements on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure with PricewaterhouseCoopers LLP.

 

Web Site Access to BB&T’s Filings with the Securities and Exchange Commission

 

All of BB&T’s electronic filings with the Securities and Exchange Commission (“SEC”), including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are made available at no cost on the Corporation’s web site, www.bbandt.com, through the Investor Relations link as soon as reasonably practicable after BB&T files such material with, or furnishes it to, the SEC. BB&T’s SEC filings are also available through the SEC’s web site at www.sec.gov.

 

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REGULATORY CONSIDERATIONS

 

General

 

As a bank holding company and a financial holding company under federal law, BB&T is subject to regulation under the Bank Holding Company Act of 1956, as amended, (the “BHCA”) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As state-chartered commercial banks, Branch Bank, BB&T-SC and BB&T-VA are subject to regulation, supervision and examination by state bank regulatory authorities in their respective home states. These authorities include the North Carolina Commissioner of Banks, in the case of Branch Bank, the South Carolina Commissioner of Banking, in the case of BB&T-SC, and the Virginia State Corporation Commission’s Bureau of Financial Institutions, in the case of BB&T-VA. In addition, BB&T Bankcard Corporation is a special purpose Georgia bank, subject to regulation, supervision and examination by the Georgia Department of Banking and Finance. Branch Bank, BB&T-SC, BB&T-VA and BB&T Bankcard Corporation are collectively referred to as the “Banks.” Each of the Banks is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”). State and Federal law also govern the activities in which the Banks engage, the investments they make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks’ operations.

 

In addition to federal and state banking laws and regulations, BB&T and certain of its subsidiaries and affiliates, including those that engage in securities underwriting, dealing, brokerage, investment advisory activities and insurance activities, are subject to other federal and state laws and regulations, and supervision and examination by other state and federal regulatory agencies, including the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state insurance and securities regulators.

 

The earnings of BB&T’s subsidiaries, and therefore the earnings of BB&T, are affected by general economic conditions, management policies, changes in state and federal laws and regulations and actions of various regulatory authorities, including those referred to above. Proposals to change the laws and regulations to which BB&T is subject are frequently introduced at both the federal and state levels. The likelihood and timing of any such changes, and the impact such changes might have on BB&T and its subsidiaries, are impossible to determine with any certainty. The following description summarizes the significant state and Federal laws to which BB&T and the Banks currently are subject. To the extent statutory or regulatory provisions are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions.

 

Financial Holding Company Regulation

 

Under current federal law, as amended by the Gramm-Leach-Bliley Act of 1999 (“GLBA”), a bank holding company, such as BB&T, may elect to become a financial holding company, which allows the holding company to offer customers virtually any type of service that is financial in nature or incidental thereto, including banking and activities closely related thereto, securities underwriting, insurance (both underwriting and agency) and merchant banking. In order to become and maintain its status as a financial holding company, the company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act of 1977 (“CRA”) rating. If the Federal Reserve determines that a financial holding company is not well-capitalized or well-managed, the company has a period of time to come into compliance, but during the period of noncompliance, the Federal Reserve can place any limitations on the financial holding company that it believes to be appropriate. Furthermore, if the Federal Reserve determines that a financial holding company has not maintained a satisfactory rating under the CRA test, the company will not be able to commence any new financial activities or acquire a company that engages in such activities, although the company will still be allowed to engage in activities closely related to banking and make investments in the ordinary course of conducting merchant banking activities. BB&T became a financial holding company on June 14, 2000 and currently satisfies the requirements to maintain its status as a financial holding company.

 

Most of the financial activities that are permissible for financial holding companies also are permissible for a “financial subsidiary” of one or more of the Banks, except for insurance underwriting, insurance company portfolio investments, real estate investments and development, and merchant banking, which must be conducted in a financial holding company. In order for these financial activities to be engaged in by a financial subsidiary of a

 

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bank, federal law requires the parent bank (and its sister-bank affiliates) to be well capitalized and well-managed; the aggregate consolidated assets of all of that bank’s financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion, the bank must have at least a satisfactory CRA rating, and if that bank is one of the 100 largest national banks, it must meet certain financial rating or other comparable requirements.

 

Current federal law also establishes a system of functional regulation under which the Federal Reserve Board is the umbrella regulator for bank holding companies, but bank holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. Certain specific activities, including traditional bank trust and fiduciary activities, may be conducted in the bank without the bank being deemed a “broker” or a “dealer” in securities for purposes of function regulation. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain identifiable areas.

 

Acquisitions

 

As an active acquirer, BB&T complies with numerous laws related to its acquisition activity. Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. Current Federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Furthermore, a bank headquartered in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states has opted out of such interstate merger authority prior to such date, and subject to any state requirement that the target bank shall have been in existence and operating for a minimum period of time, not to exceed five years; and subject to certain deposit market-share limitations. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable Federal or state law.

 

Other Safety and Soundness Regulations

 

The Federal Reserve Board has enforcement powers over bank holding companies and their non-banking subsidiaries. The Federal Reserve Board has authority to prohibit activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative order or written agreement with a federal regulator. These powers may be exercised through the issuance of cease and desist orders, civil money penalties or other actions.

 

There also are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution is insolvent or is in danger of becoming insolvent. For example, under requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit financial resources to support such institutions in circumstances where it might not do so otherwise. In addition, the “cross-guarantee” provisions of Federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund (“SAIF”) or the Bank Insurance Fund (“BIF”) as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the SAIF or the BIF or both. The FDIC’s claim for reimbursement under the cross-guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.

 

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State banking regulators also have broad enforcement powers over the Banks, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator (with the approval of the Governor in the case of a North Carolina state bank) in order to conserve the assets of any such institution for the benefit of depositors and other creditors. The North Carolina Commissioner of Banks also has the authority to take possession of a North Carolina state bank in certain circumstances, including, among other things, when it appears that such bank has violated its charter or any applicable laws, is conducting its business in an unauthorized or unsafe manner, is in an unsafe or unsound condition to transact its business or has an impairment of its capital stock.

 

Payment of Dividends

 

BB&T is a legal entity separate and distinct from its subsidiaries. The majority of BB&T’s revenue is from dividends paid to BB&T by the Banks. The Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well capitalized” under the prompt corrective action regulations summarized elsewhere in this section. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. North Carolina and Virginia laws state that, subject to certain capital requirements, the board of directors of a bank chartered under their laws may declare a dividend of as much of that bank’s undivided profits as the directors deem expedient. South Carolina allows for the payment of dividends by a state-chartered bank with the prior approval of the Commissioner of Banking. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. During the year ended December 31, 2003, the Banks declared $1.5 billion in dividends payable to BB&T. At December 31, 2003, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $2.3 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $990.0 million.

 

Capital

 

Each of the federal banking agencies, including the Federal Reserve Board and the FDIC, have issued substantially similar risk-based and leverage capital guidelines applicable to banking organizations they supervise, including bank holding companies and banks. Under the risk-based capital requirements, BB&T and the Banks are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common shareholders’ equity excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets net of applicable deferred income taxes, and certain nonfinancial equity investments. This is called “Tier 1 capital.” The remainder may consist of qualifying subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the loan loss allowance. This is called “Tier 2 capital.” Tier 1 capital and Tier 2 capital combined are referred to as total regulatory capital.

 

The Federal Reserve requires bank holding companies that engage in trading activities to adjust their risk-based capital ratios to take into consideration market risks that may result from movements in market prices of covered trading positions in trading accounts, or from foreign exchange or commodity positions, whether or not in trading accounts, including changes in interest rates, equity prices, foreign exchange rates or commodity prices. Any capital required to be maintained under these provisions may consist of a new “Tier 3 capital”, consisting of forms of short-term subordinated debt.

 

Each of the federal bank regulatory agencies, including the Federal Reserve, also has established minimum leverage capital requirements for banking organizations. These requirements provide that banking organizations that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and that have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total

 

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adjusted average assets of at least 3%. Institutions not meeting these criteria, as well as institutions with supervisory, financial or operational weaknesses, are expected to maintain a minimum Tier 1 capital to total adjusted average assets ratio equal to 100 to 200 basis points above that stated minimum. Holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve also continues to consider a “tangible Tier 1 capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activity.

 

In addition, the Federal Reserve Board and the FDIC each by regulation has adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by each agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy. The agencies also require banks and bank holding companies to adjust their regulatory capital to take into consideration the risk associated with certain recourse obligations, direct credit subsidies, residual interest and other positions in securitized transactions that expose banking organizations to credit risk.

 

The ratios of Tier 1 capital, total capital to risk-adjusted assets, and the leverage capital ratios of BB&T and the Banks as of December 31, 2003, are shown in the following table.

 

Table 7

Capital Adequacy Ratios of BB&T Corporation and Principal Banking Subsidiaries

December 31, 2003

 

    

Regulatory

Minimums


   

Regulatory

Minimums

to be Well-

Capitalized


    BB&T

    Branch
Bank


   

BB&T-

SC


   

BB&T-

VA


 

Risk-based capital ratios:

                                    

Tier 1 capital (1)

   4.0 %   6.0 %   9.4 %   9.5 %   9.7 %   12.3 %

Total risk-based capital (2)

   8.0     10.0     12.5     11.2     11.0     13.3  

Tier 1 leverage ratio (3)

   3.0     5.0     7.2     7.1     7.9     7.5  

(1)   Common shareholders’ equity excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets net of applicable deferred income taxes, and certain nonfinancial equity investments; computed as a ratio of risk-weighted assets, as defined in the risk-based capital guidelines.
(2)   The sum of Tier 1 capital, a qualifying portion of the allowance for loan and lease losses and qualifying subordinated debt; computed as a ratio of risk-weighted assets, as defined in the risk-based capital guidelines.
(3)   Tier 1 capital computed as a percentage of fourth quarter average assets less nonqualifying intangibles.

 

BB&T’s Tier 2 and total regulatory capital have included subordinated notes outstanding under BB&T’s Indenture Regarding Subordinated Securities, dated as of May 24, 1996. In December 2003, BB&T determined that this Indenture included certain provisions that did not comply with the Federal Reserve’s Tier 2 capital guidelines. BB&T has been instructed by the Federal Reserve staff to exclude approximately $1.4 billion of such notes from its calculation of Tier 2 capital and total regulatory capital for purposes of BB&T’s Federal Reserve filings beginning December 31, 2003. The exclusion of these notes from BB&T’s regulatory capital does not affect the rights of the note holders in any way and BB&T remains in full compliance with the terms of all notes outstanding under the Subordinated Indenture. On December 23, 2003, BB&T amended the Subordinated Indenture in a manner that made the provisions referred to above inapplicable to future issuances of subordinated debt. On December 23, 2003, BB&T issued $1.0 billion of subordinated notes under the amended Subordinated Indenture. As of December 31, 2003, BB&T’s consolidated Tier 2 capital included approximately $1.3 billion of subordinated debt issued by BB&T and Branch Bank.

 

The federal banking agencies, including the Federal Reserve Board and the FDIC, are required to take “prompt corrective action” in respect of depository institutions and their bank holding companies that do not meet minimum capital requirements. The law establishes five capital categories for insured depository

 

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institutions for this purpose: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” To be considered “well-capitalized” under these standards, an institution must maintain a total risk-based capital ratio of 10% or greater; a Tier 1 risk-based capital ratio of 6% or greater; a leverage capital ratio of 5% or greater; and is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. BB&T and each of the Banks are classified as “well-capitalized”. Federal law also requires the bank regulatory agencies to implement systems for “prompt corrective action” for institutions that fail to meet minimum capital requirements within the five capital categories, with progressively more severe restrictions on operations, management and capital distributions according to the category in which an institution is placed. Failure to meet capital requirements can also cause an institution to be directed to raise additional capital. Federal law also mandates that the agencies adopt safety and soundness standards relating generally to operations and management, asset quality and executive compensation, and authorizes administrative action against an institution that fails to meet such standards.

 

In addition to the “prompt corrective action” directives, failure to meet capital guidelines can subject a banking organization to a variety of other enforcement remedies, including additional substantial restrictions on its operations and activities, termination of deposit insurance by the FDIC, and under certain conditions the appointment of a conservator or receiver.

 

Deposit Insurance Assessments

 

The deposits of the Banks are insured by the FDIC up to the limits set forth under applicable law. A majority of the deposits of the Banks are subject to the deposit insurance assessments of the BIF of the FDIC. However, a portion of the Banks’ deposits (relating to the acquisitions of various savings associations) are subject to assessments imposed by the SAIF of the FDIC. The assessments imposed in BIF-insured and SAIF-insured deposits have been equalized.

 

The FDIC imposes a risk-based deposit premium assessment system, based in part on an insured institution’s capital classification under the prompt corrective action provisions, and whether that institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. The assessments are set forth in schedules issued by the FDIC that specify, at semi-annual intervals, target reserve ratios designed to maintain the reserve ratio of each of the funds at 1.25% of their estimated insured deposits. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of insured deposits, depending on the institution’s capital position and other supervisory factors. In addition, both SAIF-insured and BIF-insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2003, the FDIC assessed BIF-insured and SAIF-insured deposits 1.52 basis points per $100 of deposits to cover those obligations. At December 31, 2003, BB&T’s assessment was limited to that 1.52 basis point obligation.

 

Consumer Protection Laws

 

In connection with its lending and leasing activities, the Banks are each subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and state law counterparts.

 

Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

 

The CRA requires the Banks’ primary federal bank regulatory agency, in this case the FDIC, to assess the bank’s record in meeting the credit needs of the communities served by each Bank, including low- and moderate-

 

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income neighborhoods and persons. Institutions are assigned one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” This assessment is reviewed by any bank that applies to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. The CRA record of each subsidiary bank of a financial holding company, such as BB&T, also is assessed by the Federal Reserve in connection with any acquisition or merger application.

 

USA Patriot Act

 

The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions. Compliance with the Patriot Act by BB&T has not had a material impact on BB&T’s or the Banks’ results of operations or financial condition.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies, such as BB&T, with equity or debt securities registered under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws.

 

Corporate Governance

 

Information with respect to BB&T’s corporate governance policies and principles is presented on BB&T’s web site, www.BBandT.com, and includes:

 

  ·   BB&T’s Corporate Governance Guidelines

 

  ·   Committees of the Corporate Board of Directors and Committee Charters

 

  ·   BB&T’s Code of Ethics for Employees

 

  ·   BB&T’s Code of Ethics for Directors

 

  ·   BB&T’s Code of Ethics for Senior Financial Officers

 

  ·   Chief Executive Officer and Chief Financial Officer Certifications

 

  ·   BB&T’s Policy and Procedures for Accounting and Legal Complaints

 

BB&T intends to disclose any substantive amendments or waivers to the Codes of Ethics for Directors or Senior Financial Officers on our web site at www.BBandT.com/Investor.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Introduction

 

The following discussion and analysis of the consolidated financial condition and consolidated results of operations of BB&T Corporation and subsidiaries (“BB&T” or the “Corporation”) for each of the three years in the period ended December 31, 2003, and related financial information, are presented in conjunction with the consolidated financial statements and related notes to assist in the evaluation of BB&T’s 2003 performance.

 

Reclassifications

 

In certain circumstances, reclassifications have been made to prior period information to conform to the 2003 presentation.

 

Mergers and Acquisitions Completed During and Subsequent to 2003

 

During and subsequent to 2003, BB&T completed the following mergers and acquisitions, all of which were accounted for as purchases.

 

On March 14, 2003, BB&T completed its acquisition of Equitable Bank (“Equitable”), based in Wheaton, Maryland. BB&T issued 1.5 million shares of common stock valued at $53.8 million in exchange for all of the outstanding common shares of Equitable. Equitable’s assets totaled $446.9 million at the time of acquisition and BB&T recorded $32.4 million in goodwill and other intangible assets in connection with the acquisition.

 

On July 1, 2003, BB&T completed its acquisition of First Virginia Banks, Inc. (“First Virginia”), a bank holding company headquartered in Falls Church, Virginia. To complete the acquisition, BB&T issued 87.0 million shares of common stock valued at $3.1 billion in exchange for all of the outstanding common shares of First Virginia. First Virginia’s assets totaled $11.3 billion at the time of acquisition and BB&T recorded $2.2 billion in goodwill and other intangible assets in connection with the acquisition.

 

BB&T also acquired Southeast Fidelity Corporation (“SEFCO”) on March 31, 2003, an insurance premium finance company based in Tallahassee, Florida. The size of this acquisition was not material in relation to BB&T.

 

On February 1, 2004, BB&T Insurance Services completed its acquisition of McGriff, Seibels & Williams, Inc., of Birmingham, Alabama (“McGriff”). McGriff is the 13th largest insurance broker in the nation. Its specialty areas include energy, marine, financial services, commercial, construction, surety, employee benefits, healthcare and public entities. BB&T issued $300 million of its common stock and paid $50 million in cash to complete the acquisition. The transaction also allows for an additional payment to McGriff’s shareholders of up to $102 million in cash over a five-year period if McGriff exceeds certain performance targets. Following the completion of this acquisition, BB&T Insurance Services became the sixth largest insurance broker in the nation.

 

In addition to the mergers and acquisitions noted above, BB&T acquired a number of insurance agencies during 2003. See Note 2 in the “Notes to Consolidated Financial Statements” for further information regarding mergers and acquisitions.

 

Pending Mergers and Acquisitions

 

On December 2, 2003, BB&T announced plans to acquire Republic Bancshares Inc. (“Republic”), headquartered in St. Petersburg, Florida. At the time of the announcement, Republic had $2.8 billion in assets and operated 71 banking offices along the Gulf Coast and in central and southern Florida, including the Tampa, Clearwater, Orlando, West Palm Beach, Boca Raton and Fort Lauderdale markets. Shareholders of Republic will receive a combination of stock and cash totaling $31.79 per share. Assuming an all stock election by Republic shareholders, the maximum number of common stock shares BB&T could issue to consummate the transaction is 11.0 million. The merger, which is subject to regulatory and shareholder approval, is expected to be competed in the second quarter of 2004.

 

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On January 28, 2004, BB&T announced plans to acquire Capitol Premium Plan Inc., an insurance premium finance company based in Charlotte, North Carolina. Pending regulatory approval, the transaction is expected to be completed in the second quarter of 2004.

 

Critical Accounting Policies

 

The accounting and reporting policies of BB&T Corporation and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. BB&T’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses. Different assumptions in the application of these policies could result in material changes in BB&T’s consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting and reporting policies include BB&T’s accounting for the allowance for loan and lease losses, valuation of mortgage servicing rights, intangible assets associated with mergers and acquisitions, costs and benefit obligations associated with BB&T’s pension and postretirement benefit plans, and income taxes. Understanding BB&T’s accounting policies is fundamental to understanding BB&T’s consolidated financial position and consolidated results of operations. Accordingly, BB&T’s significant accounting policies are discussed in detail in Note 1 in the “Notes to Consolidated Financial Statements”.

 

The following is a summary of BB&T’s critical accounting policies that are highly dependent on estimates, assumptions and judgments.

 

It is the policy of BB&T to maintain an allowance for loan and lease losses that equals management’s best estimate of probable losses that are inherent in the portfolio at the balance sheet date. Estimates for loan and lease losses are determined by analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, plans for problem loan and lease administration, the results of regulatory examinations, and changes in the size, composition and risk assessment of the loan and lease portfolio. Also included in management’s estimates for loan and lease losses are considerations with respect to the impact of economic events, the outcome of which is uncertain. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which BB&T conducts business.

 

BB&T has a significant mortgage loan servicing portfolio and related mortgage servicing rights. Mortgage servicing rights represent the present value of the future net servicing fees from servicing mortgage loans acquired or originated by BB&T. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of mortgage servicing rights, which requires the development of a number of assumptions, including anticipated loan principal amortization and prepayments of principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining interest rates, the value of mortgage servicing assets declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. BB&T amortizes mortgage servicing rights over the estimated period that servicing income is expected to be received based on projections of the amount and timing of future cash flows. The amount and timing of servicing asset amortization is adjusted quarterly based on actual results and updated projections. Please refer to Note 8 in the “Notes to Consolidated Financial Statements” for quantitative disclosures reflecting the effect that changes in management’s assumptions would have on the fair value of mortgage servicing rights.

 

BB&T’s growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. Prior to 2002, BB&T’s mergers and acquisitions were accounted for using the pooling-of-interests and purchase business combination methods of accounting. Effective July 1, 2001, BB&T adopted SFAS No. 141, “Business Combinations,” which allows only the use of the purchase method of accounting. For purchase acquisitions, BB&T is required to record the assets acquired, including identified intangible assets, and liabilities assumed at their fair value, which in many instances involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The determination of the useful lives of intangible assets is subjective, as is the appropriate

 

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amortization period for such intangible assets. These estimates also include the establishment of various accruals and allowances based on planned facilities dispositions and employee severance considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in goodwill, which is subject to ongoing periodic impairment tests based on the fair value of net assets acquired compared to the carrying value of goodwill.

 

The calculation of BB&T’s income tax provision is complex and requires the use of estimates and judgments in its determination. As part of the Company’s analysis and implementation of business strategies, consideration is given to the tax laws and regulations that apply to the specific facts and circumstances for any transaction under evaluation. This analysis includes the amount and timing of the realization of income tax liabilities or benefits. Management closely monitors tax developments in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments utilized in determining the income tax provision and records adjustments as necessary.

 

BB&T offers various pension plans and postretirement benefit plans to employees. The calculation of the obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and assumptions used in the determination of future values of plan assets and liabilities are subject to management judgment and may differ significantly if different assumptions are used. Please refer to Note 13 in the “Notes to Consolidated Financial Statements” for disclosures related to BB&T’s benefit plans, including quantitative disclosures reflecting the impact that changes in certain assumptions would have on service and interest costs and benefit obligations.

 

Analysis of Financial Condition

 

For the year ended December 31, 2003, BB&T’s average assets totaled $85.3 billion, an increase of $9.5 billion, or 12.6%, compared to the 2002 average of $75.8 billion, primarily reflecting growth in average loans and leases. Average loans and leases for 2003 were up $7.0 billion, or 13.8%, from 2002. The primary components of the growth in average loans and leases were consumer loans, which increased $3.3 billion, or 25.0%; commercial loans and leases, which increased $2.0 billion, or 7.3%; and mortgage loans, which increased $1.7 billion, or 17.3%. Total earning assets averaged $75.5 billion in 2003, an increase of $7.2 billion, or 10.6%, compared to 2002. These averages and growth rates include the effects of acquisitions.

 

BB&T’s average deposits totaled $56.9 billion, reflecting growth of $7.8 billion, or 15.9%, compared to 2002. The categories of deposits with the highest growth rates were: money rate savings, which increased $2.9 billion, or 19.8%; noninterest-bearing deposits, which increased $2.3 billion, or 32.1%, and savings and interest checking, which increased $1.0 billion, or 29.8%.

 

Short-term borrowed funds include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and Federal Home Loan Bank (“FHLB”) advances. Average short-term borrowed funds totaled $5.1 billion for the year ended December 31, 2003, a decrease of $252.6 million, or 4.7%, from the 2002 average. BB&T has also utilized long-term debt for a significant portion of its funding needs. Long-term debt includes FHLB advances, other secured borrowings by subsidiary banks and subordinated debt issued by the Corporation and Branch Bank. Average long-term debt totaled $11.7 billion for the year ended December 31, 2003, down $424.4 million, or 3.5%, compared to 2002.

 

The compound annual rate of growth in average total assets for the five-year period ended December 31, 2003, was 10.7%. Over the same five-year period, average loans and leases increased at a compound annual rate of 11.1%, average securities increased at a compound annual rate of 5.7%, and average deposits grew at a compound annual rate of 9.6%. All balance sheet growth rates include the effect of acquisitions accounted for as purchases, as well as internal growth.

 

During 2003, management completed a balance sheet restructuring designed to enhance future earnings per share, reduce interest rate risk and exposure to market volatility, improve the net interest margin, and re-align the securities portfolio. The restructuring included transactions that affected mortgage loans, securities, long-term debt and repurchases of BB&T’s common stock. These transactions, as well as other factors that caused the fluctuations in the major balance sheet categories, are discussed more fully in the sections that follow.

 

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Securities

 

The securities portfolios provide earnings and liquidity, and are an effective tool in managing interest rate risk. Management has historically emphasized investments with a duration of five years or less to provide flexibility in managing the balance sheet in changing interest rate environments. Primarily as a result of the balance sheet restructuring referred to above total securities decreased 8.4% in 2003, to a total of $16.3 billion at the end of the year. The quality of the investment portfolio continues to be strong with 75.5% of the total portfolio’s fair market value at December 31, 2003 comprised of U.S. Treasury securities and U.S. government agency obligations, excluding mortgage-backed securities. The combined duration of the U.S. Treasury and U.S. government agency portfolios was 3.19 years and 1.61 years at December 31, 2003 and 2002, respectively. Mortgage-backed securities composed 9.5% of the total investment portfolio at year-end 2003. The duration of the mortgage-backed securities was 2.71 years at December 31, 2003 compared to 1.46 years at December 31, 2002. The duration of the total portfolio at December 31, 2003 was 3.19 years and 1.74 years at December 31, 2002.

 

The following table provides information regarding the composition of BB&T’s securities portfolio for the years presented:

 

Table 8

Composition of Securities Portfolio

 

     December 31,

     2003

   2002

   2001

     (Dollars in thousands)

Trading Securities (at estimated fair value):

   $ 693,819    $ 148,488    $ 97,675
    

  

  

Securities held to maturity (at amortized cost):

                    

U.S. Treasury and U.S. government agency obligations

     60,122      55,523      40,496
    

  

  

Total securities held to maturity

     60,122      55,523      40,496
    

  

  

Securities available for sale (at estimated fair value):

                    

U.S. Treasury and U.S. government agency obligations

     12,251,230      11,560,414      10,918,219

States and political subdivisions

     945,988      912,598      1,008,973

Mortgage-backed securities

     1,549,524      3,869,037      3,425,288

Equity and other securities

     816,212      1,257,428      1,269,204
    

  

  

Total securities available for sale

     15,562,954      17,599,477      16,621,684
    

  

  

Total securities

   $ 16,316,895    $ 17,803,488    $ 16,759,855
    

  

  

 

At December 31, 2003, trading securities reflected on BB&T’s consolidated balance sheet totaled $693.8 million compared to $148.5 million at December 31, 2002. This increase primarily resulted from the transfer by Branch Bank of securities available for sale having a value of $532.2 million to the trading securities portfolio. The transfer was made pursuant to a change in management’s intent related to those securities, including more frequent trading activity as part of an economic risk management strategy related to mortgage servicing rights. In addition, BB&T’s full-service brokerage subsidiary holds trading securities as a normal part of its operations. Market valuation gains and losses in the trading portfolio are reflected in current earnings.

 

Securities held to maturity are composed of investments in U.S. Treasury securities and made up less than 1% of the total portfolio at December 31, 2003. Securities held to maturity are carried at amortized cost and totaled $60.1 million at December 31, 2003, compared to $55.5 million outstanding at the end of 2002. Unrealized market valuation gains and losses on securities in the Corporation’s held-to-maturity category affect neither earnings nor shareholders’ equity.

 

Securities available for sale totaled $15.6 billion at year-end 2003 and are carried at estimated fair value. Securities available for sale at year-end 2002 totaled $17.6 billion. Unrealized market valuation gains and losses on securities classified as available for sale are recorded as a separate component of shareholders’ equity, net of deferred income taxes. The available-for-sale portfolio is primarily composed of investments in U.S. government agency obligations and mortgage-backed securities, which composed 88.7% of the portfolio. This portfolio also

 

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contains investments in U.S. Treasury securities, which composed less than 1% of the December 31, 2003 balance, obligations of states and municipalities, which composed 6.1% of the available-for-sale portfolio, and equity and other securities, which comprised 5.2% of the available-for-sale portfolio.

 

The $2.0 billion decrease in securities available for sale was primarily a consequence of the balance sheet restructuring completed during 2003. In connection with the re-alignment of the securities portfolio, management did not reinvest approximately $4.0 billion from the sale or maturity of securities during the year. These proceeds and certain other funds were instead utilized to prepay approximately $2.9 billion in FHLB long-term advances bearing relatively high interest rates and to retain, rather than sell, $2.8 billion in additional conventional mortgage loans. Late in the year, the securities available for sale portfolio grew, partially offsetting the decrease caused by the restructuring, as excess funds from strong deposit growth and slower loan demand were invested in securities.

 

During the year ended December 31, 2003, BB&T sold $12.3 billion of available-for-sale securities and realized net gains totaling $107.1 million. A portion of these gains was taken to economically offset increases in the valuation allowance necessary to reduce the carrying value of BB&T’s mortgage servicing rights.

 

During 2001, BB&T sold its ownership interest in an electronic transaction processing company to Concord EFS, Inc. (“Concord”), exchanging nonmarketable equity securities for unregistered Concord common stock. The Concord common shares were subsequently registered by Concord, and BB&T sold its holdings of Concord, which were included in securities available for sale. As a result of the transaction, BB&T recognized gains of $82.4 million that are reflected in securities gains (losses), net, in the Consolidated Statements of Income.

 

The following table presents BB&T’s securities portfolio at December 31, 2003, segregated by major category with ranges of maturities and average yields disclosed.

 

Table 9

Securities

 

     December 31, 2003

 
     Carrying
Value


  

Weighted

Average Yield (3)


 
     (Dollars in thousands)  

U.S. Treasury and U.S. government agency obligations (1):

             

Within one year

   $ 2,286,195    5.59 %

One to five years

     6,605,942    3.30  

Five to ten years

     3,496,924    4.03  

After ten years

     1,471,815    4.80  
    

  

Total

     13,860,876    4.02  
    

  

Obligations of states and political subdivisions:

             

Within one year

     114,566    4.68  

One to five years

     345,501    5.31  

Five to ten years

     350,632    6.93  

After ten years

     135,289    7.02  
    

  

Total

     945,988    6.06  
    

  

Other securities:

             

Within one year

     162,902    1.88  

One to five years

     2,525    10.57  

Five to ten years

     156,476    4.83  

After ten years

     42,337    4.63  
    

  

Total

     364,240    3.55  
    

  

Trading securities and securities with no stated maturity (2)

     1,145,791    2.90  
    

  

Total securities (4)

   $ 16,316,895    4.04 %
    

  


(1)   Included in U.S. Treasury and U.S. government agency obligations are mortgage-backed securities totaling $1.5 billion classified as available for sale and carried at estimated fair value. These securities are included in each of the maturity categories based upon final stated maturity dates. The original contractual lives of these securities range from five to 30 years; however, the weighted average maturity is substantially shorter because of the monthly return of principal on certain securities.

 

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(2)   Trading securities and securities with no stated maturity include equity investments which totaled $452.0 million and trading securities which totaled $693.8 million.
(3)   Yields on tax-exempt securities are calculated on a taxable-equivalent basis using the statutory federal income tax rate of 35%.
(4)   Includes securities held to maturity of $60.1 million carried at amortized cost and securities available for sale and trading securities carried at estimated fair values of $15.6 billion and $693.8 million, respectively.

 

The available-for-sale portfolio comprised 95.4% of total securities at December 31, 2003. Management believes that the high concentration of securities in the available-for-sale portfolio allows flexibility in the day-to-day management of the overall investment portfolio, consistent with the objective of optimizing profitability and mitigating interest rate risk.

 

The market value of the available-for-sale portfolio at year-end 2003 was $17.7 million greater than the amortized cost of these securities. At December 31, 2003, BB&T’s available-for-sale portfolio had net unrealized appreciation, net of deferred income taxes, of $11.5 million, which is reported as a component of shareholders’ equity. At December 31, 2002, the available-for-sale portfolio had net unrealized appreciation of $329.1 million, net of deferred income taxes.

 

The fully taxable equivalent (“FTE”) yield on the total securities portfolio was 4.81% for the year ended December 31, 2003, compared to 6.22% for the prior year. The decrease in FTE yield was caused by the lower interest rate environment, which resulted in cash flows from the payments, prepayments, sales, calls and maturities of higher yielding securities being reinvested at lower interest rates during 2003. The yield on U.S. Treasuries and government agency obligations decreased from 6.12% in 2002 to 4.65% in 2003, while the yield on mortgage-backed securities decreased from 6.49% to 5.09% and the FTE yield on state and municipal securities decreased from 7.47% last year to 6.83% in the current year.

 

Loans and Leases

 

Management emphasizes commercial lending to small and medium-sized businesses, consumer lending and mortgage lending with an overall goal of maximizing the profitability of the loan portfolio while maintaining strong asset quality. The various categories of loan products offered by BB&T are discussed under “Lending Activities” in the “Description of Business” section herein. BB&T is a full-service lender with approximately one-half of its loan portfolio composed of loans to businesses and one-half composed of loans to individual consumers. Average commercial loans, including lease receivables, increased $2.0 billion, or 7.3%, in 2003 as compared to 2002, and now compose 52.0% of the loan portfolio, compared to 55.1% in 2002. Average consumer loans, which include sales finance, revolving credit and direct retail, increased $3.3 billion, or 25.0%, for the year ended December 31, 2003 as compared to the same period in 2002, and compose 28.5% of average loans, compared to 26.0% in 2002. Average mortgage loans increased $1.7 billion, or 17.3%, in 2003 as compared to 2002, and represented the remaining 19.5% of average total loans for 2003, compared to 18.9% a year ago. BB&T is a large originator of residential mortgage loans, with 2003 originations of $19.4 billion. To improve the overall yield of the loan portfolio and to mitigate interest rate risk, BB&T sells most of its conforming fixed-rate mortgage loans in the secondary market. In 2003, BB&T retained a portion of the conforming originated mortgage loans as part of the balance sheet restructuring previously discussed. At December 31, 2003, BB&T was servicing $24.9 billion in residential mortgages owned by third parties and $11.6 billion of mortgage loans owned by BB&T.

 

BB&T’s loan portfolio, excluding loans held for sale, increased $10.4 billion, or 20.4%, as compared to 2002. Average total loans and leases for 2003 increased $7.0 billion, or 13.8%, compared to 2002. These increases were aided by the addition of $6.6 billion of loans held by companies that were acquired during 2003. These acquired loans consisted of $6.3 billion and $320.5 million that were acquired through the purchases of First Virginia and Equitable, respectively, during 2003. Excluding the effect of these purchase accounting transactions and reflecting the soft commercial loan demand in BB&T’s core markets, average “internal” loan growth for the year ended December 31, 2003, was 3.1% compared to 2002. By category, excluding the impact of purchase accounting transactions, average mortgage loans, including loans held for sale, increased 6.2% because of lower mortgage rates during 2003, commercial loans and leases grew 2.0% because of sluggish growth in BB&T’s core markets, and consumer loans increased 3.3% in 2003 compared to 2002.

 

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While the mix of the consolidated loan portfolio in 2003 was very similar to that of one year ago, the fluctuation reflects certain trends in the composition of the loan portfolio caused by the general economic conditions across BB&T’s footprint, the merger with First Virginia and the balance sheet restructuring mentioned earlier. During 2003, core BB&T markets in the Carolinas, southwest Virginia and parts of Georgia experienced slow economic growth due primarily to declines in the textile, furniture and tobacco industries. As a result, commercial loan demand in markets served by BB&T was slower than historically experienced.

 

The slower pace of commercial loan growth during 2003 was partially offset by positive trends in the consumer and mortgage loan portfolios. During the past two years, the low interest rate environment combined with appreciating home values and the purchase of First Virginia has led to more advances under home equity and revolving lines of credit, and the resulting increase in average direct retail loans, which were up $1.7 billion, or 19.1%, compared to the average balance in 2002. Average sales finance loans increased $1.5 billion, or 45.6%, from the prior year primarily as a result of the purchase of First Virginia, which had a loan portfolio concentrated in sales finance. Following the merger, BB&T began to reposition the sales finance portfolio, in particular the segment with very high quality but low-priced loans, which management views as having a lower risk-adjusted return than the existing BB&T portfolio. Based on current market conditions, historical results and projected portfolio liquidation, BB&T expects to profitably grow the sales finance loan portfolio at a 3% to 5% long-term annual rate, while maintaining its overall percentage of total loans and profitability.

 

As part of the balance sheet restructuring discussed earlier, management planned to retain, rather than sell $3.0 billion to $3.5 billion of fixed rate conventional mortgage loans from originations to improve net interest income and to reduce runoff of the mortgage portfolio from refinance activity. As of December 31, 2003, loans totaling approximately $2.8 billion have been retained pursuant to this strategy. Mortgage loans comprised 18.7% of the loan portfolio at December 31, 2003 compared to 19.8% at the end of 2002 and 19.6% at December 31, 2001. Management views mortgage loans as excellent long-term investments due to their lower credit risk, liquidity characteristics and current favorable spreads versus U.S. Treasury securities, and believes origination and servicing mortgage loans is integral with BB&T’s relationship-based credit culture.

 

The average annualized FTE yields on commercial, consumer and mortgage loans for 2003 were 5.34%, 7.35% and 6.07%, respectively, resulting in a yield for the total loan portfolio of 6.06%, compared to 6.93% for the total portfolio in 2002. The 87 basis point decrease in the average yield on loans resulted from a lower average prime rate during 2003 compared to 2002, which was the product of continued aggressive actions taken by the Federal Reserve Board to stimulate the economy. During the last quarter of 2002, the Federal Reserve Board reduced the intended Federal Funds Rate from 1.75%, the level at which it had been through most of 2002, to 1.25%. In the middle of 2003, the Federal Reserve Board further reduced the intended Federal Funds Rate to 1.00%. As a result of the Federal Reserve Board’s actions, the average prime rate, which is the basis for pricing many commercial and consumer loans, averaged 4.12% in 2003, compared to 4.67% for 2002.

 

Asset Quality and Credit Risk Management

 

BB&T utilizes the following general practices to manage credit risk:

 

  ·   limiting the amount of credit which individual lenders can extend

 

  ·   establishing a process for credit approval accountability

 

  ·   careful initial underwriting and analysis of borrower, transaction, market and collateral risks

 

  ·   ongoing servicing of individual loans and lending relationships

 

  ·   continuous monitoring of the portfolio, market dynamics and the economy; and

 

  ·   periodically reevaluating the bank’s strategy and overall exposure as economic, market and other relevant conditions change

 

BB&T’s lending strategy, which focuses on relationship-based lending within our markets and smaller individual loan balances, continues to produce strong credit quality. As measured by relative levels of nonperforming assets and net charge-offs, BB&T’s asset quality has remained significantly below published industry averages throughout the economic slowdown.

 

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Asset Quality

 

The following table summarizes asset quality information for BB&T for the past five years.

 

Table 10

Asset Quality

 

     December 31,

 
     2003

    2002

    2001

    2000

    1999

 
     (Dollars in thousands)  

Nonaccrual loans and leases (1)

   $ 350,440     $ 374,842     $ 316,607     $ 180,638     $ 144,247  

Restructured loans

     592       175       —         492       1,681  

Foreclosed property

     96,070       76,647       56,964       55,199       47,143  
    


 


 


 


 


Nonperforming assets

   $ 447,102     $ 451,664     $ 373,571     $ 236,329     $ 193,071  
    


 


 


 


 


Loans 90 days or more past due and still accruing

   $ 116,758     $ 115,047     $ 101,778     $ 81,629     $ 66,241  
    


 


 


 


 


Asset Quality Ratios: (2)

                                        

Nonaccrual and restructured loans and leases as a percentage of loans and leases

     .56 %     .70 %     .67 %     .40 %     .37 %

Nonperforming assets as a percentage of:

                                        

Total assets

     .49       .56       .53       .36       .33  

Loans and leases plus foreclosed property

     .72       .84       .79       .53       .48  

Net charge-offs as a percentage of average loans and leases

     .43       .48       .40       .27       .26  

Net charge-offs excluding specialized lending as a percentage of average loans and leases (3)

     .32       .38       .34       .22       .22  

Allowance for losses as a percentage of loans and leases

     1.26       1.35       1.36       1.29       1.33  

Allowance for losses as a percentage of loans and leases held for investment

     1.27       1.42       1.42       1.32       1.34  

Ratio of allowance for losses to:

                                        

Net charge-offs

     3.17 x     2.94 x     3.44 x     5.13 x     5.37 x

Nonaccrual and restructured loans and leases

     2.24       1.93       2.04       3.19       3.63  

NOTE:

 

(1)

  Includes $135.2 million, $144.8 million, $130.7 million, $73.4 million and $68.4 million of of impaired loans at December 31, 2003, 2002, 2001, 2000 and 1999, respectively.
   

(2)

  Items referring to loans and leases are net of unearned income and, except for loans and leases held for investment, include loans held for sale.
   

(3)

  Excludes net charge-offs and average loans from BB&T’s specialized lending subsidiaries.

 

During 2003, BB&T’s credit quality continued to improve. The improving economic conditions combined with BB&T’s careful loan underwriting process and active monitoring of past due loans resulted in a reduction of nonperforming assets compared to December 31, 2002.

 

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The following table summarizes nonperforming assets and past due loans by loan type for the past three years.

 

Table 11

Summary of Nonperforming Assets and Past Due Loans

 

     December 31,

 
     2003

    2002

    2001

 
     (Dollars in thousands)  

Nonaccrual loans and leases

                        

Commercial loans and leases

   $ 219,558     $ 251,428     $ 208,940  

Direct retail

     50,425       39,565       29,742  

Sales finance

     12,742       7,948       4,948  

Revolving credit

     342       243       390  

Mortgage

     67,373       75,658       72,587  
    


 


 


Total nonaccrual loans and leases

   $ 350,440     $ 374,842     $ 316,607  
    


 


 


Foreclosed real estate

   $ 78,964     $ 55,448     $ 39,106  

Other foreclosed assets

     17,106       21,199       17,858  

Restructured loans

     592       175       —    
    


 


 


Total nonperforming assets

   $ 447,102     $ 451,664     $ 373,571  
    


 


 


Nonaccrual loans and leases as a percentage of total loans and leases

                        

Commercial loans and leases

     .35 %     .47 %     .44 %

Direct retail

     .08       .07       .06  

Sales finance

     .02       .01       .01  

Revolving credit

     —         —         —    

Mortgage

     .11       .15       .16  
    


 


 


Total nonaccrual loans and leases as a percentage of loans and leases

     .56 %     .70 %     .67 %
    


 


 


Loans 90 days or more past due and still accruing interest

                        

Commercial loans and leases

   $ 17,759     $ 20,386     $ 20,193  

Direct retail

     25,695       34,386       27,626  

Sales finance

     27,863       15,800       17,793  

Revolving credit

     5,601       6,089       6,713  

Mortgage

     39,840       38,386       29,453  
    


 


 


Total loans 90 days or more past due and still accruing interest

   $ 116,758     $ 115,047     $ 101,778  
    


 


 


Total loans 90 days or more past due and still accruing interest as a percentage of total loans and leases

                        

Commercial loans and leases

     .04 %     .04 %     .04 %

Direct retail

     .04       .06       .06  

Sales finance

     .04       .03       .04  

Revolving credit

     .01       .01       .01  

Mortgage

     .06       .07       .06  
    


 


 


Total loans 90 days or more past due and still accruing interest as a percentage of total loans and leases

     .19 %     .21 %     .21 %
    


 


 


 

Allowance for Loan and Lease Losses

 

BB&T’s allowance for loan and lease losses totaled $784.9 million at December 31, 2003, compared to $723.7 million at the end of 2002, an increase of 8.5%. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.26% at December 31, 2003, compared to 1.35% at year-end 2002. Excluding loans held for sale, the ratio of the allowance for loan and lease losses to total loans and leases was 1.27% at December 31, 2003 compared to 1.42% at the end of last year.

 

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The decline in the allowance for loan and lease losses relative to loans and leases outstanding resulted partially from the acquisition of First Virginia, which had strong credit quality including lower net charge-offs and lower nonperforming assets in recent quarters compared to BB&T. This strong credit history, combined with a post-acquisition loan portfolio mix with a lower risk profile and improvements in BB&T’s overall asset quality, including lower relative levels of net charge-offs and nonperforming assets, led to the reduction in the allowance as a percentage of outstanding loans and leases.

 

During the first quarter of 2003, BB&T transferred $9.0 million, or 1.2% of the December 31, 2002 allowance for loan and lease losses, to other liabilities. The amount transferred related to BB&T’s unfunded commitments. The transfer had no effect on BB&T’s consolidated results of operations.

 

Information relevant to BB&T’s allowance for loan and lease losses for the last five years is presented in the following table.

 

Table 12

Analysis of Allowance for Loan and Lease Losses

 

     December 31,

 
     2003

    2002

    2001

    2000

    1999

 

Balance, beginning of period

   $ 723,685     $ 644,418     $ 578,107     $ 529,236     $ 490,619  
    


 


 


 


 


Charge-offs:

                                        

Commercial, financial and agricultural

     (71,874 )     (84,967 )     (63,387 )     (33,214 )     (34,693 )

Real estate

     (77,547 )     (61,608 )     (41,035 )     (20,759 )     (19,239 )

Consumer

     (161,424 )     (144,609 )     (124,359 )     (93,040 )     (79,075 )

Lease receivables

     (4,430 )     (5,965 )     (2,448 )     (3,502 )     (993 )
    


 


 


 


 


Total charge-offs

     (315,275 )     (297,149 )     (231,229 )     (150,515 )     (134,000 )
    


 


 


 


 


Recoveries:

                                        

Commercial, financial and agricultural

     25,380       18,029       14,985       12,358       13,087  

Real estate

     10,808       6,345       4,824       3,788       4,823  

Consumer

     30,251       24,890       23,955       21,430       17,344  

Lease receivables

     1,039       1,353       375       312       107  
    


 


 


 


 


Total recoveries

     67,478       50,617       44,139       37,888       35,361  
    


 


 


 


 


Net charge-offs

     (247,797 )     (246,532 )     (187,090 )     (112,627 )     (98,639 )
    


 


 


 


 


Provision charged to expense

     248,000       263,700       224,318       147,187       126,559  
    


 


 


 


 


Allowance for loans acquired in purchase transactions, net

     70,035       62,099       29,083       14,311       10,697  

Reclassification of allowance related to unfunded commitments

     (8,986 )     —         —         —         —    
    


 


 


 


 


Balance, end of period

   $ 784,937     $ 723,685     $ 644,418     $ 578,107     $ 529,236  
    


 


 


 


 


Average loans and leases (1)

   $ 57,857,069     $ 50,851,417     $ 46,587,780     $ 41,933,641     $ 37,819,870  
    


 


 


 


 


Net charge-offs as a percentage of average loans and leases (1)

     .43 %     .48 %     .40 %     .27 %     .26 %
    


 


 


 


 



(1)   Loans and leases are net of unearned income and include loans held for sale.

 

Deposits and Other Borrowings

 

Client deposits generated through the BB&T branch network are the largest source of funds used to support asset growth. Total deposits at December 31, 2003, were $59.3 billion, an increase of $8.1 billion, or 15.7%, compared to year-end 2002. The increase in deposits was driven by a $3.2 billion, or 41.1%, increase in noninterest-bearing

 

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deposits, a $3.2 billion, or 18.4%, increase in money rate savings accounts, and a $1.2 billion, or 40.2%, increase in savings and interest checking accounts. For the year ended December 31, 2003, total deposits averaged $56.9 billion, an increase of $7.8 billion, or 15.9%, compared to 2002. The increase was the result of a $2.3 billion, or 32.1%, increase in average noninterest-bearing deposits, a $1.0 billion, or 29.8%, increase in average savings and interest checking accounts, and a $2.9 billion, or 19.8%, increase in average money rate savings accounts. During the same time periods, other time deposits increased $1.6 billion, or 6.7%. Other time deposits, including individual retirement accounts and certificates of deposit, remain BB&T’s largest category of deposits, comprising 44.4% of average total deposits for the year, down from 48.3% last year. The primary driver of that growth was the purchase of First Virginia on July 1, 2003, which added $9.5 billion in deposits.

 

Together with the positive growth trend in client deposits over the last two years, there has been a noticeable shift in the overall deposit mix from CDs and other time deposits to lower-cost transaction accounts such as noninterest-bearing deposits and money rate savings accounts. This shift reflects the reduced attractiveness of time deposits and client preferences for highly liquid investments in a low interest rate environment. Another contributing factor, in light of the low interest environment, has been the tendency by many commercial customers to concentrate their deposit balances in noninterest-bearing accounts, which allowed them to minimize commercial account service charges. Furthermore, the low interest rate environment during the past two years has led to a reduction in certificates of deposit exclusive of growth from acquisitions.

 

The average rates paid on interest-bearing deposits decreased to 1.59% during 2003, from 2.39% in 2002. The declining interest rate in 2003 resulted from the actions by the Federal Reserve Board to maintain short-term interest rates at historically low levels. The average rate paid on other time deposits, including individual retirement accounts and certificates of deposit, decreased to 2.39% in the current year from 3.42% in 2002. The average cost of money rate savings accounts decreased to .77% in the current year from 1.13% in 2002; interest checking decreased from ..67% in 2002 to .39% in the current year; and the average cost of savings deposits decreased to .28% in 2003 from .80% in 2002.

 

During 2000, BB&T contracted with an independent third party for the disbursement of official checks. Under the terms of the agreement, BB&T acts as an agent for the third party in the issuance of official checks. Funds received from the buyers of official checks are transferred to the third party issuer to cover the checks when they are ultimately presented for payment. But for this arrangement with the third party, these funds would have remained at BB&T in the form of noninterest-bearing deposits. The official check program is contractually arranged to substantially limit BB&T’s exposure to loss, as the third party is required to invest the funds received and maintain a 1:1 relationship between outstanding checks and the balances available to cover the checks. BB&T monitors this relationship through a reconciliation process. The third party provided a letter of credit from another bank in favor of BB&T and has access to a revolving line of credit to further mitigate any risk that there would be inadequate funds to cover the outstanding balance of official checks sold. However, in the event that the third party failed to honor official checks BB&T had sold as its agent, it is likely that BB&T would choose to reimburse the purchasers, though not contractually obligated to do so. At December 31, 2003, the third party issuer had outstanding official checks that had been sold by BB&T totaling $440.2 million.

 

BB&T also uses various types of short-term borrowed funds in meeting funding needs. While client deposits remain the primary source for funding loan originations, management uses short-term borrowings as a supplementary funding source for loan growth. Short-term borrowings comprised 6.0% of total funding needs on average in 2003 and 7.1% in 2002. See Note 9 “Short-Term Borrowed Funds” in the “Notes to Consolidated Financial Statements” herein for further disclosure. The types of short-term borrowings utilized by the Corporation include Federal funds purchased, which composed 27.8% of total short-term borrowed funds, and securities sold under repurchase agreements, which comprised 38.6% of short-term borrowed funds at year-end 2003. Master notes, U.S. Treasury tax and loan deposit notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances are also utilized to meet short-term funding needs. Average short-term borrowed funds totaled $5.1 billion during 2003, a decrease of $252.6 million, or 4.7%, from 2002. The decrease in average short-term borrowed funds was a result of the reduced need for supplementary funding of loan originations, which were slowed by a sluggish economy in BB&T’s core markets and healthy deposit growth during 2003, which provided sufficient resources for loan growth. Short-term borrowed funds at the end of 2003 were $7.3 billion, up $1.9 billion, or 35.9%, compared to year-end 2002. The rates paid on average short-term borrowed funds decreased from 1.78% in 2002 to 1.13% during 2003. The decrease in the cost of short-term

 

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borrowed funds resulted from the lower interest rate environment during 2003, including a 55 basis point decrease in the average Federal funds rate for 2003 compared to 2002. The following table summarizes certain pertinent information for the past three years with respect to BB&T’s short-term borrowed funds:

 

Table 13

Short-Term Borrowed Funds

 

    

As of / For the Year Ended

Ended December 31,


 
     2003

    2002

    2001

 
     (Dollars in thousands)  

Securities Sold Under Agreements to Repurchase

                        

Maximum outstanding at any month-end during the year

   $ 3,177,747     $ 2,568,897     $ 2,532,813  

Balance outstanding at end of year

     2,831,068       2,511,530       2,175,510  

Average outstanding during the year

     2,603,343       2,479,185       2,162,917  

Average interest rate during the year

     1.29 %     2.02 %     3.76 %

Average interest rate at end of year

     1.11       1.64       2.07  

Other Short-term Borrowed Funds

                        

Maximum outstanding at any month-end during the year

   $ 4,157,153     $ 4,542,536     $ 4,866,565  

Balance outstanding at end of year

     4,503,832       2,885,429       4,473,590  

Average outstanding during the year

     2,537,500       2,914,294       4,101,183  

Average interest rate during the year

     0.97 %     1.58 %     3.82 %

Average interest rate at end of year

     0.91       1.00       4.45  

 

BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 13.7% of total funding needs on average during 2003 and 16.0% in 2002. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for further disclosure. Long-term debt at December 31, 2003 totaled $10.8 billion, a decrease of $2.8 billion, or 20.5%, from year-end 2002. For the year ended December 31, 2003, average long-term debt decreased $424.4 million, or 3.5%, compared to the average for 2002. BB&T’s long-term debt consists primarily of FHLB advances, which composed 56.3% of total outstanding long-term debt at December 31, 2003, and subordinated notes, which composed 28.2% of the year-end balance. FHLB advances are cost-effective long-term funding sources that provide BB&T with the flexibility to structure the debt in a manner that aids in the management of interest rate risk and liquidity. The remaining long-term debt consists of secured borrowings by Branch Bank, redeemable capital securities issued by the Corporation, mortgage indebtedness and capital leases. The average rate paid on long-term debt decreased from 4.84% during 2002 to 3.87% during 2003 because of the overall declining interest rate environment previously discussed and the balance sheet restructuring completed during 2003.

 

The substantial decrease in long-term debt in 2003 is partially due to the effects of a balance sheet restructuring completed during the year. In connection with the restructuring, BB&T refinanced $3.0 billion of FHLB advances during the second quarter of 2003, lowering the current annual interest rate paid on these advances during the next five years, after which the FHLB has the option to increase the interest rate paid on such advances. Because the refinancing gave rise to substantially similar debt, the transaction resulted in no immediate gain or loss. BB&T also prepaid $2.9 billion in FHLB advances using funds from reducing the size of the securities portfolio. The transaction resulted in prepayment penalties totaling $384.9 million that reduced 2003 after-tax earnings by $248.5 million. The prepayment penalties are reflected in BB&T’s Consolidated Statements of Income as a category of noninterest expenses. The reduction in higher-cost long-term debt is intended to improve net interest income and net interest margins. These FHLB-related transactions contributed approximately 12 basis points to the net interest margin during 2003. In December 2003, BB&T issued $1.0 billion of subordinated notes. The proceeds from the offering will be used to fund repurchases of BB&T’s common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&T’s subsidiaries and for other general corporate purposes.

 

Liquidity needs are a primary consideration in evaluating funding sources. BB&T’s strategy is to maintain funding flexibility, in order that the Corporation may react rapidly to opportunities that may become available in the marketplace. BB&T will continue to focus on traditional core funding strategies, supplemented by short-term and long-term borrowings. See “Liquidity” herein for additional discussion.

 

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Analysis of Results of Operations

 

Consolidated net income for 2003 totaled $1.1 billion, which generated basic earnings per share of $2.09 and diluted earnings per share of $2.07. Net income for 2002 was $1.3 billion and net income for 2001 totaled $973.6 million. Basic earnings per share were $2.75 in 2002 and $2.15 in 2001, while diluted earnings per share were $2.72 and $2.12 for 2002 and 2001, respectively.

 

Two important and commonly used measures of bank profitability are return on average assets (net income as a percentage of average total assets) and return on average shareholders’ equity (net income as a percentage of average common shareholders’ equity). BB&T’s returns on average assets were 1.25%, 1.72% and 1.41% for the years ended December 31, 2003, 2002 and 2001, respectively. The returns on average common shareholders’ equity were 11.97%, 18.32% and 16.78% for the last three years.

 

Merger-Related and Restructuring Charges

 

Mergers and acquisitions have played an important role in the development of BB&T’s franchise. BB&T has been an active acquirer of financial institutions, insurance agencies and other nonbank fee income producing businesses. Refer to Note 2 in the “Notes to Consolidated Financial Statements” for a summary of mergers and acquisitions consummated during the three years ended December 31, 2003. As a result of this activity, the consolidated results of operations for the three year period covered by this discussion include the effects of merger-related and restructuring charges, expenses and certain gains related to the consummation of the transactions.

 

Merger-related charges and expenses include personnel-related items such as staff relocation costs, severance benefits, early retirement packages and contract settlements. They also include furniture, equipment and occupancy costs related to department and branch consolidations as well as costs related to converting the data processing systems of the acquired companies to BB&T’s automation platform. Merger-related charges also include professional fees, advertising, and asset write-offs incurred in connection with the mergers.

 

During 2003, BB&T recorded merger-related and restructuring charges of $89.8 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of Equitable and First Virginia.

 

During 2002, BB&T recorded merger-related and restructuring charges of $39.3 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. These expenses were recorded in connection with the first quarter systems conversion of F&M National Corporation, the second quarter systems conversion of Community First Banking Company, and the mergers with MidAmerica Bancorp (“MidAmerica”), Area Bancshares (“AREA”), and Regional Financial Corp. (“Regional”).

 

During 2001, BB&T recorded merger-related and restructuring charges of $199.0 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. In addition, $36.4 million was recorded as a provision for loan and lease losses in connection with the mergers with FCNB Corporation, Century South Banks, Inc., and F&M National Corporation. This provision was recorded to conform the merged entities’ credit policies to those of BB&T, including underwriting and risk rating standards, charge-offs, past due and nonaccrual loans, as well as to reflect impending changes in the management of problem loans.

 

The following table presents the components of merger-related and restructuring charges included in noninterest expenses. This table includes increases to previously recorded merger-related accruals and period expenses for merger-related items that must be expensed as incurred. Items that are required to be expensed as incurred include certain expenses associated with systems conversions, data processing, training, travel and other costs.

 

Table 14

Summary of Merger-Related and Restructuring Charges

(Dollars in thousands)

 

     For the Year Ended December 31,

     2003

   2002

   2001

Severance and personnel-related charges

   $ 20,834    $ 4,527    $ 46,497

Occupancy and equipment charges

     22,290      9,510      50,065

Systems conversions and related charges

     5,271      11,700      35,025

Marketing and public relations

     7,565      6,446      15,311

Asset write-offs, conforming policies and other merger-related charges

     33,815      7,097      52,090
    

  

  

Total

   $ 89,775    $ 39,280    $ 198,988
    

  

  

 

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Severance and personnel-related costs include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination, which typically occur in corporate support and data processing functions. During 2003, BB&T estimated that 1,918 positions would be eliminated and 980 employees had, in fact, been terminated prior to December 31, 2003. Additional positions are expected to be eliminated pursuant to this estimate in 2004. Approximately 551 of these employees will continue to receive severance payments during 2004. During 2002, BB&T estimated that 372 positions would be eliminated and 370 employees were, in fact, terminated prior to December 31, 2002. Approximately 90 of these employees continued to receive severance payments during 2003. During 2001, BB&T estimated that 400 positions would be eliminated and approximately 350 employees were terminated and received severance by the end of 2001.

 

Occupancy and equipment charges represent merger-related costs associated with lease terminations, obsolete equipment write-offs, and the sale of duplicate facilities and equipment. Systems conversions and related charges include expenses necessary to convert and combine the acquired branches and operations of merged companies. Marketing and public relations costs represent direct media advertising related to the acquisitions. The other merger-related charges are composed of asset and supply inventory write-offs, litigation accruals, costs to conform an acquired institution’s accounting policies to those of BB&T and other similar charges.

 

In conjunction with the consummation of an acquisition and the completion of other requirements, BB&T typically accrues certain merger-related expenses related to estimated severance costs, costs to terminate lease contracts, costs related to the disposal of duplicate facilities and equipment, costs to terminate data processing contracts and other costs associated with the acquisition. The following tables present a summary of activity with respect to BB&T’s merger and restructuring accruals related to the mergers listed above, with the more significant mergers (First Virginia and F&M National Corporation) presented separately. These tables include costs reflected as expenses, as presented in the table above, and accruals recorded through purchase accounting adjustments.

 

     First Virginia Banks, Inc.

     (Dollars in thousands)
     Additions
in 2003


   Utilized
in 2003


  

Balance

December 31,

2003


Severance and personnel-related charges

   $ 26,723    $ 7,828    $ 18,895

Occupancy and equipment charges

     46,989      23,300      23,689

Systems conversions and related charges

     22,397      1,662      20,735

Other merger-related charges

     6,920      4,245      2,675
    

  

  

Total

   $ 103,029    $ 37,035    $ 65,994
    

  

  

 

Merger-related and restructuring accruals related to First Virginia are generally expected to be utilized during 2004, unless they relate to specific contracts or legal obligations that expire in later years, or they relate to the disposal of duplicate facilities and equipment, which may take longer to complete.

 

     F&M National Corporation

     (Dollars in thousands)
     Balance
December 31,
2001


   Additions
in 2002


   Utilized
in 2002


   Balance
December 31,
2002


   Additions
in 2003


   Utilized
in 2003


  

Balance

December 31,

2003


Severance and personnel-related charges

   $ 11,055    $ 1,417    $ 11,592    $ 880    $ —      $ 817    $ 63

Occupancy and equipment charges

     10,992      —        797      10,195      1,307      4,405      7,097

Systems conversions and related charges

     4,375      2,825      7,200      —        —        —        —  

Other merger-related charges

     3,110      —        2,113      997      —        10      987
    

  

  

  

  

  

  

Total

   $ 29,532    $ 4,242    $ 21,702    $ 12,072    $ 1,307    $ 5,232    $ 8,147
    

  

  

  

  

  

  

 

The remaining accruals at December 31, 2003 for F&M National Corporation are related primarily to costs to exit certain leases and to dispose of excess facilities and equipment. These liabilities will be utilized in the future upon termination of the various leases and sale of duplicate property. These accruals are expected to be utilized in 2004 unless they relate to specific contracts expiring in later years.

 

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Table of Contents

Activity with respect to the merger and restructuring accruals for all other mergers, which are discussed above, is presented in the accompanying table:

 

     All Other Merger Accrual Activity

     (Dollars in thousands)
     Balance
December 31,
2001


   Additions
in 2002


   Utilized
in 2002


   Balance
December 31,
2002


   Additions
in 2003


   Utilized
in
2003


   Balance
December 31,
2003


Severance and personnel-related charges

   $ 20,316    $ 38,597    $ 42,964    $ 15,949    $ 4,842    $ 11,899    $ 8,892

Occupancy and equipment charges

     26,071      31,668      26,181      31,558      13,759      27,407      17,910

Systems conversions and related charges

     6,964      9,453      14,679      1,738      940      2,678      —  

Other merger-related charges

     12,000      21,438      23,154      10,284      16,676      19,552      7,408
    

  

  

  

  

  

  

Total

   $ 65,351    $ 101,156    $ 106,978    $ 59,529    $ 36,217    $ 61,536    $ 34,210
    

  

  

  

  

  

  

 

The liabilities for severance and personnel-related costs relate to severance liabilities that will be paid out based on such factors as expected termination dates, the provisions of employment contracts and the terms of BB&T’s severance plans. The remaining occupancy and equipment accruals relate to costs to exit certain leases and to dispose of excess facilities and equipment. Such liabilities will be utilized upon termination of the various leases and sale of duplicate property. Liabilities associated with systems conversions relate to termination penalties on contracts with information technology service providers. These liabilities will be utilized as the contracts are paid out and expire. The other merger-related liabilities relate to litigation, accruals to conform the accounting policies of acquired institutions to those of BB&T, and other similar charges.

 

Because BB&T often has multiple merger integrations in process, and, due to limited resources, must schedule in advance significant events in the merger conversion and integration process, BB&T’s merger process and utilization of merger accruals may cover an extended period of time. In general, a major portion of accrued costs are utilized in conjunction with or immediately following the systems conversion, when most of the duplicate positions are eliminated and the terminated employees begin to receive severance. Other accruals are utilized over time based on the sale, closing or disposal of duplicate facilities or equipment or the expiration of lease contracts. Merger accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at December 31, 2003 are expected to be utilized during 2004, unless they relate to specific contracts that expire in later years.

 

The accruals utilized during 2003 in the tables above include reversals of $40.1 million of previously recorded merger-related and restructuring accruals principally related to the finalization of estimates for employee terminations, contract cancellations and occupancy costs primarily in connection with the AREA, MidAmerica and First Virginia acquisitions. The above reversals include $30 million of pretax adjustments to goodwill and had no effect on BB&T’s consolidated results of operations. The remaining $10.1 million were included as reductions of merger-related and restructuring charges during 2003 in the Consolidated Statements of Income.

 

Net Interest Income

 

Net interest income is BB&T’s primary source of revenue. Net interest income is influenced by a number of factors, including the volume, mix and maturity of interest-earning assets and interest-bearing liabilities and the interest rates earned and paid thereon. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by the net interest margin. The accompanying table presents the dollar amount of changes in interest income and interest expense, and distinguishes between the changes related to increases or decreases in average outstanding balances of interest-earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Changes attributable to both volume and rate have been allocated proportionately.

 

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Table 15

FTE Net Interest Income and Rate/Volume Analysis

For the Years Ended December 31, 2003, 2002 and 2001

 

                                              2003 vs. 2002

    2002 vs. 2001

 
    Average Balances

  Yield/Rate

    Income/Expense

 

Increase

(Decrease)


    Change due to

   

Increase

(Decrease)


    Change due to

 
    2003

  2002

  2001

  2003

    2002

    2001

    2003

  2002

  2001

    Rate

    Volume

      Rate

    Volume

 
    (Dollars in thousands)  

Assets

                                                                                                     

Securities (1):

                                                                                                     

U.S. Treasury, U.S. government agency and other (5)

  $ 16,156,301   $ 16,005,557   $ 14,830,331   4.70 %   6.15 %   7.04 %   $ 759,712   $ 983,967   $ 1,043,583   $ (224,255 )   $ (233,438 )   $ 9,183     $ (59,616 )   $ (138,287 )   $ 78,671  

States and political subdivisions

    901,579     933,532     1,056,401   6.83     7.47     7.37       61,571     69,743     77,868     (8,172 )     (5,843 )     (2,329 )     (8,125 )     1,042       (9,167 )
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total securities (5)

    17,057,880     16,939,089     15,886,732   4.81     6.22     7.06       821,283     1,053,710     1,121,451     (232,427 )     (239,281 )     6,854       (67,741 )     (137,245 )     69,504  

Other earning assets (2)

    548,403     439,097     430,912   1.39     1.79     3.99       7,659     7,848     17,185     (189 )     (1,967 )     1,778       (9,337 )     (9,657 )     320  

Loans and leases, net of unearned income (1)(3)(4)(5)

    57,857,069     50,851,417     46,587,780   6.06     6.93     8.37       3,504,656     3,523,050     3,900,844     (18,394 )     (471,856 )     453,462       (377,794 )     (713,443 )     335,649  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total earning assets

    75,463,352     68,229,603     62,905,424   5.74     6.72     8.01       4,333,598     4,584,608     5,039,480     (251,010 )     (713,104 )     462,094       (454,872 )     (860,345 )     405,473  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Non-earning assets

    9,864,376     7,549,430     5,917,605                                                                                    
   

 

 

                                                                                   

Total assets

  $ 85,327,728   $ 75,779,033   $ 68,823,029                                                                                    
   

 

 

                                                                                   

Liabilities and Shareholders’ Equity

                                                                                                     

Interest-bearing deposits:

                                                                                                     

Savings and interest checking

  $ 4,364,473   $ 3,363,118   $ 3,361,694   0.32     0.75     1.44       14,179     25,062     48,408     (10,883 )     (16,891 )     6,008       (23,346 )     (23,366 )     20  

Money rate savings

    17,760,127     14,824,396     12,502,120   0.77     1.13     2.48       136,399     167,329     310,196     (30,930 )     (60,015 )     29,085       (142,867 )     (192,504 )     49,637  

Other time deposits

    25,309,123     23,728,465     22,171,321   2.39     3.42     5.45       605,099     810,667     1,207,665     (205,568 )     (256,626 )     51,058       (396,998 )     (476,803 )     79,805  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing deposits

    47,433,723     41,915,979     38,035,135   1.59     2.39     4.12       755,677     1,003,058     1,566,269     (247,381 )     (333,532 )     86,151       (563,211 )     (692,673 )     129,462  

Short-term borrowed funds

    5,140,843     5,393,479     6,264,100   1.13     1.78     3.80       58,842     95,823     238,315     (36,981 )     (33,193 )     (3,788 )     (142,492 )     (113,021 )     (29,471 )

Long-term debt

    11,710,281     12,134,712     11,030,312   3.87     4.84     5.53       458,268     587,703     610,352     (129,435 )     (114,175 )     (15,260 )     (22,649 )     (80,366 )     57,717  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing liabilities

    64,284,847     59,444,170     55,329,547   1.97     2.84     4.36       1,272,787     1,686,584     2,414,936     (413,797 )     (480,900 )     67,103       (728,352 )     (886,060 )     157,708  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Noninterest-bearing deposits

    9,514,435     7,202,129     6,206,746                                                                                    

Other liabilities

    2,633,214     2,019,244     1,484,547                                                                                    

Shareholders’ equity

    8,895,232     7,113,490     5,802,189                                                                                    
   

 

 

                                                                                   

Total liabilities and shareholders’ equity

  $ 85,327,728   $ 75,779,033   $ 68,823,029                                                                                    
   

 

 

                                                                                   

Average interest rate spread

                    3.77 %   3.88 %   3.65 %                                                                  
                     

 

 

                                                                 

Net interest margin

                    4.06 %   4.25 %   4.17 %   $ 3,060,811   $ 2,898,024   $ 2,624,544   $ 162,787     $ (232,204 )   $ 394,991     $ 273,480     $ 25,715     $ 247,765  
                     

 

 

 

 

 

 


 


 


 


 


 



(1)   Interest income from securities, loans and leases includes the effects of taxable-equivalent adjustments (reduced by the nondeductible portion of interest expense) using a federal income tax rate of approximately 35% for all years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable-equivalent adjustment amounts included in the above table were $(21.2 million), $150.6 million and $190.9 million in the three years ended December 31, 2003, 2002 and 2001, respectively.
(2)   Includes Federal funds sold and securities purchased under resale agreements or similar arrangements.
(3)   Loan fees, which are not material for any of the periods shown, have been included for rate calculation purposes.
(4)   Nonaccrual loans have been included in the average balances. Only the interest collected on such loans has been included as income.
(5)   Includes assets which were held for sale or available for sale at amortized cost and trading securities at fair value.

 

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For 2003, net interest income on an FTE-adjusted basis totaled $3.1 billion, compared with $2.9 billion in 2002 and $2.6 billion in 2001. The increase in net interest income during 2003 resulted primarily from a decrease of $413.8 million in total interest expense, which was caused by the decline in interest rates during 2003 as compared to 2002. On an FTE-adjusted basis, interest income from loans decreased $18.4 million, and interest income from investment securities decreased $232.4 million.

 

In the declining interest rate environment of 2003, the average yield on interest earning assets fell 98 basis points compared to the average yield during 2002, while the average cost of funds over the same time period fell 87 basis points, causing a reduction in the net interest margin. In addition to the effect of changes in yields on earning assets compared to the cost of funds, the margin was also negatively affected by the reinvestment of proceeds from the sales, maturities and prepayments of securities in lower yielding securities, the additional net loan and deposit premium amortization related to the purchase of First Virginia, and the additional interest expense incurred in connection with BB&T’s stock buy-back program. Several factors had a positive effect on the margin. The most significant among them was the balance sheet restructuring completed during the year.

 

The FTE-adjusted net interest margin is the primary measure used in evaluating the gross profit margin from the portfolios of earning assets. The FTE-adjusted net interest margin was 4.06% in 2003, 4.25% in 2002 and 4.17% in 2001. In addition to changes in the composition of BB&T’s earning assets and interest bearing liabilities, the primary driver of the fluctuations in the net interest margin was the rapidly declining interest rate environment prevailing during the last two years as the Federal Reserve reduced short-term interest rates to stimulate the weak economy. Over the past three years, the Federal Reserve has taken aggressive actions to lower the level of interest rates by reducing the benchmark federal funds rate from 6.50% at the beginning of 2001 to 1.00% at the end of 2003. As a result, the prime lending rate, which is the basis for pricing many commercial and consumer loans, also declined from 9.50% at the beginning of 2001 to 4.00% at the end of 2003. The majority of the decline occurred during 2001 when the prime rate declined to 4.75% and averaged 6.91% for the year. In 2002 the rate declined to 4.25% and averaged 4.67% for the year and, in 2003, the prime rate declined to 4.00% and averaged 4.12% for the full year. This sharp decline in short-term rates initially contributed to BB&T’s interest sensitive assets repricing more quickly overall than its interest-bearing liabilities during 2001. During 2002, as interest rates stabilized, BB&T’s interest-bearing liabilities also repriced at the lower interest rates, which, together with a shift in the composition of deposits toward lower cost transaction accounts, resulted in an eight basis points increase in the FTE-adjusted net interest margin during 2002 compared to 2001.

 

Provision for Loan and Lease Losses

 

A provision for loan and lease losses is charged against earnings in order to maintain an allowance for credit losses that reflects management’s best estimate of probable losses inherent in the portfolio at the balance sheet date. The amount of the provision is based on continuing assessments of nonperforming and “watch list” loans, analytical reviews of loan loss experience in relation to outstanding loans, loan charge-offs, nonperforming asset trends and management’s judgment with respect to current and expected economic conditions and their impact on the loan portfolio. The methodology used is described in the “Description of Business” section under the heading “Allowance for Loan and Lease Losses.” The provision for loan and lease losses recorded by BB&T in 2003 was $248.0 million, compared with $263.7 million in 2002 and $224.3 million in 2001.

 

The $15.7 million, or 6.0% decrease in the provision during 2003 reflects BB&T’s continued efforts to monitor and address problem loans, improving credit quality trends, as evidenced by the decrease in relative levels of nonperforming assets and net charge-offs, and changes in the composition and relative risk of the overall portfolio following the acquisition of First Virginia. Management expects these positive internal trends to continue into 2004 if the economic environment improves. Net charge-offs were .43% of average loans and leases for 2003 compared to .48% of average loans during 2002. The allowance for loan and lease losses was 1.26% of loans and leases outstanding and was 2.24x total nonaccrual and restructured loans and leases at year-end 2003, compared to 1.35% and 1.93x, respectively, at December 31, 2002.

 

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Table of Contents

Noninterest Income

 

Noninterest income includes service charges on deposit accounts, trust revenue, mortgage banking income, investment banking and brokerage fees, insurance commissions, gains and losses on securities transactions and other commissions and fees derived from other activities.

 

Noninterest income for 2003 totaled $1.9 billion, compared with $1.6 billion in 2002 and $1.3 billion in 2001. The 2003 noninterest income reflects an increase of $296.7 million, or 18.6%, compared to 2002. Noninterest income for 2002 was $258.1 million, or 19.3%, higher than 2001. The increase in noninterest income for 2003 is primarily the result of substantial growth in mortgage banking income, increased insurance commissions from BB&T’s agency network and higher levels of investment banking and brokerage fees and commissions as well as increased service charges on deposits and trust income. The major categories of noninterest income and their fluctuations are discussed in the following paragraphs.

 

The following table provides a breakdown of BB&T’s noninterest income:

 

Table 16

Noninterest Income

 

     Years Ended December 31,

   % Change

 
        2003 v.
2002


    2002 v.
2001


 
     2003

   2002

   2001

    
     (Dollars in thousands)  

Service charges on deposits

   $ 437,524    $ 402,476    $ 349,522    8.7 %   15.2 %

Mortgage banking income

     198,510      72,749      102,904    172.9     (29.3 )

Trust income

     113,227      94,463      90,898    19.9     3.9  

Insurance commissions

     395,820      313,436      190,446    26.3     64.6  

Securities gains (losses), net

     107,078      170,100      122,126    (37.0 )   39.3  

Bankcard fees and merchant discounts

     83,927      66,848      60,859    25.5     9.8  

Investment banking and brokerage fees and commissions

     245,361      210,586      175,296    16.5     20.1  

Other bank service fees and commissions

     180,045      141,654      126,638    27.1     11.9  

Income from bank-owned life insurance

     98,700      88,613      65,872    11.4     34.5  

Other noninterest income

     28,943      31,470      49,746    (8.0 )   (36.7 )
    

  

  

  

 

Total noninterest income

   $ 1,889,135    $ 1,592,395    $ 1,334,307    18.6 %   19.3 %
    

  

  

  

 

 

Service charges on deposit accounts represent BB&T’s largest category of noninterest revenue. Such revenues totaled $437.5 million in 2003, an increase of $35.0 million, or 8.7%, compared to 2002. Service charges during 2002 totaled $402.5 million, which represented an increase of $53.0 million, or 15.2% compared to 2001. The current year growth in service charges was attributable to the acquisition of First Virginia at the beginning of the third quarter. Excluding the effect of this acquisition, service charges on deposits would have decreased 1.6% compared to 2002. The decrease in service charges on deposits was the result of changes in deposit mix and competitive pricing pressure. In light of the low interest rate environment, many commercial customers concentrated a large portion of their deposit balances in transaction accounts rather than interest-bearing accounts, which allowed them to minimize commercial account analysis fees. Price reductions on certain retail deposit-related services and new lower-fee deposit products were introduced during 2003 in response to market conditions and competition within BB&T’s market area. The primary factors contributing to the 2002 increase in service charges on deposits compared to 2001 were NSF and overdraft charges on personal accounts, which were $34.9 million more than in 2001, and commercial account analysis fees, which grew $20.9 million.

 

Income from mortgage banking activities (which includes revenues from originating, marketing and servicing mortgage loans, and valuation adjustments and amortization related to mortgage servicing rights) totaled $198.5 million in 2003, $72.7 million in 2002 and $102.9 million in 2001. The significant fluctuations in net mortgage banking revenues are primarily a function of high interest rate volatility that has affected the value of BB&T’s mortgage servicing rights. While the low interest rate environment during the last two years

 

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contributed to high mortgage origination volume, it also resulted in higher prepayment speed assumptions for existing serviced loans, which lowered the value of BB&T’s mortgage servicing rights causing writedowns in their value. During the latter half of 2003, as mortgage rates rose from the historically low levels to which they had declined during 2002 and early 2003, BB&T recaptured some of the previous writedowns in the value of mortgage servicing rights. As a result, mortgage banking income during 2003 included a net writedown of $36.8 million compared with a net charge of $152.4 million in 2002. These charges were substantially offset by gains from sales of securities available for sale. BB&T originated a record $19.4 billion in mortgage loans in 2003 compared to $14.1 billion in 2002 and $10.5 billion in 2001. The 26.6% increase in mortgage production volume resulted in an increase of $55.1 million in mortgage production income to $262.2 million in the current year compared to $207.1 million during 2002. The increase in the current year mortgage banking income that resulted from higher mortgage production income and a reduction in the writedowns of mortgage servicing rights was offset in part by an increase in the amortization expense of mortgage servicing rights. Amortization is recorded based on the proportion of current period net servicing to total expected future net servicing revenues over the expected life of the loans serviced. Consequently, a shorter expected life, as a result of faster prepayment speed assumptions, results in higher amortization expense. Amortization expense associated with mortgage servicing rights increased by $54.8 million to $154.9 million for the year ended December 31, 2003 compared to $100.1 million for the year ended December 31, 2002. In 2002, mortgage banking income decreased $30.2 million, or 29.3%, compared to 2001 primarily as a result of increases in the provision for the valuation of mortgage servicing rights and higher amortization expense recorded during 2002 compared to 2001.

 

BB&T has an extensive insurance agency network, which at December 31, 2003 ranked as the 8th largest in the nation. Commission income from BB&T’s insurance operations totaled $395.8 million in 2003, an increase of $82.4 million, or 26.3%, compared to 2002. Commission income for 2002 totaled $313.4 million, an increase of $123.0 million, or 64.6% compared to 2001. Internal growth combined with the expansion of BB&T’s insurance agency network and insurance brokerage operations through acquisitions during the last two years were primarily responsible for this strong growth. Excluding the effect of these acquisitions, insurance commissions would have increased 12.8%. Revenues from BB&T’s insurance brokerage operations contributed $42.8 million in revenue growth for the current year, while property and casualty insurance commissions, employee benefits commissions, and accident and health insurance commissions increased $23.0 million, $4.7 million, and $3.8 million, respectively, compared to 2002. Similar growth in these product lines and revenues from purchased insurance agencies also drove the 2001 increase.

 

Revenue from corporate and personal trust services totaled $113.2 million in 2003, $94.5 million in 2002 and $90.9 million in 2001. The 2003 revenue reflects an increase of $18.7 million, or 19.9% compared to 2002, which was $3.6 million, or 3.9%, more than 2001. The revenue increase in 2003 was partially due to the acquisition of First Virginia and to increases in mutual fund and estate management fees. The value of trust assets under management, including custodial accounts, increased from $24.2 billion at December 31, 2002 to $27.2 billion at December 31, 2003. Total trust assets under management at December 31, 2003 include $2.2 billion in trust assets from the acquisition of First Virginia and reflect a reduction of $2.4 billion in trust assets from the North Carolina state employees’ 401-K plan, which transferred to a successor trustee. The majority of the growth in trust revenue in 2002 resulted from the acquisitions of AREA and MidAmerica, which had significant trust operations. The overall growth in trust revenues was depressed during 2002 and 2001 by declining equity markets, which affected the value of managed assets.

 

Net gains on sales of securities totaled $107.1 million in 2003, $170.1 million in 2002 and $122.1 million in 2001. The current year gains resulted primarily from the sale of securities available for sale. A portion of such gains was used to offset the net writedown in the value of mortgage servicing rights of $36.8 million during 2003. Securities gains realized during 2002 and 2001 were taken primarily to economically offset increases in the valuation allowance of mortgage servicing rights. Net security gains in 2001 results also include the gain realized from the sale of BB&T’s investment in an electronic transaction processing company, which totaled $78.9 million.

 

Investment banking and brokerage fees and commissions totaled $245.4 million in 2003, $210.6 million in 2002 and $175.3 million in 2001. The 2003 revenue reflects an increase of $34.8 million, or 16.5% over 2002, which was $35.3 million, or 20.1% greater than 2001. The increase in this category of revenue in 2003 compared to 2002 and in 2002 compared to 2001 resulted primarily from growth in retail brokerage commissions and growth in investment banking income at BB&T’s full-service brokerage and investment banking subsidiary, Scott & Stringfellow.

 

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Other nondeposit fees and commissions, including bankcard fees and merchant discounts, totaled $264.0 million in 2003, an increase of $55.5 million, or 26.6%, compared with $208.5 million earned in 2002, which represented an increase of $21.0 million, or 11.2%, over the $187.5 million in 2001 revenue. The principal drivers of the increase were bankcard fees and merchant discounts, check card interchange fees, business check card interchange fees, and check card foreign ATM fees, which increased $17.1 million, $8.7 million, $2.7 million, and $5.3 million, respectively, compared to 2002. In addition, fees from money orders and official checks, commercial standby letters of credit fees, and other ATM fees, increased $4.2 million, $2.8 million, and $3.6 million, respectively, compared to 2002. Furthermore, the acquisition of First Virginia contributed to the revenue growth during the current year. Excluding the effects of this and other acquisitions completed during 2003 and 2002, other nondeposit fees and commissions, would have increased 16.0% for the year ended December 31, 2003, compared to the year ended December 31, 2002. Major sources of the increase in 2002 revenue include bankcard fees and merchant discounts, which increased $6.0 million, or 9.8%, check card interchange fees, which increased $8.4 million, or 31.7%, and gift card income, which increased $5.1 million compared to 2001.

 

BB&T has purchased life insurance coverage on certain of its officers for whom it has an insurable interest. Income from bank-owned life insurance totaled $98.7 million in 2003, an increase of $10.1 million, or 11.4%, compared with $88.6 million earned in 2002, which represented an increase of $22.7 million, or 34.5%, over the $65.9 million earned in 2001. The growth in income was driven by additional purchases of bank-owned life insurance made in mid-year 2002.

 

Other income totaled $28.9 million in 2003, a decrease of $2.5 million, or 8.0%, compared with $31.5 million earned in 2002, which represented a decrease of $18.3 million, or 36.7%, compared with $49.7 million earned in 2001. The decreases were primarily caused by lower income from limited partnership investments, which declined $14.7 million and $11.1 million during 2003 and 2002, respectively. The current year decrease was largely offset by non-taxable income from the increase in the value of various financial assets isolated for the purpose of providing post-employment benefits. The 2002 decrease was also caused by a decrease in amortization of negative goodwill in the amount of $4.8 million compared to 2001, and a loss on non-hedging derivatives in the amount of $5.6 million.

 

The ability to generate significant amounts of noninterest revenues in the future will be very important to the continued success of BB&T. Through its subsidiaries, BB&T will continue to focus on asset management, mortgage banking, trust, insurance, investment banking and brokerage services, as well as other fee-producing products and services. BB&T plans to continue to pursue acquisitions of additional insurance agencies and asset management companies, as well as explore strategic acquisitions of other nonbank entities as a means of expanding fee-based revenues. Also, among BB&T’s principal strategies following the acquisition of a financial institution is the cross-sell of noninterest income generating products and services to the acquired institution’s client base.

 

Noninterest Expense

 

Noninterest expense totaled $3.1 billion in 2003, $2.3 billion in 2002 and $2.2 billion in 2001. Certain significant items principally stemming from mergers and acquisitions were recorded as noninterest expenses during 2003, 2002 and 2001. In 2003, $89.8 million in pretax merger-related charges were recorded, while 2002 included $39.3 million in merger-related charges and $199.0 million were recognized in 2001. Additional disclosures related to these merger-related charges are presented above in “Merger-Related and Restructuring Charges.” In addition, noninterest expense for the current year includes a loss from the early termination of FHLB advances in the amount of $384.9 million. See “Deposits and Other Borrowings” section above for further discussion of this loss.

 

Total noninterest expense increased $820.7 million, or 35.9%, from 2002 to 2003 and $102.2 million, or 4.7%, from 2001 to 2002. The 2003 growth rate includes the effects of acquisitions accounted for as purchases during 2003, including First Virginia, Equitable and several insurance companies. Excluding the effects of the timing of such purchase acquisitions and penalties arising from FHLB terminations, noninterest expense would have increased by 5.6% compared to 2002. The growth in 2002 was similarly affected by acquisitions accounted for as purchases during 2002, including Regional, AREA, MidAmerica, CRC, and several nonbank financial services companies and insurance agencies, which added costs of $67.9 million. Excluding the effects of the timing of such

 

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purchase acquisitions, noninterest expense would have decreased by 3.2% compared to 2001. The table below shows the components of noninterest expense and the discussion that follows explains the composition of certain categories and the factors that caused them to change in 2003 and 2002.

 

Table 17

Noninterest Expense

 

     Years Ended December 31,

   % Change

 
        2003 v.
2002


    2002 v.
2001


 
     2003

   2002

   2001

    
     (Dollars in thousands)             

Salaries and wages

   $ 1,226,648    $ 1,063,261    $ 932,635    15.4 %   14.0 %

Pension and other employee benefits

     280,688      234,586      194,223    19.7     20.8  
    

  

  

  

 

Total personnel expenses

     1,507,336      1,297,847      1,126,858    16.1     15.2  

Net occupancy expense on bank premises

     180,029      156,670      133,768    14.9     17.1  

Furniture and equipment expense

     191,138      184,402      169,618    3.7     8.7  
    

  

  

  

 

Total occupancy and equipment expenses

     371,167      341,072      303,386    8.8     12.4  

Regulatory charges

     13,348      11,807      11,684    13.1     1.1  

Foreclosed property expense

     19,329      7,321      2,745    164.0     166.7  

Amortization of intangibles

     55,650      20,885      72,693    166.5     (71.3 )

Software

     43,966      36,608      28,415    20.1     28.8  

Telephone

     45,118      44,005      43,010    2.5     2.3  

Advertising and public relations

     31,110      27,537      26,134    13.0     5.4  

Travel and transportation

     27,607      24,012      23,555    15.0     1.9  

Professional services

     70,518      73,496      59,255    (4.1 )   24.0  

Supplies

     36,792      32,464      32,484    13.3     (0.1 )

Loan processing expenses

     78,887      64,225      52,007    22.8     23.5  

Deposit related expense

     28,571      25,750      20,492    11.0     25.7  

Merger-related and restructuring charges

     89,775      39,280      198,988    128.6     (80.3 )

Loss on early extinguishment of debt

     384,898      —        —      NM     —    

Other noninterest expenses

     302,038      239,149      181,534    26.3     31.7  
    

  

  

  

 

Total noninterest expense

   $ 3,106,110    $ 2,285,458    $ 2,183,240    35.9 %   4.7 %
    

  

  

  

 


NM—not meaningful

 

Total personnel expense, the largest component of noninterest expense, totaled $1.5 billion in 2003, an increase of 16.1%, compared to the $1.3 billion in personnel expense incurred in 2002. The 2002 expense reflected an increase of $171.0 million, or 15.2%, compared to the $1.1 billion recorded in 2001. Total personnel expense includes salaries and wages, as well as pension and other employee benefit costs. The increase in 2003 personnel expenses was primarily attributable to the acquisition of First Virginia, as well as higher mortgage loan production incentive compensation, investment banking incentive compensation, and other annual performance compensation, which grew $20.3 million, $20.4 million, and $23.3 million, respectively, compared to last year. In addition, pension plan expenses and flexible benefit expenses increased $12.9 million and $12.0 million, respectively, compared to 2002. Excluding the effect of acquisitions completed during 2003, personnel expenses in the current year increased 3.8% compared to 2002. The 2002 increase in personnel expenses was primarily caused by the effect of acquisitions, which accounted for $137.2 million of the increase, as well as higher mortgage loan production incentive compensation and investment banking incentive compensation, which grew $15.1 million and $14.8 million, respectively.

 

Net occupancy and equipment expense totaled $371.2 million in 2003, $341.1 million in 2002 and $303.4 million in 2001. The net occupancy and equipment expense for 2003 reflects an increase of $30.1 million, or 8.8% compared to 2002, which was $37.7 million, or 12.4% greater than the expense incurred in 2001. The increase during 2003 was largely due to the acquisition of First Virginia, which resulted in higher rent on buildings and premises, information technology equipment expenses, and building maintenance expenses, which increased $9.9 million, $2.6 million, and $4.3 million, respectively, compared to 2002. Additionally, utility expenses and other

 

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miscellaneous furniture and equipment expenses increased $2.7 million and $3.3 million, respectively. The increase in 2002 compared to 2001 was affected by acquisitions completed during 2002 and was generally due to the same factors that caused the 2003 increase.

 

Amortization expense associated with intangible assets totaled $55.7 million in 2003, $20.9 million in 2002 and $72.7 million in 2001. The increase in the current year was primarily due to acquisitions completed during 2003, the largest of which was the purchase of First Virginia, which was responsible for most of the increase. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of completed mergers and acquisitions during the three year period ending December 31, 2003. The decrease in 2002 is due to the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets”, which ended the amortization of goodwill effective January 1, 2002.

 

Loan processing expenses totaled $78.9 million, an increase of $14.7 million, or 22.8%, compared to the $64.2 million incurred in 2002. This increase was primarily driven by higher mortgage, sales finance, home equity lines of credit and retail loans origination expenses, which increased $2.5 million, $1.5 million, $1.4 million and $3.2 million, respectively, compared to 2002, as a result of the increase in volume of such loans due to the favorable interest rate environment. The 2002 loan processing expenses reflect a $12.2 million, or 23.5%, increase over 2001. The increase was caused by similar factors that affected the 2003 increase.

 

Other noninterest expenses, including professional services, totaled $618.4 million for 2003, an increase of $96.2 million, or 18.4%, compared to 2002, which reflected an increase of $92.8 million, or 21.6% compared to the $429.3 million incurred in 2001. In addition to the effect of purchasing First Virginia, the majority of the 2003 increase resulted from higher advertising and public relations expenses, charitable contributions, employee travel, supplies expenses, and net losses from the disposition of fixed assets. The 2002 increase was caused by increases in substantially the same categories that affected the 2003 expenses.

 

Provision for Income Taxes

 

BB&T’s provision for income taxes totaled $552.1 million for 2003, an increase of $54.7 million, or 11.0%, compared to 2002. The provision for income taxes totaled $497.5 million in 2002 and $386.8 million in 2001. BB&T’s effective tax rates for the years ended 2003, 2002 and 2001 were 34.1%, 27.8% and 28.4%, respectively. The higher provision in 2003 was a result of the increase in the effective tax rate compared to 2002 including the effects of adjustments related to deferred income taxes associated with BB&T’s leasing operations, which are discussed below. The increase in the provision in 2002 compared to 2001 resulted from a higher level of pretax income, offset in part by a lower effective tax rate.

 

BB&T has extended credit to and invested in the obligations of states and municipalities and their agencies. The income generated from these investments together with certain other transactions that have favorable tax treatment have reduced BB&T’s overall effective tax rate from the statutory rate in 2003, 2002 and 2001. These transactions include investments in leveraged leases, entering into option contracts transferring the future management of residual interests of certain leverage leases to a wholly-owned foreign subsidiary for which BB&T intends to permanently reinvest the earnings, and the transfer of securities and real estate secured loans to a subsidiary that resulted in a difference between BB&T’s tax basis and financial statement basis in the equity of the subsidiary.

 

BB&T continually monitors and evaluates the potential impact of current events and circumstances on the estimates and assumptions used in the analysis of its income tax positions and, accordingly, BB&T’s effective tax rate may fluctuate in the future. On a periodic basis, BB&T evaluates its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of current Internal Revenue Service (“IRS”) examinations of BB&T’s tax returns, recent positions taken by the IRS on similar transactions, if any, and the overall tax environment in relation to tax-advantaged transactions. In 2003, BB&T determined that it was appropriate to defer recognition of benefits from the option contracts described above until such benefits were realized for income tax purposes and recorded adjustments to reflect that determination.

 

In the normal course of business, BB&T is subject to examinations from various tax authorities. These examinations may alter the timing or amount of taxable income or deductions, or the allocation of income among

 

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tax jurisdictions. During 2003, the IRS concluded its examination of BB&T’s federal income tax returns for the years ended December 31, 1996, 1997 and 1998. Following their examination, the IRS issued a Revenue Agent Report assessing taxes and interest in the amount of $59.3 million related to BB&T’s income tax treatment of certain leveraged lease transactions which were entered into during the years under examination. The assessment, which was paid by BB&T during 2003, did not affect BB&T’s consolidated results of operations in the current year as it related primarily to differences in the timing of recognizing income and deductions for income tax purposes for which deferred taxes had been previously provided. Management continues to believe that BB&T’s treatment of these leveraged leases was appropriate and in compliance with existing tax laws and regulations for the years examined, and is currently evaluating its options regarding obtaining a refund of this assessment.

 

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. The primary objective of interest rate risk management is to minimize the effect that changes in interest rates have on net interest income. This is accomplished through active management of asset and liability portfolios with a focus on the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The goal of these activities is the development of appropriate maturity and repricing opportunities in BB&T’s portfolios of assets and liabilities that will produce consistent net interest income during periods of changing interest rates. BB&T’s Asset / Liability Management Committee (“ALCO”) monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes under various interest rate scenarios.

 

The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The ALCO meets regularly to review BB&T’s interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards.

 

BB&T utilizes a variety of financial instruments to manage various financial risks. These instruments, commonly referred to as derivatives, primarily consist of interest rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. BB&T uses derivatives primarily to hedge business loans, federal funds purchased, long-term debt, mortgage servicing rights, mortgage banking operations, and certificates of deposit. These derivatives resulted in an increase in net interest income of $124.2 million, $45.0 million and $8.8 million in 2003, 2002 and 2001, respectively.

 

Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. On December 31, 2003, BB&T had derivative financial instruments outstanding with notional amounts totaling $14.6 billion. The estimated fair value of open contracts used for risk management purposes at December 31, 2003 had net unrealized gains of $136.0 million.

 

See Note 18 “Derivative Financial Instruments” in the Notes to Consolidated Financial Statements for additional disclosures.

 

Impact of Inflation and Changing Interest Rates

 

The majority of BB&T’s assets and liabilities are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories.

 

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Fluctuations in interest rates and actions of the Board of Governors of the Federal Reserve System (“FRB”) to regulate the availability and cost of credit have a greater effect on a financial institution’s profitability than do the effects of higher costs for goods and services. Through its balance sheet management function, which is monitored by the ALCO, BB&T is positioned to respond to changing needs for liquidity, changes in interest rates and inflationary trends.

 

BB&T’s interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions at December 31, 2003, and is not necessarily indicative of positions on other dates. The carrying amounts of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. The table does not reflect the impact of hedging strategies.

 

Table 18

Interest Rate Sensitivity Gap Analysis

December 31, 2003

 

    

Within

One Year


  

One to

Three Years


   

Three to

Five Years


  

After

Five Years


   Total

     (Dollars in thousands)

Assets

                                   

Securities and other interest-earning assets (1)

   $ 4,338,708    $ 3,852,631     $ 3,932,465    $ 4,446,539    $ 16,570,343

Federal funds sold and securities purchased under resale agreements or similar arrangements

     332,849      —         —        —        332,849

Loans and leases (2)

     41,512,379      8,783,269       5,887,368      6,122,370      62,305,386
    

  


 

  

  

Total interest-earning assets

     46,183,936      12,635,900       9,819,833      10,568,909      79,208,578
    

  


 

  

  

Liabilities

                                   

Savings and interest checking (3)

     —        2,584,241       861,414      861,414      4,307,069

Money rate savings (3)

     10,174,485      10,174,484       —        —        20,348,969

Time deposits

     16,437,541      4,750,305       2,403,324      4,326      23,595,496

Federal funds purchased and securities sold under repurchase agreements or similar arrangements

     4,866,960      —         —        —        4,866,960

Long-term debt and other borrowings

     2,495,783      272,998       2,313,132      8,193,727      13,275,640
    

  


 

  

  

Total interest-bearing liabilities

     33,974,769      17,782,028       5,577,870      9,059,467      66,394,134
    

  


 

  

  

Asset-liability gap

     12,209,167      (5,146,128 )     4,241,963      1,509,442       
    

  


 

  

      

Cumulative interest rate sensitivity gap

   $ 12,209,167    $ 7,063,039     $ 11,305,002    $ 12,814,444       
    

  


 

  

      

(1)   Securities based on amortized cost.
(2)   Loans and leases include loans held for sale and are net of unearned income.
(3)   Projected runoff of deposits that do not have a contractual maturity date was computed based upon decay rate assumptions developed by bank regulators to assist banks in addressing FDICIA rule 305.

 

Management uses Interest Sensitivity Simulation Analysis (“Simulation”) to measure the sensitivity of projected earnings to changes in interest rates. Simulation takes into account the current contractual agreements that BB&T has made with its customers on deposits, borrowings, loans, investments and any commitments to enter into those transactions. Management monitors BB&T’s interest sensitivity by means of a computer model that incorporates current volumes, average rates earned and paid, and scheduled maturities and payments of asset and liability portfolios, together with multiple scenarios of projected prepayments, repricing opportunities and anticipated volume growth. Using this information, the model projects earnings based on projected portfolio balances under multiple interest rate scenarios. This level of detail is needed to simulate the effect that changes in interest rates and portfolio balances may have on the earnings of BB&T. This method is subject to the accuracy

 

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of the assumptions that underlie the process, but it provides a better illustration of the sensitivity of earnings to changes in interest rates than other analyses such as static or dynamic gap.

 

The asset/liability management process requires a number of key assumptions. Management determines the most likely outlook for the economy and interest rates by analyzing external factors, including published economic projections and data, the effects of likely monetary and fiscal policies as well as any enacted or prospective regulatory changes. BB&T’s current and prospective liquidity position, current balance sheet volumes and projected growth, accessibility of funds for short-term needs and capital maintenance are also considered. This data is combined with various interest rate scenarios to provide management with information necessary to analyze interest sensitivity and to aid in the development of strategies to reach performance goals.

 

The following table shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next twelve months under the “most likely” interest rate scenario incorporated into the Interest Sensitivity Simulation computer model. Key assumptions in the preparation of the table include prepayment speeds on mortgage-related assets, cash flows and maturities of derivative financial instruments, changes in market conditions, loan volumes and pricing, deposit sensitivity, customer preferences, and capital plans. The resulting change in net interest income reflects the level of sensitivity that net interest income has in relation to changing interest rates.

 

Table 19

Interest Sensitivity Simulation Analysis

 

Interest Rate Scenario


 

Annualized Hypothetical

Percentage Change in

Net Interest Income


Linear

Change in

Prime Rate


 

Prime Rate


 
 

December 31,


 

December 31,


 

2003


 

2002


 

2003


 

2002


3.00%

  7.00%   7.25%   (1.37)%   0.52%

1.50

  5.50   5.75   (1.10)   0.52

No Change

  4.00   4.25   —     —  

(1.00)

  3.00   NA(2)   (1.17)   NA(2)

(1.50)

  NA(1)   2.75   NA(1)   (2.99)

(3.00)

  NA(1)   1.25   NA(1)   (3.99)

(1) BB&T’s model assumes a 300 basis point difference between the federal funds target rate and the prime rate and does not calculate a scenario where the federal funds rate would fall below zero.

 

(2) BB&T’s model did not calculate a 1% decrease in 2002.

 

Management has established parameters for asset/liability management, which prescribe a maximum impact on net interest income of 3% for a 150 basis point parallel change in interest rates over six months from the most likely interest rate scenario, and a maximum of 6% for a 300 basis point change over 12 months. It is management’s ongoing objective to effectively manage the impact of changes in interest rates and minimize the resulting effect on earnings.

 

Liquidity

 

Liquidity represents BB&T’s continuing ability to meet funding needs, primarily deposit withdrawals, timely repayment of borrowings and other liabilities and funding of loan commitments. In addition to the level of liquid assets, such as trading securities and securities available for sale, many other factors affect the ability to meet liquidity needs, including access to a variety of funding sources, maintaining borrowing capacity in national money markets, growing core deposits, the repayment of loans and the capability to securitize or package loans for sale.

 

The main purpose of BB&T (the “Parent Company”) is to serve as the primary capital financing vehicle for its operating subsidiaries. The assets of the Parent Company consist primarily of cash on deposit with subsidiary banks, equity investments in subsidiaries, advances to subsidiaries, accounts receivable from subsidiaries, and other miscellaneous assets. The primary obligations of the Parent Company are principal and interest on master notes, long-term debt, and redeemable capital securities. The main sources of funds for the Parent Company are

 

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dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from issuance of long-term debt and master notes. The primary uses of funds by the Parent Company are for the retirement of common stock, investments in subsidiaries, advances to subsidiaries, dividend payments to shareholders, and interest and principal payments due on long-term debt and master notes.

 

The primary source of funds used for Parent Company cash requirements has been dividends from the subsidiary banks, which totaled $1.5 billion during 2003, and proceeds from the issuance of subordinated notes, which totaled $991.3 million in 2003. Funds raised through master note agreements with commercial clients are placed on deposit with bank subsidiaries primarily for their use in meeting short-term funding needs and, to a limited extent, to support temporary cash needs of the Parent Company. At December 31, 2003 and 2002, master note balances totaled $1.0 billion and $721.1 million, respectively.

 

The Parent Company has a $250 million revolving credit agreement with a group of unaffiliated banks, which serves as a backup liquidity facility for the master note program referred to above. This agreement has historically been negotiated annually. The current agreement is scheduled to expire April 2, 2004. Management will evaluate whether to renew the facility. No borrowings have occurred under this backup facility.

 

During 2003, BB&T filed a shelf registration with the Securities and Exchange Commission to provide for the issuance of up to $2.0 billion of securities, which could include unsecured debt securities, shares of common stock, shares of preferred stock, stock purchase contracts, stock purchase units, warrants to purchase debt securities, preferred stock or common stock, or units consisting of a combination of these. On December 23, 2003, BB&T issued $1.0 billion of subordinated notes leaving $1.0 billion available for issuance under this universal shelf registration.

 

The Parent Company has five issues of subordinated notes outstanding, which collectively totaled $2.8 billion at December 31, 2003, and $2.0 billion at December 31, 2002. Please refer to Note 10 in the “Notes to Consolidated Financial Statements” for additional information with respect to these subordinated notes.

 

BB&T’s subsidiary banks have several major sources of funding to meet their liquidity requirements, including access to capital markets through issuance of senior or subordinated bank notes and institutional certificates of deposit, availability to the FHLB system, dealer repurchase agreements and repurchase agreements with commercial clients, participation in the Treasury, Tax and Loan and Special Direct Investment programs with the Federal Reserve Board, availability to the overnight and term Federal funds markets, use of the Cayman branch facility, access to retail brokered certificates of deposit and a borrower in custody program with the Federal Reserve Board for availability to the discount window.

 

Management believes current sources of liquidity are adequate to meet BB&T’s current requirements and plans for continued growth. See Note 6 “Premises and Equipment”, Note 10 “Long-Term Debt” and Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements” for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations.

 

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Contractual Obligations, Commitments, Contingent Liabilities, Off-Balance Sheet Arrangements, and Related Party Transactions

 

The following table presents, as of December 31, 2003, BB&T’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. Further discussion of the nature of each obligation is included in the “Notes to Consolidated Financial Statements.”

 

Table 20

Contractual Obligations and Other Commitments

December 31, 2003

 

     Total

   Less than
One Year


  

1 to 3

Years


  

3 to 5

Years


  

After 5

Years


     (dollars in thousands)

Contractual Cash Obligations

                                  

Long-term debt

   $ 10,805,585    $ 28,891    $ 272,401    $ 2,312,607    $ 8,191,686

Capital lease obligations

     3,494      331      597      525      2,041

Operating leases

     476,891      69,985      118,036      85,510      203,360

Commitments to fund low income housing developments

     214,961      66,034      110,976      32,589      5,362

Time deposits

     23,595,496      16,437,541      4,750,305      2,403,324      4,326
    

  

  

  

  

Total contractual cash obligations

   $ 35,096,427    $ 16,602,782    $ 5,252,315    $ 4,834,555    $ 8,406,775
    

  

  

  

  

 

BB&T’s significant off-balance sheet arrangements include certain investments in low-income housing and historic building rehabilitation projects throughout its market area. BB&T enters into such arrangements as a means of supporting local communities and recognizes tax credits relating to its investments. At December 31, 2003, BB&T’s investments in such projects totaled $12.7 million. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. BB&T’s subsidiary banks typically provide financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. Outstanding commitments to fund low income housing investments totaled $215.0 million at December 31, 2003. BB&T’s risk exposure relating to such off-balance sheet arrangements is generally limited to the amount of investments and commitments made. Please refer to Note 1 in the “Notes to Consolidated Financial Statements” for further discussion of these investments in limited partnerships.

 

In addition, BB&T enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the Consolidated Balance Sheets with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December 31, 2003 do not represent the amounts that may ultimately be paid under these contracts. Further discussion of derivative instruments is included in Notes 1 and 18 in the “Notes to Consolidated Financial Statements”.

 

In the normal course of business, BB&T is also a party to financial instruments to meet the financing needs of clients and to mitigate exposure to interest rate risk. Such financial instruments include commitments to extend credit and certain contractual agreements, including standby letters of credit and financial guarantee arrangements. Further discussion of these commitments is included in Note 14 in the “Notes to Consolidated Financial Statements.”

 

BB&T’s significant commitments obligations are summarized in the accompanying table. Not all of the commitments presented in the table will be drawn upon, thus the actual cash requirements are likely to be significantly less than the amounts reported.

 

 

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Table 21

Summary of Significant Commitments

December 31, 2003

(Dollars in thousands)

 

Lines of credit

   $ 9,391,339

Commercial letters of credit

     36,733

Standby letters of credit

     1,564,187

Other commitments(1)

     11,805,421
    

Total other commitments

   $ 22,797,680
    

(1)   Other commitments include unfunded business loan commitments, unfunded overdraft protection on demand deposit accounts and other unfunded commitments to lend.

 

Related Party Transactions

 

BB&T has no material related party transactions. The Corporation may extend credit to certain officers and directors in the ordinary course of business. These loans are made under substantially the same terms as comparable third-party lending arrangements and are in compliance with applicable banking regulations.

 

Capital

 

The maintenance of appropriate levels of capital is a management priority and is monitored on an ongoing basis. BB&T’s principal goals related to capital are to provide an adequate return to shareholders while retaining a sufficient base from which to support future growth and to comply with all regulatory standards.

 

The capital of the subsidiaries is regularly monitored to determine if the levels that management believes are the most beneficial and efficient for their operations are maintained. Management intends to maintain capital at BB&T’s subsidiary banks at levels that will result in the banks being classified as “well-capitalized” for regulatory purposes. Further, it is management’s policy to maintain capital levels at the subsidiary banks that result in regulatory risk-based capital ratios that are in line with peers and target a Tier 1 leverage ratio of 7.0%. If the capital levels of the banking subsidiaries increase above these guidelines and target, excess capital may be transferred to the Parent Company, subject to regulatory and other operating considerations, in the form of special dividend payments.

 

As is the case with the subsidiary banks, management also regularly monitors the capital position of BB&T on a consolidated basis. In this regard, management’s policy is to maintain capital at levels that will result in BB&T being classified as “well-capitalized” for regulatory purposes. Further, it is management’s intention to maintain consolidated capital levels that result in regulatory risk-based capital ratios that are in line with peers and to maintain a Tier 1 leverage ratio in the range of 7.0% to 8.0%. Payments of cash dividends to BB&T’s shareholders, generally in the range of 30.0% to 40.0% of earnings and repurchases of common shares are the methods used to manage any excess capital generated. In addition, management closely monitors the Parent Company’s double leverage ratio (investments in subsidiaries as a percentage of stockholders’ equity) with the intention of maintaining the ratio below 125.0%. The active management of the subsidiaries’ equity capital, as described above, is the process utilized to manage this important driver of Parent Company liquidity and is a key element in the management of BB&T’s capital position.

 

Shareholders’ Equity

 

Shareholders’ equity totaled $9.9 billion at December 31, 2003, an increase of $2.5 billion, or 34.5%, from year-end 2002. During 2003, BB&T issued 93.0 million shares in connection with business combinations, the exercise of stock options and other stock-based incentive plans, which increased shareholders’ equity by $3.2 billion. Additionally, growth of $397.3 million in shareholders’ equity resulted from BB&T’s earnings retained after dividends to shareholders. This growth was partially offset by a decrease in unrealized holding gains on securities available for sale of $317.7 million during 2003, net of deferred income taxes, and by the repurchase of 21.5 million shares of common stock at a cost of $797.9 million. For additional information regarding BB&T’s share repurchase program refer to Note 11 in the “Notes to Consolidated Financial Statements” herein.

 

 

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Capital Adequacy and Resources

 

Bank holding companies and their subsidiaries are subject to regulatory requirements with respect to risk-based capital adequacy. Capital adequacy is an important indicator of financial stability and performance. Risk-based capital ratios measure capital as a percentage of a combination of risk-weighted balance sheet and off-balance sheet risk. The risk-weighted values of both balance sheet and off-balance sheet items are determined in accordance with risk factors specified by Federal bank regulatory pronouncements.

 

Tier 1 capital is calculated as common shareholders’ equity, excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sales and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets, net of applicable deferred income taxes, and certain nonfinancial equity investments. Tier 1 capital is required to be at least 4% of risk-weighted assets, and total capital (the sum of Tier 1 capital, a qualifying portion of the allowance for loan and lease losses and qualifying subordinated debt) must be at least 8% of risk-weighted assets, with one half of the minimum consisting of Tier 1 capital.

 

BB&T’s Tier 2 and total regulatory capital have included subordinated notes outstanding under BB&T’s Indenture Regarding Subordinated Securities, dated as of May 24, 1996. In December 2003, BB&T determined that certain provisions of the Subordinated Indenture did not comply with the Federal Reserve’s Tier 2 Capital guidelines. BB&T was instructed by the Federal Reserve staff to exclude approximately $1.4 billion of such notes from its calculation of Tier 2 capital and total regulatory capital for purposes of BB&T’s Federal Reserve filings beginning December 31, 2003. The exclusion of these notes from BB&T’s regulatory capital does not affect the rights of the note holders in any way and BB&T remains in full compliance with the terms of all notes outstanding under the Subordinated Indenture. On December 23, 2003, BB&T amended the Subordinated Indenture in a manner that made the provisions referred to above inapplicable to future issuances of subordinated debt. On December 23, 2003, BB&T issued $1.0 billion of subordinated notes under the amended Subordinated Indenture. As of December 31, 2003, BB&T’s consolidated Tier 2 capital included approximately $1.3 billion of subordinated debt issued by BB&T and Branch Bank.

 

In addition to the risk-based capital measures described above, regulators have also established minimum leverage capital requirements for banking organizations. This is the primary measure of capital adequacy used by management and is calculated by dividing period-end Tier 1 capital by average tangible assets for the most recent quarter. The minimum required Tier 1 leverage ratio ranges from 3% to 5% depending upon Federal bank regulatory agency evaluation of an organization’s overall safety and soundness. BB&T’s regulatory capital and ratios are set forth in the following table.

 

Table 22

Capital—Components and Ratios

 

     December 31,

 
     2003

    2002

 
     (Dollars in thousands)  

Tier 1 capital

   $ 6,166,160     $ 5,290,310  

Tier 2 capital

     2,045,514       2,450,738  
    


 


Total regulatory capital

   $ 8,211,674     $ 7,741,048  
    


 


Risk-based capital ratios:

                

Tier 1 capital

     9.4 %     9.2 %

Total regulatory capital

     12.5       13.4  

Tier 1 leverage ratio

     7.2       6.9  

 

Common Stock and Dividends

 

BB&T’s ability to pay dividends is primarily dependent on earnings from operations, the adequacy of capital and the availability of liquid assets for distribution. BB&T’s ability to generate liquid assets for distribution is dependent on the ability of the Subsidiary Banks to pay dividends to the Parent Company. The payment of cash dividends is an integral part of providing a competitive return on shareholders’ investments. The Corporation’s policy is to accomplish this while retaining sufficient capital to support future growth and to meet regulatory requirements. BB&T’s common dividend payout ratio, computed by dividing dividends paid per common share by

 

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basic earnings per common share, was 58.37% in 2003 as compared to 40.00% in 2002. BB&T’s annual cash dividends paid per common share increased 10.9% during 2003 to $1.22 per common share for the year, as compared to $1.10 per common share in 2002. This increase marked the 32nd consecutive year that the Corporation’s annual cash dividend paid to shareholders has been increased. A discussion of dividend restrictions is included in Note 15 “Regulatory Requirements and Other Restrictions” in the “Notes to Consolidated Financial Statements” and in the “Regulatory Considerations” section.

 

BB&T’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “BBT”. BB&T’s common stock was held by approximately 274,000 shareholders at December 31, 2003 compared to 228,000 at December 31, 2002. The accompanying table, “Quarterly Summary of Market Prices and Dividends Paid on Common Stock,” sets forth the quarterly high and low trading prices and closing sales prices for BB&T’s common stock and the dividends paid per share of common stock for each of the last eight quarters.

 

Table 23

Quarterly Summary of Market Prices and Cash Dividends Paid on Common Stock

 

     2003

   2002

     Sales Prices

  

Cash
Dividends

Paid


   Sales Prices

  

Cash
Dividends

Paid


     High

   Low

   Last

      High

   Low

   Last

  

Quarter Ended:

                                                       

March 31

   $ 38.80    $ 30.66    $ 31.43    $ .29    $ 39.40    $ 34.06    $ 38.11    $ .26

June 30

     35.93      31.42      34.30      .29      39.47      36.32      38.60      .26

September 30

     38.19      33.72      35.91      .32      38.68      31.46      35.04      .29

December 31

     39.69      35.98      38.64      .32      38.39      31.03      36.99      .29
                         

                       

Year

   $ 39.69    $ 30.66    $ 38.64    $ 1.22    $ 39.47    $ 31.03    $ 36.99    $ 1.10
                         

                       

Share Repurchase Activity

 

BB&T has periodically repurchased shares of its own common stock. Prior to the adoption of SFAS No. 141, substantially all repurchased shares were reissued in business combinations accounted for as purchases. During the years ended December 31, 2003, 2002 and 2001, BB&T repurchased 21.5 million shares, 21.8 million shares and 14.0 million shares of common stock, respectively. In accordance with North Carolina law, repurchased shares cannot be held as treasury stock, but revert to the status of authorized and unissued shares upon repurchase.

 

On August 26, 2003, BB&T’s Board of Directors granted authority for the repurchase of up to 50 million shares of BB&T’s common stock as needed for general corporate purposes. The plan remains in effect until all the authorized shares are repurchased unless modified by the Board of Directors. The 2003 authorization was in addition to a plan approved by the Board of Directors in February 2002, which authorized the repurchase of up to 40 million shares of BB&T’s common stock. As of August 26, 2003, BB&T had repurchased 35.4 million shares pursuant to the February 2002 authorization. The August 26, 2003 authorization also ratified the repurchase of the 4.6 million shares remaining under the February 2002 authorization. As of December 31, 2003, all of the shares authorized in connection with the February 2002 authorization had been repurchased.

 

The following table presents all repurchases made by BB&T during the fourth quarter of 2003.

 

     2003

    

Total

Shares

Repurchased


  

Average

Price Paid

Per Share


  

Total Shares Purchased

Pursuant to

Publicly-Announced Plan


  

Maximum Remaining

Number of Shares

Available for

Repurchase Pursuant to

Publicly-Announced Plan


October

   3,442,600    $ 37.50    3,442,600    51,154,400

November

   4,457,100      39.09    4,457,100    46,697,300

December

   —        —      —      46,697,300
    
  

  
  

Total

   7,899,700    $ 38.40    7,899,700    46,697,300
    
  

  
  

 

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Segment Results

 

BB&T’s operations are divided into seven reportable business segments: the Banking Network, Mortgage Banking, Trust Services, Insurance Services, Investment Banking and Brokerage, Specialized Lending, and Treasury. These operating segments have been identified based primarily on BB&T’s organizational structure. See Note 20 “Operating Segments”, in the “Notes to Consolidated Financial Statements” herein, for a full discussion of the segments, the internal accounting and reporting practices utilized to manage these segments and financial disclosures for these segments as required by SFAS No. 131. Fluctuations in noninterest income from external customers and noninterest expense incurred directly by the segments are more fully discussed in the “Noninterest Income” and “Noninterest Expense” sections of this discussion and analysis. During 2003, BB&T refined the methodologies used to allocate corporate expenses to the segments as further discussed herein. Also, merger-related expenses in 2003, 2002 and 2001, the loss on early extinguishment of debt incurred in 2003 and a gain from the sale of an equity investment in an electronic transaction processing company during 2001, as previously discussed, are retained in the Corporate Office and are excluded from segment results as presented herein.

 

Banking Network

 

The Banking Network grew internally during 2003 as well as through mergers with Equitable and First Virginia. The total Banking Network was composed of 1,359 banking offices at the end of 2003, up from 1,122 banking offices at December 31, 2002. Net interest income for the Banking Network totaled $2.4 billion in 2003, an increase of $267.1 million, or 12.4%, compared to 2002. Net interest income for 2002 amounted to $2.2 billion, an increase of $137.1 million, or 6.8%, compared to 2001. The increase in net interest income in 2003 is composed of a 13.2% increase in net interest income from external customers and a 10.6% increase in the net credit generated by the internal funds transfer pricing (“FTP”) system. The increase in net intersegment interest income reflects additional FTP credits allocated to the segment because of deposit balances exceeding loan balances at the institutions acquired during 2003 and internal growth. The increase in net interest income from external customers was primarily the result of the acquisitions of Equitable and First Virginia.

 

The provision for loan and lease losses increased $9.7 million, or 4.5%, from 2002 to 2003. The increase was primarily due to added provisions as a result of the acquired institutions. The 2002 provision reflected a smaller increase of $1.8 million, or .9%, compared to 2001. This slight increase reflects the relatively stable levels of nonperforming assets as a percentage of total assets during 2002 compared with 2001.

 

Noninterest income produced from external customers in the Banking Network increased $117.4 million, or 20.0% during 2003, due primarily to growth in service charges on deposits and other nondeposit fees and commissions caused primarily by the acquisitions of Equitable and First Virginia, while noninterest income allocated from other segments increased $105.5 million, or 30.5%, due to intersegment revenue received as a result of substantially higher mortgage loan originations. Comparing 2002 to 2001, noninterest income from external customers increased $43.3 million, or 8.0%, and intersegment noninterest income increased $106.5 million, or 44.4%. Noninterest expenses incurred within the Banking Network increased $195.5 million, or 18.3%, in 2003 compared with 2002 because of increased employee related expenses and additional expenses resulting from acquired institutions, while corporate expenses allocated to the Banking Network decreased $82.9 million, or 14.3%, over the same time frame, because of a refinement in BB&T’s expense allocation methodologies during 2003 to allocate expenses based on loan and deposit volumes and total segment assets or full-time equivalent employees assigned to the segment, as applicable. The change resulted in a reduction in the amount of expenses allocated to certain segments. Comparing 2002 to 2001, noninterest expense incurred within the Banking Network increased $37.6 million, or 3.6%, and corporate expenses allocated to the Banking Network increased $74.9 million, or 14.9%.

 

The provision for income taxes allocated to the Banking Network increased $141.3 million, or 41.2%, because of a 30.0% increase in pretax income, as well as an increase in the effective tax rate compared to 2002. The 2002 provision for income taxes increased $39.8 million, or 13.1%, compared to 2001, also due to an increase in pretax income.

 

Total identifiable assets at December 31, 2003 for the Banking Network totaled $47.5 billion, an increase of $7.5 billion, or 18.8%, compared to 2002. Total identifiable assets at December 31, 2002 totaled $39.9 billion, an increase of $1.8 billion, or 4.7%, compared to 2001. These increases were largely due to acquisitions completed during the past two years.

 

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Mortgage Banking

 

The low interest rate environment was the most significant factor in the substantial growth in BB&T’s Mortgage Banking segment during 2003 and 2002. BB&T’s mortgage originations totaled $19.4 billion for 2003, up 37.9% compared to 2002. In 2002, mortgage originations totaled $14.1 billion, an increase of 34.3% compared to 2001. BB&T’s residential mortgage servicing portfolio totaled $36.6 billion at year-end 2003 compared with $34.8 billion in 2002.

 

Net interest income for the Mortgage Banking segment totaled $383.6 million, up $74.5 million, or 24.1%, compared to 2002. Net interest income for 2002 amounted to $309.1 million, an increase of $150.1 million, or 94.4%, compared with 2001. These increases reflect the continued growth in mortgage originations as a result of historically low interest rates. The provision for loan and lease losses increased $3.6 million from 2002 to 2003. This increase resulted primarily from BB&T’s decision to retain, rather than sell, an additional $2.8 billion of mortgage loans during 2003 and, in so doing, BB&T recorded additional provision for loan losses related to these retained mortgage loans. The provision for loan and lease losses remained relatively stable during 2001 and 2002 reflecting the strong credit quality of the mortgage portfolio.

 

Noninterest income produced from external customers increased $118.4 million compared to 2002 due to a substantial decrease in the net provision for the valuation of mortgage servicing rights in 2003 compared with 2002. From 2001 to 2002, noninterest income from external customers decreased $24.4 million, or 35.2%, primarily as a result of additional provisions recorded to reduce the value of mortgage servicing rights in a declining interest rate environment. Noninterest expenses incurred within the Mortgage Banking segment increased $8.2 million, or 17.2%, primarily as a result of higher mortgage-related incentive compensation costs, while noninterest expenses allocated to Mortgage Banking decreased $17.9 million, or 60.5%. The decrease in expenses allocated to the Mortgage Banking segment during 2003 was due to the refinement of BB&T’s expense allocation methodologies as discussed above. Comparing 2002 and 2001, noninterest expenses incurred by the Mortgage Banking segment increased $23.2 million, or 93.3% due to higher mortgage loan incentive compensation, while allocated corporate expenses increased $3.1 million, or 11.9%.

 

The provision for income taxes allocated to the Mortgage Banking segment increased $68.7 million, or 89.2%, due to higher pretax income compared to 2002. For 2002, the provision for income taxes increased $22.9 million, or 42.4%, compared to 2001 also because of growth in pretax income.

 

Total identifiable assets for the Mortgage Banking segment were $12.2 billion at December 31, 2003, an increase of $1.5 billion, or 14.4%, from 2002. During 2002, total Mortgage Banking assets grew $1.7 billion, or 19.2%, from 2001. These increases were due to record mortgage origination volumes during the last two years.

 

Trust Services

 

Net interest income for the Trust Services segment totaled $23.0 million, a decrease of $4.4 million, or 16.2%, compared to 2002. This decrease is composed of a 35.5% decrease in net interest expense paid to external customers and a 24.4% decrease in the net credit for funds as calculated by BB&T’s internal FTP system. Net interest income in 2002, which totaled $27.5 million, was $15.1 million, or 122.1% greater than the income recorded in 2001. These changes were caused by the declining interest rate environment and the level of funds on deposit generated by trust activities during the past two years.

 

Noninterest income from external customers totaled $116.0 million, an increase of $18.1 million, or 18.5% during 2003. Noninterest income from external customers amounted to $97.9 million in 2002, an increase of $5.7 million, or 6.2%, compared to 2001. The revenue increase in 2003 was primarily due to the acquisition of First Virginia and increases in mutual fund and estate management revenues. Noninterest expenses incurred by Trust Services increased $10.9 million, or 13.6%, while corporate expenses allocated to Trust Services decreased $.3 million, or 3.4%. For 2002, noninterest expense incurred by Trust Services increased $19.8 million, or 33.0%, while corporate expenses allocated to the Trust Services segment increased $5.4 million.

 

The provision for income taxes allocated to Trust Services increased $1.8 million, or 17.0%, due to higher pretax income and a slightly higher effective tax rate compared to 2002. Comparing 2002 and 2001, the provision for income taxes decreased $1.0 million, or 9.1%, due to a decrease in pretax income compared to 2001. Total identifiable segment assets for Trust Services increased 6.3% to a total of $83.6 million at December 31, 2003,

 

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compared to 2002, and increased 25.4% from 2001 to 2002, primarily due to acquisitions of financial institutions during 2003 and 2002.

 

Insurance Services

 

Noninterest income produced from external customers by the Insurance Services segment totaled $373.0 million during 2003, an increase of $84.3 million, or 29.2%, compared to 2002. During 2002, noninterest income from external customers amounted to $288.7 million, an increase of $118.7 million, or 69.8%, compared to 2001. Internal growth combined with the expansion of BB&T’s insurance agency network and insurance brokerage operations through acquisitions during the last two years were primarily responsible for this strong growth. For 2003, noninterest expenses incurred within the Insurance Services segment increased $56.8 million, or 25.7% from 2002, while corporate expenses allocated to the segment in 2003 declined $8.8 million, or 37.0%. For 2002, noninterest expenses incurred within Insurance Services increased $97.7 million, or 79.2% from 2001, while allocated corporate expenses increased $19.5 million from 2001. The increase in noninterest expenses within the Insurance Services segment principally resulted from the continued expansion of the BB&T insurance agency network.

 

The provision for income taxes allocated to Insurance Services increased $13.5 million, or 74.4%, in 2003 compared to 2002 and $1.1 million, or 6.3%, in 2002 compared to 2001, consistent with the growth in pretax income during the past two years. Total identifiable segment assets for Insurance Services increased 26.8% to a total of $699.7 million in 2003 primarily due to the acquisition of insurance agencies. During 2002, total identifiable segment assets more than tripled to $551.7 million primarily due to the acquisition of CRC Insurance Services, which was the 4th largest wholesale insurance broker in the country at the time of the acquisition.

 

Specialized Lending

 

BB&T’s Specialized Lending segment continued to expand during 2003 compared to 2002 and 2001. Net interest income from external customers totaled $224.7 million, up $38.8 million, or 20.9%, compared to 2002. Net interest income from external customers in 2002 amounted to $185.9 million, an increase of $42.9 million, or 30.0%, compared with 2001. These increases were caused by internal growth and broader diversification among the specialty finance alternatives offered to clients by the business units comprising the Specialized Lending segment. In addition, as a result of the declining interest rate environment during 2002 and 2003, the net interest margin for this segment widened, which further contributed to the increase in net interest income.

 

The provision for loan and lease losses totaled $87.7 million in 2003, an increase of $24.8 million, or 39.4%, from 2002. The provision for loan and lease losses amounted to $62.9 million for 2002, an increase of $20.1 million, or 46.9%, compared to 2001. Due to the generally higher credit risk profiles of the clients of Specialized Lending, loss rates are expected to be higher than conventional bank lending. Loss rates are also affected by shifts in the portfolio mix of the underlying subsidiaries. As a result of the prolonged economic slowdown during the past three years and loan growth in this segment, BB&T increased the provision for loan and leases losses allocated to Specialized Lending.

 

Noninterest income produced from external customers totaled $54.7 million in 2003, a decrease $3.4 million, or 5.8% compared to 2002, which reflected an increase of $6.0 million, or 11.6%, from 2001. The 2003 decrease was primarily due to changes in the mix of product offerings and associated fees. For 2003, noninterest expenses incurred within the Specialized Lending segment increased $8.3 million, or 7.7% compared to 2002, while allocated corporate expenses decreased $3.4 million, or 26.4% from 2002 to 2003. Comparing 2002 and 2001, noninterest expenses incurred within the Specialized Lending segment increased $3.4 million, or 3.2%, and allocated corporate expenses increased $10.4 million. The increases in noninterest expenses incurred within the Specialized Lending segment primarily resulted from increased performance compensation commissions and personnel expenses.

 

The provision for income taxes allocated to the Specialized Lending segment decreased by $1.1 million, or 5.1%, due to lower effective tax rate in 2003. For 2002, the provision for income taxes increased $5.4 million, or 34.1%, compared to 2001 due to higher pretax income.

 

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Total identifiable assets for the Specialized Lending segment totaled $2.1 billion, an increase of $301.8 million, or 17.0%, from 2002. At December 31, 2002, Specialized Lending assets totaled $1.8 billion, an increase of $365.5 million, or 25.8%, compared to 2001, due to internal growth and branch expansion during the last two years.

 

Investment Banking and Brokerage

 

Net interest income for the Investment Banking and Brokerage segment totaled $6.7 million, a decrease of $.7 million compared to 2002. Net interest income in 2002 amounted to $7.5 million, a decrease of $1.3 million compared to 2001 due to the decline in interest rates over the last three years. Noninterest income produced from external customers during 2003 totaled $252.9 million, an increase of $37.1 million, or 17.2% compared to 2002. For 2002, noninterest income from external customers amounted to $215.7 million, an increase of $34.8 million, or 19.2% compared to 2001. These increases primarily resulted from higher fixed income securities underwriting fees, retail brokerage fees and investment banking income. Noninterest expenses incurred within the Investment Banking and Brokerage segment totaled $215.9 million in 2003, an increase of $24.3 million, primarily as a result of higher incentive compensation, while allocated corporate expenses decreased $5.8 million because of the refinement in BB&T’s expense allocation methodologies during 2003. Comparing 2002 and 2001, noninterest expenses incurred by the Investment Banking and Brokerage segment increased $10.9 million, and allocated corporate expenses increased $13.2 million.

 

The provision for income taxes allocated to Investment Banking and Brokerage increased $6.9 million during 2003 compared to 2002, which in turn was $3.9 million higher than 2001. These increases were due to higher pretax income in both 2003 and 2002. Total identifiable assets for the Investment Banking and Brokerage segment decreased slightly to a total of $947.5 million. For 2002, total identifiable segment assets increased $280.7 million.

 

Treasury

 

Net interest income for the Treasury segment totaled $267.1 million in 2003, an increase of $45.0 million, or 20.2%, compared to 2002. For 2002, net interest income amounted to $222.1 million, a decrease of $52.2 million or 19.0% compared with 2001. These fluctuations were principally due to the declining interest rate environment and its effect on the rates of return on securities held by the Treasury segment. Noninterest income produced from external customers decreased $41.9 million during 2003, primarily due to lower gains on sales of securities realized compared to 2002. For 2002, noninterest income from external customers increased $201.6 million principally due to gains on sales of securities which economically offset writedowns in the carrying value of BB&T’s capitalized mortgage servicing rights. Noninterest expenses incurred within the Treasury segment increased $.9 million, or 6.2%, while allocated corporate expenses decreased $.7 million. For 2002, noninterest expenses within the Treasury segment increased $7.4 million, and allocated corporate expenses decreased $.3 million.

 

The provision for income taxes allocated to the Treasury segment decreased $6.9 million due to a slightly lower effective tax rate compared to 2002. In 2002, the provision for income taxes increased $45.5 million, consistent with an increase in pretax income. Total identifiable assets for the Treasury segment decreased $185.2 million, or .9% during 2003 to a total of $20.3 billion. For 2002, total identifiable segment assets for the Treasury segment increased $4.3 billion, or 26.4%.

 

Fourth Quarter Results

 

Net income for the fourth quarter of 2003 was $305.0 million, compared to $337.3 million for the comparable period of 2002. On a per share basis, diluted net income for the fourth quarter of 2003 was $.55 compared to $.70 for the same period a year ago. Annualized returns on average assets and average shareholders’ equity were 1.34% and 11.98%, respectively, for the fourth quarter of 2003, compared to 1.71% and 17.97%, respectively, for the fourth quarter of 2002.

 

Net interest income amounted to $879.9 million for the fourth quarter of 2003, an increase of 24.3% compared to $708.1 million for the same period of 2002. Noninterest income totaled $471.0 million for the fourth quarter of 2003, up 3.2% from $456.6 million earned during the fourth quarter of 2002. BB&T’s noninterest expense for the fourth quarter of 2003 totaled $734.1 million, up 18.5% from the $619.6 million recorded in the fourth quarter of 2002.

 

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Due to a decrease in the level of charge-offs and nonperforming assets and a loan portfolio with a lower risk profile following the acquisition of First Virginia, the fourth quarter 2003 provision for loan and lease losses decreased 30.9% to $58.5 million, compared to $84.7 million for the fourth quarter of 2002.

 

The fourth quarter 2003 provision for income taxes totaled $253.3 million compared to $123.2 million for the fourth quarter of 2002, an increase of 105.6%.

 

The accompanying table, “Quarterly Financial Summary—Unaudited,” presents condensed information relating to quarterly periods in the years ended December 31, 2003 and 2002.

 

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Table 24

 

Quarterly Financial Summary—Unaudited

 

     2003

   2002

     Fourth
Quarter


    Third
Quarter


    Second
Quarter


   First
Quarter


   Fourth
Quarter


   Third
Quarter


   Second
Quarter


   First
Quarter


     (Dollars in thousands, except per share data)

Consolidated Summary of Operations:

                                                         

Net interest income

   $ 879,949     $ 806,458     $ 703,420    $ 692,178    $ 708,071    $ 702,092    $ 690,031    $ 647,266

Provision for loan and lease losses

     58,500       65,000       61,500      63,000      84,700      64,000      58,500      56,500

Securities (losses) gains, net

     (7,529 )     (29,127 )     109,500      34,234      1,508      135,519      19,666      13,407

Other noninterest income

     478,544       541,230       351,596      410,687      455,113      257,840      365,198      353,924

Noninterest expense

     734,136       1,116,966       650,920      604,088      619,566      577,173      557,584      531,135

Provision for income taxes

     253,301       20,704       135,859      142,263      123,171      126,121      130,859      117,317
    


 


 

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