BB&T CORPORATION
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, 2004

 

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 whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES þ    NO ¨

 

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

 

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

 

At February 28, 2005, the Corporation had 548,455,745 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation is approximately $20.2 billion (based on the closing price of such stock as of June 30, 2004.)

 

Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 26, 2005, 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, 86
     Item 3    Legal Proceedings    105
     Item 4   

Submission of Matters to a Vote of Security Holders

None.

    

PART II

   Item 5    Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities    53
     Item 6    Selected Financial Data    60
     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, 2004 and 2003    65
          Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2004    66
          Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2004    67
          Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2004    68
          Notes to Consolidated Financial Statements    69
          Report of Independent Registered Public Accounting Firm    63
          Quarterly Financial Summary for 2004 and 2003    59
     Item 9   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

    
     Item 9A    Controls and Procedures    62
     Item 9B   

Other Information

None.

    

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    *
     Item 13    Certain Relationships and Related Transactions    *
     Item 14    Principal Accounting Fees and Services    *

PART IV

   Item 15    Exhibits, Financial Statement Schedules     
     (a)    Financial Statements—See Listing in Item 8 above.     
     (b)    Exhibits     
     (c)    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” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for the 2005 Annual Meeting of Shareholders.

 

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The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation of Executive Officers”, “Retirement Plans” and “Compensation Committee Report on Executive Compensation” in the Registrant’s Proxy Statement for the 2005 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 2005 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 2005 Annual Meeting of Shareholders.

 

The information required by Item 14 is incorporated herein by reference to the information that appears under the headings “Fees to Auditors” and “Corporate Governance Matters—Audit Committee Pre-Approval Policy” in the Registrant’s Proxy Statement for the 2005 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 bank holding company and 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”), Branch Banking and Trust Company of Virginia (“BB&T-VA”) collectively the (“Subsidiary Banks”), and BB&T Bankcard Corporation. Branch Bank, BB&T’s largest subsidiary, was chartered in 1872 and is the oldest bank headquartered in North Carolina.

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements with respect to the financial condition, results of operations and business of BB&T. These forward-looking statements involve certain risks and uncertainties and are based on the beliefs and assumptions of the management of BB&T, and 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 recently completed mergers may not be fully realized or realized within the expected time frame; (7) deposit attrition, customer loss or revenue loss following 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.

 

Primary Subsidiaries of BB&T Corporation

 

At December 31, 2004, the principal operating subsidiaries of BB&T included the following:

 

  ·   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, BB&T’s largest subsidiary, operated 905 banking offices at December 31, 2004, which were primarily located in North Carolina, Georgia, Kentucky, Maryland, Florida and West Virginia. Branch Bank is the largest bank in West Virginia and, excluding home office deposits, is the second largest bank in North Carolina in terms of deposit market share. 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, 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;

 

  ·   CRC Insurance Services, Inc., based in Birmingham, Alabama, which is authorized to do business nationwide and was the 2nd largest wholesale insurance broker in the country with 23 offices in 14 states at December 31, 2004; and

 

  ·   McGriff, Seibels & Williams, Inc., based in Birmingham, Alabama, which is authorized to do business nationwide and specializes in providing insurance products to large commercial and energy clients, including many Fortune 500 companies.

 

BB&T-SC operated 98 banking offices at December 31, 2004 and is the third largest bank in South Carolina in terms of deposit market share.

 

BB&T-VA operated 410 banking offices at December 31, 2004 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, 2004, Scott & Stringfellow operated 41 full-service retail brokerage offices; 21 in Virginia, 12 in North Carolina, 7 in South Carolina, and 1 office in West Virginia. 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

 

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  ·   home equity lending

 

  ·   sales finance

 

  ·   home mortgage lending

 

  ·   commercial mortgage lending

 

  ·   leasing

 

  ·   asset management

 

  ·   retail and wholesale agency insurance

 

  ·   institutional trust services

 

  ·   wealth management / private banking

 

  ·   investment brokerage services

 

  ·   capital markets services

 

  ·   factoring

 

  ·   asset-based lending

 

  ·   international banking services

 

  ·   treasury services

 

  ·   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, 2004.

 

Table 1

BB&T Deposit Market Share and Branch Locations by State

December 31, 2004

 

     % of
BB&T’s
Deposits (2)


    Deposit
Market
Share
Rank (2)


   Number of
Branches


North Carolina (1)

   26 %   2nd    334

Virginia

   28     2nd    410

Georgia

   9     6th    119

Kentucky

   6     3rd    98

South Carolina

   7     3rd    98

West Virginia

   6     1st    81

Maryland

   8     6th    125

Tennessee

   2     8th    46

Florida

   6     10th    91

Washington, D.C.

   2     5th    8

  (1)   Excludes home office deposits.
  (2)   Source: SNL Financial—data as of June 30, 2004 and updated for actual and pending mergers.

 

In addition to the markets described in the table above, BB&T operates two branches in Alabama and one branch in Indiana. Please refer to Note 20 “Operating Segments” in the “Notes to Consolidated Financial Statements” for additional disclosures.

 

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Executive Overview

 

Significant accomplishments in 2004

 

In the opinion of BB&T’s management, the Corporation’s most significant accomplishments during 2004 were as follows (amounts include the impact of acquisitions where applicable):

 

  ·   Performance improved compared to 2003

 

  ·   Average noninterest-bearing deposits increased 22.8%

 

  ·   Efficiency improved and internal cost control initiatives were implemented

 

  ·   BB&T reached $100 billion in assets

 

  ·   Nonperforming assets and charge-offs substantially improved

 

  ·   Households utilizing 5 or more BB&T services grew to 26.6%

 

  ·   The number of customers using online banking services increased 37.8%

 

  ·   The integration of First Virginia Banks, Inc., was substantially completed

 

  ·   BB&T acquired and completed the systems conversion of Republic Bancshares, Inc.

 

  ·   Several insurance agencies, a premium finance company and an asset management company were acquired during 2004

 

  ·   BB&T completed a successful Executive Management transition

 

Challenges

 

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

 

  ·   Building revenue momentum

 

  ·   Further improving efficiency

 

  ·   Effectively managing in a rapidly changing economic environment in BB&T’s core markets

 

  ·   Costs and risks associated with the current heightened regulatory environment

 

  ·   Restoring relative superior performance

 

  ·   Intense price competition

 

  ·   Increased global event risk

 

  ·   Dilution from mergers

 

Competition

 

The financial services industry is highly competitive and dramatic change continues to occur in all aspects of the Company’s business. The ability of nonbank financial entities to provide services previously reserved for commercial banks has intensified competition. BB&T’s subsidiaries compete actively with national, regional and local financial services providers, including banks, thrifts, securities dealers, mortgage bankers, finance companies and insurance companies. Competition among providers of financial products and services continues to increase with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to consolidate, which affects competition by eliminating some regional and

 

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local institutions, while strengthening the franchises of acquirers. For additional information concerning markets, BB&T’s competitive position and business strategies, see “Market Area” and “General Business Development” below.

 

Market Area

 

BB&T’s primary market area consists of North and South Carolina, Virginia, Maryland, Georgia, eastern Tennessee, West Virginia, Kentucky, Florida and Washington, D.C. This area’s employment base is diverse and primarily consists of manufacturing, general services, agricultural, wholesale/retail trade, technology and financial services. BB&T believes its current market area is economically strong and will support consistent growth in assets and deposits in the future. Even so, management intends to continue expanding and diversifying the BB&T franchise, although at a slower pace than in recent years. Management strongly believes that BB&T’s community bank approach to providing client service is a competitive advantage 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 11.0%, 11.8%, and 10.8%, respectively, over the last five years.

 

Merger Strategy

 

BB&T’s growth in business, profitability and market share over the past several years was enhanced significantly by mergers and acquisitions. Management made a strategic decision not to pursue any bank or thrift acquisitions during 2004 or 2005, instead focusing on fully integrating recent mergers. Management intends to resume strategic mergers and acquisitions, including bank and thrift acquisitions primarily within BB&T’s existing footprint in 2006. BB&T will continue to pursue economically advantageous acquisitions of insurance agencies, asset managers and other consumer and commercial finance companies to grow existing product lines and expand into related financial businesses. BB&T’s acquisition strategy is focused on three 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 $500 million or more;

 

  ·   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 consummated acquisitions of 58 community banks and thrifts, 73 insurance agencies and 24 nonbank 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 book value of the underlying net assets acquired, which could have a dilutive effect on BB&T’s earnings. In addition, acquisitions often result in significant front-end charges against earnings; however, cost savings and revenue enhancements, especially incident to in-market bank and thrift acquisitions, are also typically anticipated.

 

Lending Activities

 

The primary goal of the BB&T lending function is to help clients achieve their financial goals by providing quality loan products that are fair to the client and profitable to the Corporation. Management believes that this purpose can best be accomplished by building strong, profitable client relationships over time, with BB&T

 

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becoming an important contributor to the prosperity and well-being of its clients. In addition to the importance placed on client knowledge and continuous involvement with clients, BB&T’s lending process incorporates the standards of a consistent company-wide credit culture and an in-depth local market knowledge. Furthermore, the Company employs strict underwriting criteria governing the degree of assumed risk and the diversity of the loan portfolio in terms of type, industry and geographical concentration. In this context, BB&T strives to meet the credit needs of businesses and consumers in its markets while pursuing a balanced strategy of loan profitability, loan growth and loan quality.

 

BB&T conducts the majority of its lending activities within the framework of the Corporation’s community bank operating model, with lending decisions made as close to the client as practicable.

 

The following table summarizes BB&T’s loan portfolio based on the regulatory classification of the portfolio, which focuses on the underlying loan collateral, and differs from internal classifications presented herein which focus on the primary purpose of the loan.

 

Table 2

Composition of Loan and Lease Portfolio

 

     December 31,

 
     2004

    2003

    2002

    2001

    2000

 
     (Dollars in thousands)  

Commercial, financial and agricultural loans

   $ 7,711,876     $ 7,143,759     $ 6,975,340     $ 6,551,604     $ 6,555,831  

Lease receivables

     5,281,076       5,127,068       5,153,192       5,011,579       4,453,345  

Real estate—construction and land development loans

     8,601,112       6,477,313       5,291,719       5,334,108       4,264,275  

Real estate—mortgage loans

     39,257,447       36,251,269       30,023,470       25,542,288       25,239,698  

Consumer loans

     9,237,815       9,208,182       6,501,831       5,965,010       5,891,059  
    


 


 


 


 


Total loans and leases held for investment

     70,089,326       64,207,591       53,945,552       48,404,589       46,404,208  

Loans held for sale

     613,476       725,459       2,377,707       1,907,416       906,244  
    


 


 


 


 


Total loans and leases

     70,702,802       64,933,050       56,323,259       50,312,005       47,310,452  

Less: unearned income

     (2,540,201 )     (2,627,664 )     (2,805,246 )     (2,868,832 )     (2,483,377 )
    


 


 


 


 


Net loans and leases

   $ 68,162,601     $ 62,305,386     $ 53,518,013     $ 47,443,173     $ 44,827,075  
    


 


 


 


 


 

BB&T’s loan portfolio is approximately 50% business and 50% retail by design, and is divided into three major categories—business, consumer and mortgage. Loans from BB&T’s specialized lending segment, as discussed in Note 20, “Operating Segments” of the “Notes to Consolidated Financial Statements,” are included in the applicable categories. BB&T lends to a diverse customer base that is substantially located within the 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 local and regional economic downturns.

 

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

 

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 and secondary sources 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.

 

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 as follows—commercial loans, generally 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. Traditionally, lending to small and mid-sized businesses has been among BB&T’s strongest markets.

 

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, the bank has adopted an internal maximum credit exposure lending limit of $215 million for a “best grade” credit, which is considerably below the Banks’ maximum legal lending limit. Commercial loans are typically priced with an interest rate tied to market indexes, such as the prime rate and the London Interbank Offered Rate (“LIBOR”). Business loans are individually monitored and reviewed for any possible deterioration in the ability of the client to repay the loan. Approximately 95% of BB&T’s commercial loans are secured by real estate, business equipment, inventories, and other types of collateral.

 

BB&T provides commercial leasing services through BB&T Leasing Corp. (“Leasing”), a subsidiary of Branch Bank. Leasing provides three primary products: finance or capital leases, true leases (as defined under the Internal Revenue Code) and other operating leases for vehicles, rolling stock and tangible personal property. Leasing also provides lease-related services for small to medium-sized commercial customers. In addition to the services offered by Leasing, other BB&T subsidiaries provide leases to municipalities and invest in various types of leveraged lease transactions. Substantially all of BB&T’s leases are secured.

 

Consumer Loan Portfolio

 

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

 

The consumer loan portfolio consists of three primary sub-portfolios—direct retail, revolving credit and sales finance. The direct retail category consists mainly of home equity loans and lines of credit, which are secured by residential real estate. It also includes installment loans and some unsecured lines of credit other than credit cards. The revolving credit category is comprised of the outstanding balances on credit cards and BB&T’s checking account overdraft protection product, Constant Credit. Such balances are generally unsecured and actively managed by BB&T Bankcard Corporation. Finally, the sales finance category primarily includes secured indirect installment loans to consumers for the purchase of automobiles. Such loans are originated through

 

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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. Substantially all consumer loans, excluding the revolving credit portfolio, are secured.

 

Mortgage Loan Portfolio

 

BB&T is a large originator of residential mortgage loans, with originations in 2004 totaling $10.0 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. BB&T primarily originates conforming mortgage loans. These are loans that are underwritten in accordance with the underwriting standards set forth by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). They are generally collateralized by one-to-four-family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing.

 

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

 

The following table presents BB&T’s total loan portfolio based upon the primary purpose of the loan, as discussed herein, rather than upon regulatory reporting classifications:

 

Table 3

Composition of Loan and Lease Portfolio Based on Loan Purpose

 

     December 31,

     2004

   2003

   2002

   2001

   2000

     (Dollars in thousands)

Loans and leases, net of unearned income:

                                  

Commercial loans

   $ 31,433,304    $ 28,500,428    $ 26,440,906    $ 23,640,612    $ 21,885,899

Lease receivables

     2,887,663      2,677,058      2,524,058      2,318,530      2,100,712
    

  

  

  

  

Total commercial loans and leases

     34,320,967      31,177,486      28,964,964      25,959,142      23,986,611
    

  

  

  

  

Sales finance

     6,362,990      6,193,928      3,500,158      2,940,364      2,844,970

Revolving credit

     1,276,876      1,180,480      1,050,738      951,319      863,089

Direct retail

     13,932,879      12,130,101      9,400,230      8,273,829      8,336,368
    

  

  

  

  

Total consumer loans

     21,572,745      19,504,509      13,951,126      12,165,512      12,044,427
    

  

  

  

  

Residential mortgage loans

     12,268,889      11,623,391      10,601,923      9,318,519      8,796,037
    

  

  

  

  

Total loans and leases (1)

   $ 68,162,601    $ 62,305,386    $ 53,518,013    $ 47,443,173    $ 44,827,075
    

  

  

  

  


(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 real estate construction loans:

 

Table 4

Selected Loan Maturities and Interest Sensitivity (1)

 

     December 31, 2004

     Commercial,
Financial
and
Agricultural


   Real Estate:
Construction


   Total

     (Dollars in thousands)

Fixed rate:

                    

1 year or less (2)

   $ 372,992    $ 106,230    $ 479,222

1-5 years

     721,615      960,322      1,681,937

After 5 years

     140,701      187,606      328,307
    

  

  

Total

     1,235,308      1,254,158      2,489,466
    

  

  

Variable rate:

                    

1 year or less (2)

     3,190,550      3,573,903      6,764,453

1-5 years

     2,844,011      3,086,143      5,930,154

After 5 years

     442,007      686,908      1,128,915
    

  

  

Total

     6,476,568      7,346,954      13,823,522
    

  

  

Total loans and leases (3)

   $ 7,711,876    $ 8,601,112    $ 16,312,988
    

  

  


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

 

     (Dollars in
thousands)


(3)    The above table excludes:

      

(i)     consumer loans

   $ 9,237,815

(ii)    real estate mortgage loans

     39,257,447

(iii)   loans held for sale

     613,476

(iv)   lease receivables

     5,281,076
    

Total

   $ 54,389,814
    

 

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

 

Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments

 

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

 

The 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 credit losses, which is reflected on the Consolidated Statements of Income. Loans or leases deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance.

 

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In addition to the allowance for loan and lease losses, BB&T also estimates probable losses related to binding unfunded lending commitments. The methodology to determine such losses is inherently similar to the methodology utilized in calculating the allowance for commercial loans, adjusted for factors specific to binding commitments, including the probability of funding and exposure at funding. The reserve for unfunded lending commitments is included in accounts payable and other liabilities on the Consolidated Balance Sheets. Changes to the reserve for unfunded lending commitments are made by changes to the provision for credit losses.

 

Reserve Policy and Methodology

 

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

 

Reserves established pursuant to the provisions of SFAS No. 5 for collective loan impairment are primarily based on historical charge-off experience using a rolling twelve quarter annualized net charge-off rate. However, historical charge-off experience may be adjusted to reflect the effects of current conditions. BB&T considers information derived from its loan risk ratings; internal observable data related to trends within the loan and lease portfolios, including credit quality, concentrations, aging of the portfolio, growth and acquisitions; volatility adjustments to reflect changes in historical net charge-off rates and changes in probabilities of default; external observable data related to industry and general economic trends; and any significant, relevant changes to BB&T’s policies and procedures. Any adjustments to historical loss experience are based on one or more sets of observable data as described above and are directionally consistent with changes in the data from period to period, taking into account the interaction of components over time. The adjusted historical loss information is applied to pools of loans grouped according to similar risk characteristics to calculate components of the allowance. In the commercial lending portfolio, each loan is assigned a “risk grade” at origination by the account officer and the assigned risk grade is subsequently reviewed and finalized through BB&T’s established loan review committee process. Loans are assigned risk grades based on an assessment of conditions that affect the borrower’s ability to meet contractual obligations under the loan agreement. This process includes reviewing borrowers’ financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. The established risk management regimen includes a review of all credit relationships with total credit exposure of $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 assess any risk migration in the existing portfolio.

 

A portion of the Corporation’s allowance for loan and lease losses is not allocated to any specific category of loans. This unallocated portion of the allowance reflects management’s best estimate of the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion considered unallocated may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current economic conditions,

 

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industry or borrower concentrations and the status of merged institutions. The allocated and unallocated portions of the allowance are available to absorb losses in any loan or lease category. Management evaluates the adequacy of the allowance for loan and lease losses based on the combined total of the allocated and unallocated components.

 

While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance or to the reserving methodology may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments to original estimates, 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 estimated allocation of the allowance for loan and lease losses at the end of each of the past five years. This table is presented based on the regulatory reporting classifications of the loans. Amounts applicable to years prior to 2002 reflect acquisitions accounted for as poolings of interests. This allocation of the allowance for loan and lease losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.

 

Table 5

Allocation of Allowance for Loan and Lease Losses by Category

 

    December 31,

 
    2004

    2003

    2002

    2001

    2000

 
    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

  $ 116,602   10.9 %   $ 142,293   11.0 %   $ 150,700   12.4 %   $ 133,238   13.0 %   $ 120,486   13.9 %

Real estate:

                                                           

Construction and land development

    95,925   12.2       93,924   10.0       85,525   9.4       79,443   10.6       55,874   9.0  

Mortgage

    403,433   56.4       381,678   56.9       332,490   57.5       234,872   54.6       199,864   55.3  
   

 

 

 

 

 

 

 

 

 

Total real estate

    499,358   68.6       475,602   66.9       418,015   66.9       314,315   65.2       255,738   64.3  
   

 

 

 

 

 

 

 

 

 

Consumer

    111,356   13.1       79,765   14.2       64,209   11.5       54,668   11.9       49,575   12.5  

Lease receivables

    34,600   7.4       42,440   7.9       45,173   9.2       38,098   9.9       30,702   9.3  

Unallocated

    43,016   —         44,837   —         45,588   —         104,099   —         121,606   —    
   

 

 

 

 

 

 

 

 

 

Total

  $ 804,932   100.0 %   $ 784,937   100.0 %   $ 723,685   100.0 %   $ 644,418   100.0 %   $ 578,107   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 and corporations 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. The investment policy is carried out by the Corporation’s Asset / Liability Management Committee (“ALCO”), which meets regularly to review the economic environment and establish investment strategies. The ALCO also has much broader responsibilities, which are discussed in the “Market Risk Management” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.

 

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Investment strategies are established by ALCO 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).

 

Funding Activities

 

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

 

Deposits

 

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

 

The following table provides information regarding the scheduled maturities of time deposits that are $100,000 and greater at December 31, 2004:

 

Table 6

Scheduled Maturities of Time Deposits $100,000 and Greater

December 31, 2004

(Dollars in thousands)

 

Maturity Schedule       

Three months or less

   $ 3,720,936

Over three through six months

     1,254,801

Over six through twelve months

     1,622,068

Over twelve months

     3,483,934
    

Total

   $ 10,081,739
    

 

Borrowed Funds

 

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

 

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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 and capital leases. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for additional disclosures related to long-term borrowings.

 

Employees

 

At December 31, 2004, BB&T had approximately 26,100 full-time equivalent employees compared to approximately 26,300 full-time equivalent employees at December 31, 2003.

 

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, 2004, BB&T’s subsidiary banks operated 1,413 branch offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. BB&T also operates numerous insurance agencies and other businesses that occupy facilities. Office locations are 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

 

The following table lists the members of BB&T’s executive management team as of December 31, 2004:

 

Name of Executive Officer


  

Title


   Years of Service

   Age

John A. Allison, IV

   Chairman and Chief Executive Officer    34    56

Ricky K. Brown

   Senior Executive Vice President and Manager of Banking Network    27    49

W. Kendall Chalk

   Senior Executive Vice President and Chief Credit Officer    30    59

Barbara F. Duck

   Senior Executive Vice President and Production and Risk Manager    17    38

Robert E. Greene

   President of Branch Banking and Trust Company and Senior Executive Vice President for Administrative Services    32    54

Christopher L. Henson

   Senior Executive Vice President and Assistant Chief Financial Officer    20    43

Kelly S. King

   Chief Operating Officer    33    56

Scott E. Reed

   Senior Executive Vice President and Chief Financial Officer    33    56

Steven B. Wiggs

   Senior Executive Vice President and Chief Marketing Officer    26    47

C. Leon Wilson

   Senior Executive Vice President and Operations Division Manager    28    49

 

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

 

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

 

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REGULATORY CONSIDERATIONS

 

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

 

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

 

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

 

Acquisitions

 

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 have opted out of such interstate merger authority prior to such date, and subject to any state requirement that the target bank shall have been in existence and operating for a minimum period of time, not to exceed five years; and subject to certain deposit market-share limitations. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable Federal or state law.

 

Other Safety and Soundness Regulations

 

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

 

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

 

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

 

Payment of Dividends

 

BB&T is a legal entity separate and distinct from its subsidiaries. The majority of BB&T’s revenue is from dividends paid to BB&T by the Banks. The Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well-capitalized” under the prompt corrective action regulations summarized elsewhere in this section. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. North Carolina and Virginia laws state that, subject to certain capital requirements, the board of directors of a bank chartered under their laws may declare a dividend of as much of that bank’s undivided profits as the directors deem expedient. South Carolina allows for the payment of dividends by a state-chartered bank with the prior approval of the Commissioner of Banking. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. During the year ended December 31, 2004, the Banks declared $977.1 million in dividends payable to BB&T. At December 31, 2004, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $2.9 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $1.3 billion.

 

Capital

 

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

 

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

 

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

 

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

 

In addition, each of the Federal Reserve Board and the FDIC has adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by each agency in assessing an institution’s overall capital adequacy. The capital guidelines 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 considerations 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 Subsidiary Banks as of December 31, 2004, are shown in the following table.

 

Table 7

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

December 31, 2004

 

     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 %   9.2 %   10.0 %   10.2 %   12.2 %

Total risk-based capital (2)

   8.0     10.0     14.5     11.5     11.5     13.2  

Tier 1 leverage ratio (3)

   3.0     5.0     7.1     7.5     8.4     7.8  

(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 credit losses, qualifying subordinated debt and qualifying unrealized gains on available for sale equity securities; 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 and certain nonfinancial equity investments.

 

The federal banking agencies, including the Federal Reserve Board and the FDIC, are required to take “prompt corrective action” in respect of depository institutions and their bank holding companies that do not meet minimum capital requirements. The law establishes five capital categories for insured depository institutions for this purpose: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” To be considered “well-capitalized” under these standards, an institution must maintain a total risk-based capital ratio of 10% or greater; a Tier 1 risk-based capital ratio of 6% or greater; a leverage capital ratio of 5% or greater; and must not be subject to any order or written directive to meet and maintain a specific capital level for any capital measure. BB&T and each of the Banks are classified as “well-capitalized.” Federal law also requires the bank regulatory agencies to implement systems for “prompt corrective action” for institutions that fail to meet minimum capital requirements within the five capital categories, with progressively more severe restrictions on operations, management and capital distributions according to the category in which an institution is placed. Failure to meet capital requirements can also cause an

 

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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 assessable deposits, depending on the institution’s capital position and other supervisory factors. In addition, both SAIF-insured and BIF-insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2004, the FDIC assessed BIF-insured and SAIF-insured deposits 1.46 basis points per $100 of deposits to cover those obligations. At December 31, 2004, BB&T’s assessment was limited to that 1.46 basis point obligation.

 

Consumer Protection Laws

 

In connection with their lending and leasing activities, the Banks are each subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, 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-income neighborhoods and persons. Institutions are assigned one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” This assessment is reviewed for any bank that applies to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. The CRA record of each subsidiary bank of a financial holding company, such as BB&T, also is assessed by the Federal Reserve in connection with any acquisition or merger application.

 

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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, as amended. 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 reporting companies and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws.

 

The American Jobs Creation Act of 2004

 

The American Jobs Creation Act of 2004 (“the Act”) was signed into law by the President on October 22, 2004. The Act includes a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. Under the provisions of the Act, BB&T would receive a tax deduction of 85% of certain foreign earnings if repatriated during 2005 pursuant to a domestic reinvestment plan. BB&T is currently evaluating the potential income tax effects of these provisions. Upon the completion of such evaluation, BB&T expects to make a determination concerning repatriation of these foreign earnings.

 

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 Code of Ethics for Directors or Senior Financial Officers on our web site at www.BBandT.com/Investor.

 

NYSE Certification

 

The annual certification of BB&T’s Chief Executive Officer required to be furnished to the New York Stock Exchange pursuant to Section 303A.12(a) of the NYSE Listed Company Manual was previously filed with the New York Stock Exchange on May 18, 2004.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

The following discussion and analysis of the consolidated financial condition and consolidated results of operations of BB&T Corporation and subsidiaries (“BB&T” or the “Corporation”) for each of the three years in the period ended December 31, 2004, 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 2004 performance.

 

Reclassifications

 

In certain circumstances, reclassifications have been made to prior period information to conform to the 2004 presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income.

 

Mergers and Acquisitions Completed During 2004

 

During 2004, BB&T completed the following mergers and acquisitions.

 

On February 1, 2004, BB&T Insurance Services completed its acquisition of McGriff, Seibels & Williams, Inc., of Birmingham, Alabama (“McGriff”). BB&T issued 8.2 million shares of common stock valued at $300.5 million 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 $127.9 million in cash over a five-year period if McGriff’s performance exceeds certain targets. BB&T recorded $396.0 million in goodwill and other intangible assets in connection with the acquisition, including subsequent reallocations of purchase price.

 

On April 14, 2004, BB&T completed its acquisition of Republic Bancshares Inc. (“Republic”), headquartered in St. Petersburg, Florida. BB&T issued 6.5 million shares of common stock valued at $262.3 million and paid $171.1 million in cash in exchange for all of the outstanding common shares of Republic. Republic’s assets totaled $2.9 billion at the time of acquisition and BB&T recorded $260.5 million in goodwill and other intangible assets in connection with the acquisition, including subsequent reallocations of purchase price.

 

In addition to the mergers and acquisitions noted above, BB&T acquired a number of nonbank financial services companies and insurance agencies during 2004, all of which were immaterial in relation to the consolidated results of BB&T. See Note 2. “Business Combinations” in the “Notes to Consolidated Financial Statements” for further information regarding mergers and acquisitions.

 

Pending Mergers

 

On February 16, 2005, BB&T announced plans to acquire a 70% ownership interest in Charlotte, North Carolina-based Sterling Capital Management LLC, a provider of investment management services with more than $8.0 billion in assets under management. Pending regulatory approval, the transaction is expected to be completed in the second quarter of 2005.

 

Critical Accounting Policies

 

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

 

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Understanding BB&T’s accounting policies is fundamental to understanding BB&T’s consolidated financial position and consolidated results of operations. Accordingly, BB&T’s significant accounting policies and changes in accounting principles and effects of new accounting pronouncements are discussed in detail in Note 1 in the “Notes to Consolidated Financial Statements”.

 

The following is a summary of BB&T’s critical accounting policies that are highly dependent on estimates, assumptions and judgments. These critical accounting policies are reviewed with the Audit Committee of BB&T’s Corporate Board of Directors on a periodic basis.

 

Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments

 

It is the policy of BB&T to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that equals management’s best estimate of probable credit losses that are inherent in the portfolio at the balance sheet date. Estimates for loan and lease losses are determined by analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, plans for problem loan and lease administration, the results of regulatory examinations, and changes in the size, composition and risk assessment of the loan and lease portfolio. Also included in management’s estimates for loan and lease losses are considerations with respect to the impact of current economic events, the 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. The methodology used to determine an estimate for the reserve for unfunded lending commitments is inherently similar to the methodology utilized in calculating the allowance for loans and leases adjusted for factors specific to binding commitments, including the probability of funding and exposure at the time of funding. A detailed discussion of the methodology used in determining the allowance for loan and lease losses and the reserve for unfunded lending commitments is included in the “Overview and Description of Business—Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments.”

 

Valuation of Mortgage Servicing Rights

 

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

 

Intangible Assets

 

BB&T’s growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. BB&T’s mergers and acquisitions are accounted for using the purchase method of accounting. Under the purchase method, BB&T is required to record the assets acquired, including identified intangible assets and liabilities assumed at their fair value, which often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. The amortization of identified intangible assets is based upon the estimated economic benefits to be received, which is also subjective. These estimates also include the establishment of various accruals and allowances based on planned facility dispositions and employee severance considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in

 

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goodwill, which is subject to ongoing periodic impairment tests based on the fair value of net assets acquired compared to the carrying value of goodwill. Please refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for a description of our impairment testing process. The major assumptions used in the impairment testing process include the estimated future cash flows of each business unit and discount rates. Discount rates are unique to each business unit and based upon the cost of capital specific to the industry in which the business unit operates. Management has evaluated the effect of lowering the estimated future cash flows or increasing the discount rate for each business unit by 10% and determined that no impairment of goodwill would have been recognized under this evaluation.

 

Pension and Postretirement Benefit Obligations

 

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

 

Income Taxes

 

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

 

Analysis of Financial Condition

 

A summary of the more significant fluctuations in balance sheet accounts is presented below.

 

For the year ended December 31, 2004, BB&T’s average assets totaled $96.3 billion, an increase of $10.9 billion, or 12.8%, compared to the 2003 average primarily reflecting growth in average loans and leases. Average loans and leases for 2004 were up $8.3 billion, or 14.3%, from 2003. The primary components of the growth in average loans and leases were consumer loans, which increased $4.0 billion, or 23.8%; commercial loans and leases, which increased $3.1 billion, or 10.2%; and mortgage loans, which increased $1.2 billion, or 10.9%. Total earning assets averaged $84.9 billion in 2004, an increase of $9.5 billion, or 12.6%, compared to 2003. These averages and growth rates include the effects of acquisitions.

 

BB&T’s average deposits totaled $64.8 billion, reflecting growth of $7.9 billion, or 13.8%, compared to 2003. The categories of deposits with the highest growth rates were: money rate savings, which increased $3.7 billion, or 20.2%; noninterest-bearing deposits, which increased $2.2 billion, or 22.8%; and savings and interest checking, which increased $892.8 million, or 22.9%.

 

Shorter-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances. Average shorter-term borrowings totaled $6.6 billion for the year ended December 31, 2004, an increase of $1.4 billion, or 28.2%, from the 2003 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 $10.9 billion for the year ended December 31, 2004, down $824.1 million, or 7.0%, compared to 2003.

 

The compound annual rate of growth in average total assets for the five-year period ended December 31, 2004, was 11.0%. Over the same five-year period, average loans and leases increased at a compound annual rate of 11.8%, average securities increased at a compound annual rate of 4.2%, and average deposits grew at a compound

 

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annual rate of 10.8%. All balance sheet growth rates referred to include the effect of acquisitions accounted for as purchases, as well as internal growth.

 

For more detailed discussions concerning the causes of these fluctuations, please refer to the sections that follow.

 

Securities

 

The securities portfolios provide earnings and liquidity, and are managed as part of the overall asset and liability management process to optimize net interest income and reduce exposure to interest rate risk. Management has historically emphasized investments with durations of five years or less to provide flexibility in managing the balance sheet in changing interest rate environments. Total securities increased 17.5% in 2004, to a total of $19.2 billion at the end of the year. The quality of the investment portfolio continues to be strong with 66.6% of the total portfolio’s fair market value at December 31, 2004 comprised of U.S. Treasury securities and U.S. government entity securities, excluding mortgage-backed securities. The combined duration of the U.S. Treasury and U.S. government entity portfolios was 3.23 years and 3.19 years at December 31, 2004 and 2003, respectively. Mortgage-backed securities composed 23.6% of the total investment portfolio at year-end 2004. The duration of the mortgage-backed securities was 2.78 years at December 31, 2004 compared to 2.71 years at December 31, 2003. The duration of the total portfolio at December 31, 2004 was 3.13 years compared to 3.19 years at December 31, 2003.

 

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, 2004

     2004

   2003

   2002

     (Dollars in thousands)

Trading securities (at estimated fair value):

   $ 334,256    $ 693,819    $ 148,488
    

  

  

Securities held to maturity (at amortized cost):

                    

U.S. Treasuries

     125      60,122      51,088

U.S. government entities

     —        —        4,435
    

  

  

Total securities held to maturity

     125      60,122      55,523
    

  

  

Securities available for sale (at estimated fair value):

                    

U.S. Treasuries

     122,455      142,758      100,453

U.S. government entities

     12,640,065      12,108,472      11,459,961

States and political subdivisions

     784,379      945,988      912,598

Mortgage-backed securities

     4,530,426      1,549,524      3,869,037

Equity and other securities

     760,871      816,212      1,257,428
    

  

  

Total securities available for sale

     18,838,196      15,562,954      17,599,477
    

  

  

Total securities

   $ 19,172,577    $ 16,316,895    $ 17,803,488
    

  

  

 

At December 31, 2004, trading securities reflected on BB&T’s Consolidated Balance Sheets totaled $334.3 million compared to $693.8 million at December 31, 2003. The decrease in trading securities primarily resulted from management’s decision to liquidate a portion of the trading portfolio being used as an economic risk management strategy in connection with BB&T’s mortgage servicing rights. In addition, approximately half of the trading portfolio is held by BB&T’s full-service brokerage subsidiary as a normal part of its operations and, as a result, is subject to significant fluctuations. 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, 2004. Securities held to maturity are carried at amortized cost and totaled $125 thousand at December 31, 2004, compared to $60.1 million outstanding at the end of 2003. This

 

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decrease resulted primarily from the maturity of these securities and the decision to classify the reinvestment of the proceeds as trading securities. 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 $18.8 billion at year-end 2004 and are carried at estimated fair value. Securities available for sale at year-end 2003 totaled $15.6 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 entities and mortgage-backed securities, which composed 91.8% of the portfolio. This portfolio also contains investments in U.S. Treasury securities, which represented less than 1% of the December 31, 2004 balance, obligations of states and municipalities, which represented 4.2% of the available-for-sale portfolio, and equity and other securities, which made up 4.0% of the available-for-sale portfolio.

 

The $3.3 billion increase in securities available for sale was the result of a combination of factors including the securitization of approximately $1.0 billion in mortgage loans, the acquisition of Republic and the investment of funds generated by strong deposit growth. During the year ended December 31, 2004, BB&T sold $2.3 billion of available-for-sale securities and realized net gains totaling $6.1 million.

 

The following table presents BB&T’s securities portfolio at December 31, 2004, segregated by major category with ranges of maturities and average yields disclosed.

 

Table 9

Securities Maturities and Yields

 

     December 31, 2004

 
     Carrying
Value


   Weighted
Average Yield (3)


 
     (Dollars in thousands)  

U.S. Treasuries and U.S. government entities (1):

             

Within one year

   $ 1,756,803    3.68 %

One to five years

     6,795,893    3.23  

Five to ten years

     4,601,552    4.03  

After ten years

     4,138,823    4.45  
    

  

Total

     17,293,071    3.78  
    

  

Obligations of states and political subdivisions:

             

Within one year

     76,304    5.17  

One to five years

     372,931    5.86  

Five to ten years

     219,060    6.96  

After ten years

     116,084    7.25  
    

  

Total

     784,379    6.30  
    

  

Other securities:

             

Within one year

     25    7.45  

One to five years

     7,653    3.48  

Five to ten years

     182,230    4.88  

After ten years

     16,396    5.69  
    

  

Total

     206,304    4.89  
    

  

Trading securities and securities with no stated maturity (2)

     888,823    2.53  
    

  

Total securities (4)

   $ 19,172,577    3.83 %
    

  


(1)   Included in U.S. Treasuries and U.S. government entities are mortgage-backed securities totaling $4.5 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 $554.5 million and trading securities which totaled $334.3 million.
(3)   Yields on tax-exempt securities are calculated on a taxable-equivalent basis using the statutory federal income tax rate of 35%. Yields for available for sale securities are calculated based on the amortized cost of the securities.
(4)   Includes securities held to maturity of $125 thousand carried at amortized cost and securities available for sale and trading securities carried at estimated fair values of $18.8 billion and $334.3 million, respectively.

 

The available-for-sale portfolio comprised 98.3% of total securities at December 31, 2004. 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 2004 was $139.5 million lower than the amortized cost of these securities. At December 31, 2004, BB&T’s available-for-sale portfolio had net unrealized depreciation, net of deferred income taxes, of $87.5 million, which is reported as a component of shareholders’ equity. At December 31, 2003, the available-for-sale portfolio had net unrealized appreciation of $11.4 million, net of deferred income taxes.

 

On December 31, 2004, BB&T held certain investments having continuous unrealized loss positions for more than 12 months totaling $131.0 million. The vast majority of these investments were in U.S. government entity securities and it is expected that the securities would not be settled at a price less than their amortized cost. Because the decline in market value was caused by interest rate increases and not credit quality, and because BB&T has the ability to hold these investments until a recovery of fair value, which may be maturity, BB&T has not recognized any other-than-temporary impairment in connection with these investments.

 

The fully taxable equivalent (“FTE”) yield on the total securities portfolio was 4.05% for the year ended December 31, 2004, compared to 4.81% for the prior year. The decrease in FTE yield resulted principally from the prolonged historically low interest rate environment and purchases of lower-yielding securities. As BB&T’s higher-yielding securities matured or were called or were rapidly prepaid, in the case of mortgage-backed securities, the resulting cash flows were reinvested in lower-yielding securities paying then-current market interest rates. The yield on U.S. Treasuries and U.S. government entities decreased from 4.65% in 2003 to 3.88% in 2004, while the yield on mortgage-backed securities decreased from 5.09% to 4.52% and the FTE yield on state and municipal securities decreased from 6.83% last year to 6.51% in the current year.

 

Loans and Leases

 

Management emphasizes commercial lending to small and medium-sized businesses, consumer lending and mortgage lending with an overall goal of maximizing the profitability of the loan portfolio while maintaining strong asset quality. The various categories of loan products offered by BB&T are discussed under “Lending Activities” in the “Overview and Description of Business” section herein. BB&T is a full-service lender with approximately one-half of its loan portfolio composed of loans to businesses and one-half composed of loans to individual consumers. Average commercial loans, including lease receivables, increased $3.1 billion, or 10.2%, in 2004 as compared to 2003, and now compose 50.0% of the loan portfolio, compared to 51.8% in 2003. Average consumer loans, which include sales finance, revolving credit and direct retail, increased $4.0 billion, or 23.8%, for the year ended December 31, 2004 as compared to the same period in 2003, and compose 31.1% of average loans, compared to 28.7% in 2003. Average mortgage loans increased $1.2 billion, or 10.9%, in 2004 as compared to 2003, and represented the remaining 18.9% of average total loans for 2004, compared to 19.5% a year ago. BB&T is a large originator of residential mortgage loans, with 2004 originations of $10.0 billion. To improve the overall yield of the loan portfolio and to mitigate interest rate risk, BB&T sells most of its fixed-rate mortgage loans in the secondary market. However, in late 2003, BB&T began retaining a portion of the originated mortgage loans as part of a balance sheet restructuring initiative. The total amount of fixed-rate mortgage loans retained pursuant to this initiative was approximately $3.6 billion. At December 31, 2004, BB&T was servicing $24.5 billion in residential mortgages owned by third parties and $13.4 billion of mortgage loans owned by BB&T, including $1.1 billion classified as securities available for sale.

 

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BB&T’s loan portfolio, excluding loans held for sale, increased $6.0 billion, or 9.7%, as compared to 2003. Average total loans and leases for 2004 increased $8.3 billion, or 14.3%, compared to 2003. In addition to strong internal loan growth, these increases were aided by the addition of loans held by Republic, which was acquired on April 14, 2004, and had loans of $1.7 billion. During the third quarter of 2004, BB&T securitized $1.0 billion in residential mortgage loans and transferred the related mortgage-backed securities to the available-for-sale securities portfolio. The securitization was undertaken to rebalance the loan portfolio which had grown significantly as a result of strong mortgage loan originations over the last two years and the retention of approximately $3.6 billion in fixed-rate mortgage loans.

 

While the mix of the consolidated loan portfolio in 2004 was very similar to that of one year ago, the fluctuation reflects certain trends in the composition of the loan portfolio caused by improving general economic conditions across BB&T’s footprint and the mortgage loan securitization mentioned earlier. During 2004, commercial loan activity in the markets served by BB&T improved. BB&T expects these positive trends to continue into 2005 as BB&T’s commercial customers utilize liquid assets accumulated in recent years and their needs for funds increase.

 

The pace of commercial loan growth during 2004 was complemented by stronger trends in the consumer loan portfolio. 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 $2.5 billion, or 23.5%, compared to the average balance in 2003. Average sales finance loans increased $1.3 billion, or 27.3%, from the prior year primarily as a result of the purchase of First Virginia, which had a loan portfolio concentrated in sales finance. However, sales finance loans were up only $169.1 million, or 2.7%, at December 31, 2004 compared to year-end 2003. Following the merger, BB&T began to reposition the sales finance portfolio by ceasing origination of certain components of the First Virginia business, 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. Furthermore, management believes that such loans do not fit the potential niches and pricing goals of automobile dealers serviced by BB&T. In addition, during 2004, the sales finance business continued to be highly competitive as many finance subsidiaries of automobile manufacturers were offering large financing discounts and rebates to consumers. Based on current market conditions, historical results and projected portfolio liquidation, BB&T expects slow growth in the sales finance loan portfolio.

 

Mortgage loans comprised 18.0% of the loan portfolio at December 31, 2004 compared to 18.7% at the end of 2003. Management views mortgage loans as excellent long-term investments due to their lower credit risk, liquidity characteristics and current favorable spreads versus U.S. Treasury securities, and believes originating and servicing mortgage loans is an integral part of BB&T’s relationship-based credit culture. The decrease in the percentage of mortgage loans in the total loan portfolio was the result of slower mortgage origination activity compared to 2003 when interest rates were at historically low levels, the growth in commercial and consumer loans, and the securitization of $1.0 billion of mortgage loans. During 2004, BB&T securitized approximately $1.0 billion in residential mortgage loans and transferred the related mortgage-backed securities to the available-for-sale securities portfolio. The securitization was undertaken to rebalance the loan portfolio which had grown significantly as a result of strong mortgage loan originations over the last two years and the retention, rather than sale, of approximately $3.6 billion in fixed-rate mortgage loans as part of a balance sheet restructuring largely completed during 2003.

 

The average annualized FTE yields on commercial, consumer and mortgage loans for 2004 were 5.41%, 6.79% and 5.57%, respectively, resulting in a yield for the total loan portfolio of 5.87%, compared to 6.06% for the total portfolio in 2003. The 19 basis point decrease in the average yield on loans resulted primarily from the runoff of higher-yielding fixed-rate loans and leases and more intense competition in loan pricing. During the second half of 2004, the Federal Reserve started to gradually increase the intended Federal funds rate in response to an increase in economic activity. As a result of the Federal Reserve Board’s actions, the prime rate, which is the basis for pricing many commercial and consumer loans, was 5.25% at year-end 2004, compared to 4.00% at both year-end 2003 and during the first half of 2004. Therefore, as loans gradually reprice at higher rates or mature and are replaced with higher-yielding loans, the annualized interest yield of the loan portfolio is expected to increase. Evidence of this trend is visible from the changes in the quarterly annualized interest yield of the loan portfolio, which improved from its low of 5.72% during the second quarter to 6.00% during the fourth quarter of 2004.

 

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Asset Quality and Credit Risk Management

 

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

 

  ·   limiting the amount of credit that individual lenders may 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 Company’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 excellent credit quality. As measured by relative levels of nonperforming assets and net charge-offs, BB&T’s asset quality has remained significantly better than published industry averages.

 

Asset Quality

 

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

 

Table 10

Asset Quality

 

     December 31,

 
     2004

    2003

    2002

    2001

    2000

 
     (Dollars in thousands)  

Nonaccrual loans and leases

   $ 268,636     $ 350,440     $ 374,842     $ 316,607     $ 180,638  

Restructured loans

     555       592       175       —         492  

Foreclosed property

     88,903       96,070       76,647       56,964       55,199  
    


 


 


 


 


Nonperforming assets

   $ 358,094     $ 447,102     $ 451,664     $ 373,571     $ 236,329  
    


 


 


 


 


Loans 90 days or more past due and still accruing

   $ 100,170     $ 116,758     $ 115,047     $ 101,778     $ 81,629  
    


 


 


 


 


Asset Quality Ratios: (1)

                                        

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

     .39 %     .56 %     .70 %     .67 %     .40 %

Nonperforming assets as a percentage of:

                                        

Total assets

     .36       .49       .56       .53       .36  

Loans and leases plus foreclosed property

     .52       .72       .84       .79       .53  

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

     .36       .43       .48       .40       .27  

Allowance for loan and lease losses as a percentage of loans and leases

     1.18       1.26       1.35       1.36       1.29  

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

     1.19       1.27       1.42       1.42       1.32  

Ratio of allowance for loan and leases to:

                                        

Net charge-offs

     3.42 x     3.17 x     2.94 x     3.44 x     5.13 x

Nonaccrual and restructured loans and leases

     2.99       2.24       1.93       2.04       3.19  

NOTE:  (1)   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.

 

During 2004, BB&T’s credit quality continued to improve. The improving economic conditions combined with BB&T’s careful loan underwriting process and active monitoring of past due loans resulted in a reduction in total nonperforming assets and relative levels of nonperforming assets and net charge-offs, the second year of these trends.

 

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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,

 
     2004

    2003

    2002

 
     (Dollars in thousands)  

Nonaccrual loans and leases

                        

Commercial loans and leases

   $ 143,420     $ 219,558     $ 251,428  

Direct retail

     46,187       50,085       39,565  

Sales finance

     14,670       13,082       7,948  

Revolving credit

     349       342       243  

Mortgage

     64,010       67,373       75,658  
    


 


 


Total nonaccrual loans and leases

   $ 268,636     $ 350,440     $ 374,842  
    


 


 


Foreclosed real estate

   $ 69,324     $ 78,964     $ 55,448  

Other foreclosed assets

     19,579       17,106       21,199  

Restructured loans

     555       592       175  
    


 


 


Total nonperforming assets

   $ 358,094     $ 447,102     $ 451,664  
    


 


 


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

                        

Commercial loans and leases

     .21 %     .35 %     .47 %

Direct retail

     .07       .08       .07  

Sales finance

     .02       .02       .01  

Revolving credit

     —         —         —    

Mortgage

     .09       .11       .15  
    


 


 


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

     .39 %     .56 %     .70 %
    


 


 


Loans 90 days or more past due and still accruing interest

                        

Commercial loans and leases

   $ 9,986     $ 17,759     $ 20,386  

Direct retail

     19,917       25,695       34,386  

Sales finance

     21,205       27,863       15,800  

Revolving credit

     4,837       5,601       6,089  

Mortgage

     44,225       39,840       38,386  
    


 


 


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

   $ 100,170     $ 116,758     $ 115,047  
    


 


 


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

                        

Commercial loans and leases

     .01 %     .04 %     .04 %

Direct retail

     .03       .04       .06  

Sales finance

     .03       .04       .03  

Revolving credit

     .01       .01       .01  

Mortgage

     .07       .06       .07  
    


 


 


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

     .15 %     .19 %     .21 %
    


 


 


 

Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments

 

The allowance for loan and lease losses and the reserve for unfunded lending commitments compose BB&T’s allowance for credit losses. The allowance for credit losses totaled $828.3 million at December 31, 2004, compared to $793.4 million at the end of 2003, an increase of 4.4%. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.18% at December 31, 2004, compared to 1.26% at year-end 2003. As a percentage of loans held for investment, the ratio of the allowance for loan and lease losses to total loans and leases was 1.19% at December 31, 2004 compared to 1.27% at the end of last year. BB&T’s strong credit history and recent trends, combined with improvements in BB&T’s relative levels of net charge-offs and nonperforming assets, led to the

 

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reduction in the allowance as a percentage of outstanding loans and leases for a third consecutive year. Please refer to Note 5 “Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments” in the “Notes to Consolidated Financial Statements” for additional disclosures.

 

Information relevant to BB&T’s allowance for credit losses for the last five years is presented in the following table. The table is presented using regulatory classifications.

 

Table 12

Analysis of Allowance for Credit Losses

 

     December 31,

 
     2004

    2003

    2002

    2001

    2000

 
     (Dollars in thousands)  

Balance, beginning of period

   $ 793,398     $ 723,685     $ 644,418     $ 578,107     $ 529,236  
    


 


 


 


 


Charge-offs:

                                        

Commercial, financial and agricultural

     (59,617 )     (71,984 )     (84,967 )     (63,387 )     (33,214 )

Real estate

     (60,688 )     (77,547 )     (61,608 )     (41,035 )     (20,759 )

Consumer

     (165,218 )     (161,424 )     (144,609 )     (124,359 )     (93,040 )

Lease receivables

     (11,156 )     (4,430 )     (5,965 )     (2,448 )     (3,502 )
    


 


 


 


 


Total charge-offs

     (296,679 )     (315,385 )     (297,149 )     (231,229 )     (150,515 )
    


 


 


 


 


Recoveries:

                                        

Commercial, financial and agricultural

     16,365       25,380       18,029       14,985       12,358  

Real estate

     9,801       10,808       6,345       4,824       3,788  

Consumer

     34,302       30,251       24,890       23,955       21,430  

Lease receivables

     936       1,039       1,353       375       312  
    


 


 


 


 


Total recoveries

     61,404       67,478       50,617       44,139       37,888  
    


 


 


 


 


Net charge-offs

     (235,275 )     (247,907 )     (246,532 )     (187,090 )     (112,627 )
    


 


 


 


 


Provision charged to expense

     249,269       247,585       263,700       224,318       147,187  
    


 


 


 


 


Allowance for loans acquired in purchase transactions, net

     20,909       70,035       62,099       29,083       14,311  
    


 


 


 


 


Balance, end of period

   $ 828,301     $ 793,398     $ 723,685     $ 644,418     $ 578,107  
    


 


 


 


 


Average loans and leases (1)

   $ 66,107,479     $ 57,857,069     $ 50,851,417     $ 46,587,780     $ 41,933,641  
    


 


 


 


 


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

     .36 %     .43 %     .48 %     .40 %     .27 %
    


 


 


 


 



(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, 2004, were $67.7 billion, an increase of $8.3 billion, or 14.1%, compared to year-end 2003. The increase in deposits was driven by a $3.9 billion, or 16.7% increase in certificates of deposit (“CDs”) and other time deposits, a $3.1 billion, or 15.1% increase in money rate savings accounts, and a $1.1 billion, or 10.3% increase in noninterest-bearing deposits. For the year ended December 31, 2004, total deposits averaged $64.8 billion, an increase of $7.9 billion, or 13.8%, compared to 2003. The increase in average deposits was the result of a $2.2 billion, or 22.8% increase in average noninterest-bearing deposits, and a $3.7 billion, or 20.2% increase in average money rate savings accounts. Average certificates of deposit and other time deposits increased $1.1 billion, or 4.4%, during 2004 compared to 2003. Other time deposits, including individual retirement accounts and certificates of deposit, remain BB&T’s largest category of deposits, comprising 40.8% of average total deposits for the year, down from 44.4% last year. The primary drivers of the overall increase in average deposits were the purchases of First Virginia at the beginning of the third quarter of 2003 and Republic during the second quarter of 2004, which added deposits of $9.5 billion and $2.5 billion, respectively, and significant internal deposit growth.

 

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Together with the positive growth trends in client deposits over the last two years, there has been a noticeable shift in the overall deposit mix from certificates of deposit 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 more 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 allows them to minimize commercial account service charges. Furthermore, in recent years BB&T has intentionally not replaced many of the high-rate certificates of deposit that matured, instead focusing on core deposit growth in noninterest-bearing deposits due to their low cost and their potential for generating service fee income.

 

The average rate paid on interest-bearing deposits decreased to 1.37% during 2004, from 1.59% in 2003. This decrease resulted primarily from the shift in deposit mix from certificates of deposit and higher-cost time deposits to lower-cost savings and transaction accounts. The average rates paid on the various categories of interest-bearing deposits also decreased as follows: other time deposits, including individual retirement accounts and certificates of deposit, decreased to 2.11% in the current year from 2.39% in 2003; money rate savings accounts decreased to .74% in the current year from .76% in 2003; interest checking decreased from .42% in 2003 to .33% in the current year; and savings deposits decreased to .17% in 2004 from .28% in 2003. Recent actions by the Federal Reserve Board during the second half of 2004 to raise the targeted Federal funds rate are beginning to cause increases in the above rates paid on interest-bearing deposits.

 

BB&T also uses various types of shorter-term borrowings in meeting funding needs. While client deposits remain the primary source for funding loan originations, management uses shorter-term borrowings as a supplementary funding source for loan growth. Shorter-term borrowings comprised 6.8% of total funding needs on average in 2004 as compared to 6.0% in 2003. See Note 9 “Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Short-Term Borrowed Funds” in the “Notes to Consolidated Financial Statements” herein for further disclosure. The types of shorter-term borrowings utilized by the Corporation include Federal funds purchased, which composed 42.9% of total shorter-term borrowings, and securities sold under repurchase agreements, which comprised 37.7% of shorter-term borrowings at year-end 2004. Master notes, U.S. Treasury tax and loan deposit notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances are also utilized to meet short-term funding needs. Shorter-term borrowings at the end of 2004 were $6.7 billion, down $647.0 million, or 8.8%, compared to year-end 2003. The decrease in average shorter-term borrowings was primarily a result of healthy deposit growth during 2004, which provided sufficient resources for funding loan and other balance sheet growth. The rates paid on average shorter-term borrowings increased from 1.13% in 2003 to 1.37% during 2004. The increase in the cost of shorter-term borrowings resulted from recent actions by the Federal Reserve Board, which increased the targeted Federal funds rate by 125 basis points during the second half of 2004 to 2.25% from its lowest level of 1.00% set in June 2003. The following table summarizes certain pertinent information for the past three years with respect to BB&T’s shorter-term borrowings:

 

Table 13

Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Other Borrowings

 

     As of / For the Year Ended
December 31,


 
     2004

    2003

    2002

 
     (Dollars in thousands)  
Securities Sold Under Agreements to Repurchase                         

Maximum outstanding at any month-end during the year

   $ 3,689,890     $ 3,177,747     $ 2,568,897  

Balance outstanding at end of year

     2,520,956       2,831,068       2,511,530  

Average outstanding during the year

     3,077,625       2,603,343       2,479,185  

Average interest rate during the year

     1.38 %     1.29 %     2.02 %

Average interest rate at end of year

     2.12       1.11       1.64  
Federal Funds Purchased and Short-term Borrowed Funds                         

Maximum outstanding at any month-end during the year

   $ 5,319,379     $ 4,503,832     $ 4,542,536  

Balance outstanding at end of year

     4,166,916       4,503,832       2,885,429  

Average outstanding during the year

     3,512,846       2,537,500       2,914,294  

Average interest rate during the year

     1.36 %     0.97 %     1.58 %

Average interest rate at end of year

     2.03       0.91       1.00  

 

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BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 11.3% of total funding needs on average during 2004 and 13.7% in 2003. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for further disclosure. Long-term debt at December 31, 2004 totaled $11.4 billion, an increase of $611.9 million, or 5.7%, from year-end 2003. For the year ended December 31, 2004, average long-term debt decreased $824.1 million, or 7.0%, compared to the average for 2003. BB&T’s long-term debt consists primarily of FHLB advances, which composed 48.8% of total outstanding long-term debt at December 31, 2004, and subordinated notes of BB&T Corporation, which composed 29.2% 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 both secured and subordinated borrowings by Branch Bank, junior subordinated debt to unconsolidated trusts issued by the Corporation, and capital leases. The average rate paid on long-term debt decreased from 3.87% during 2003 to 3.48% during 2004 primarily because of the balance sheet restructuring completed during 2003, which was intended to improve net interest income and the net interest margin.

 

During the third quarter of 2004, Branch Bank issued $500 million of senior floating rate debt maturing in June 2007. The proceeds from the offering are being used for general bank funding purposes. On October 27, 2004, BB&T Corporation also issued $600 million of subordinated global notes maturing in November 2019. The proceeds from this offering are being used to fund repurchases of BB&T’s common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&T’s subsidiaries and for other general corporate purposes.

 

During 2003, BB&T completed a balance sheet restructuring. In connection with the restructuring, BB&T refinanced $3.0 billion of FHLB advances, lowering the annual interest rate paid on these advances during the next four 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 obtained from the reduction 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 separate category of noninterest expenses. Management estimates that these long-term debt transactions contributed approximately 18 basis points to the net interest margin during 2004 and 12 basis points during 2003.

 

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

 

Analysis of Results of Operations

 

Consolidated net income for 2004 totaled $1.56 billion, which generated basic earnings per share of $2.82 and diluted earnings per share of $2.80. Net income for 2003 was $1.06 billion and net income for 2002 totaled $1.30 billion. Basic earnings per share were $2.09 in 2003 and $2.75 in 2002, while diluted earnings per share were $2.07 and $2.72 for 2003 and 2002, 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 1.62%, 1.25% and 1.72% for the years ended December 31, 2004, 2003 and 2002, respectively. The returns on average common shareholders’ equity were 14.71%, 11.97% and 18.32% 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 for many years. Refer to Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of mergers and acquisitions consummated during the three years ended December 31,

 

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2004. As a result of these activities, the consolidated results of operations for the three year period covered by this discussion include the effects of merger-related and restructuring charges, as well as expenses and certain gains related to the consummation of the transactions.

 

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

 

During 2004, BB&T recorded merger-related and restructuring charges of $5.5 million, which are reflected in BB&T’s Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of McGriff and Republic.

 

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

 

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”).

 

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

 

Table 14

Summary of Merger-Related and Restructuring Charges

(Dollars in thousands)

 

     For the Year Ended December 31,

     2004

     2003

   2002

Severance and personnel-related charges

   $ 8,976      $ 20,834    $ 4,527

Occupancy and equipment charges

     (11,752 )      22,290      9,510

Systems conversions and related charges

     580        5,271      11,700

Marketing and public relations

     4,038        7,565      6,446

Asset write-offs and other merger-related charges

     3,676        33,815      7,097
    


  

  

Total

   $ 5,518      $ 89,775    $ 39,280
    


  

  

 

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 2004, BB&T estimated that 200 positions would be eliminated and receive severance in connection with the acquisition of Republic and 225 employees did, in fact, receive severance in 2004. Nine former employees will continue to receive severance payments during 2005. During 2003, BB&T estimated that 1,918 positions would be eliminated and receive severance and 980 employees did, in fact, receive severance during 2003. Substantially all of the remaining positions involved employees who voluntarily resigned or were offered positions elsewhere within BB&T. These former employees did not receive severance. Approximately 551 of the employees whose jobs were eliminated received severance payments during 2004. During 2002, BB&T estimated that 372 positions would be eliminated and receive severance and 370 employees did, in fact, receive severance during 2002. Approximately 90 of these former employees continued to receive severance payments during 2003.

 

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Occupancy and equipment charges or credits represent merger-related costs or gains associated with lease terminations, obsolete equipment write-offs, and the sale of duplicate facilities and equipment. Credits may result when obsolete properties or equipment are sold for more than originally estimated. Systems conversions and related charges include expenses necessary to convert and combine the acquired branches and operations of merged companies. Marketing and public relations costs represent direct media advertising related to the acquisitions. The other merger-related charges are composed of asset and supply inventory write-offs, litigation accruals and other similar charges.

 

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

 

     First Virginia Banks, Inc

     (Dollars in thousands)
     Balance
January 1,
2003


   Accrued at
acquisition


   Merger-
related and
restructuring
charges


    Utilized

    Other,
net (1)


    Balance
December 31,
2003


Severance and personnel-related charges

   $ —      $ 26,723    $ 19,172     $ (27,000 )   $ —       $ 18,895

Occupancy and equipment charges

     —        29,579      5,247       (10,560 )     (577 )     23,689

Systems conversions and related charges

     —        20,594      12,113       (11,972 )     —         20,735

Other merger-related charges

     —        4,245      45,192       (46,762 )     —         2,675
    

  

  


 


 


 

Total

   $ —      $ 81,141    $ 81,724     $ (96,294 )   $ (577 )   $ 65,994
    

  

  


 


 


 

     Balance
January 1,
2004


   Accrued at
acquisition


   Merger-
related and
restructuring
charges


    Utilized

    Other,
net (1)


    Balance
December 31,
2004


Severance and personnel-related charges

   $ 18,895    $ —      $ 3,126     $ (13,455 )   $ (1,007 )   $ 7,559

Occupancy and equipment charges

     23,689      —        2,107       (18,132 )     (1,518 )     6,146

Systems conversions and related charges

     20,735      —        2,227       (8,815 )     (14,147 )     —  

Other merger-related charges

     2,675      —        (4,048 )     1,460       —         87
    

  

  


 


 


 

Total

   $ 65,994    $ —      $ 3,412     $ (38,942 )   $ (16,672 )   $ 13,792
    

  

  


 


 


 


(1)   Other, net is primarily composed of adjustments to goodwill resulting from changes to original estimates of merger-related accruals.

 

The remaining accruals at December 31, 2004 for First Virginia are related primarily to costs related to severance payments for certain executive officers and costs to exit certain leases and to dispose of excess facilities and equipment. These liabilities will be utilized in the future because they relate to specific contracts or legal obligations that expire in later years, or they relate to the disposal of duplicate facilities and equipment, which may take longer to complete.

 

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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 Mergers

     (Dollars in thousands)
     Balance
January 1,
2003


   Accrued at
acquisition


   Merger-
related and
restructuring
charges


    Utilized

    Other,
net (1)


    Balance
December 31,
2003


Severance and personnel-related charges

   $ 16,829    $ 3,602    $ 1,662     $ (10,918 )   $ (2,220 )   $ 8,955

Occupancy and equipment charges

     41,753      3,944      17,043       (26,268 )     (11,465 )     25,007

Systems conversions and related charges

     1,738      940      (6,842 )     5,230       (1,066 )     —  

Other merger-related charges

     11,281      15,279      (3,812 )     (11,660 )     (2,693 )     8,395
    

  

  


 


 


 

Total

   $ 71,601    $ 23,765    $ 8,051     $ (43,616 )   $ (17,444 )   $ 42,357
    

  

  


 


 


 

     Balance
January 1,
2004


   Accrued at
acquisition


   Merger-
related and
restructuring
charges


    Utilized

    Other,
net(1)


    Balance
December 31,
2004


Severance and personnel-related charges

   $ 8,955    $ 6,732    $ 5,850     $ (10,959 )   $ (3,479 )   $ 7,099

Occupancy and equipment charges

     25,007      3,261      (13,859 )     (5,001 )     —         9,408

Systems conversions and related charges

     —        7,196      (1,647 )     (4,871 )     (678 )     —  

Other merger-related charges

     8,395      2,483      11,762       (19,143 )     700       4,197
    

  

  


 


 


 

Total

   $ 42,357    $ 19,672    $ 2,106     $ (39,974 )   $ (3,457 )   $ 20,704
    

  

  


 


 


 


(1)   Other, net is primarily composed of adjustments to goodwill resulting from changes to original estimates of merger-related accruals.

 

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 and other similar charges.

 

Because BB&T has often had multiple merger integrations in process, and, due to limited resources, has had to schedule in advance significant events in the merger conversion and integration process, BB&T’s merger process and utilization of merger accruals has typically covered 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, 2004 are expected to be utilized during 2005, unless they relate to specific contracts that expire in later years.

 

Net Interest Income

 

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

 

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Table of Contents

Table 15

FTE Net Interest Income and Rate/Volume Analysis

For the Years Ended December 31, 2004, 2003 and 2002

 

                                              2004 vs. 2003

    2003 vs. 2002

 
    Average Balances

  Yield/Rate

    Income/Expense

 

Increase

(Decrease)


    Change due to

   

Increase

(Decrease)


    Change due to

 
    2004

  2003

  2002

  2004

    2003

    2002

    2004

  2003

  2002

    Rate

    Volume

      Rate

    Volume

 
    (Dollars in thousands)  
Assets                                                                                                      

Securities, at amortized cost (1):

                                                                                                     

U.S. Treasuries, U.S. government agencies and entities and other (5)

  $ 17,391,012   $ 16,156,301   $ 16,005,557   3.94 %   4.70 %   6.15 %   $ 684,607   $ 759,712   $ 983,967   $ (75,105 )   $ (130,145 )   $ 55,040     $ (224,255 )   $ (233,438 )   $ 9,183  

States and political subdivisions

    827,260     901,579     933,532   6.51     6.83     7.47       53,822     61,571     69,743     (7,749 )     (2,826 )     (4,923 )     (8,172 )     (5,843 )     (2,329 )
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total securities (5)

    18,218,272     17,057,880     16,939,089   4.05     4.81     6.22       738,429     821,283     1,053,710     (82,854 )     (132,971 )     50,117       (232,427 )     (239,281 )     6,854  

Other earning assets (2)

    620,451     548,403     439,097   1.79     1.39     1.79       11,088     7,659     7,848     3,429       2,340       1,089       (189 )     (1,916 )     1,727  

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

    66,107,479     57,857,069     50,851,417   5.87     6.06     6.93       3,878,548     3,504,656     3,523,050     373,892       (113,000 )     486,892       (18,394 )     (471,856 )     453,462  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total earning assets

    84,946,202     75,463,352     68,229,603   5.45     5.74     6.72       4,628,065     4,333,598     4,584,608     294,467       (243,631 )     538,098       (251,010 )     (713,053 )     462,043  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Non-earning assets

    11,329,792     9,864,376     7,549,430                                                                                    
   

 

 

                                                                                   

Total assets

  $ 96,275,994   $ 85,327,728   $ 75,779,033                                                                                    
   

 

 

                                                                                   

Liabilities and Shareholders’ Equity

                                                                                                     

Interest-bearing deposits:

                                                                                                     

Savings and interest checking

  $ 4,797,668   $ 3,904,880   $ 3,363,118   0.22     0.33     0.75       10,709     12,778     25,062     (2,069 )     (4,602 )     2,533       (12,284 )     (15,816 )     3,532  

Money rate savings

    21,907,558     18,219,720     14,824,396   0.74     0.76     1.13       162,561     137,800     167,329     24,761       (2,649 )     27,410       (29,529 )     (62,672 )     33,143  

Other time deposits

    26,427,935     25,309,123     23,728,465   2.11     2.39     3.42       556,390     605,099     810,667     (48,709 )     (74,595 )     25,886       (205,568 )     (256,626 )     51,058  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing deposits

    53,133,161     47,433,723     41,915,979   1.37     1.59     2.39       729,660     755,677     1,003,058     (26,017 )     (81,846 )     55,829       (247,381 )     (335,114 )     87,733  

Federal funds purchased, securities sold under repurchase agreements and short-term borrowed funds

    6,590,471     5,140,843     5,393,479   1.37     1.13     1.78       90,117     58,842     95,823     31,275       13,388       17,887       (36,981 )     (33,193 )     (3,788 )

Long-term debt

    10,886,199     11,710,281     12,134,712   3.48     3.87     4.84       378,695     458,268     587,703     (79,573 )     (44,298 )     (35,275 )     (129,435 )     (114,175 )     (15,260 )
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing liabilities

    70,609,831     64,284,847     59,444,170   1.70     1.97     2.84       1,198,472     1,272,787     1,686,584     (74,315 )     (112,756 )     38,441       (413,797 )     (482,482 )     68,685  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Noninterest-bearing deposits

    11,682,911     9,514,435     7,202,129                                                                                    

Other liabilities

    3,386,538     2,633,214     2,019,244                                                                                    

Shareholders’ equity

    10,596,714     8,895,232     7,113,490                                                                                    
   

 

 

                                                                                   

Total liabilities and shareholders’ equity

  $ 96,275,994   $ 85,327,728   $ 75,779,033                                                                                    
   

 

 

                                                                                   

Average interest rate spread

                    3.75 %   3.77 %   3.88 %                                                                  
                     

 

 

                                                                 

Net interest margin

                    4.04 %   4.06 %   4.25 %   $ 3,429,593   $ 3,060,811   $ 2,898,024   $ 368,782     $ (130,875 )   $ 499,657     $ 162,787     $ (230,571 )   $ 393,358  
                     

 

 

 

 

 

 


 


 


 


 


 



(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 $81.4 million, $(21.2 million) and $150.6 million for the three years ended December 31, 2004, 2003 and 2002, respectively.
(2)   Includes Federal funds sold, securities purchased under resale agreements or similar arrangements and interest-bearing deposits with banks.
(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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Table of Contents

For 2004, net interest income on an FTE-adjusted basis totaled $3.4 billion, compared with $3.1 billion in 2003 and $2.9 billion in 2002. The 12.0% increase in net interest income during 2004 resulted because the benefit from strong earning asset growth more than offset the adverse impact of the low interest rate environment. Also contributing to the year over year increase was the shift in the overall deposit mix to lower-cost transaction accounts.

 

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 4.04% in 2004, 4.06% in 2003 and 4.25% in 2002. The average yield on interest earning assets fell 29 basis points compared to the average yield during 2003, while the average cost of funds over the same time period fell 27 basis points. 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 interest expense incurred in connection with BB&T’s stock buy-back program, and dilution from the purchase of Republic, which had a net interest margin below 3%. Several factors had a positive impact on the margin. The most significant of them was the balance sheet restructuring completed during 2003. The margin also benefited from the impact of interest rate swap derivatives.

 

In addition to changes in the composition of BB&T’s earning assets and interest bearing liabilities, the other primary driver of the fluctuations in the net interest margin is the interest rate environment. Over the past three and a half 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%, where it remained until June 2004. During the second half of 2004, the Federal Reserve increased the target Federal funds rate five times, finishing 2004 with the rate set at 2.25%. At the beginning of 2004, BB&T started repositioning its balance sheet to a more asset-sensitive position in anticipation of rising interest rates. However, as interest rates have risen, the benefit on the margin has been less than expected because BB&T’s interest-bearing liabilities have repriced more quickly than anticipated relative to the repricing of interest-earning assets. BB&T’s management anticipates that the margin will stabilize during 2005.

 

Provision for Credit Losses

 

A provision for credit losses is charged against earnings in order to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that reflects management’s best estimate of probable losses inherent in the credit portfolios at the balance sheet date. The amount of the provision is based on continuing assessments of nonperforming and “watch list” loans and associated unfunded credit commitments, analytical reviews of loss experience in relation to outstanding loans and funded credit commitments, loan charge-offs, nonperforming asset trends and management’s judgment with respect to current and expected economic conditions and their impact on the loan portfolio and outstanding unfunded credit commitments. The methodology used is described in the “Overview and Description of Business” section under the heading “Allowance for Loan and Lease Losses and Reserve for Unfunded Credit Commitments.” The provision for credit losses recorded by BB&T in 2004 was $249.3 million, compared with $247.6 million in 2003 and $263.7 million in 2002.

 

The provision for credit losses increased less than 1% during 2004 while the total loan and lease portfolio increased 9.4% compared to the balance outstanding at the end of 2003. Net charge-offs were .36% of average loans and leases for 2004 compared to .43% of average loans during 2003. The allowance for loan and lease losses was 1.18% of loans and leases outstanding and was 2.99x total nonaccrual and restructured loans and leases at year-end 2004, compared to 1.26% and 2.24x, respectively, at December 31, 2003. The decrease from 2002 and the small increase compared with 2003 in the provision for credit losses reflects these improving credit quality trends and growth in the credit portfolios. Management expects these positive internal trends to stabilize in 2005.

 

Noninterest Income

 

Noninterest income has become, and will continue to be, a significant contributor to BB&T’s financial success. Noninterest income includes service charges on deposit accounts, trust revenue, mortgage banking income, investment banking and brokerage fees and commissions, insurance commissions, gains and losses on securities transactions and other commissions and fees derived from other activities. Noninterest income as a

 

39


Table of Contents

percentage of total revenues has steadily increased in recent years due to BB&T’s emphasis on growing and expanding its fee-based businesses. Fee-based service revenues lessen BB&T’s dependence on traditional spread-based interest income and are a relatively stable revenue source during periods of changing interest rates.

 

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

 

Table 16

Noninterest Income

 

                    % Change

 
     Years Ended December 31,

   2004 v.
2003


    2003 v.
2002


 
     2004

   2003

   2002

    
     (Dollars in thousands)             

Service charges on deposits

   $ 523,319    $ 437,524    $ 402,476    19.6 %   8.7 %

Mortgage banking income

     110,075      109,423      21,601    .6     NM  

Trust income

     119,479      113,227      94,463    5.5     19.9  

Insurance commissions

     619,055      395,820      313,436    56.4     26.3  

Securities gains (losses), net

     6,133      126,211      170,100    (95.1 )   (25.8 )

Bankcard fees and merchant discounts

     102,098      83,927      66,848    21.7     25.5  

Investment banking and brokerage fees and commissions

     264,789      247,394      210,586    7.0     17.5  

Other nondeposit fees and commissions

     216,498      180,045      141,654    20.2     27.1  

Income from bank-owned life insurance

     91,883      98,700      88,613    (6.9 )   11.4  

Other noninterest income

     65,942      35,068      31,470    88.0     11.4  
    

  

  

  

 

Total noninterest income

   $ 2,119,271    $ 1,827,339    $ 1,541,247    16.0 %   18.6 %
    

  

  

  

 


NM—not meaningful

 

The 16.0% growth in noninterest income was led by increased revenues from BB&T’s insurance operations as well as growth in income from service charges on deposit accounts, bankcard fees and merchant discounts, and other nondeposit fees and commissions. These increases were partially offset by a significant decline in gains from sales of securities. The 18.6% increase in noninterest income for 2003 was 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, trust income and other nondeposit fees and commissions. The major categories of noninterest income and their fluctuations are discussed in the following paragraphs. These fluctuations reflect the impact of acquisitions.

 

Service charges on deposit accounts represent BB&T’s second largest category of noninterest revenue. During 2004, BB&T experienced a 19.6% increase in revenue from service charges on deposit accounts compared to 2003. The primary reasons for the increase were the purchases of Republic and First Virginia, improved collection of NSF and overdraft charges on commercial and personal accounts, and growth in commercial account analysis fees, which were $8.4 million, $60.8 million, and $11.8 million, respectively, more than in 2003. Additionally, the robust growth in noninterest bearing commercial and consumer deposit accounts during 2004 led to a higher level of transaction activity and related service fees, which offset the effect of the introduction of new lower-fee deposit products during 2003 and 2004 in response to intense price competition within BB&T’s markets. Management frequently monitors the pricing of various deposit products and services to ensure that BB&T remains competitive. The 2003 increase of 8.7% in service charges on deposits compared to 2002 was substantially caused by the acquisition of First Virginia at the beginning of the third quarter of 2003. Excluding the contribution of First Virginia, service charges on deposits actually decreased in 2003 as a result of changes in deposit mix and competitive pricing pressure. In light of the low interest rate environment during 2003, many commercial customers concentrated a larger portion of their deposit balances in transaction accounts rather than interest-bearing accounts, which allowed them to minimize commercial account analysis fees. In addition, 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.

 

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Income from mortgage banking activities (which includes revenues from originating mortgage loans, net of direct origination cost, revenue from servicing mortgage loans, valuation adjustments, mortgage banking-related derivative gains / losses and amortization related to mortgage servicing rights) totaled $110.1 million in 2004, $109.4 million in 2003 and $21.6 million in 2002. Overall mortgage banking income in 2004 was relatively unchanged compared to 2003; however, the components of income fluctuated as higher mortgage interest rates resulted in lower refinance activity and, consequently, less mortgage production revenue, but resulted in less amortization of mortgage servicing rights and a recapture of the valuation allowance offsetting mortgage servicing rights. This is in contrast to 2003 when refinance activity resulting from very low mortgage rates produced record levels of mortgage production and related revenues, but also resulted in a large impairment in the value of BB&T’s mortgage servicing rights. The mortgage servicing rights impairment that resulted in 2002 and 2003 was largely offset by securities gains, which were utilized by BB&T as an economic risk management strategy. In 2004, BB&T employed a risk management strategy for mortgage servicing rights that was entirely dependent upon derivative financial instruments. The following table provides a breakdown of the various components of mortgage banking income:

 

Mortgage Banking Income and Related Statistical Information

 

                       % Change

 
     As of/For the Years
Ended December 31,


   

2004
v.

2003


   

2003
v.

2002


 

Mortgage Banking Income


   2004

    2003

    2002

     
     (Dollars in thousands)              

Residential mortgage production revenues

   $ 61,805     $ 200,234     $ 164,185     (69.1 )%   22.0 %

Residential mortgage servicing revenues

     92,536       101,619       92,811     (8.9 )   9.5  

Commercial mortgage banking revenues

     21,545       18,820       17,056     14.5     10.3  

Mortgage servicing rights valuation (impairments) recaptures, net of related derivative gains or losses

     25,183       (56,345 )     (152,371 )   (144.7 )   (63.0 )

Amortization of mortgage servicing rights

     (90,994 )     (154,905 )     (100,080 )   (41.3 )   54.8  
    


 


 


           

Total mortgage banking income

   $ 110,075     $ 109,423     $ 21,601     .6 %   NM  
    


 


 


           

Mortgage Banking Statistical Information (in billions)


                              

Residential mortgage originations

   $ 10.0     $ 19.4     $ 14.1     (48.5 )%   37.6 %

Residential mortgage loans serviced for others

     24.5       24.9       24.2     (1.6 )   2.9  

Commercial mortgage originations

     1.6       1.7       1.4     (5.9 )   21.4  

Commercial mortgage loans serviced for others

     6.7       6.9       6.3     (2.9 )   9.5  

NM—not meaningful

 

BB&T has an extensive insurance agency/brokerage operation, which at December 31, 2004, ranked as the 6th largest in the nation. Revenues from BB&T’s insurance operations were the largest source of noninterest income during 2004. Internal growth combined with the expansion of BB&T’s insurance agency network through acquisitions during the last two years, the largest of which was McGriff, generated the strong growth in insurance revenues. Commission income from McGriff contributed approximately $152.0 million to the $223.2 million increase in insurance revenues during 2004 compared to 2003. Revenues from CRC Insurance Services, BB&T’s wholly owned wholesale insurance broker, contributed an additional $47.4 million in growth for the current year. The overall growth of 26.3% in insurance revenues during 2003 was caused by similar factors, including strong internal growth and targeted acquisitions of insurance agencies within BB&T’s market area. These increases were in the categories of property and casualty insurance, employee benefits, and accident and health insurance commissions, which increased $23.0 million, $4.7 million, and $3.8 million, respectively, compared to 2002.

 

Revenue from corporate and personal trust services increased by $6.3 million, or 5.5%, in 2004 compared to 2003. Trust revenues are based on the types of services provided as well as the overall value of the assets managed, which is affected by stock market conditions. The increase in trust revenues was primarily due to the acquisition of First Virginia and to increases in proprietary mutual fund management fees. The value of trust assets under management, including custodial accounts, increased during each of the last three years and was $24.2 billion, $27.2 billion, and $28.4 billion at December 31, 2002, 2003 and 2004, respectively. At the beginning of the third quarter of 2003, trust assets under management increased by $2.2 billion because of the acquisition of First Virginia, which was offset by the loss of $2.4 billion in trust assets from the North Carolina state employees’

 

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401 (k) plan, which transferred to a successor trustee at the end of the quarter. The timing of these transactions had a net positive impact on 2004 trust income compared to 2003. The 19.9% increase in trust revenues during 2003 was caused by similar factors that affected the 2004 increase.

 

Net gains on sales of securities declined by 95.1% during 2004. During 2004, BB&T shifted to a risk management strategy related to mortgage servicing rights and mortgage banking operations entirely dependent on derivatives. During the period of declining interest rates that existed in 2002 and 2003, BB&T utilized the increases in the value of the available-for-sale securities portfolio as an economic hedge against the decline in the carrying value of BB&T’s mortgage servicing rights. The net securities gains in 2003 and 2002 were used to offset the net writedowns in the value of mortgage servicing rights.

 

Investment banking and brokerage fees and commissions increased $17.4 million in 2004 compared to 2003 and $36.8 million in 2003 compared to 2002. These increases resulted primarily from growth in investment banking revenues at BB&T’s full-service brokerage and investment banking subsidiary, Scott & Stringfellow, which contributed approximately $10.2 million of the 2004 increase. During 2004, Scott & Stringfellow experienced higher demand for its investment services due to the continued expansion of a new product line and the improving economic environment. The majority of the remaining $7.2 million increase in investment banking and brokerage fees and commissions in 2004 compared to 2003 were related to BB&T Investment Services, Inc., and caused by higher investment services revenues from BB&T’s newer markets through the increase in the number of investment counselors in those markets. In addition, production levels from BB&T’s existing investment counselors also increased. The increase in investment banking and brokerage fees and commissions in 2003 compared to 2002 resulted from similar factors.

 

Other nondeposit fees and commissions, including bankcard fees and merchant discounts, increased $54.6 million, or 20.7%, during 2004 compared to 2003. The principal drivers of the increase were bankcard fees and merchant discounts, check card interchange fees, debit card network interchange fees, business check card interchange fees, and check card foreign ATM fees, which increased $18.2 million, $13.2 million, $4.0 million, $4.2 million, and $4.6 million, respectively, compared to 2003. In addition, fees from money orders and official checks, commercial standby letters of credit fees, and ATM surcharge income increased $1.9 million, $2.6 million, and $2.1 million, respectively, compared to 2003. Furthermore, the acquisitions of Republic and First Virginia contributed to the revenue growth during the current year. Major sources of the 26.6% increase in 2003 revenue included bankcard fees and merchant discounts, check card interchange fees, fees from money orders and official checks, and check card foreign ATM fees, which increased $17.1 million, $8.7 million, $4.2 million, and $5.3 million, respectively, compared to 2002. The increase in nondeposit fees and commissions revenue also includes the impact of acquisitions completed during 2003 and 2002.

 

BB&T has purchased life insurance coverage on certain officers for whom it has an insurable interest. Income from bank-owned life insurance decreased by 6.9% compared to 2003 primarily due to a decline in the market yields used to credit interest income to such policies. The growth in 2003 was driven by additional purchases of bank-owned life insurance made in mid-year 2002.

 

Other income increased 88.0% in the current year primarily due to a $12.7 million fair value adjustment related to miscellaneous investments made by a small business investment company and higher income from investments in limited partnerships, which were up $6.2 million. Another contributing factor was growth in revenues from check sales, which increased $5.6 million, primarily due to the acquisitions of First Virginia and Republic. During 2003, lower income from limited partnership investments, which declined $14.7 million, 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. Additionally, revenues from check sales and gains from non-hedging derivatives each increased $1.7 million compared to 2002.

 

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

 

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Noninterest Expense

 

Noninterest expense totaled $2.9 billion in 2004, $3.0 billion in 2003 and $2.2 billion in 2002. Certain significant items principally stemming from mergers and acquisitions were recorded as noninterest expenses during 2004, 2003 and 2002. In 2004, $5.5 million in pretax merger-related charges were recorded, while 2003 included $89.8 million in merger-related charges and $39.3 million were recognized in 2002. Additional disclosures related to these merger-related charges are presented in “Merger-Related and Restructuring Charges.” In addition, noninterest expense for 2003 includes a loss from the early termination of FHLB advances in the amount of $384.9 million. See “Deposits and Other Borrowings” section for further discussion of this loss.

 

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 2004 and 2003.

 

Table 17

Noninterest Expense

 

                    % Change

 
     Years Ended December 31,

  

2004
v.

2003


    2003
v.
2002


 
     2004

   2003

   2002

    
     (Dollars in thousands)             

Salaries and wages

   $ 1,338,308    $ 1,174,121    $ 1,019,785    14.0 %   15.1 %

Pension and other employee benefits

     293,449      271,419      226,914    8.1     19.6  
    

  

  

  

 

Total personnel expenses

     1,631,757      1,445,540      1,246,699    12.9     15.9  

Net occupancy expense on bank premises

     212,346      180,029      156,670    18.0     14.9  

Furniture and equipment expense

     203,178      191,138      184,402    6.3     3.7  
    

  

  

  

 

Total occupancy and equipment expenses

     415,524      371,167      341,072    12.0     8.8  

Regulatory charges

     14,910      13,348      11,807    11.7     13.1  

Foreclosed property expense

     26,272      19,329      7,321    35.9     164.0  

Amortization of intangibles

     106,348      55,650      20,885    91.1     166.5  

Software

     43,347      43,966      36,608    (1.4 )   20.1  

Telephone

     47,034      45,118      44,005    4.2     2.5  

Advertising and public relations

     31,643      31,110      27,537    1.7     13.0  

Travel and transportation

     32,009      27,607      24,012    15.9     15.0  

Professional services

     75,822      70,518      73,496    7.5     (4.1 )

Supplies

     37,212      36,792      32,464    1.1     13.3  

Loan processing expenses

     84,253      78,887      64,225    6.8     22.8  

Deposit related expense

     34,249      28,571      25,750    19.9     11.0  

Merger-related and restructuring charges

     5,518      89,775      39,280    (93.9 )   128.6  

Loss on early extinguishment of debt

     —        384,898      —      NM     NM  

Other noninterest expenses

     309,965      302,453      239,149    2.5     26.5  
    

  

  

  

 

Total noninterest expense

   $ 2,895,863    $ 3,044,729    $ 2,234,310    (4.9 )%   36.3 %
    

  

  

  

 


NM—not meaningful

 

The 4.9% decrease in total noninterest expense during 2004 compared to 2003 was primarily caused by the combination of lower merger-related charges and the losses on early termination of FHLB advances in 2003. No such losses were incurred in 2004. These comparative decreases were partially offset by additional noninterest expenses as a result of the acquisitions of Republic, McGriff and several other nonbank financial services companies during 2004, and the acquisition of First Virginia in July of 2003. The 2003 increase in noninterest expenses was caused by the effects of acquisitions accounted for as purchases during 2003, including First Virginia, Equitable Bank and several insurance companies, and the aforementioned merger charges and losses on extinguishment of debt.

 

Total personnel expense is the largest component of noninterest expense and includes salaries and wages, as well as pension and other employee benefit costs. The 2004 increase of 12.9% resulted primarily from additional

 

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personnel expenses associated with the First Virginia, McGriff and Republic mergers. The 14.0% increase in salaries and wages was primarily attributable to the above mentioned mergers, as well as higher insurance incentive compensation, investment banking incentive compensation, and other annual performance compensation, which grew $28.3 million, $12.2 million, and $16.3 million, respectively, compared to 2003. These increases were partially offset by lower mortgage loan production incentive compensation, which decreased $34.2 million compared to last year due to significantly lower mortgage loan production in 2004. The 8.1% increase in pension and other employee benefit costs was also affected by the above mergers, which caused increases in all categories of benefit expenses compared to 2003. The 15.9% increase in 2003 personnel expenses was mainly 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 2002.

 

Net occupancy and equipment expense increased by $44.4 million in 2004. Substantially all of the increase resulted from the acquisitions of Republic, McGriff and First Virginia, which collectively added approximately $37.1 million in occupancy and equipment expenses. This amount was comprised of higher rent on buildings and premises, furniture and equipment expenses, utilities expenses, and depreciation expenses, which increased by $16.1 million, $12.6 million, $4.4 million, and $4.0 million, respectively, compared to 2003. Additionally, building maintenance expenses and real estate taxes increased by $2.3 million and $2.7 million, respectively. The increase in 2003 compared to 2002 was affected by acquisitions completed during 2003, the largest of which was First Virginia, and was generally due to the same factors that caused the 2004 increase.

 

The increases in amortization expense associated with intangible assets in 2004 compared to 2003 and in 2003 compared to 2002 were primarily due to the acquisitions of First Virginia, McGriff and Republic, which added $21.7 million, $19.6 million and $6.5 million, respectively, in amortization expenses during 2004 compared to 2003. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of completed mergers and acquisitions during the three year period ended December 31, 2004.

 

Loan processing expenses were up $5.4 million compared to 2003. This increase was primarily driven by higher origination expenses on retail loans and home equity lines of credit, merchant expenses and retail bankcard expenses, which increased $3.0 million, $3.3 million, and $1.2 million, respectively, compared to 2003. However, this increase was partially offset by declines of $1.2 million and $1.1 million in mortgage loan processing and sales finance expenses, respectively, as a result of the lower volume of such loans in 2004. The 2003 loan processing expenses reflected a $14.7 million, or 22.8%, increase over 2002. This increase was caused by higher loan processing expenses associated with all major loan categories, including mortgage, direct retail and sales finance, as a result of the higher number of loan originations due to the more favorable interest rate environment that existed in 2003 compared to 2002.

 

Other noninterest expenses, including professional services, increased $33.7 million, or 5.4%, compared to 2003, which reflected an increase of $96.7 million, or 18.5% compared to 2002. In addition to the effect of purchasing Republic, McGriff and First Virginia, the majority of the 2004 increase resulted from higher taxes and license expenses, insurance claims expenses, employee travel, and higher net losses from the disposition of fixed assets. The 2003 increase was caused by higher advertising and public relations expenses, charitable contributions, employee travel, supplies expense, and net losses from the disposition of fixed assets. Please refer to Table 17 for additional detail on fluctuations in other categories of noninterest expense.

 

The effective management of the Company’s noninterest operating costs is another key contributor to BB&T’s financial success, especially as BB&T becomes a larger and more diverse company. In 2004, management announced plans to implement cost savings and revenue enhancement initiatives with a goal to produce $175 million in combined annual cost savings and revenue enhancements. Implementation of the initiatives began in the fourth quarter of 2004. Management expects that approximately $60 million will be realized in 2005 pursuant to this effort and anticipates that substantially all of the initiatives will be implemented by the fourth quarter of 2006.

 

Provision for Income Taxes

 

BB&T’s provision for income taxes totaled $764.0 million for 2004, an increase of $211.9 million, or 38.4%, compared to 2003. The provision for income taxes totaled $552.1 million in 2003 and $497.5 million in 2002. BB&T’s effective tax rates for the years ended 2004, 2003 and 2002 were 32.9%, 34.1% and 27.8%, respectively. The

 

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increased provision for income taxes in 2004 was the result of higher pretax income. 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. A reconciliation of the effective tax rate to the statutory tax rate is included in Note 12 “Income Taxes” in the “Notes to Consolidated Financial Statements” herein.

 

BB&T has extended credit to, and invested in, the obligations of states and municipalities and their agencies. 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 2004, 2003 and 2002. These transactions include investments in leveraged leases, entering into option contracts transferring future management of residual interests of certain leveraged leases to a wholly-owned foreign subsidiary for which BB&T intends to permanently reinvest the earnings, 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 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 significantly affect BB&T’s consolidated results of operations in 2003 as it related primarily to differences in the timing of recognizing income and deductions for income tax purposes for which deferred taxes had been previously provided. Management continues to believe that BB&T’s treatment of these leveraged leases was appropriate and in compliance with the tax law and regulations applicable for the years examined. BB&T filed a refund request for the taxes and interest related to this matter which was denied by the IRS during the second quarter of 2004. Early in the fourth quarter of 2004, BB&T filed a lawsuit in the United States District Court for the Middle District of North Carolina to pursue a refund of $3.3 million in taxes plus interest assessed by the IRS related to a leveraged lease transaction entered into during 1997. While management expects that this litigation will not be resolved for two to three years, management believes that there will be no material impact on the results of operations or the financial condition of BB&T, regardless of the outcome of the litigation.

 

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.

 

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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 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. ALCO also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. ALCO meets regularly to review BB&T’s interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards.

 

BB&T utilizes a variety of financial instruments to manage various financial risks. These instruments, commonly referred to as derivatives, primarily consist of interest rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. BB&T uses derivatives primarily to manage risk related to business loans, federal funds purchased, long-term debt, mortgage servicing rights, mortgage banking operations, and certificates of deposit. BB&T’s derivatives resulted in an increase in net interest income of $155.4 million, $124.2 million and $45.0 million in 2004, 2003 and 2002, 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, 2004, BB&T had derivative financial instruments outstanding with notional amounts totaling $20.5 billion. The estimated fair value of open contracts used for risk management purposes at December 31, 2004 had net unrealized gains of $73.3 million.

 

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

 

Impact of Inflation and Changing Interest Rates

 

The majority of BB&T’s assets and liabilities are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Fluctuations in interest rates and actions of the Board of Governors of the Federal Reserve System (“FRB”) to regulate the availability and cost of credit have a greater effect on a financial institution’s profitability than do the effects of higher costs for goods and services. Through its balance sheet management function, which is monitored by ALCO, management believes that 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, 2004, 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.

 

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Table 18

Interest Rate Sensitivity Gap Analysis

December 31, 2004

 

     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)

   $ 5,496,913    $ 3,184,800    $ 5,281,495    $ 6,351,984     $ 20,315,192

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

     240,387      —        —        —         240,387

Loans and leases (2)

     45,443,753      9,824,785      6,287,548      6,606,515       68,162,601
    

  

  

  


 

Total interest-earning assets      51,181,053      13,009,585      11,569,043      12,958,499       88,718,180
    

  

  

  


 

Liabilities                                    

Savings and interest checking (3)

     2,155,302      538,826      269,413      1,526,673       4,490,214

Money rate savings (3)

     11,245,342      2,811,336      1,405,668      7,965,451       23,427,797

Other time deposits

     18,795,313      2,763,341      2,664,819      3,311,605       27,535,078

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

     5,274,506      112,737      —        —         5,387,243

Short-term borrowings

     1,300,629      —        —        —         1,300,629

Long-term debt

     150,482      2,613,087      29,292      8,626,763       11,419,624
    

  

  

  


 

Total interest-bearing liabilities      38,921,574      8,839,327      4,090,012      21,709,672       73,560,585
    

  

  

  


 

Asset-liability gap      12,259,479      4,170,258      7,479,031      (8,751,173 )      
    

  

  

  


     
Cumulative interest rate sensitivity gap    $ 12,259,479    $ 16,429,737    $ 23,908,768    $ 15,157,595        
    

  

  

  


     

(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 on internal decay rate studies.

 

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

 

The asset/liability management process requires a number of key assumptions. Management determines the most likely outlook for the economy and interest rates by analyzing external factors, including published economic projections and data, the effects of likely monetary and fiscal policies as well as any enacted or prospective regulatory changes. BB&T’s current and prospective liquidity position, current balance sheet 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

 

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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

 

         

Annualized Hypothetical

Percentage Change in

Net Interest Income


Interest Rate Scenario


  

Linear

Change in

Prime Rate


  

Prime Rate


  
  

December 31,


  

December 31,


  

2004


  

2003


  

2004


  

2003


3.00%

   8.25%    7.00%    2.59%    (1.37)%

1.50   

   6.75       5.50       2.07       (1.10)   

No Change

   5.25       4.00       —      —  

(1.00)   

   NA    3.00       NA    (1.17)   

(1.50)   

   3.75       NA    (2.73)       NA

(2.25)   

   3.00       NA    (3.92)       NA

NA = BB&T’s model did not calculate results for these scenarios.

 

Management has established parameters for asset/liability management that 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 purpose of BB&T Corporation (the “Parent Company”) is to serve as the capital financing vehicle for the operating subsidiaries. The assets of the Parent Company consist primarily of cash on deposit with subsidiary banks, equity investments in subsidiaries, advances to subsidiaries, receivables from subsidiaries, and other miscellaneous assets. The principal obligations of the Parent Company are principal and interest on master notes, long-term debt, and redeemable capital securities. The main sources of funds for the Parent Company are dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from issuance of long-term debt and master notes. The primary uses of funds by the Parent Company are for the retirement of common stock, investments in subsidiaries, advances to subsidiaries, dividend payments to shareholders, and interest and principal payments due on long-term debt and master notes.

 

The primary source of funds used for Parent Company cash requirements has been dividends declared from the Subsidiary Banks, which totaled $977.1 million during 2004, and proceeds from the issuance of long-term debt, which totaled $599.7 million in 2004. Funds raised through master note agreements with commercial clients are placed on deposit with bank subsidiaries primarily for their use in meeting short-term funding needs and, to a lesser extent, to support the short-term temporary cash needs of the Parent Company. At December 31, 2004 and 2003, master note balances totaled $910.2 million and $941.1 million, respectively.

 

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

 

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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. During 2003, BB&T issued $1.0 billion of subordinated notes under this registration. On October 27, 2004, BB&T issued $600.0 million of subordinated notes leaving $400.0 million available for issuance under this universal shelf registration.

 

The Parent Company had six issues of subordinated notes outstanding totaling $3.4 billion at December 31, 2004, and had five issues of subordinated notes outstanding which totaled $2.8 billion at December 31, 2003. Please refer to Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” for additional information with respect to these subordinated notes.

 

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

 

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

 

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

 

The following table presents, as of December 31, 2004, BB&T’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. Further discussion of the nature of each obligation is included in Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”

 

Table 20

Contractual Obligations and Other Commitments

December 31, 2004

 

     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

   $ 11,417,658    $ 150,462    $ 2,612,955    $ 29,292    $ 8,624,949

Capital lease obligations (1)

     3,540      325      611      536      2,068

Operating leases

     627,110      100,782      157,160      112,019      257,149

Commitments to fund affordable housing investments

     215,244      103,700      89,541      21,909      94

Time deposits

     27,535,078      18,795,313      2,763,341      2,664,819      3,311,605
    

  

  

  

  

Total contractual cash obligations

   $ 39,798,630    $ 19,150,582    $ 5,623,608    $ 2,828,575    $ 12,195,865
    

  

  

  

  


(1)   Including interest.

 

BB&T’s significant commitments include certain investments in affordable housing and historic building rehabilitation projects throughout its market area. BB&T enters into such arrangements as a means of supporting local communities and recognizes tax credits relating to its investments. At December 31, 2004, BB&T’s investments in such projects totaled $257.7 million, which includes outstanding commitments of $215.2 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

 

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the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. BB&T’s risk exposure relating to such commitments is generally limited to the amount of investments and commitments made.

 

In addition, BB&T enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the Consolidated Balance Sheets with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December 31, 2004, do not represent the amounts that may ultimately be paid under these contracts. Further discussion of derivative instruments is included in Note 1 “Summary of Significant Accounting Policies” and Note 18 “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements.”

 

In the ordinary course of business, BB&T indemnifies its officers and directors to the fullest extent permitted by law against liabilities arising from litigation. BB&T also issues standard representation warranties in underwriting agreements, merger and acquisition agreements, loan sales, brokerage activities and other similar arrangements. Counterparties in many of these indemnifications provide similar indemnifications to BB&T. Although these agreements often do not specify limitations, BB&T has not been required to act on the guarantees and does not believe that any payments pursuant to them would materially change the financial condition or results of operations of BB&T.

 

Merger and acquisition agreements of businesses other than financial institutions occasionally include additional incentives to the acquired entities to offset the loss of future cash flows previously received through ownership positions. Typically, these incentives are based on the acquired entity’s contribution to BB&T’s earnings compared to agreed-upon amounts. When offered, these incentives are typically issued for terms of three to eight years. As certain provisions of these agreements do not specify dollar limitations, it is not possible to quantify the maximum exposure resulting from these agreements.

 

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

 

BB&T contracts with an independent third party for the disbursement of official checks. Under the terms of the agreement, BB&T acts as an agent for the third party in the issuance of official checks. Funds received from the buyers of official checks are transferred to the third party issuer to cover the checks when they are ultimately presented for payment. But for this arrangement with the third party, these funds would have remained at BB&T in the form of noninterest-bearing deposits. The official check program is contractually arranged to substantially limit BB&T’s exposure to loss, 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 has provided a letter of credit from another bank in favor of BB&T and has access to a revolving line of credit to further mitigate any risk that there would be inadequate funds to cover the outstanding balance of official checks sold. However, in the event that the third party failed to honor official checks BB&T had sold as its agent, it is likely that BB&T would choose to reimburse the purchasers, though not contractually obligated to do so. At December 31, 2004, the third party issuer had outstanding official checks that had been sold by BB&T totaling $516.7 million.

 

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

 

Table 21

Summary of Significant Lending Commitments

December 31, 2004

(Dollars in thousands)

 

Lines of credit

   $ 10,841,533

Commercial letters of credit

     31,515

Standby letters of credit

     2,030,503

Other commitments (1)

     14,057,903
    

Total other commitments

   $ 26,961,454
    


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

 

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 target a Tier 1 leverage ratio of 7.0%. If the capital levels of the banking subsidiaries increase above these guidelines, excess capital may be transferred to the Parent Company, subject to regulatory and other operating considerations, in the form of special dividend payments.

 

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, which have generally been in the range of 40.0% to 50.0% of earnings over the last six years, and repurchases of common shares are the methods used to manage any excess capital generated. In addition, management closely monitors the Parent Company’s double leverage ratio (investments in subsidiaries as a percentage of 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 $10.9 billion at December 31, 2004, an increase of $939.7 million, or 9.5%, from year-end 2003. During 2004, BB&T issued 19.7 million shares in connection with business combinations, the

 

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exercise of stock options and other stock-based incentive plans, which increased shareholders’ equity by $696.0 million. Additionally, growth of $802.4 million in shareholders’ equity resulted from BB&T’s earnings retained after dividends to shareholders. This growth was partially offset by a $133.1 million decrease in accumulated other comprehensive income primarily related to available for sale securities, net of deferred income taxes, and by the repurchase of 11.3 million shares of common stock at a cost of $441.4 million.

 

Capital Adequacy and Resources

 

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

 

Tier 1 capital is calculated as common shareholders’ equity, excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets, net of applicable deferred income taxes, and certain nonfinancial equity investments. Tier 1 capital is required to be at least 4% of risk-weighted assets, and total capital (the sum of Tier 1 capital, a qualifying portion of the allowance for credit 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 (“Subordinated Indenture”), 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 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 did 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 subordinated debt issued after the date of the amendment. On October 27, 2004, BB&T issued an additional $600 million of subordinated notes under the amended Subordinated Indenture.

 

During the third quarter of 2004, BB&T solicited and received the consent of the majority of holders of two outstanding issues of subordinated debt totaling $1.1 billion to amend the terms of the notes and certain provisions of the Subordinated Indenture under which the notes were issued that prevented the notes from qualifying as Tier 2 capital. On September 24, 2004, BB&T amended the Subordinated Indenture and the terms of the notes to permit BB&T to include the notes in its calculation of Tier 2 capital and total regulatory capital for purposes of Federal Reserve filings. This resulted in the total risk-based capital ratio increasing to 14.5% at December 31, 2004 compared to 12.5% at December 31, 2003. As of December 31, 2004, BB&T’s consolidated Tier 2 capital included approximately $3.0 billion of subordinated debt issued by BB&T and Branch Bank.

 

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

 

Table 22

Capital—Components and Ratios

 

     December 31,

 
     2004

    2003

 
     (Dollars in thousands)  

Tier 1 capital

   $ 6,687,082     $ 6,166,160  

Tier 2 capital

     3,884,044       2,045,514  
    


 


Total regulatory capital

   $ 10,571,126     $ 8,211,674  
    


 


Risk-based capital ratios:

                

Tier 1 capital

     9.2 %     9.4 %

Total regulatory capital

     14.5       12.5  

Tier 1 leverage ratio

     7.1       7.2  

 

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 basic earnings per common share, was 47.52% in 2004 as compared to 58.37% in 2003. BB&T’s annual cash dividends paid per common share increased 9.8% during 2004 to $1.34 per common share for the year, as compared to $1.22 per common share in 2003. This increase marked the 33rd 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 255,000 total shareholders at December 31, 2004 compared to approximately 261,000 at December 31, 2003. 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

 

     2004

   2003

     Sales Prices

  

Cash
Dividends

Paid


   Sales Prices

  

Cash
Dividends

Paid


     High

   Low

   Last

      High

   Low

   Last

  

Quarter Ended:

                                                       

March 31

   $ 38.80    $ 34.48    $ 35.30    $ .32    $ 38.80    $ 30.66    $ 31.43    $ .29

June 30

     37.91      33.02      36.97      .32      35.93      31.42      34.30      .29

September 30

     40.46      36.38      39.69      .35      38.19      33.72      35.91      .32

December 31

     43.25      38.67      42.05      .35      39.69      35.98      38.64      .32
                         

                       

Year

   $ 43.25    $ 33.02    $ 42.05    $ 1.34    $ 39.69    $ 30.66    $ 38.64    $ 1.22
       &