Form 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 


 

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the fiscal year ended:

 

December 31, 2005

 

Commission File Number: 1-10853

 

BB&T CORPORATION

(Exact name of Registrant as specified in its Charter)

 

North Carolina   56-0939887
(State of Incorporation)   (I.R.S. Employer Identification No.)

 

200 West Second Street
Winston-Salem, North Carolina
  27101
(Address of principal executive offices)   (Zip Code)

 

(336) 733-2000

(Registrant’s telephone number, including area code)

 


 

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

 

Title of each class


 

Name of each exchange
on which registered


Common Stock, $5 par value   New York Stock Exchange

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES þ    NO ¨

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES ¨    NO þ

 

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

 

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

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer    þ

   Accelerated filer    ¨    Non-accelerated filer    ¨

 

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

 

At February 28, 2006, the Corporation had 535,418,674 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation is approximately $21.6 billion (based on the closing price of such stock as of June 30, 2005.)

 

Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 25, 2006, are incorporated by reference in Part III of this report.

 


 



CROSS REFERENCE INDEX

 

               Page

PART I

   Item 1    Business    4
     Item 1A    Risk Factors    4
     Item 1B   

Unresolved Staff Comments

None.

    
     Item 2    Properties    19
     Item 3    Legal Proceedings    110
     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   

58

     Item 6    Selected Financial Data    64
     Item 7    Management’s Discussion and Analysis of Financial Condition and Results of Operations   

27

     Item 7A    Quantitative and Qualitative Disclosures About Market Risk    50
     Item 8    Financial Statements and Supplementary Data     
          Consolidated Balance Sheets at December 31, 2005 and 2004    69
          Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2005   

70

          Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2005   

71

          Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2005   

72

          Notes to Consolidated Financial Statements    73
          Report of Independent Registered Public Accounting Firm    67
          Quarterly Financial Summary for 2005 and 2004    63
     Item 9   

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

None.

    
     Item 9A    Controls and Procedures    66
     Item 9B   

Other Information

None.

    

PART III

   Item 10    Directors and Executive Officers of the Registrant    *, 19
     Item 11    Executive Compensation    *
     Item 12    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   

*

     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.     

 

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  * The information required by Item 10 is incorporated herein by reference to the information that appears under the headings “Proposal 3-Election of Directors”, “Corporate Governance Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation of Executive Officers”, “Compensation Committee Report on Executive Compensation”, “Compensation Committee Interlocks and Insider Participation”, “Performance Graph” and “Compensation of Directors” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

The information required by Item 12 is incorporated herein by reference to the information that appears under the headings “Security Ownership” and “Compensation of Executive Officers” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

The information required by Item 13 is incorporated herein by reference to the information that appears under the headings “Compensation Committee Interlocks and Insider Participation” and “Transactions with Executive Officers and Directors” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

The information required by Item 14 is incorporated herein by reference to the information that appears under the headings “Fees to Auditors” and “Corporate Governance Matters-Audit Committee Pre-Approval Policy” in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

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OVERVIEW AND DESCRIPTION OF BUSINESS

 

General

 

BB&T Corporation (“BB&T”, “the Company” or “the Corporation”), is a financial holding company headquartered in Winston-Salem, North Carolina. BB&T conducts its business operations primarily through its commercial bank subsidiaries, which have offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. Substantially all of the loans by BB&T’s bank and nonbank subsidiaries are to businesses and individuals in these market areas. BB&T’s principal bank subsidiaries are Branch Banking and Trust Company (“Branch Bank”), Branch Banking and Trust Company of South Carolina (“Branch Bank-SC”), Branch Banking and Trust Company of Virginia (“Branch Bank-VA”), and BB&T Bankcard Corporation. BB&T’s principal assets are all of the issued and outstanding shares of common stock of its subsidiary banks and its nonbank subsidiaries.

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements with respect to the financial condition, results of operations and businesses of BB&T. These forward-looking statements involve certain risks and uncertainties and are based on the beliefs and assumptions of the management of BB&T and the information available to management at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following:

 

  ·   competitive pressures among depository and other financial institutions may increase significantly;

 

  ·   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;

 

  ·   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;

 

  ·   legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which BB&T is engaged;

 

  ·   adverse changes may occur in the securities markets;

 

  ·   competitors of BB&T may have greater financial resources and develop products that enable them to compete more successfully than BB&T;

 

  ·   costs or difficulties related to the integration of the businesses of BB&T and its merger partners may be greater than expected;

 

  ·   expected cost savings associated with completed mergers may not be fully realized or realized within the expected time frames; and

 

  ·   deposit attrition, customer loss or revenue loss following completed mergers may be greater than expected.

 

Risk Factors Relating to BB&T’s Business

 

Changes in national and local economic conditions could lead to higher loan charge-offs and reduce BB&T’s net income and growth.

 

BB&T’s business is subject to periodic fluctuations based on national and local economic conditions. These fluctuations are not predictable, cannot be controlled, and may have materially adverse impact for the Company’s operations and financial condition even if other favorable events occur. BB&T’s banking operations are locally oriented and community-based. Accordingly, the Company expects to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets it serves. For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities BB&T serves. Weakness in BB&T’s market area could depress the Company’s earnings and consequently the financial condition of the Company because:

 

  ·   customers may not want or need BB&T’s products or services;

 

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  ·   borrowers may not be able to repay their loans;

 

  ·   the value of the collateral securing loans to borrowers may decline; and

 

  ·   the quality of BB&T’s loan portfolio may decline.

 

Any of the latter three scenarios could require the Company to charge-off a higher percentage of loans and/or increase provisions for credit losses, which would reduce the Company’s net income. For an analysis of the Company’s recent charge-off experience, please refer to the “Asset Quality and Credit Risk Management” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.

 

Changes in interest rates may have an adverse effect on BB&T’s profitability.

 

BB&T’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect BB&T’s earnings and financial condition. The Company cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. The Company has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. However, changes in interest rates still may have an adverse effect on BB&T’s profitability. For example, high interest rates could adversely affect BB&T’s mortgage banking business because higher interest rates could cause customers to request fewer mortgage refinancings and purchase money mortgage originations.

 

BB&T’s accounting policies and methods are key to how the Company reports its financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.

 

BB&T’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report its financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in the Company reporting materially different amounts than would have been reported under a different alternative. Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” describes the Company’s significant accounting policies. These accounting policies are critical to presenting the Company’s financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions. For additional information regarding the more critical accounting policies, please refer to the “Critical Accounting Policies” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein.

 

Changes in accounting standards could materially impact BB&T’s financial statements.

 

From time to time the Financial Accounting Standards Board “FASB” changes the financial accounting and reporting standards that govern the preparation of BB&T’s financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.

 

BB&T may not be able to successfully integrate bank or nonbank mergers and acquisitions.

 

Difficulties may arise in the integration of the business and operations of bank holding companies, banks and other non-bank entities the Company acquires and, as a result, the Company may not be able to achieve the cost savings and synergies that it expects will result from such transactions. Achieving cost savings is dependent on

 

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consolidating certain operational and functional areas, eliminating duplicative positions and terminating certain agreements for outside services. Additional operational savings are dependent upon the integration of the acquired or merged entity’s businesses with BB&T or one of BB&T’s subsidiaries, the conversion of core operating systems, data systems and products and the standardization of business practices. Complications or difficulties in the conversion of the core operating systems, data systems and products may result in the loss of customers, damage to BB&T’s reputation within the financial services industry, operational problems, one-time costs currently not anticipated or reduced cost savings resulting from such mergers or acquisitions. Annual cost savings in each such transaction may be materially less than anticipated if the holding company, bank merger or nonbank merger or acquisition is delayed unexpectedly, the integration of operations is delayed beyond what is anticipated or the conversion to a single data system is not accomplished on a timely basis.

 

Difficulty in integrating an acquired company may cause the Company not to realize expected revenue increases, cost savings, increases in geographic or product presence and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of BB&T’s businesses or the businesses of the acquired company, or otherwise adversely affect the Company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.

 

BB&T may not receive the regulatory approvals required to complete a bank merger.

 

BB&T must generally receive federal regulatory approval before it can acquire a bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition and future prospects including current and projected capital ratios and levels, the competence, experience and integrity of management and record of compliance with laws and regulations, the convenience and needs of the communities to be served, including the acquiring institution’s record of compliance under the Community Reinvestment Act and the effectiveness of the acquiring institution in combating money laundering activities. In addition, BB&T cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted. In specific cases the Company may be required to sell banks or branches, or take other actions as a condition to receiving regulatory approval.

 

BB&T may experience significant competition in its market area, which may reduce the Company’s customer base.

 

There is intense competition among commercial banks in BB&T’s market area. In addition, BB&T competes with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, commercial finance and leasing companies, the mutual funds industry, full-service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than BB&T is with respect to the products and services they provide. Some of BB&T’s larger competitors, including certain national banks that have a significant presence in the Company’s market area, have greater resources than BB&T, may have higher lending limits and may offer products and services not offered by BB&T.

 

We also experience competition from a variety of institutions outside of the Company’s market area. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.

 

Changes in banking laws could have a material adverse effect on BB&T.

 

BB&T is extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole. In addition, the Company is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. BB&T cannot predict whether any of these changes may adversely and materially affect the Company. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on BB&T’s activities that could have a

 

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material adverse effect on the Company’s business and profitability. For a further discussion regarding other uncertainties arising from how the Company is regulated and supervised, please refer to the “Regulatory Considerations” section herein.

 

BB&T’s business could suffer if it fails to attract and retain skilled people.

 

BB&T’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities the Company engages is intense. The Company may not be able to hire the best people or retain them.

 

BB&T’s stock price can be volatile.

 

BB&T’s stock price can fluctuate widely in response to a variety of factors including:

 

  ·   actual or anticipated variations in quarterly operating results;

 

  ·   recommendations by securities analysts;

 

  ·   new technology used, or services offered, by competitors;

 

  ·   significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company or the Company’s competitors;

 

  ·   failure to integrate acquisitions or realize anticipated benefits from acquisitions;

 

  ·   operating and stock price performance of other companies that investors deem comparable to BB&T;

 

  ·   news reports relating to trends, concerns and other issues in the financial services industry;

 

  ·   changes in government regulations; and

 

  ·   geopolitical conditions such as acts or threats of terrorism or military conflicts.

 

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations could also cause BB&T’s stock price to decrease regardless of the Company’s operating results.

 

Operating Subsidiaries

 

At December 31, 2005, the principal operating subsidiaries of BB&T included the following:

 

  ·   Branch 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

 

  ·   BB&T Bankcard Corporation, Columbus, Georgia

 

  ·   Scott & Stringfellow, Inc., Richmond, Virginia

 

  ·   Regional Acceptance Corporation, Greenville, North Carolina

 

  ·   Sheffield Financial LLC, Clemmons, North Carolina

 

  ·   MidAmerica Gift Certificate Company, Louisville, Kentucky

 

  ·   BB&T Asset Management, Inc., Raleigh, North Carolina

 

Branch Bank, BB&T’s largest subsidiary, was chartered in 1872 and is the oldest bank headquartered in North Carolina. Branch Bank provides a wide range of banking and trust services for retail and commercial clients in its geographic markets, including small and mid-size businesses, public agencies, local governments and individuals through 901 offices (as of December 31, 2005) located in North Carolina, Maryland, Georgia, Kentucky, Florida, West Virginia, Tennessee, Washington D.C., Alabama and Indiana. Branch Bank’s principal operating subsidiaries include:

 

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

 

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  ·   BB&T Investment Services, Inc., a registered broker-dealer located in Charlotte, North Carolina, which offers clients non-deposit investment alternatives, including discount brokerage services, equities, fixed-rate and variable-rate annuities, mutual funds and government and municipal bonds;

 

  ·   BB&T Insurance Services, Inc., headquartered in Raleigh, North Carolina, which 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 flexible benefit plans, and investment advisory, actuarial and benefit consulting services;

 

  ·   Prime Rate Premium Finance Corporation, Inc., located in Florence, South Carolina, which provides insurance premium financing primarily to clients in BB&T’s geographic markets;

 

  ·   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 credit and mortgage loan underwriting guidelines;

 

  ·   CRC Insurance Services, Inc., based in Birmingham, Alabama, which is a wholesale insurance broker authorized to do business nationwide; and

 

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

 

Branch Bank-SC, Branch Bank-VA and BB&T Bankcard Corporation

 

Branch Bank-SC provides a wide range of banking and trust services to retail and commercial clients, including small and mid-size businesses, public agencies, local governments and individuals through 99 banking offices (as of December 31, 2005) located in the State of South Carolina. Branch Bank-VA offers a full range of commercial and retail banking services through 404 banking offices (as of December 31, 2005) located in the Commonwealth of Virginia. BB&T Bankcard Corporation is a special purpose credit card bank.

 

Major Nonbank Subsidiaries

 

BB&T also has a number of nonbank subsidiaries, including:

 

  ·   Scott & Stringfellow, Inc., which is a registered investment banking and full-service brokerage firm that provides services in retail brokerage, equity and debt underwriting, investment advice, corporate finance and equity research; and facilitates the origination, trading and distribution of fixed-income securities and equity products in both the public and private capital markets. It also has a public finance department that provides investment banking, financial advisory services and debt underwriting services to a variety of regional taxable and tax-exempt issuers. Scott & Stringfellow’s investment banking and corporate and public finance areas do business as BB&T Capital Markets;

 

  ·   Regional Acceptance Corporation, which specializes in indirect financing for consumer purchases of primarily mid-model and late-model used automobiles;

 

  ·   Sheffield Financial LLC, which specializes in loans to individuals and small commercial lawn care businesses across the country for the purchase of outdoor power equipment and power sport equipment;

 

  ·   MidAmerica Gift Certificate Company, which specializes in the issuance and sale of retail gift certificates and giftcards through a nationwide network of authorized mall agents; and

 

  ·   BB&T Asset Management, Inc., which is an independent Registered Investment Advisor and the advisor to the BB&T Funds, provides tailored investment management solutions to meet the specific needs and objectives of individual and institutional clients through a full range of investment strategies, including domestic and international equity and fixed income investing.

 

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Services

 

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

 

  ·   small business lending

 

  ·   commercial middle market lending

 

  ·   real estate lending

 

  ·   retail lending

 

  ·   home equity lending

 

  ·   sales finance

 

  ·   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, 2005.

 

Table 1

BB&T Deposit Market Share and Branch Locations by State

December 31, 2005

 

     % of
BB&T’s
Deposits (2)


    Deposit
Market
Share
Rank (2)


   Number of
Branches


North Carolina (1)

   27 %   2nd    334

Virginia

   29     2nd    404

Georgia

   8     6th    119

Kentucky

   5     4th    92

South Carolina

   8     3rd    99

West Virginia

   6     1st    80

Maryland

   8     6th    127

Tennessee

   2     7th    47

Florida

   5     11th    90

Washington, D.C.

   2     5th    9

 

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  (1)   Excludes home office deposits
  (2)   Source: SNL Financial—data as of June 30, 2005 and updated for actual and pending mergers, except pending mergers by BB&T.

 

In addition to the markets described in the table above, BB&T operates two branches in Alabama and one branch in Indiana. After the completion of pending acquisitions with Main Street Banks, Inc., and First Citizens Bancorp, BB&T will operate 144 branches in Georgia, 63 branches in Tennessee and 336 branches in North Carolina, and increase its deposit market share rank to 5th in Georgia. BB&T’s presence and deposit market share in other states listed in the table above will not change as a result of these pending acquisitions. Please refer to Note 20 “Operating Segments” in the “Notes to Consolidated Financial Statements” for additional disclosures.

 

Executive Overview

 

Significant accomplishments in 2005

 

In the opinion of BB&T’s management, the Corporation’s most significant accomplishments during 2005 were as follows (amounts include the impact of acquisitions where applicable):

 

  ·   Performance improved compared to 2004

 

  ·   Average loans increased 8.2%

 

  ·   Average noninterest-bearing deposits increased 10.2%

 

  ·   Nonperforming assets and charge-offs substantially improved

 

  ·   Added 89,600 net new deposit accounts

 

  ·   Households utilizing 5 or more BB&T services grew to 27.4%

 

  ·   The number of customers utilizing online banking services increased 31.3%

 

  ·   Executed cost savings initiative

 

  ·   Several insurance agencies, two investment banking firms, two commercial mortgage companies and an investment management company were acquired or announced during 2005

 

  ·   Re-entered the bank and thrift acquisition market with the announcement of the acquisitions of Main Street Banks, Inc., and early in 2006, First Citizens Bancorp

 

Challenges

 

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

 

  ·   Difficulty growing revenues due to net interest margin compression, which is largely a result of a difficult interest rate environment, including a flat yield curve, irrational pricing for deposit services in the marketplace, and overcapacity in the insurance industry

 

  ·   Cost and risk associated with the current heightened regulatory environment

 

  ·   Employee turnover

 

  ·   Intense competition within the financial services industry

 

  ·   Maximizing the potential of new markets BB&T has entered through acquisitions

 

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Competition

 

The financial services industry is highly competitive and dramatic change continues to occur in all aspects of the Company’s business. The ability of nonbank financial entities to provide services previously reserved for commercial banks has intensified competition. BB&T’s subsidiaries compete actively with national, regional and local financial services providers, including banks, thrifts, securities dealers, mortgage bankers, finance companies and insurance companies. Competition among providers of financial products and services continues to increase with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to consolidate, which affects competition by eliminating some regional and local institutions, while strengthening the franchises of acquirers. For additional information concerning markets, BB&T’s competitive position and business strategies, see “Market Area” and “General Business Development” below.

 

Market Area

 

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

 

General Business Development

 

BB&T is a regional financial holding company. The core of its business and franchise was created by the merger-of-equals between BB&T and Southern National Corporation in 1995 and the acquisition of United Carolina Bancshares in 1997. BB&T has maintained a long-term focus on a strategy that includes expanding and diversifying the BB&T franchise in terms of revenues, profitability and asset size. Tangible evidence of this focus is the growth in average total assets, loans and deposits, which have increased over the last five years at compound annual rates of 11.1%, 11.3%, and 11.2%, respectively.

 

Merger Strategy

 

BB&T’s growth in business, profitability and market share over the past several years was enhanced significantly by mergers and acquisitions. Management made a strategic decision not to pursue bank or thrift acquisitions during 2004 or 2005, instead focusing on fully integrating recent mergers and improving internal growth. Management intends to resume strategic mergers and acquisitions, including bank and thrift acquisitions primarily within BB&T’s existing footprint, and, in fact, recently announced plans to acquire two banks. BB&T will continue to pursue economically advantageous acquisitions of insurance agencies, asset managers, consumer and commercial finance companies, and other strategic opportunities to grow existing businesses and potentially to expand into other related financial businesses. BB&T’s acquisition strategy is focused on three primary objectives:

 

  ·   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 to $15 billion, with an informal target of growing approximately 5% of BB&T’s assets through acquisitions;

 

  ·   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 markets that are economically feasible and provide positive long-term benefits.

 

BB&T consummated acquisitions of 53 community banks and thrifts, 77 insurance agencies and 28 nonbank financial services providers over the last fifteen years. In the long-term, BB&T expects to continue to take advantage of the consolidation in the financial services industry and expand and enhance its franchise through

 

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mergers and acquisitions. The consideration paid for these acquisitions may be in the form of cash, debt or BB&T stock. The amount of consideration paid to complete these transactions may be in excess of the book value of the underlying net assets acquired, which could have a dilutive effect on BB&T’s earnings. In addition, acquisitions often result in significant front-end charges against earnings; however, cost savings and revenue enhancements, especially incident to in-market bank and thrift acquisitions, are also typically anticipated.

 

Lending Activities

 

The primary goal of the BB&T lending function is to help clients achieve their financial goals by providing quality loan products that are fair to the client and profitable to the Corporation. Management believes that this purpose can best be accomplished by building strong, profitable client relationships over time, with BB&T becoming an important contributor to the prosperity and well-being of its clients. In addition to the importance placed on client knowledge and continuous involvement with clients, BB&T’s lending process incorporates the standards of a consistent company-wide credit culture and an in-depth local market knowledge. Furthermore, the Corporation employs strict underwriting criteria governing the degree of assumed risk and the diversity of the loan portfolio in terms of type, industry and geographical concentration. In this context, BB&T strives to meet the credit needs of businesses and consumers in its markets while pursuing a balanced strategy of loan profitability, loan growth and loan quality.

 

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

 

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

 

Table 2

Composition of Loan and Lease Portfolio

 

     December 31,

 
     2005

    2004

    2003

    2002

    2001

 
     (Dollars in thousands)  

Commercial, financial and agricultural loans

   $ 8,252,590     $ 7,711,876     $ 7,143,759     $ 6,975,340     $ 6,551,604  

Lease receivables

     5,529,647       5,281,076       5,127,068       5,153,192       5,011,579  

Real estate—construction and land development loans

     11,942,458       8,601,112       6,477,313       5,291,719       5,334,108  

Real estate—mortgage loans

     41,539,400       39,257,447       36,251,269       30,023,470       25,542,288  

Consumer loans

     9,603,925       9,237,815       9,208,182       6,501,831       5,965,010  
    


 


 


 


 


Total loans and leases held for investment

     76,868,020       70,089,326       64,207,591       53,945,552       48,404,589  

Loans held for sale

     628,834       613,476       725,459       2,377,707       1,907,416  
    


 


 


 


 


Total loans and leases

     77,496,854       70,702,802       64,933,050       56,323,259       50,312,005  

Less: unearned income

     (2,473,366 )     (2,540,201 )     (2,627,664 )     (2,805,246 )     (2,868,832 )
    


 


 


 


 


Net loans and leases

   $ 75,023,488     $ 68,162,601     $ 62,305,386     $ 53,518,013     $ 47,443,173  
    


 


 


 


 


 

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

 

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

 

12


Underwriting Approach

 

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

 

  ·   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.

 

  ·   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.

 

Commercial Loan and Lease Portfolio

 

The commercial loan and lease portfolio represents the largest category of the Corporation’s total loan portfolio and is segmented as follows—business loans, generally defined as client relationships with total credit exposure above $1,000,000, small business loans, and leases. BB&T’s commercial lending program is generally targeted to serve small-to-middle market businesses with sales of $200 million or less. Traditionally, lending to small and mid-sized businesses has been among BB&T’s strongest markets.

 

Commercial loans are primarily originated through BB&T’s banking network. In accordance with the Corporation’s lending policy, each loan undergoes a detailed underwriting process, which incorporates BB&T’s underwriting approach, procedures and evaluations described above. In addition, the bank has adopted an internal maximum credit exposure lending limit of $220 million for a “best grade” credit, which is considerably below the Banks’ maximum legal lending limit. Commercial loans are typically priced with an interest rate tied to market indexes, such as the prime rate and the London Interbank Offered Rate (“LIBOR”). Commercial loans are individually monitored and reviewed for any possible deterioration in the ability of the client to repay the loan. Approximately 94% of BB&T’s commercial loans are secured by real estate, business equipment, inventories and other types of collateral.

 

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

 

Consumer Loan Portfolio

 

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

 

13


The consumer loan portfolio consists of three primary sub-portfolios—direct retail, revolving credit and sales finance. The direct retail category consists mainly of home equity loans and lines of credit, which are secured by residential real estate. It also includes installment loans and some unsecured lines of credit other than credit cards. The revolving credit category is comprised of the outstanding balances on credit cards and BB&T’s checking account overdraft protection product, Constant Credit. Such balances are generally unsecured and actively managed by BB&T Bankcard Corporation. Finally, the sales finance category primarily includes secured indirect installment loans to consumers for the purchase of automobiles. Such loans are originated through approved franchised and independent automobile dealers throughout the BB&T market area and, to a lesser degree, states outside BB&T’s market area. On a very limited basis, sales finance loans are also originated through qualified non-automotive dealers for the purchase of boats, recreational vehicles and other consumer equipment. Substantially all consumer loans, excluding the revolving credit portfolio, are secured.

 

Mortgage Loan Portfolio

 

BB&T is a large originator of residential mortgage loans, with originations in 2005 totaling $10.5 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. BB&T primarily originates conforming mortgage loans. These are loans that are underwritten in accordance with the underwriting standards set forth by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). They are generally collateralized by one-to-four-family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing.

 

Risks associated with the mortgage lending function include interest rate risk, which is mitigated through the sale of substantially all conforming fixed-rate loans in the secondary mortgage market and an effective mortgage servicing rights hedge process. Borrower risk is lessened through rigorous underwriting procedures and mortgage insurance. The right to service the loans and receive servicing income is generally retained when conforming loans are sold. Management believes that the retention of mortgage servicing is a primary relationship driver in retail banking and a vital part of management’s strategy to establish profitable long-term customer relationships and offer high quality client service. BB&T also purchases residential mortgage loans from correspondent originators. The loans purchased from third-party originators are subject to the same underwriting and risk-management criteria as loans originated internally.

 

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

 

Table 3

Composition of Loan and Lease Portfolio Based on Loan Purpose

 

     December 31,

     2005

   2004

   2003

   2002

   2001

     (Dollars in thousands)

Loans and leases, net of unearned income (1):

                                  

Commercial loans

   $ 34,491,099    $ 31,397,433    $ 28,483,728    $ 26,444,740    $ 23,647,330

Lease receivables

     3,164,372      2,887,663      2,677,058      2,524,058      2,318,530
    

  

  

  

  

Total commercial loans and leases

     37,655,471      34,285,096      31,160,786      28,968,798      25,965,860
    

  

  

  

  

Sales finance

     6,598,509      6,362,990      6,193,928      3,500,158      2,940,364

Revolving credit

     1,347,309      1,276,876      1,180,480      1,050,738      951,319

Direct retail

     14,940,638      13,932,879      12,130,101      9,400,230      8,273,829
    

  

  

  

  

Total consumer loans

     22,886,456      21,572,745      19,504,509      13,951,126      12,165,512
    

  

  

  

  

Residential mortgage loans

     14,481,561      12,304,760      11,640,091      10,598,089      9,311,801
    

  

  

  

  

Total loans and leases

   $ 75,023,488    $ 68,162,601    $ 62,305,386    $ 53,518,013    $ 47,443,173
    

  

  

  

  


(1)   Includes loans held for sale.

 

14


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, 2005

     Commercial,
Financial
and
Agricultural


   Real Estate:
Construction


   Total

     (Dollars in thousands)

Fixed rate:

                    

1 year or less (2)

   $ 399,509    $ 89,657    $ 489,166

1-5 years

     909,877      1,445,058      2,354,935

After 5 years

     272,842      270,047      542,889
    

  

  

Total

     1,582,228      1,804,762      3,386,990
    

  

  

Variable rate:

                    

1 year or less (2)

     3,488,867      5,155,854      8,644,721

1-5 years

     2,659,642      4,218,303      6,877,945

After 5 years

     521,853      763,539      1,285,392
    

  

  

Total

     6,670,362      10,137,696      16,808,058
    

  

  

Total loans and leases (3)

   $ 8,252,590    $ 11,942,458    $ 20,195,048
    

  

  


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

 

     (Dollars in
thousands)


(3)    The above table excludes:

      

(i)     consumer loans

   $ 9,603,925

(ii)    real estate mortgage loans

     41,539,400

(iii)   loans held for sale

     628,834

(iv)   lease receivables

     5,529,647
    

Total

   $ 57,301,806
    

 

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

 

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

 

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

 

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

 

15


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

 

Reserve Policy and Methodology

 

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

 

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

 

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

 

16


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

 

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

 

The following table presents an estimated allocation of the allowance for loan and lease losses at the end of each of the past five years. This table is presented based on the regulatory reporting classifications of the loans. Amounts applicable to years prior to 2002 reflect acquisitions accounted for as poolings of interests. This allocation of the allowance for loan and lease losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.

 

Table 5

Allocation of Allowance for Loan and Lease Losses by Category

 

    December 31,

 
    2005

    2004

    2003

    2002

    2001

 
    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

  $ 123,959   10.6 %   $ 116,602   10.9 %   $ 142,293    11.0 %   $ 150,700   12.4 %   $ 133,238   13.0 %

Real estate:

                                                            

Construction and land development

    131,731   15.4       95,925   12.2       93,924    10.0       85,525   9.4       79,443   10.6  

Mortgage

    381,110   54.4       403,433   56.4       381,678    56.9       332,490   57.5       234,872   54.6  
   

 

 

 

 

  

 

 

 

 

Total real estate

    512,841   69.8       499,358   68.6       475,602    66.9       418,015   66.9       314,315   65.2  
   

 

 

 

 

  

 

 

 

 

Consumer

    100,642   12.4       111,356   13.1       79,765    14.2       64,209   11.5       54,668   11.9  

Lease receivables

    37,794   7.2       34,600   7.4       42,440    7.9       45,173   9.2       38,098   9.9  

Unallocated

    50,064   —         43,016   —         44,837    —         45,588   —         104,099   —    
   

 

 

 

 

  

 

 

 

 

Total

  $ 825,300   100.0 %   $ 804,932   100.0 %   $ 784,937    100.0 %   $ 723,685   100.0 %   $ 644,418   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, U.S. government agencies, U.S. government sponsored entities, including mortgage-backed securities, bank eligible obligations of any state or political subdivision, bank eligible corporate obligations, including commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. BB&T’s bank subsidiaries may also deal in securities subject to the provisions of the Gramm-Leach-Bliley Act. Scott & Stringfellow, Inc., BB&T’s full-service brokerage and investment banking subsidiary, engages in the underwriting, trading and sales of equity and debt securities subject to the risk management policies of the Corporation.

 

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

 

17


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

 

Funding Activities

 

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

 

Deposits

 

Deposits are attracted principally from clients within BB&T’s branch network through the offering of a broad selection of deposit instruments to individuals and businesses, including noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money rate savings accounts, investor deposit accounts, certificates of deposit and individual retirement accounts. Deposit account terms vary with respect to the minimum balance required, the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (i) the interest rates offered by competitors, (ii) the anticipated amount and timing of funding needs, (iii) the availability and cost of alternative sources of funding, and (iv) the anticipated future economic conditions and interest rates. Client deposits are attractive sources of funding because of their stability and relative cost. Deposits are regarded as an important part of the overall client relationship and provide opportunities to cross-sell other BB&T services. In addition, BB&T gathers a portion of its deposit base through wholesale funding products, which include negotiable certificates of deposit and Eurodollar deposits through the use of a Cayman branch facility. At December 31, 2005, these sources of deposits represented approximately 12% of BB&T’s total deposits.

 

The following table provides information regarding the scheduled maturities of time deposits that are $100,000 and greater at December 31, 2005:

 

Table 6

Scheduled Maturities of Time Deposits $100,000 and Greater

December 31, 2005

(Dollars in thousands)

 

Maturity Schedule       

Three months or less

   $ 4,061,007

Over three through six months

     1,701,126

Over six through twelve months

     1,890,634

Over twelve months

     2,751,941
    

Total

   $ 10,404,708
    

 

18


Borrowed Funds

 

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

 

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

 

Employees

 

At December 31, 2005, BB&T had approximately 27,700 full-time equivalent employees compared to approximately 26,100 full-time equivalent employees at December 31, 2004.

 

Properties

 

BB&T and its significant subsidiaries occupy headquarters offices that are either owned or operated under long-term leases. BB&T also owns free-standing operations centers, with its primary operations and information technology center located in Wilson, North Carolina. BB&T also owns or leases significant office space used as the Corporation’s headquarters in Winston-Salem, North Carolina. At December 31, 2005, BB&T’s subsidiary banks operated 1,404 branch offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. BB&T also operates numerous insurance agencies and other businesses that occupy facilities. Office locations are either owned or leased. Management believes that the premises occupied by BB&T and its subsidiaries are well-located and suitably equipped to serve as financial services facilities. See Note 6 “Premises and Equipment” in the “Notes to Consolidated Financial Statements” in this report for additional disclosures related to BB&T’s properties and other fixed assets.

 

Executive Officers of BB&T

 

The following table lists the members of BB&T’s executive management team as of December 31, 2005:

 

Name of Executive Officer


  

Title


   Years of Service

   Age

John A. Allison, IV

   Chairman and Chief Executive Officer    35    57

Ricky K. Brown

   Senior Executive Vice President and Manager of Banking Network    29    50

W. Kendall Chalk

   Senior Executive Vice President and Chief Credit Officer    31    60

Barbara F. Duck

   Senior Executive Vice President and Production and Risk Manager    18    39

Robert E. Greene

   Senior Executive Vice President and Manager of Administrative Services    33    55

Christopher L. Henson

   Senior Executive Vice President and Chief Financial Officer    21    44

Kelly S. King

   Chief Operating Officer    34    57

Steven B. Wiggs

   Senior Executive Vice President and Chief Marketing Officer    27    48

C. Leon Wilson

   Senior Executive Vice President and Operations Division Manager    29    50

 

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

 

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

 

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REGULATORY CONSIDERATIONS

 

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 herein as the “Banks.” Each of the Banks is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”). State and Federal law also govern the activities in which the Banks engage, the investments they make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks’ operations.

 

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

 

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

 

Financial Holding Company Regulation

 

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

 

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

 

21


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

 

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

 

Acquisitions

 

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

 

Other Safety and Soundness Regulations

 

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

 

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

 

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

 

Payment of Dividends

 

BB&T is a legal entity separate and distinct from its subsidiaries. The majority of BB&T’s revenue is from dividends paid to BB&T by the Banks. The Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well-capitalized” under the prompt corrective action regulations summarized elsewhere in this section. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. North Carolina and Virginia laws state that, subject to certain capital requirements, the board of directors of a bank chartered under their laws may declare a dividend of as much of that bank’s undivided profits as the directors deem expedient. South Carolina allows for the payment of dividends by a state-chartered bank with the prior approval of the Commissioner of Banking. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. During the year ended December 31, 2005, the Banks declared $1.4 billion in dividends payable to BB&T. At December 31, 2005, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $3.2 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $880.7 million.

 

Capital

 

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

 

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

 

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

 

23


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

 

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

 

The ratios of Tier 1 capital, total capital to risk-adjusted assets, and leverage capital of BB&T and the Banks as of December 31, 2005, are shown in the following table.

 

Table 7

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

December 31, 2005

 

     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 %   9.3 %   9.4 %   10.6 %   11.6 %

Total risk-based capital (2)

   8.0     10.0     14.4     10.7     11.9     12.5  

Tier 1 leverage ratio (3)

   3.0     5.0     7.2     7.3     8.6     7.6  

(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 may also cause an institution to be directed to raise additional capital. Federal law also mandates that the agencies adopt safety

 

24


and soundness standards relating generally to operations and management, asset quality and executive compensation, and authorizes administrative action against an institution that fails to meet such standards.

 

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

 

Deposit Insurance Assessments

 

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

 

The FDIC imposes a risk-based deposit premium assessment system, based in part on an insured institution’s capital classification under the prompt corrective action provision, and whether the institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. The assessments are set forth in schedules issued by the FDIC that specify, at semi-annual intervals, target reserve ratios designed to maintain the reserve ratio of each of the funds at 1.25% of its estimated insured deposits. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of assessable deposits, depending on the institution’s capital position and other supervisory factors. In addition, both SAIF-insured and BIF-insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2005, the FDIC assessed BIF-insured and SAIF-insured deposits 1.32 basis points per $100 of deposits to cover those obligations. At December 31, 2005, BB&T’s assessment was limited to this 1.32 basis point obligation.

 

Consumer Protection Laws

 

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

 

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

 

The CRA requires the Banks’ primary federal bank regulatory agency, in this case the FDIC, to assess the bank’s record in meeting the credit needs of the communities served by each Bank, including low- and moderate-income neighborhoods and persons. Institutions are assigned one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” This assessment is reviewed for any bank that applies to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. The CRA record of each subsidiary bank of a financial holding company, such as BB&T, also is assessed by the Federal Reserve in connection with any acquisition or merger application.

 

USA Patriot Act

 

The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such

 

25


financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies, such as BB&T, with equity or debt securities registered under the Securities Exchange Act of 1934, as amended. In particular, the Sarbanes-Oxley Act established: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) certification responsibilities for the Chief Executive Officer and Chief Financial Officer with respect to the Company’s financial statements; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the federal securities laws.

 

Other Regulatory Matters

 

BB&T and its subsidiaries and affiliates are subject to numerous examinations by federal and state banking regulators, as well as the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state insurance and securities regulators. BB&T and its subsidiaries have from time to time received requests for information from regulatory authorities in various states, including state insurance commissions and state attorneys general, securities regulators and other regulatory authorities, concerning their business practices. Such requests are considered incidental to the normal conduct of business.

 

Corporate Governance

 

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

 

  ·   BB&T’s Corporate Governance Guidelines

 

  ·   BB&T’s Corporate Board of Directors

 

  ·   Committees of the Corporate Board of Directors and Committee Charters

 

  ·   BB&T’s Codes of Ethics for Directors, Senior Financial Officers and Employees

 

  ·   Chief Executive Officer and Chief Financial Officer Certifications

 

  ·   BB&T’s Executive Officers

 

  ·   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 26, 2005.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

The following discussion and analysis of the consolidated financial condition and consolidated results of operations of BB&T Corporation and subsidiaries (“BB&T” or the “Corporation”) for each of the three years in the period ended December 31, 2005, and related financial information, are presented in conjunction with the consolidated financial statements and related notes to assist in the evaluation of BB&T’s 2005 performance.

 

Reclassifications

 

In certain circumstances, reclassifications have been made to prior period information to conform to the 2005 presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income.

 

Mergers and Acquisitions Completed During 2005

 

During 2005, BB&T acquired a number of nonbank financial services companies and insurance agencies, all of which were immaterial in relation to the consolidated results of BB&T. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for further information regarding mergers and acquisitions.

 

Pending Mergers

 

On December 15, 2005, BB&T announced plans to acquire Main Street Banks, Inc. (“Main Street”), based in Atlanta, Georgia. At the time of announcement, Main Street had $2.5 billion in assets and operated 24 full-service banking offices in the Atlanta and Athens, Georgia metro areas. Shareholders of Main Street will receive .6602 shares of BB&T stock in exchange for each share of Main Street common stock held. The transaction, which is subject to shareholder and regulatory approval, is expected to be completed in the second quarter of 2006.

 

On January 12, 2006, BB&T announced plans to acquire First Citizens Bancorp (“First Citizens”), a bank holding company headquartered in Cleveland, Tennessee. First Citizens is the parent company to three community banks and operated 19 full-service branches at the time of the announcement. As of September 30, 2005, First Citizens had $686 million in assets. Shareholders of First Citizens, which is a privately held company, may elect to receive cash, subject to certain limitations, or 1.30 shares of BB&T stock for each share of First Citizen common stock held. The merger, which is subject to regulatory and shareholder approval, is expected to be completed in the second quarter of 2006.

 

Critical Accounting Policies

 

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

 

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

 

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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 outcomes of which are uncertain. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which BB&T conducts business. The methodology used to determine an estimate for the reserve for unfunded lending commitments is inherently similar to the methodology utilized in calculating the allowance for loans and leases adjusted for factors specific to binding commitments, including the probability of funding and exposure at the time of funding. A detailed discussion of the methodology used in determining the allowance for loan and lease losses and the reserve for unfunded lending commitments is included in the “Overview and Description of Business—Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments.”

 

Valuation of Mortgage Servicing Rights

 

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

 

Intangible Assets

 

BB&T’s growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. BB&T’s mergers and acquisitions are accounted for using the purchase method of accounting. Under the purchase method, BB&T is required to record the assets acquired, including identified intangible assets and liabilities assumed at their fair value, which often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. The amortization of identified intangible assets is based upon the estimated economic benefits to be received, which is also subjective. These estimates also include the establishment of various accruals and allowances based on planned facility dispositions and employee severance considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in goodwill, which is subject to ongoing periodic impairment tests based on the fair value of net assets acquired compared to the carrying value of goodwill. Please refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for a description of BB&T’s impairment testing process. The major assumptions used in the impairment testing process include the estimated future cash flows of each business unit and discount rates. Discount rates are unique to each business unit and are based upon the cost of capital specific to the industry in which the business unit operates. Management has evaluated the effect of lowering the estimated future cash flows or increasing the discount rate for each business unit by 10% and determined that no impairment of goodwill would have been recognized under this evaluation.

 

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Pension and Postretirement Benefit Obligations

 

BB&T offers various pension plans and postretirement benefit plans to employees. The calculation of the obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and assumptions used in the determination of future values of plan assets and liabilities are subject to management judgment and may differ significantly if different assumptions are used. The discount rate assumption used to measure the postretirement benefit obligations is set by reference to published high-quality bond indices, as well as certain hypothetical spot-rate yield curves. These yield curves were constructed from the underlying bond price and yield data collected as of the plan’s measurement date and are represented by a series of annualized, individual discount rates with durations ranging from six months to thirty years. Each discount rate in the curve was derived from an equal weighting of the double A or higher bond universe, apportioned into distinct maturity groups. For durations where no bond maturities were available, the discount rates for these maturities were extrapolated based on historical relationships from observable data in similar markets. These indices and hypothetical curves give only an indication of the appropriate discount rate because the cash flows of the bonds comprising the indices and curves do not match the projected benefit payment stream of the plan precisely. For this reason, we also consider the individual characteristics of the plan, such as projected cash flow patterns and payment durations, when setting the discount rate. Please refer to Note 13 “Benefit Plans” in the “Notes to Consolidated Financial Statements” for disclosures related to BB&T’s benefit plans, including quantitative disclosures reflecting the impact that changes in certain assumptions would have on service and interest costs and benefit obligations.

 

Income Taxes

 

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

 

Analysis of Financial Condition

 

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

 

For the year ended December 31, 2005, BB&T’s average assets totaled $104.6 billion, an increase of $8.3 billion, or 8.7%, compared to the 2004 average of $96.3 billion, primarily reflecting growth in average loans and leases and investment securities. Average loans and leases for 2005 were up $5.4 billion, or 8.2%, from 2004 and average investment securities increased $2.2 billion, or 12.3% compared to 2004. The primary components of the growth in average loans and leases were commercial loans and leases, which increased $2.9 billion, or 8.7%; consumer loans, which increased $1.6 billion, or 7.9%; and mortgage loans, which increased $934.1 million, or 7.5%. Total earning assets averaged $92.7 billion in 2005, an increase of $7.8 billion, or 9.1%, compared to 2004. These averages and growth rates include the effects of acquisitions.

 

BB&T’s average deposits totaled $70.3 billion, reflecting growth of $5.5 billion, or 8.5%, compared to 2004. The categories of deposits with the highest growth rates were: certificates of deposit and other time deposits, which increased $2.9 billion, or 10.9%; noninterest-bearing deposits, which increased $1.2 billion, or 10.2%; and money rate savings, which increased $1.4 billion, or 6.2%.

 

Shorter-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances. Average shorter-term borrowings totaled $7.4 billion for the year ended December 31, 2005, an increase of $795.4 million, or 12.1% from the 2004 average. BB&T has also utilized long-term debt for a significant portion of its funding needs. Long-term debt includes FHLB advances, other secured borrowings by the Banks and senior and subordinated debt issued by the Corporation and Branch Bank. Average long-term debt totaled $12.0 billion for the year ended December 31, 2005, up $1.1 billion, or 9.9%, compared to 2004.

 

The compound annual rate of growth in average total assets for the five-year period ended December 31, 2005, was 11.1%. Over the same five-year period, average loans and leases increased at a compound annual rate of

 

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11.3%, average securities increased at a compound annual rate of 6.1%, and average deposits grew at a compound annual rate of 11.2%. All balance sheet growth rates referred to include the effect of acquisitions accounted for as purchases, as well as internal growth.

 

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

 

Securities

 

The securities portfolio provides earnings and liquidity, and is managed as part of the overall asset and liability management process to optimize net interest income and reduce exposure to interest rate risk. Management has historically emphasized investments with duration of five years or less to provide flexibility in managing the balance sheet in changing interest rate environments. Total securities increased 6.9% in 2005, to a total of $20.5 billion at the end of the year. The quality of the investment portfolio continues to be strong with 55.0% of the total portfolio’s fair market value at December 31, 2005 comprised of U.S. Treasury securities and U.S. government-sponsored entity obligations, excluding mortgage-backed securities. The combined duration of the U.S. Treasury and U.S. government-sponsored entity portfolios was 3.41 years and 3.23 years at December 31, 2005 and 2004, respectively. Mortgage-backed securities composed 32.3% of the total investment portfolio at year-end 2005. The duration of the mortgage-backed securities was 3.18 years at December 31, 2005 compared to 2.78 years at December 31, 2004. The duration of the available-for-sale portfolio at December 31, 2005 was 3.26 years compared to 3.13 years at December 31, 2004.

 

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

 

Table 8

Composition of Securities Portfolio

 

     December 31,

     2005

   2004

   2003

     (Dollars in thousands)

Trading securities (at estimated fair value):

   $ 706,518    $ 334,256    $ 693,819
    

  

  

Securities held to maturity (at amortized cost):

                    

U.S. Treasury securities

     —        125      60,122
    

  

  

Total securities held to maturity

     —        125      60,122
    

  

  

Securities available for sale (at estimated fair value):

                    

U.S. Treasury securities

     111,905      122,455      142,758

U.S. government-sponsored entity securities

     11,153,714      12,640,065      12,108,472

States and political subdivisions

     674,702      784,379      945,988

Mortgage-backed securities

     6,611,058      4,530,426      1,549,524

Equity and other securities

     1,231,587      760,871      816,212
    

  

  

Total securities available for sale

     19,782,966      18,838,196      15,562,954
    

  

  

Total securities

   $ 20,489,484    $ 19,172,577    $ 16,316,895
    

  

  

 

At December 31, 2005, trading securities reflected on BB&T’s consolidated balance sheet totaled $706.5 million compared to $334.3 million at December 31, 2004. Approximately two-thirds of the trading portfolio at December 31, 2005, was held by BB&T’s full-service brokerage subsidiary as a normal part of its operations and, as a result, is subject to significant fluctuations based on market conditions, which affect the timing of purchases and sales of securities. Market valuation gains and losses in the trading portfolio are reflected in current earnings.

 

Securities available for sale totaled $19.8 billion at year-end 2005 and are carried at estimated fair value. Securities available for sale at year-end 2004 totaled $18.8 billion. Unrealized market valuation gains and losses on securities classified as available for sale are recorded as a separate component of shareholders’ equity, net of deferred income taxes. The available-for-sale portfolio is primarily composed of investments in U.S. government-

 

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sponsored entity securities and mortgage-backed securities, which together composed 89.8% of the portfolio. This portfolio also contains investments in U.S. Treasury securities, which represented less than 1% of the December 31, 2005 balance, obligations of states and municipalities, which represented 3.4% of the available-for-sale portfolio, and equity and other securities, which made up 6.2% of the available-for-sale portfolio.

 

The $944.8 million increase in securities available for sale was the result of a combination of factors, including management’s decision to increase its securities portfolio to offset variances in projected loan growth during the early part of 2005, the reinvestment of cash flows from securities that matured in 2004 that were not reinvested until 2005 due to prevailing market conditions at the time the securities matured and the securitization of approximately $210 million in mortgage loans that were held in BB&T’s loan portfolio and subsequently transferred to the securities portfolio. During the year ended December 31, 2005, BB&T sold $1.3 billion of available-for-sale securities and realized net gains totaling $113 thousand.

 

The following table presents BB&T’s securities portfolio at December 31, 2005, segregated by major category with ranges of maturities and average yields disclosed.

 

Table 9

Securities

 

     December 31, 2005

 
     Carrying
Value


   Weighted
Average Yield (1)


 
     (Dollars in thousands)  
U.S. Treasury securities:              

Within one year

   $ 72,992    2.51 %

One to five years

     38,913    3.44  

Five to ten years

     —      —    

After ten years

     —      —    
    

  

Total

     111,905    2.84  
    

  

U.S. government-sponsored entity securities:              

Within one year

     95,346    4.32  

One to five years

     8,047,195    3.39  

Five to ten years

     3,011,173    4.46  

After ten years

     —      —    
    

  

Total

     11,153,714    3.69  
    

  

Mortgage-backed securities (2):              

Within one year

     93    6.26  

One to five years

     239,275    3.76  

Five to ten years

     56,175    5.75  

After ten years

     6,315,515    4.59  
    

  

Total

     6,611,058    4.57  
    

  

Obligations of states and political subdivisions:              

Within one year

     83,345    4.77  

One to five years

     410,796    6.49  

Five to ten years

     96,190    7.06  

After ten years

     84,371    7.35  
    

  

Total

     674,702    6.46  
    

  

Other securities (3):              

Within one year

     25    6.10  

One to five years

     9,528    3.67  

Five to ten years

     155,479    5.53  

After ten years

     564,338    5.15  
    

  

Total

     729,370    5.22  
    

  

Trading securities and securities with no stated maturity (4)      1,208,735    3.36  
    

  

Total securities (5)

   $ 20,489,484    4.09 %
    

  

 

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(1)   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.
(2)   For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted average contractual maturities of underlying collateral.
(3)   Includes privately-issued mortgage-backed securities totaling $560.0 million. For purposes of the maturity table, these securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted average contractual maturities of underlying collateral.
(4)   Trading securities and securities with no stated maturity include equity investments which totaled $502.2 million and trading securities which totaled $706.5 million.
(5)   Includes securities available-for-sale and trading securities carried at estimated fair values of $19.8 billion and $706.5 million, respectively.

 

The available-for-sale portfolio comprised 96.6% of total securities at December 31, 2005. Management believes that the high concentration of securities in the available-for-sale portfolio allows flexibility in the day-to-day management of the overall investment portfolio, consistent with the objective of optimizing profitability and mitigating interest rate risk.

 

The market value of the available-for-sale portfolio at year-end 2005 was $533.2 million lower than the amortized cost of these securities. At December 31, 2005, BB&T’s available-for-sale portfolio had net unrealized losses, net of deferred income taxes, of $337.6 million, which is reported as a component of shareholders’ equity. At December 31, 2004, the available-for-sale portfolio had net unrealized losses of $87.5 million, net of deferred income taxes.

 

On December 31, 2005, BB&T held certain investment securities having continuous unrealized loss positions for more than 12 months totaling $479.1 million. Substantially all of these investments were in U.S. government-sponsored entity securities, which are primarily comprised of debentures and mortgage-backed securities issued by the Federal Farm Credit Bureau, the Federal Home Loan Bank System, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These agencies are rated AAA and the unrealized losses are the result of increases in market interest rates rather than the credit quality of the issuers. Furthermore, in excess of 85% of the total value of these securities is within 5% of their amortized cost at December 31, 2005. BB&T has the ability and intent to retain these securities for a period of time sufficient to recover all unrealized losses. Accordingly, BB&T has not recognized any other-than-temporary impairment in connection with these securities.

 

The fully taxable equivalent (“FTE”) yield on the total securities portfolio was 4.17% for the year ended December 31, 2005, compared to 4.05% for the prior year. The increase in FTE yield resulted principally from the changes in the overall composition of the securities portfolio with a larger concentration of higher-yielding mortgage-backed securities. The yield on U.S. Treasuries and U.S. government sponsored-entity securities decreased from 3.88% in 2004 to 3.84% in 2005, while the yield on mortgage-backed securities increased from 4.52% to 4.72% and the FTE yield on state and municipal securities increased from 6.51% last year to 6.73% in the current year.

 

Loans and Leases

 

Management emphasizes commercial lending to small and medium-sized businesses, consumer lending and mortgage lending with an overall goal of maximizing the profitability of the loan portfolio while maintaining strong asset quality. The various categories of loan products offered by BB&T are discussed under “Lending Activities” in the “Overview and Description of Business” section herein. BB&T is a full-service lender with approximately one-half of its loan portfolio comprised of loans to businesses and one-half comprised of loans to individual consumers. Average commercial loans, including lease receivables, comprise 50.2% of the loan portfolio, compared to 50.0% in 2004. Average consumer loans, which include sales finance, revolving credit and direct retail, comprise 31.0% of average loans, compared to 31.1% in 2004. Average mortgage loans represented the remaining 18.8% of average total loans for 2005, compared to 18.9% a year ago.

 

32


BB&T’s loan portfolio, excluding loans held for sale, increased $6.8 billion, or 10.1%, as compared to 2004. Average total loans and leases for 2005 increased $5.4 billion, or 8.2%, compared to 2004. In addition to strong internal loan growth, the average loan increase was aided by the addition of loans held by Republic Bancshares, Inc. (“Republic”), which was acquired on April 14, 2004, and had loans of $1.7 billion. Average loan growth was reduced by the securitization of $210 million and $1.0 billion of residential mortgage loans during the fourth quarter of 2005 and the third quarter of 2004, respectively. The resulting mortgage-backed securities were transferred to the available-for-sale securities portfolio. The securitization in the third quarter of 2004 was undertaken to rebalance the loan portfolio, which had grown significantly as a result of strong mortgage loan originations over the prior two years and the retention of approximately $3.6 billion in fixed-rate mortgage loans during the second-half of 2003. The securitization completed during 2005 was to provide additional collateral-eligible assets needed to satisfy client demands.

 

Average commercial loans and leases increased $2.9 billion, or 8.7%, in 2005 as compared to 2004 and the pace of growth in this portfolio continued to improve throughout 2005 as a result of improving general economic conditions across BB&T’s footprint. Average consumer loans increased $1.6 billion, or 7.9%, as compared to 2004, which was comprised of increases in direct retail loans of 10.0%, sales finance loans of 3.7% and revolving credit loans of 6.0%. The pace of growth in the consumer loan portfolio slowed somewhat in 2005, especially direct retail loans, due to higher interest rates causing a slowdown in demand for home equity loan products. Sales finance loans produced positive trends, as two of BB&T’s primary competitors faced significant challenges in the latter part of 2005 and BB&T was able to capitalize on its position as the leading bank lender of sales finance loans in most of its markets. Average mortgage loans increased $934.1 million, or 7.5%, compared to 2004. Management views mortgage loans as excellent long-term investments due to their lower credit risk, liquidity characteristics and current favorable spreads versus U.S. Treasury securities, and believes originating and servicing mortgage loans is an integral part of BB&T’s relationship-based credit culture. The growth in the portfolio of mortgage loans in 2005 was reduced by the securitizations previously discussed. BB&T is a large originator of residential mortgage loans, with 2005 originations of $10.5 billion. To improve the overall yield of the loan portfolio and to mitigate interest rate risk, BB&T sells most of its fixed-rate mortgage loans in the secondary market. At December 31, 2005, BB&T was servicing $25.8 billion in residential mortgages owned by third parties and $15.3 billion of mortgage loans owned by BB&T, including $781.1 million classified as securities available for sale.

 

The average annualized FTE yields on commercial, consumer and mortgage loans for 2005 were 6.58%, 7.31% and 5.44%, respectively, resulting in a yield for the total loan portfolio of 6.59%. The FTE yields on commercial, consumer and mortgage loans for 2004 were 5.41%, 6.79% and 5.55%, respectively, resulting in a yield for the total loan portfolio of 5.87%. The 72 basis point increase in the average yield on loans resulted primarily from an increase in rates on commercial loans as variable-rate loans were repriced and fixed-rate loans with lower yields were replaced with higher-yielding loans and leases. During the second half of 2004, the Federal Reserve started to steadily increase the intended Federal funds rate in response to a pick up in economic activity. As a result of the Federal Reserve Board’s actions, the prime rate, which is the basis for pricing many commercial and consumer loans, was 7.25% at year-end 2005, compared to 5.25% at year-end 2004 and 4.00% during the first half of 2004. Therefore, as loans gradually reprice at higher rates or mature and are replaced with higher-yielding loans, the annualized yield of the loan portfolio is expected to increase. Evidence of this trend is visible from the changes in the quarterly annualized interest yield of the loan portfolio, which improved from 6.25% in the first quarter of 2005 to 6.90% during the fourth quarter of 2005. The rise in short-term interest rates was not matched by a similar rise in long-term interest rates. Therefore, mortgage rates, which are influenced by long-term interest rates in the marketplace, remained relatively unchanged compared to last year. As a result, the overall yield on mortgage loans declined slightly for 2005 compared to 2004, as older higher-yielding mortgage loans, which matured or were refinanced, were replaced with lower-yielding mortgage loans.

 

Asset Quality and Credit Risk Management

 

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

 

  ·   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;

 

33


  ·   ongoing servicing of individual loans and lending relationships;

 

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

 

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

 

BB&T’s lending strategy, which focuses on relationship-based lending within our markets and smaller individual loan balances, continues to produce 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,

 
     2005

    2004

    2003

    2002

    2001

 
     (Dollars in thousands)  

Nonaccrual loans and leases

   $ 228,879     $ 268,636     $ 350,440     $ 374,842     $ 316,607  

Restructured loans

     515       555       592       175       —    

Foreclosed property

     70,735       88,903       96,070       76,647       56,964  
    


 


 


 


 


Nonperforming assets

   $ 300,129     $ 358,094     $ 447,102     $ 451,664     $ 373,571  
    


 


 


 


 


Loans 90 days or more past due and still accruing

   $ 103,445     $ 100,170     $ 116,758     $ 115,047     $ 101,778  
    


 


 


 


 


Asset Quality Ratios: (1)

                                        

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

     .31 %     .39 %     .56 %     .70 %     .67 %

Nonperforming assets as a percentage of:

                                        

Total assets

     .27       .36       .49       .56       .53  

Loans and leases plus foreclosed property

     .40       .52       .72       .84       .79  

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

     .30       .36       .43       .48       .40  

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

     1.10       1.18       1.26       1.35       1.36  

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

     1.11       1.19       1.27       1.42       1.42  

Ratio of allowance for loan and leases to:

                                        

Net charge-offs

     3.84 x     3.42 x     3.17 x     2.94 x     3.44 x

Nonaccrual and restructured loans and leases

     3.60       2.99       2.24       1.93       2.04  

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 2005, BB&T’s credit quality continued to improve. The improving economic conditions combined with BB&T’s careful loan underwriting process and active monitoring of past due loans resulted in a reduction in total nonperforming assets and relative levels of nonperforming assets and net charge-offs. This is third consecutive year in which BB&T has experienced improvement in these asset quality ratios.

 

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

 

Table 11

Summary of Nonperforming Assets and Past Due Loans

 

     December 31,

 
     2005

    2004

    2003

 
     (Dollars in thousands)  

Nonaccrual loans and leases

                        

Commercial loans and leases

   $ 109,276     $ 143,420     $ 219,558  

Direct retail

     49,102       46,187       50,085  

Sales finance

     18,742       14,670       13,082  

Revolving credit

     233       349       342  

Mortgage

     51,526       64,010       67,373  
    


 


 


Total nonaccrual loans and leases

     228,879       268,636       350,440  
    


 


 


Foreclosed real estate

     48,315       69,324       78,964  

Other foreclosed assets

     22,420       19,579       17,106  

Restructured loans

     515       555       592  
    


 


 


Total nonperforming assets

   $ 300,129     $ 358,094     $ 447,102  
    


 


 


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

                        

Commercial loans and leases

     .15 %     .21 %     .35 %

Direct retail

     .07       .07       .08  

Sales finance

     .02       .02       .02  

Revolving credit

     —         —         —    

Mortgage

     .07       .09       .11  
    


 


 


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

     .31 %     .39 %     .56 %
    


 


 


Loans 90 days or more past due and still accruing interest

                        

Commercial loans and leases

   $ 16,953     $ 9,986     $ 17,759  

Direct retail

     20,814       19,917       25,695  

Sales finance

     22,137       21,205       27,863  

Revolving credit

     4,713       4,837       5,601  

Mortgage

     38,828       44,225       39,840  
    


 


 


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

   $ 103,445     $ 100,170     $ 116,758  
    


 


 


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

                        

Commercial loans and leases

     .02 %     .01 %     .04 %

Direct retail

     .03       .03       .04  

Sales finance

     .03       .03       .04  

Revolving credit

     .01       .01       .01  

Mortgage

     .05       .07       .06  
    


 


 


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

     .14 %     .15 %     .19 %
    


 


 


 

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 $829.8 million at December 31, 2005, a slight increase compared to $828.3 million at the end of 2004. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.10% at December 31, 2005, compared to 1.18% at year-end 2004. As a percentage of loans held for investment, the ratio of the allowance for loan and lease losses to total loans and leases was 1.11% at December 31, 2005 compared to 1.19% at the end of last year. BB&T’s strong credit history, combined with improvements in BB&T’s relative levels of net charge-offs and nonperforming assets, led to the reduction in the

 

35


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

 

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

 

Table 12

Analysis of Allowance for Credit Losses

 

     December 31,

 
     2005

    2004

    2003

    2002

    2001

 
     (Dollars in thousands)  

Balance, beginning of period

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


 


 


 


 


Charge-offs:

                                        

Commercial, financial and agricultural

     (52,150 )     (59,617 )     (71,984 )     (84,967 )     (63,387 )

Real estate

     (44,898 )     (60,688 )     (77,547 )     (61,608 )     (41,035 )

Consumer

     (174,520 )     (165,218 )     (161,424 )     (144,609 )     (124,359 )

Lease receivables

     (6,179 )     (11,156 )     (4,430 )     (5,965 )     (2,448 )
    


 


 


 


 


Total charge-offs

     (277,747 )     (296,679 )     (315,385 )     (297,149 )     (231,229 )
    


 


 


 


 


Recoveries:

                                        

Commercial, financial and agricultural

     14,081       16,365       25,380       18,029       14,985  

Real estate

     7,562       9,801       10,808       6,345       4,824  

Consumer

     38,713       34,302       30,251       24,890       23,955  

Lease receivables

     2,567       936       1,039       1,353       375  
    


 


 


 


 


Total recoveries

     62,923       61,404       67,478       50,617       44,139  
    


 


 


 


 


Net charge-offs

     (214,824 )     (235,275 )     (247,907 )     (246,532 )     (187,090 )
    


 


 


 


 


Provision charged to expense

     217,263       249,269       247,585       263,700       224,318  
    


 


 


 


 


Allowance for loans (sold) acquired, net

     (970 )     20,909       70,035       62,099       29,083  
    


 


 


 


 


Balance, end of period

   $ 829,770     $ 828,301     $ 793,398     $ 723,685     $ 644,418  
    


 


 


 


 


Average loans and leases (1)

   $ 71,517,308     $ 66,107,479     $ 57,857,069     $ 50,851,417     $ 46,587,780  
    


 


 


 


 


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

     .30 %     .36 %     .43  %     .48 %     .40  %
    


 


 


 


 



(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, 2005, were $74.3 billion, an increase of $6.6 billion, or 9.7%, compared to year-end 2004. The increase in deposits during 2005 was driven by a $4.4 billion, or 15.8% increase in certificates of deposit (“CDs”) and other time deposits, a $1.2 billion, or 10.0% increase in noninterest-bearing deposits, and a $1.1 billion, or 4.8% increase in money-rate savings accounts. For the year ended December 31, 2005, total deposits averaged $70.3 billion, an increase of $5.5 billion, or 8.5%, compared to 2004. The increase in average deposits was the result of a $2.9 billion, or 10.9% increase in average CDs and other time deposits, a $1.4 billion, or 6.2% increase in average money rate savings accounts, and a $1.2 billion, or 10.2% increase in noninterest-bearing deposits. The overall increase in average deposits included the impact of the acquisition of Republic during the second quarter of 2004, which added deposits of $2.5 billion.

 

CDs and other time deposits represent the largest component of BB&T’s deposits and composed 41.7% of total average deposits for 2005, compared to 40.8% at year-end 2004. Average money-rate savings accounts are the second largest source and comprised 33.1% of total average deposits for 2005 compared to 33.8% for 2004. The

 

36


remainder of the portfolio is comprised of noninterest-bearing deposits and savings and interest-checking accounts, which comprised 18.3% and 7.0%, respectively, of total average deposits in the current year, compared to 18.0% and 7.4%, respectively, for last year. The increase in the percentage of CDs and other time deposits to total deposits during 2005 was primarily a result of the Corporation decreasing its reliance on federal funds purchased and securities sold under repurchase agreements, and instead relying to a greater degree on wholesale deposit products. The decision to use wholesale deposit products was primarily due to more attractive pricing of these types of funding sources. During the fourth quarter of 2005, the growth in CDs and other time deposits was generated by retail CDs in BB&T’s branch network, while wholesale funding products declined compared to the third quarter, as management emphasized retail CDs.

 

The average rate paid on interest-bearing deposits increased to 2.18% during 2005, from 1.37% in 2004. This increase resulted primarily from the steady interest rate increases by the Federal Reserve which began during the second half of 2004 and resulted in BB&T increasing its rates on its interest-bearing deposit products. The average rates paid on the various categories of interest-bearing deposits also increased as follows: other time deposits, including individual retirement accounts and certificates of deposit, increased to 3.07% in the current year from 2.11% in 2004; money rate savings accounts increased to 1.42% in the current year from .74% in 2004; interest checking increased to .80% in 2005 from .33% in 2004; and savings deposits increased to .22% in 2005 from .17% in 2004.

 

BB&T also uses various types of shorter-term borrowings in meeting funding needs. While client deposits remain the primary source for funding loan originations, management uses shorter-term borrowings as a supplementary funding source for loan growth. Shorter-term borrowings comprised 7.1% of total funding needs on average in 2005 as compared to 6.8% in 2004. See Note 9 “Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Short-Term Borrowed Funds” in the “Notes to Consolidated Financial Statements” herein for further disclosure. The types of shorter-term borrowings utilized by the Corporation include Federal funds purchased, which composed 17.1% of total shorter-term borrowings, and securities sold under repurchase agreements, which comprised 41.1% of shorter-term borrowings at year-end 2005. Master notes, U.S. Treasury tax and loan deposit notes, short-term bank notes and short-term Federal Home Loan Bank (“FHLB”) advances are also utilized to meet short-term funding needs. Shorter-term borrowings at the end of 2005 were $6.6 billion, relatively unchanged compared to year-end 2004. Average shorter-term borrowings totaled $7.4 billion during 2005 compared to $6.6 billion last year. The increase in average shorter-term borrowings was primarily to fund healthy loan growth during 2005; however, these funds were replaced with other funding sources later in the year resulting in the slight decline in the balance at December 31, 2005 compared to year-end 2004. The rates paid on average shorter-term borrowings increased from 1.37% in 2004 to 3.04% during 2005. The increase in the cost of shorter-term borrowings resulted from recent actions by the Federal Reserve Board, which increased the targeted Federal funds rate by 125 basis points during the second half of 2004 and 200 basis points during 2005. At December 31, 2005, the targeted federal funds rate was 4.25% as compared to its lowest level of 1.00% set in June 2003. The following table summarizes certain pertinent information for the past three years with respect to BB&T’s shorter-term borrowings:

 

Table 13

Federal Funds Purchased, Securities Sold Under

Agreements to Repurchase and Short-Term Borrowed Funds

 

     As of / For the Year Ended Ended
December 31,


 
     2005

    2004

    2003

 
     (Dollars in thousands)  
Securities Sold Under Agreements to Repurchase                         

Maximum outstanding at any month-end during the year

   $ 4,269,150     $ 3,689,890     $ 3,177,747  

Balance outstanding at end of year

     2,699,435       2,520,956       2,831,068  

Average outstanding during the year

     3,504,940       3,077,625       2,603,343  

Average interest rate during the year

     3.04 %     1.38 %     1.29 %

Average interest rate at end of year

     3.73       2.12       1.11  
Federal Funds Purchased and Short-term Borrowed Funds                         

Maximum outstanding at any month-end during the year

   $ 5,447,348     $ 5,319,379     $ 4,503,832  

Balance outstanding at end of year

     3,862,284       4,166,916       4,503,832  

Average outstanding during the year

     3,880,886       3,512,846       2,537,500  

Average interest rate during the year

     3.04 %     1.36 %     0.97 %

Average interest rate at end of year

     3.93       2.03       0.91  

 

37


BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 11.4% of total funding needs on average during 2005 and 11.3% in 2004. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for further disclosure. Long-term debt at December 31, 2005 totaled $13.1 billion, an increase of $1.7 billion, or 14.9%, from year-end 2004. For the year ended December 31, 2005, average long-term debt increased $1.1 billion, or 9.9%, compared to the average for 2004. BB&T’s long-term debt consists primarily of FHLB advances, which composed 43.3% of total outstanding long-term debt at December 31, 2005, and subordinated notes of BB&T Corporation, which composed 25.5% of the year-end balance. FHLB advances are cost-effective long-term funding sources that provide BB&T with the flexibility to structure the debt in a manner that aids in the management of interest rate risk and liquidity. The remaining long-term debt consists of both secured and unsecured senior and subordinated borrowings by Branch Bank, junior subordinated debt to unconsolidated trusts issued by the Corporation, and capital leases. The average rate paid on long-term debt increased from 3.48% during 2004 to 4.22% during 2005 primarily because BB&T has issued floating rate instruments or elected to swap a portion of its fixed-rate long-term debt to floating rates.

 

The increase in long-term debt during 2005 was primarily the result of the issuance of $500 million of capital securities by BB&T Corporation and $1.25 billion of senior floating rate debt issued by Branch Bank during 2005. The proceeds from the capital securities offering are being used to fund repurchases of BB&T’s common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&T’s subsidiaries and for other general corporate purposes. The proceeds from the senior floating rate debt offerings are being used for general bank funding purposes.

 

During the second quarter of 2005, BB&T redeemed $89.0 million of trust preferred securities. These trust preferred securities were assumed by BB&T through various acquisitions. The average interest rate paid on such securities was approximately 8.5%, which was significantly higher than BB&T’s current borrowing rates. BB&T recorded a $2.9 million loss on early extinguishment of debt in connection with the redemption, which is reflected in BB&T’s Consolidated Statements of Income as a category of noninterest expenses.

 

On June 30, 2005, BB&T exchanged $350 million of subordinated notes maturing in 2025 and bearing an interest rate of 6.375% for $400 million aggregate principal amount of subordinated global notes maturing in 2017 and bearing an interest rate of 4.90%. This exchange was accounted for in accordance with Emerging Issues Task Force 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” (“EITF 96-19”). The transaction gave rise to substantially similar debt as defined by EITF 96-19 and, therefore, resulted in no immediate gain or loss. The financing costs relating to this exchange were deferred and will be amortized over the life of the $400 million subordinated global notes.

 

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

 

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

 

Analysis of Results of Operations

 

Consolidated net income for 2005 totaled $1.65 billion, which generated basic earnings per share of $3.02 and diluted earnings per share of $3.00. Net income for 2004 was $1.56 billion and net income for 2003 totaled $1.06 billion. Basic earnings per share were $2.82 in 2004 and $2.09 in 2003, while diluted earnings per share were $2.80 and $2.07 for 2004 and 2003, respectively.

 

Two important and commonly used measures of bank profitability are return on average assets (net income as a percentage of average total assets) and return on average shareholders’ equity (net income as a percentage of average common shareholders’ equity). BB&T’s returns on average assets were 1.58%, 1.62% and 1.25% for the years ended December 31, 2005, 2004 and 2003, respectively. The returns on average common shareholders’ equity were 14.95%, 14.71% and 11.97% for the last three years.

 

38


Merger-Related and Restructuring Charges

 

Mergers and acquisitions have played an important role in the development of BB&T’s franchise. BB&T has been an active acquirer of financial institutions, insurance agencies and other nonbank fee income producing businesses for many years. However, in 2004, management elected not to announce any new bank or thrift acquisitions during 2004 and 2005, and instead focus on integrating recent acquisitions and improving internal growth. Refer to Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of mergers and acquisitions consummated during the three years ended December 31, 2005. As a result of these activities, the consolidated results of operations for the three year period covered by this discussion include the effects of merger-related and restructuring charges, as well as expenses and certain gains related to the consummation of the transactions.

 

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

 

During 2005, BB&T recorded net merger-related and restructuring credits, or gains of $10.7 million, which are reflected in BB&T’s Consolidated Statements of Income as a separate category of noninterest expenses. These amounts were primarily associated with the sale of duplicate facilities and the finalization of severance and other personnel-related liabilities in connection with the First Virginia Banks, Inc. (“First Virginia”) and Republic acquisitions on terms more beneficial than originally estimated.

 

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

 

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

 

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

 

Table 14

Summary of Merger-Related and Restructuring Charges

(Dollars in thousands)

 

     For the Year Ended
December 31,


     2005

    2004

    2003

Severance and personnel-related charges

   $ (4,808 )   $ 8,976     $ 20,834

Occupancy and equipment charges

     (5,093 )     (11,752 )     22,290

Systems conversions and related charges

     3       580       5,271

Marketing and public relations

     —         4,038       7,565

Asset write-offs, and other merger-related charges

     (843 )     3,676       33,815
    


 


 

Total

   $ (10,741 )   $ 5,518     $ 89,775
    


 


 

 

Severance and personnel-related costs or credits include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination or reversals of previously estimated amounts, which typically occur in corporate support and data processing functions. BB&T did not have any job eliminations in connection with mergers during 2005. During 2004, BB&T estimated that 200 positions would be eliminated and receive severance in connection with the acquisition of Republic and 225 employees did, in fact, receive severance in 2004. Nine former employees

 

39


continued to receive severance payments during 2005. During 2003, BB&T estimated that 1,918 positions would be eliminated and receive severance and 980 employees did, in fact, receive severance during 2003. Substantially all of the remaining positions involved employees who voluntarily resigned or were offered positions elsewhere within BB&T. These former employees did not receive severance. A total of 551 of the employees whose jobs were eliminated received severance payments during 2004.

 

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

 

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

 

    First Virginia Banks, Inc

    (Dollars in thousands)
    Balance
January 1,
2004


  Accrued at
acquisition


 

Merger-

related and
restructuring
charges


    Utilized

    Purchase Price
Adjustments (1)


    Other,
net


  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
   

 

 


 


 


 

 

    Balance
January 1,
2005


  Accrued at
acquisition


  Merger-
related and
restructuring
charges


    Utilized

    Purchase Price
Adjustments


    Other,
net


  Balance
December 31,
2005


Severance and personnel-related charges

  $ 7,559   $ —     $ (1,190 )   $ (1,865 )   $ —       $ —     $ 4,504

Occupancy and equipment charges

    6,146     —       (3,526 )     (1,024 )     —         1,121     2,717

Systems conversions and related charges

    —       —       3       (3 )     —         —       —  

Other merger-related charges

    87     —       (107 )     (235 )     —         255     —  
   

 

 


 


 


 

 

Total

  $ 13,792   $ —     $ (4,820 )   $ (3,127 )   $ —       $ 1,376   $ 7,221
   

 

 


 


 


 

 


(1)   Primarily relates to favorable settlement of information technology contracts as a result of leveraging existing relationships with vendors.

 

The remaining accruals at December 31, 2005, for First Virginia primarily relate severance payments for certain executive officers and costs to exit certain leases and to dispose of excess facilities and equipment. These liabilities will be utilized in the future because they relate to specific contracts or legal obligations that expire in later years, or they relate to the disposal of duplicate facilities and equipment, which may take longer to complete.

 

40


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,
2004


  Accrued at
acquisition


  Merger-
related and
restructuring
charges


    Utilized

    Purchase
Price
Adjustments


    Other,
net


    Balance
December 31,
2004


Severance and personnel-related charges

  $ 8,955   $ 6,732   $ 5,850     $ (10,959 )   $ 723     $ (4,202 )   $ 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 )     (333 )     1,033       4,197
   

 

 


 


 


 


 

Total

  $ 42,357   $ 19,672   $ 2,106     $ (39,974 )   $ (288 )   $ (3,169 )   $ 20,704
   

 

 


 


 


 


 

    Balance
January 1,
2005


  Accrued at
acquisition


  Merger-
related and
restructuring
charges


    Utilized

    Purchase
Price
Adjustments


    Other,
net


    Balance
December 31,
2005


Severance and personnel-related charges

  $ 7,099   $ 75   $ (3,618 )   $ (2,382 )   $ 333     $ —       $ 1,507

Occupancy and equipment charges

    9,408     170     (1,567 )     (2,970 )     —         (152 )     4,889

Systems conversions and related charges

    —       —       —         —         —         —         —  

Other merger-related charges

    4,197     1,440     (736 )     (2,102 )     526       (401 )     2,924
   

 

 


 


 


 


 

Total

  $ 20,704   $ 1,685   $ (5,921 )   $ (7,454 )   $ 859     $ (553 )   $ 9,320
   

 

 


 


 


 


 

 

The liabilities for severance and personnel-related costs relate to severance liabilities that will be paid out based on such factors as expected termination dates, the provisions of employment contracts and the terms of BB&T’s severance plans. The remaining occupancy and equipment accruals relate to costs to exit certain leases and to dispose of excess facilities and equipment. Such liabilities will be utilized upon termination of the various leases and sale of duplicate property. The other merger-related liabilities relate to litigation and other similar charges.

 

In general, a major portion of accrued costs are utilized in conjunction with or immediately following the systems conversion, when most of the duplicate positions are eliminated and the terminated employees begin to receive severance. Other accruals are utilized over time based on the sale, closing or disposal of duplicate facilities or equipment or the expiration of lease contracts. Merger accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at December 31, 2005 are expected to be utilized during 2006, unless they relate to specific contracts that expire in later years.

 

Net Interest Income

 

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

 

41


Table 15

FTE Net Interest Income and Rate / Volume Analysis

For the Years Ended December 31, 2005, 2004 and 2003

 

                                              2005 vs. 2004

    2004 vs. 2003

 
    Average Balances

  Yield / Rate

    Income / Expense

 

Increase
(Decrease)


    Change due to

   

Increase
(Decrease)


    Change due to

 
    2005

  2004

  2003

  2005

    2004

    2003

    2005

  2004

  2003

    Rate

    Volume

      Rate

    Volume

 
    (Dollars in thousands)  

Assets

                                                                                                     

Securities, at amortized cost (1):

                                                                                                     

U.S. Treasury securities

  $ 120,535   $ 131,997   $ 171,028   3.05 %   2.93 %   3.04 %   $ 3,676   $ 3,865   $ 5,203   $ (189 )   $ 156     $ (345 )   $ (1,338 )   $ (189 )   $ (1,149 )

U.S. government-sponsored entity securities (6)

    12,298,615     13,882,763     11,603,010   3.78     3.91     4.65       465,491     542,720     539,560     (77,229 )     (16,841 )     (60,388 )     3,160       (93,526 )     96,686  

Mortgage-backed securities

    6,105,802     2,593,452     3,430,021   4.72     4.52     5.09       288,088     117,175     174,703     170,913       5,414       165,499       (57,528 )     (18,208 )     (39,320 )

States and political subdivisions

    699,380     827,260     901,579   6.73     6.51     6.83       47,079     53,822     61,571     (6,743 )     1,812       (8,555 )     (7,749 )     (2,826 )     (4,923 )

Other securities

    695,704     386,591     635,555   4.97     3.25     5.01       34,551     12,569     31,825     21,982       8,738       13,244       (19,256 )     (9,096 )     (10,160 )

Trading securities

    547,124     396,209     316,687   2.64     2.09     2.66       14,469     8,278     8,421     6,191       2,544       3,647       (143 )     (2,013 )     1,870  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total securities (5)

    20,467,160     18,218,272     17,057,880   4.17     4.05     4.81       853,354     738,429     821,283     114,925       1,823       113,102       (82,854 )     (125,858 )     43,004  

Other earning assets (2)

    718,325     620,451     548,403   3.06     1.79     1.39       22,009     11,088     7,659     10,921       8,945       1,976       3,429       2,340       1,089  

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

    71,517,308     66,107,479     57,857,069   6.59     5.87     6.06       4,713,136     3,878,548     3,504,656     834,588       501,581       333,007       373,892       (113,000 )     486,892  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total earning assets

    92,702,793     84,946,202     75,463,352   6.03     5.45     5.74       5,588,499     4,628,065     4,333,598     960,434       512,349       448,085       294,467       (236,518 )     530,985  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Non-earning assets

    11,909,089     11,329,792     9,864,376                                                                                    
   

 

 

                                                                                   

Total assets

  $ 104,611,882   $ 96,275,994   $ 85,327,728                                                                                    
   

 

 

                                                                                   

Liabilities and Shareholders’ Equity

                                                                                                     

Interest-bearing deposits:

                                                                                                     

Savings and interest checking

  $ 4,894,886   $ 4,797,668   $ 3,904,880   0.43     0.22     0.33       21,011     10,709     12,778     10,302       10,081       221       (2,069 )     (4,602 )     2,533  

Money rate savings

    23,264,482     21,907,558     18,219,720   1.42     0.74     0.76       330,744     162,561     137,800     168,183       157,530       10,653       24,761       (2,649 )     27,410  

Other time deposits

    29,308,871     26,427,935     25,309,123   3.07     2.11     2.39       900,079     556,390     605,099     343,689       277,694       65,995       (48,709 )     (74,595 )     25,886  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing deposits

    57,468,239     53,133,161     47,433,723   2.18     1.37     1.59       1,251,834     729,660     755,677     522,174       445,305       76,869       (26,017 )     (81,846 )     55,829  

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

    7,385,826     6,590,471     5,140,843   3.04     1.37     1.13       224,552     90,117     58,842     134,435       122,365       12,070       31,275       13,388       17,887  

Long-term debt

    11,958,681     10,886,199     11,710,281   4.22     3.48     3.87       504,583     378,695     458,268     125,888       86,067       39,821       (79,573 )     (44,298 )     (35,275 )
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Total interest-bearing liabilities

    76,812,746     70,609,831     64,284,847   2.58     1.70     1.97       1,980,969     1,198,472     1,272,787     782,497       653,737       128,760       (74,315 )     (112,756 )     38,441  
   

 

 

 

 

 

 

 

 

 


 


 


 


 


 


Noninterest-bearing deposits

    12,878,120     11,682,911     9,514,435                                                                                    

Other liabilities

    3,855,523     3,386,538     2,633,214                                                                                    

Shareholders’ equity

    11,065,493     10,596,714     8,895,232                                                                                    
   

 

 

                                                                                   

Total liabilities and shareholders’ equity

  $ 104,611,882   $ 96,275,994   $ 85,327,728                                                                                    
   

 

 

                                                                                   

Average interest rate spread

                    3.45 %   3.75 %   3.77 %                                                                  
                     

 

 

                                                                 

Net interest margin

                    3.89 %   4.04 %   4.06 %   $ 3,607,530   $ 3,429,593   $ 3,060,811   $ 177,937     $ (141,388 )   $ 319,325     $ 368,782     $ (123,762 )   $ 492,544  
                     

 

 

 

 

 

 


 


 


 


 


 



(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 $82.7 million, $81.4 million and $(21.2 million) for the three years ended December 31, 2005, 2004 and 2003, respectively.
(2)   Includes Federal funds sold, securities purchased under resale agreements or similar arrangements, interest-bearing deposits with banks, and other earning assets.
(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.
(6)   Includes stock issued by the FHLB of Atlanta.

 

42


For 2005, net interest income on an FTE-adjusted basis totaled $3.6 billion, compared with $3.4 billion in 2004 and $3.1 billion in 2003. The 5.2% increase in net interest income during 2005 resulted because the benefit from strong earning asset growth more than offset the adverse impact of the steady increase in short-term rates, which caused funding costs to increase faster than interest on earning assets.

 

The FTE-adjusted net interest margin is the primary measure used in evaluating the gross profit margin from the portfolios of earning assets. The FTE-adjusted net interest margin was 3.89% in 2005, 4.04% in 2004 and 4.06% in 2003. The average yield on interest earning assets increased 58 basis points compared to the average yield during 2004, while the average cost of funds over the same time period increased 88 basis points. The faster increase in the cost of funds compared to interest-earning assets is primarily a result of a delay in the repricing of earning assets compared to interest-bearing liabilities. While many of BB&T’s liabilities reprice in a short period of time after an increase in rates, there is typically a delay of between three and eighteen months before BB&T’s assets will be repriced. Therefore, once interest rates stabilize BB&T will continue to benefit from repricing of earning-assets and should not experience a similar rise in its cost of funding. In addition to the lag effect described above, the margin was also negatively affected by a flattening yield curve during 2005. Financial services companies, like BB&T, borrow money from clients and pay short-term rates, and invest assets in longer-term maturities, which generally produce an interest spread. During 2005, while short-term rates were rising in response to the Federal Reserve Boards actions, there was not a similar increase in longer-term rates. BB&T’s net interest margin was also negatively impacted by a reduction in benefits from interest-rate swaps when compared to 2004. BB&T’s management expects that interest rates will stabilize during 2006 and, given a return to a more traditional yield curve, BB&T’s net interest margin will also stabilize.

 

Provision for Credit Losses

 

A provision for credit losses is charged against earnings in order to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that reflects management’s best estimate of probable losses inherent in the credit portfolios at the balance sheet date. The amount of the provision is based on continuing assessments of nonperforming and “watch list” loans and associated unfunded credit commitments, analytical reviews of loss experience in relation to outstanding loans and funded credit commitments, loan charge-offs, nonperforming asset trends and management’s judgment with respect to current and expected economic conditions and their impact on the loan portfolio and outstanding unfunded credit commitments. The methodology used is described in the “Overview and Description of Business” section under the heading “Allowance for Loan and Lease Losses and Reserve for Unfunded Credit Commitments.” The provision for credit losses recorded by BB&T in 2005 was $217.3 million, compared with $249.3 million in 2004 and $247.6 million in 2003.

 

The provision for credit losses decreased 12.8% during 2005 while the total loan and lease portfolio increased 10.1% compared to the balance outstanding at the end of 2004. Net charge-offs were .30% of average loans and leases for 2005 compared to .36% of average loans during 2004. The allowance for loan and lease losses was 1.10% of loans and leases outstanding and was 3.60x total nonaccrual and restructured loans and leases at year-end 2005, compared to 1.18% and 2.99x, respectively, at December 31, 2004. The small increase from 2003 and the decrease compared with 2004 in the provision for credit losses reflects these improving credit quality trends and growth in the credit portfolios. Management expects these positive asset quality trends to stabilize in 2006.

 

Noninterest Income

 

Noninterest income has become, and will continue to be, a significant contributor to BB&T’s financial success. Noninterest income includes service charges on deposit accounts, trust revenue, mortgage banking income, investment banking and brokerage fees and commissions, insurance commissions, gains and losses on securities transactions and other commissions and fees derived from other activities. Noninterest income as a percentage of total revenues has steadily increased in recent years, totaling 39.1% for 2005 due to BB&T’s emphasis on growing and expanding its fee-based businesses. Fee-based service revenues lessen BB&T’s dependence on traditional spread-based interest income and are a relatively stable revenue source during periods of changing interest rates.

 

43


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

 

Table 16

Noninterest Income

 

                    % Change

 
     Years Ended December 31,

  

2005
v.

2004


   

2004
v.

2003


 
     2005

   2004

   2003

    
     (Dollars in thousands)             

Service charges on deposits

   $ 542,655    $ 523,319    $ 437,524    3.7 %   19.6 %

Mortgage banking income

     103,757      110,075      109,423    (5.7 )   .6  

Trust income

     140,630      119,479      113,227    17.7     5.5  

Insurance commissions

     714,189      619,055      395,820    15.4     56.4  

Securities gains, net

     113      6,133      126,211    (98.2 )   (95.1 )

Bankcard fees and merchant discounts

     112,132      102,098      83,927    9.8     21.7  

Investment banking and brokerage fees and commissions

     289,647      264,789      247,394    9.4     7.0  

Other nondeposit fees and commissions

     257,173      216,498      180,045    18.8     20.2  

Income from bank-owned life insurance

     93,770      91,883      98,700    2.1     (6.9 )

Other noninterest income

     71,556      65,942      35,068    8.5     88.0  
    

  

  

  

 

Total noninterest income

   $ 2,325,622    $ 2,119,271    $ 1,827,339    9.7 %   16.0 %
    

  

  

  

 

 

The 9.7% growth in noninterest income was the result of increased revenues from insurance commissions, trust income, bankcard fees and merchant discounts, service charges on deposit accounts, investment banking brokerage fees and commissions and other nondeposit fees and commissions. These increases were partially offset by a decline in gains from sales of securities and mortgage banking income. The 16.0% growth in noninterest income for 2004 was led by increased revenues from BB&T’s insurance operations as well as growth in income from service charges on deposit accounts, bankcard fees and merchant discounts, and other nondeposit fees and commissions. These increases were partially offset by a significant decline in gains from sales of securities. The major categories of noninterest income and fluctuations in these amounts are discussed in the following paragraphs. These fluctuations reflect the impact of acquisitions.

 

Service charges on deposit accounts represent BB&T’s second largest category of noninterest revenue. During 2005, BB&T experienced a 3.7% increase in revenue from service charges on deposit accounts compared to 2004. The primary reasons for the increase were higher revenues from overdraft items due to pricing increases and changes in fee structure, which increased revenues $40.1 million compared to 2004. This increase was partially offset by declines in commercial account analysis fees as a result of higher earnings credits and a reduction in monthly account service fees on certain personal and business services, which reduced revenues $8.0 million and $10.7 million, respectively, compared to last year. Management frequently monitors the pricing of various deposit products and services to ensure that BB&T remains competitive. During 2004, BB&T experienced a 19.6% increase in revenue from service charges on deposit accounts compared to 2003. The primary reasons for the increase were the purchases of Republic and First Virginia, improved collection of NSF and overdraft charges on commercial and personal accounts, and growth in commercial account analysis fees, which were $8.4 million, $60.8 million, and $11.8 million, respectively, more than in 2003. Additionally, the robust growth in noninterest bearing commercial and consumer deposit accounts during 2004 led to a higher level of transaction activity and related service fees, which offset the effect of the introduction of new lower-fee deposit products during 2003 and 2004 in response to intense price competition within BB&T’s markets.

 

44


Income from mortgage banking activities includes gains and losses from the sale of mortgage loans, revenue from servicing mortgage loans, valuation adjustments for mortgage servicing rights, mortgage servicing rights-related derivative gains/losses and amortization related to mortgage servicing rights. Mortgage banking income totaled $103.8 million in 2005, $110.1 million in 2004 and $109.4 million in 2003. The following table provides a breakdown of the various components of mortgage banking income and related statistical information:

 

Table 17

Mortgage Banking Income and Related Statistical Information

 

                       % Change

 
    

As of/ For the Years

Ended December 31,


   

2005
v.

2004


   

2004
v.

2003


 

Mortgage Banking Income


   2005

    2004

    2003

     
     (Dollars in thousands)              

Residential mortgage production revenues

   $ 58,217     $ 61,805     $ 200,234     (5.8 )%   (69.1 )%

Residential mortgage servicing revenues

     95,903       92,536       101,619     3.6     (8.9 )

Commercial mortgage banking revenues

     27,338       21,545       18,820     26.9     14.5  

Amortization of mortgage servicing rights

     (87,175 )     (90,994 )     (154,905 )   (4.2 )   (41.3 )

Mortgage servicing rights valuation recaptures (impairment)

     85,991       8,496       (36,844 )   NM     NM  

Mortgage servicing rights derivative hedge (losses) gain

     (76,517 )     16,687       (19,501 )   NM     NM  
    


 


 


           

Net

     9,474       25,183       (56,345 )   (62.4 )   (144.7 )
    


 


 


           

Total mortgage banking income

   $ 103,757     $ 110,075     $ 109,423     (5.7 )%   .6 %
    


 


 


           

NM—notmeaningful

                     % Change

 
    

As of/ For the Years

Ended December 31,


   

2005
v.

2004


   

2004
v.

2003


 

Mortgage Banking Statistical Information


   2005

    2004

    2003

     
     (Dollars in millions)              

Residential mortgage originations

   $ 10,528     $ 9,961     $ 19,392     5.7 %   (48.6 )%

Residential mortgage loans serviced for others

     25,844       24,526       24,868     5.4     (1.4 )

Residential mortgage loan sales

     4,835       5,323       13,100     (9.2 )   (59.4 )

10 Year Treasury Note Rate at period end

     4.39 %     4.22 %     4.25 %            

Change in 10 Year Treasury Note Rate during period

     0.17       (0.03 )     0.43              

Commercial mortgage originations

   $ 2,038     $ 1,554     $ 1,668     31.1     (6.8 )

Commercial mortgage loans serviced for others

     8,092       6,706       6,936     20.7     (3.3 )

 

The 5.7% decline in mortgage banking income was primarily a result of a decrease in the net impact of the valuation adjustment for mortgage servicing rights and related derivatives, which declined $15.7 million, or 62.4% compared to 2004. During 2005, BB&T recorded $86.0 million of recapture for the valuation of mortgage servicing rights as compared to $8.5 million in 2004. BB&T enters into a variety of derivative financial instruments to mitigate the risk associated with the valuation of mortgage servicing rights and has in the past used other economic risk management strategies, including the use of trading securities. During 2005 and 2004, BB&T recorded (losses)/gains related to its derivative financial instruments and other risk management strategies of $(76.5 million) and $16.7 million, respectively. In addition, mortgage production revenues declined 5.8% due to a lower volume of residential mortgage loan sales in 2005 compared to 2004. While residential mortgage originations increased from $10.0 billion in 2004 to $10.5 billion in 2005, a higher percentage of the 2005 originations were adjustable-rate mortgages, which BB&T typically retains in its loan portfolio. Commercial mortgage banking revenues, which are generated by BB&T’s subsidiary, Laureate Capital LLC (“Laureate”), increased 26.9%, or $5.8 million, due to a higher volume of loan originations. Laureate also increased its presence during 2005 with the acquisition of two firms specializing in commercial mortgage banking. Overall, mortgage banking income in 2004 was relatively unchanged compared to 2003; however, the components of income fluctuated as higher mortgage interest rates resulted in lower refinance activity and, consequently, less mortgage production revenue, but resulted in a recapture of the valuation allowance offsetting mortgage servicing rights. This is in contrast to 2003 when refinance activity resulting from very low mortgage rates produced record levels of mortgage production and related revenues, but also resulted in a large impairment in the value of BB&T’s

 

45


mortgage servicing rights. The mortgage servicing rights impairment which resulted in 2003 was largely offset by securities gains, which were utilized by BB&T as an economic risk management strategy prior to BB&T adopting a strategy that is dependent upon derivative financial instruments.

 

Revenues from BB&T’s extensive insurance agency/brokerage operations were the largest source of noninterest income during 2005 and 2004. Internal growth, combined with the expansion of BB&T’s insurance agency network through acquisitions during the last two years, resulted in growth of 15.4% in 2005 and 56.4% in 2004. Commission income from CRC Insurance Services (“CRC”), BB&T’s wholly owned wholesale insurance broker, contributed approximately $31.3 million in growth for the current year, while BB&T Insurance Services, Inc. and McGriff contributed an additional $18.9 million and $16.4 million of growth, respectively, compared to 2004. These increases were in property and casualty insurance commissions, which increased $66.6 million compared to 2004. Employee benefits commissions increased $15.7 million compared to 2004 and insurance fees and charges increased $14.5 million. The increase in commission income during 2004 was primarily related to the acquisition of McGriff, which contributed approximately $152.0 million of the $223.2 million increase. In addition, revenues from CRC contributed $47.4 million in growth in 2004 compared to 2003.

 

Revenue from corporate and personal trust services increased by $21.2 million, or 17.7%, in 2005 compared to 2004. Trust revenues are based on the types of services provided as well as the overall value of the assets managed, which is affected by stock market conditions. The increase in trust service income in 2005 was primarily a result of the acquisition of Sterling Capital Management LLC (“Sterling”), which contributed approximately $15.2 million in growth in the current year. In addition, administrative fees from proprietary mutual funds increased $5.2 million in 2005 compared to 2004. The increase in trust revenues during 2004 was primarily due to the acquisition of First Virginia, which added $2.2 billion in assets under management at the beginning of the third quarter of 2003 and to increases in proprietary mutual fund management fees. The increase in assets under management from First Virginia was offset by the loss of $2.4 billion in trust assets from the North Carolina state employees’ 401 (k) plan, which transferred to a successor trustee at the end of the quarter. The timing of these transfers had a net positive impact on 2004 trust income compared to 2003. The value of trust assets under management, including custodial accounts, increased during each of the last three years and was $32.9 billion, $28.4 billion and $27.2 billion at December 31, 2005, 2004 and 2003, respectively. The increase in assets under management during 2005 was primarily a result of the acquisition of Sterling, which added approximately $8 billion in assets. This increase was partially offset by a discontinuation of custodial responsibilities for approximately $4.5 billion of the assets of certain BB&T proprietary funds. The change in custodial responsibilities resulted in greater efficiencies for the shareholders of the BB&T Funds.

 

Net gains on sales of securities were $113 thousand in 2005 compared to $6.1 million in 2004. Net gains from sales of securities declined by 95.1% during 2004. During 2004, BB&T shifted to a risk management strategy related to mortgage servicing rights and mortgage banking operations entirely dependant on derivatives. During the period of declining interest rates that existed in 2003, BB&T utilized the increases in the value of the available-for-sale securities portfolio as an economic hedge against the decline in the carrying value of BB&T’s mortgage servicing rights. The net securities gains taken in 2003 were used to offset the net writedowns in the value of mortgage servicing rights.

 

Investment banking and brokerage fees and commissions increased $24.9 million in 2005 compared to 2004 and $17.4 million in 2004 compared to 2003. These increases resulted primarily from growth in investment banking and retail brokerage revenues at BB&T’s full-service brokerage and investment banking subsidiary, Scott & Stringfellow. The primary contributor to the 2005 increase was the acquisition of Windsor Group, LLC by Scott and Stringfellow. The 2004 increase was a result of higher demand for investment services at Scott & Stringfellow due to the continued expansion of a new product line and an improving economic environment, which resulted in increased revenues of $10.2 million during 2004 compared to 2003. The majority of the remaining $7.2 million increase in investment banking and brokerage fees and commissions in 2004 compared to 2003 were related to BB&T Investment Services, Inc., and caused by higher investment services revenues from BB&T’s newer markets through the increase in the number of investment counselors in those markets. In addition, production levels from BB&T’s existing investment counselors also increased during 2004.

 

Other nondeposit fees and commissions, including bankcard fees and merchant discounts increased $50.7 million, or 15.9%, during 2005 compared to 2004. The principal drivers of the increase were check card interchange fees, bankcard fees and merchant discounts and debit card network interchange fees, which

 

46


increased $16.1 million, $10.0 million, $9.4 million, respectively, compared to 2004. In addition, fees from money orders and official checks increased $8.2 million compared to 2004. The primary sources of the 2004 increase compared to 2003 were bankcard fees and merchant discounts, check card interchange fees, debit card network interchange fees, business check card interchange fees, and check card foreign ATM fees, which increased $18.2 million, $13.2 million, $4.0 million, $4.2 million, and $4.6 million, respectively, compared to 2003. In addition, the acquisitions of Republic and First Virginia contributed to the revenue growth.

 

BB&T has purchased life insurance coverage on certain of its officers for whom it has an insurable interest. Income from bank-owned life insurance increased slightly compared to 2004 primarily due to an increase in death proceeds on certain policies, which were partially offset by a decline in the market yields used to credit interest income to such policies. The 6.9% decline in 2003 was a result of declining market yields. BB&T has not purchased any additional contracts under this program since mid-year 2002.

 

Other income increased by 8.5%, or $5.6 million in 2005 compared to 2004. The increase during 2005 was primarily due to higher income from limited partnership investments, which increased $7.2 million compared to last year. In addition, trading income at Scott & Stringfellow increased $6.9 million compared to last year due to increased activity in the trading portfolio. This increase was offset by decreases related to derivative valuations and ineffectiveness of hedging derivatives, and lower income from various financial assets isolated for the purpose of providing post-employee benefits of $4.5 million and $2.8 million, respectively, during 2005 as compared to 2004. During 2004, other income increased by 88.0% primarily due to a $12.7 million fair value

adjustment related to miscellaneous investments made by a small business investment company and higher income from investments in limited partnerships, which were up $6.2 million. Another contributing factor was growth in revenues from check sales, which increased $5.6 million, primarily due to the acquisitions of First Virginia and Republic.

 

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

 

Noninterest Expense

 

Noninterest expense totaled $3.2 billion in 2005, $2.9 billion in 2004 and $3.0 billion in 2003. Certain significant items principally stemming from mergers and acquisitions were recorded as noninterest expenses during 2005, 2004 and 2003. In 2005, $10.7 million in pretax merger-related credits were recorded, in 2004 there was $5.5 million in merger-related charges, and in 2003, $89.8 million of merger-related charges were recognized. Additional disclosures related to these merger-related charges are presented in “Merger-Related and Restructuring Charges.” Noninterest expenses for 2005 also include a $44.0 million pre-tax one-time, non-cash adjustment that was recorded to account for escalating lease payments and the amortization of leasehold improvements. In addition, noninterest expense for 2003 includes a loss from the early termination of FHLB advances in the amount of $384.9 million, which was part of a balance sheet restructuring that management undertook to enhance future earnings, reduce interest rate risk and exposure to market volatility, improve the net interest margin and re-align the securities portfolio.

 

47


The table below shows the components of noninterest expense and the discussion that follows explains the composition of certain categories and the factors that caused them to change in 2005 and 2004.

 

Table 18

Noninterest Expense

 

                     % Change

 
     Years Ended December 31,

  

2005
v.

2004


   

2004
v.

2003


 
     2005

    2004

   2003

    
     (Dollars in thousands)             

Salaries and wages

   $ 1,474,135     $ 1,338,308    $ 1,174,121    10.1 %   14.0 %

Pension and other employee benefits

     311,069       293,449      271,419    6.0     8.1  
    


 

  

  

 

Total personnel expenses

     1,785,204       1,631,757      1,445,540    9.4     12.9  

Net occupancy expense on bank premises

     273,824       212,346      180,029    29.0     18.0  

Furniture and equipment expense

     197,674       203,178      191,138    (2.7 )   6.3  
    


 

  

  

 

Total occupancy and equipment expenses

     471,498       415,524      371,167    13.5     12.0  

Regulatory charges

     13,775       14,910      13,348    (7.6 )   11.7  

Foreclosed property expense

     23,176       26,272      19,329    (11.8 )   35.9  

Amortization of intangibles

     112,307       106,348      55,650    5.6     91.1  

Software

     52,184       43,347      43,966    20.4     (1.4 )

Telephone

     42,574       47,034      45,118    (9.5 )   4.2  

Advertising and public relations

     48,167       31,643      31,110    52.2     1.7  

Travel and transportation

     38,431       32,009      27,607    20.1     15.9  

Professional services

     93,272       75,822      70,518    23.0     7.5  

Supplies

     37,551       37,212      36,792    0.9     1.1  

Loan processing expenses

     98,239       84,253      78,887    16.6     6.8  

Deposit related expense

     37,578       34,249      28,571    9.7     19.9  

Merger-related and restructuring charges

     (10,741 )     5,518      89,775    NM     (93.9 )

Loss on early extinguishment of debt

     2,943       —        384,898    NM     NM  

Other noninterest expenses

     320,343       309,965      302,453    3.3     2.5  
    


 

  

  

 

Total noninterest expense

   $ 3,166,501     $ 2,895,863    $ 3,044,729    9.3 %   (4.9 )%
    


 

  

  

 


NM—not meaningful

 

The 9.3% increase in total noninterest expense during 2005 compared to 2004 was primarily due to increased personnel costs, the one-time lease adjustment noted above, and increased advertising and professional services. The 4.9% decrease in total noninterest expense during 2004 compared to 2003 was primarily caused by the combination of lower merger-related charges and the losses on early termination of FHLB advances in 2003. No such losses were incurred in 2004. These comparative decreases were partially offset by additional noninterest expenses as a result of the acquisitions of Republic, McGriff and several other nonbank financial services companies during 2004, and the acquisition of First Virginia in July of 2003.

 

Total personnel expense is the largest component of noninterest expense and includes salaries and wages, as well as pension and other employee benefit costs. The 2005 increase of 9.4% resulted primarily from additional salaries and wages as a result of increased incentive compensation and increased staffing. Total salaries and wages expense increased $135.8 million in 2005 compared to 2004 as a result of higher insurance incentive compensation, investment banking incentive compensation, mortgage loan production incentive compensation and other annual performance compensation, which grew $33.9 million, $19.2 million, $8.2 million and $19.3 million, respectively, compared to 2004. In addition, other compensation costs increased $54.5 million, primarily due to increased costs associated with additional staffing. The 6.0% increase in pension and other employee benefit costs was also affected by the additional salaries and wages expense, which caused increases in social security taxes and defined contribution plan expenses, of $8.7 million and $3.5 million, respectively, compared to 2004. In addition, pension expense increased $2.4 million and health care expenses increased $5.7 million compared to 2004. These increases were offset by a $12.4 million reduction in the cost of retiree health care due to a change in the level of subsidy for post-retirement medical benefits, which was made effective during 2004. The 2004 increase of

 

48


12.9% resulted primarily from additional personnel expenses associated with the First Virginia, McGriff and Republic mergers. The 14.0% increase in salaries and wages was primarily attributable to the above mentioned mergers, as well as higher insurance incentive compensation, investment banking incentive compensation, and other annual performance compensation, which grew $28.3 million, $12.2 million, and $16.3 million, respectively, compared to 2003. These increases were partially offset by lower mortgage loan production incentive compensation, which decreased $34.2 million compared to last year due to significantly lower mortgage loan production in 2004. The 8.1% increase in pension and other employee benefit costs was also affected by the above mergers, which caused increases in all categories of benefit expenses compared to 2003. Additional disclosures relating to BB&T’s benefit plans can be found in Note 13 “Benefit Plans” in the “Notes to Consolidated Financial Statements.”

 

Net occupancy and equipment expense increased by $56.0 million, or 13.5% in 2005. The increase is primarily the result of the $44.0 million one-time lease adjustment previously mentioned. In addition, rent expense on building and premises, depreciation and amortization expense and building maintenance expense increased an additional $7.5 million, $3.0 million and $2.9 million, respectively, compared to 2004. During 2004, net occupancy and equipment expense increased 12.0%. Substantially all of the increase resulted from the acquisitions of Republic, McGriff and First Virginia, which collectively added approximately $37.1 million in occupancy and equipment expenses. This amount was comprised of higher rent on buildings and premises, furniture and equipment expenses, utilities expenses, and depreciation expenses, which increased by $16.1 million, $12.6 million, $4.4 million, and $4.0 million, respectively, compared to 2003. Additionally, building maintenance expenses and real estate taxes increased by $2.3 million and $2.7 million, respectively.

 

The increase in amortization expense associated with intangible assets in 2005 compared to 2004 was primarily due to the acquisitions of Windsor and Sterling, which added $4.5 million and $1.9 million, respectively in amortization expense in 2005 as compared to 2004. The increase during 2004 was primarily due to the acquisitions of First Virginia, McGriff and Republic, which added $21.7 million, $19.6 million and $6.5 million, respectively, in amortization expenses during 2004 compared to the prior year. See Note 2 “Business Combinations” in the “Notes to Consolidated Financial Statements” for a summary of completed mergers and acquisitions during the three year period ended December 31, 2005.

 

Loan processing expenses were up $14.0 million, or 16.6% compared to 2004. This increase was primarily driven by higher expenses on retail loans and home equity lines of credit and retail bankcard expenses, which increased $5.9 million and $7.8 million, respectively, compared to 2004. The 2004 increase of $5.4 million compared to 2003 was also primarily driven by higher expenses on retail loans and home equity lines of credit, merchant expenses and retail bankcard expenses, which increased $3.0 million, $3.3 million, and $1.2 million, respectively, compared to 2003. However, this increase was partially offset by declines of $1.2 million and $1.1 million in mortgage loan processing and sales finance expenses, respectively, as a result of the lower volume of such loans in 2004.

 

Other noninterest expenses, including professional services, increased $54.6 million, or 8.4%, compared to 2004, which reflected an increase of $33.7 million, or 5.4% compared to 2003. The 2005 increase was primarily the result of higher advertising expenses, professional fees, and software expenses. The majority of the 2004 increase resulted from higher taxes and license expenses, insurance claims expenses, employee travel, and higher net losses from the disposition of fixed assets and the acquisitions of Republic, McGriff and First Virginia. Please refer to Table 18 for additional detail on fluctuations in other categories of noninterest expense.

 

The effective management of the Company’s noninterest operating costs is another key contributor to BB&T’s financial success, especially as BB&T becomes a larger and more diverse company. In 2004, management announced plans to implement cost savings and revenue enhancement initiatives with a goal to produce $175 million in combined annual cost savings and revenue enhancements. Implementation of the initiatives began in the fourth quarter of 2004. Management expected that approximately $60 million would be realized in 2005 pursuant to this effort. During 2005, management estimates that approximately $75 million of cost savings and revenue enhancements were achieved. Management anticipates that substantially all of the $175 million of annual benefits will be achieved in 2006 or in early 2007.

 

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Provision for Income Taxes

 

BB&T’s provision for income taxes totaled $813.0 million for 2005, an increase of $49.0 million, or 6.4%, compared to 2004. The provision for income taxes totaled $764.0 million in 2004 and $552.1 million in 2003. BB&T’s effective tax rates for the years ended 2005, 2004 and 2003 were 33.0%, 32.9% and 34.1%, respectively. The increased provision for income taxes in 2005 was the result of higher pretax income. The higher provision in 2004 compared to 2003 was due to higher pretax income during the year, which was offset by a decrease in the effective tax rate compared to 2003 attributable to the effects of adjustments related to deferred income taxes associated with BB&T’s leasing operations, which are discussed below. A reconciliation of the effective tax rate to the statutory tax rate is included in Note 12 “Income Taxes” in the “Notes to Consolidated Financial Statements” herein.

 

BB&T has extended credit to, and invested in, the obligations of states and municipalities and their agencies, and has made other investments and loans that produce tax-exempt income. The income generated from these investments together with certain other transactions that have favorable tax treatment have reduced BB&T’s overall effective tax rate from the statutory rate in 2005, 2004 and 2003. These transactions include entering into option contracts transferring future management of residual interests of certain leveraged leases to a wholly-owned foreign subsidiary for which BB&T intends to permanently reinvest the earnings.

 

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

 

In the normal course of business, BB&T is subject to examinations from various tax authorities. These examinations may alter the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. During 2003, the IRS concluded its examination of BB&T’s federal income tax returns for the years ended December 31, 1996, 1997 and 1998. Following its examination, the IRS issued a Revenue Agent Report assessing taxes and interest in the amount of $59.3 million related to BB&T’s income tax treatment of certain leveraged lease transactions which were entered into during the years under examination. The assessment, which was paid by BB&T during 2003, did not significantly affect BB&T’s consolidated results of operations in 2003 as it related primarily to differences in the timing of recognizing income and deductions for income tax purposes for which deferred taxes had been previously provided. Management continues to believe that BB&T’s treatment of these leveraged leases was appropriate and in compliance with the tax law and regulations applicable for the years examined. BB&T filed a refund request for the taxes and interest related to this matter which was denied by the IRS during the second quarter of 2004. Early in the fourth quarter of 2004, BB&T filed a lawsuit in the United States District Court for the Middle District of North Carolina to pursue a refund of $3.3 million in taxes plus interest assessed by the IRS related to a leveraged lease transaction entered into during 1997. While management expects that this litigation will not be resolved for one to two years, management believes that there will be no material impact on the results of operations or the financial condition of BB&T, regardless of the outcome of this litigation. Management continues to evaluate its alternatives with regard to the remaining amounts paid, which are related to BB&T’s tax treatment of leveraged lease transactions for the year ended December 31, 1998.

 

Market Risk Management

 

The effective management of market risk is essential to achieving BB&T’s strategic financial objectives. As a financial institution, BB&T’s most significant market risk exposure is interest rate risk; however, market risk also includes product liquidity risk, price risk and volatility risk. The primary objective of interest rate risk management is to minimize any adverse effect that changes in interest rates have on net interest income. This is accomplished through active management of asset and liability portfolios with a focus on the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The goal of

 

50


these activities is the development of appropriate maturity and repricing opportunities in BB&T’s portfolios of assets and liabilities that will produce consistent net interest income during periods of changing interest rates. BB&T’s ALCO monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes under various interest rate scenarios.

 

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

 

BB&T utilizes a variety of financial instruments to manage various financial risks. These instruments, commonly referred to as derivatives, primarily consist of interest rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. BB&T uses derivatives primarily to manage the economic risk related to business loans, federal funds purchased, long-term debt, mortgage servicing rights, mortgage banking operations, and institutional certificates of deposit. BB&T’s derivatives resulted in an increase in net interest income of $52.0 million, $155.4 million and $124.2 million in 2005, 2004 and 2003, respectively.

 

Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. On December 31, 2005, BB&T had derivative financial instruments outstanding with notional amounts totaling $23.7 billion. The estimated fair value of open contracts used for risk management purposes at December 31, 2005 had net unrealized losses of $10.6 million.

 

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

 

Impact of Inflation and Changing Interest Rates

 

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

 

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BB&T’s interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions at December 31, 2005, and is not necessarily indicative of positions on other dates. The carrying amounts of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. The table does not reflect the impact of hedging strategies.

 

Table 19

Interest Rate Sensitivity Gap Analysis

December 31, 2005

 

     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)

   $ 3,056,343    $ 6,878,475    $ 7,453,373    $ 4,079,093     $ 21,467,284

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

     286,233      —        —        —         286,233

Loans and leases (2)

     46,907,400      12,589,064      8,216,535      7,310,489       75,023,488
    

  

  

  


 

Total interest-earning assets      50,249,976      19,467,539      15,669,908      11,389,582       96,777,005
    

  

  

  


 

Liabilities                                    

Savings and interest checking (3)

     1,746,406      654,902      349,281      1,615,426       4,366,015

Money rate savings (3)

     9,819,548      3,682,331      1,963,910      9,083,083       24,548,872

Other time deposits

     23,032,032      4,306,873      2,008,717      2,542,351       31,889,973

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

     6,476,047      85,672      —        —         6,561,719

Long-term debt

     270,834      3,748,994      271,011      8,827,720       13,118,559
    

  

  

  


 

Total interest-bearing liabilities      41,344,867      12,478,772      4,592,919      22,068,580       80,485,138
    

  

  

  


 

Asset-liability gap    $ 8,905,109    $ 6,988,767    $ 11,076,989    $ (10,678,998 )      
    

  

  

  


     
Cumulative interest rate sensitivity gap    $ 8,905,109    $ 15,893,876    $ 26,970,865    $ 16,291,867        
    

  

  

  


     

(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

 

52


volumes and projected growth, accessibility of funds for short-term needs and capital maintenance are also considered. This data is combined with various interest rate scenarios to provide management with information necessary to analyze interest sensitivity and to aid in the development of strategies to reach performance goals.

 

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

 

Table 20

Interest Sensitivity Simulation Analysis

 

      

Interest Rate Scenario


  

Annualized Hypothetical

Percentage Change in

Net Interest Income


Linear

Change in

Prime Rate


  

Prime Rate


  
  

December 31,


  

December 31,


  

2005


  

2004


  

2005


  

2004


3.00%

   10.25%    8.25%    1.20%    2.59%

1.50   

   8.75       6.75       0.76       2.07   

No Change

   7.25       5.25       —      —  

(1.50)   

   5.75       3.75       (1.13)       (2.73)   

(2.25)   

   NA    3.00       NA    (3.92)   

(3.00)   

   4.25       NA    (1.95)       NA

NA = BB&T’s model typically calculates interest rate scenarios for both an increase and decrease of 1.50% and 3.00% change in rates. However, during 2004 a decrease of 3.00% in rates would have resulted in a negative federal funds rate and therefore an alternative scenario was modeled.

 

Management has established parameters for asset/liability management, which prescribe a maximum negative impact on interest sensitive income of 3% for the next twelve months for a linear change of 150 basis points for six months followed by a flat interest rate scenario for the remaining six month period, and a maximum negative impact of 6% for a linear change of 300 basis points over 12 months. It is management’s ongoing objective to effectively manage the impact of changes in interest rates and minimize any negative effects on earnings.

 

Liquidity

 

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

 

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

 

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The primary source of funds used for Parent Company cash requirements has been dividends declared from the Banks, which totaled $1.4 billion during 2005, and net proceeds from the issuance of long-term debt, which totaled $415.9 million in 2005. Funds raised through master note agreements with commercial clients are placed on deposit with bank subsidiaries primarily for their use in meeting short-term funding needs and, to a lesser extent, to support the short-term temporary cash needs of the Parent Company. At December 31, 2005 and 2004, master note balances totaled $1.1 billion and $910.2 million, respectively.

 

During 2005, BB&T filed a universal shelf registration statement with the Securities and Exchange Commission to provide for the issuance of up to $2.5 billion of securities, which could include unsecured debt securities, shares of common stock, shares of preferred stock, depositary shares representing fractional interest in preferred stock, stock purchase contracts, stock purchase units, warrants to purchase debt securities, preferred stock or common stock, or units consisting of a combination of these securities. In addition, the universal shelf registration statement provided for the issuance of capital securities issued by BB&T Capital Trust I. During 2005, BB&T issued $500 million of capital securities under this registration statement, leaving $2.0 billion available for issuance under this universal shelf registration statement.

 

The Parent Company had six issues of subordinated notes outstanding at December 31, 2005 and 2004 totaling $3.3 billion and $3.4 billion, respectively. Please refer to Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” for additional information with respect to these subordinated notes.

 

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

 

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

 

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

 

The following table presents, as of December 31, 2005, BB&T’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. Further discussion of the nature of each obligation is included in Note 14 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”

 

Table 21

Contractual Obligations and Other Commitments

December 31, 2005

 

     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

   $ 13,116,728    $ 270,834    $ 3,748,910