BB&T CORPORATION
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 


 

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the fiscal year ended:

 

December 31, 2006

 

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 January 31, 2007, the Corporation had 541,986,233 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation is approximately $22.4 billion (based on the closing price of such stock as of June 30, 2006.)

 

Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 24, 2007, are incorporated by reference in Part III of this report.

 


 



Table of Contents

CROSS REFERENCE INDEX

 

               Page

PART I

  

Item 1

   Business    4
  

Item 1A

   Risk Factors    4
  

Item 1B

  

Unresolved Staff Comments

None.

  
  

Item 2

   Properties    20
  

Item 3

   Legal Proceedings    113
  

Item 4

  

Submission of Matters to a Vote of Security Holders

None.

  

PART II

  

Item 5

   Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   

21,59

  

Item 6

   Selected Financial Data    67
  

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   

28

  

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    52
  

Item 8

   Financial Statements and Supplementary Data   
      Consolidated Balance Sheets at December 31, 2006 and 2005    71
      Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2006   

72

      Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2006   

73

      Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2006   

74

      Notes to Consolidated Financial Statements    75
      Report of Independent Registered Public Accounting Firm    69
      Quarterly Financial Summary for 2006 and 2005    66
  

Item 9

  

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

None.

  
  

Item 9A

   Controls and Procedures    68
  

Item 9B

  

Other Information

None.

  

PART III

  

Item 10

   Directors, Executive Officers and Corporate Governance    *,20
  

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, and Director Independence    *
  

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 1—Election of Directors”, “Corporate Governance Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders.

 

The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation Discussion and Analysis”, “Compensation of Executive Officers”, “Compensation Committee Report on Executive Compensation”, “Compensation Committee Interlocks and Insider Participation”, and “Compensation of Directors” in the Registrant’s Proxy Statement for the 2007 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—Equity Compensation Plan Information” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders.

 

The information required by Item 13 is incorporated herein by reference to the information that appears under the headings “Corporate Governance Matters”, “Compensation Committee Interlocks and Insider Participation”, “Compensation of Directors”, and “Transactions with Executive Officers and Directors” in the Registrant’s Proxy Statement for the 2007 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 2007 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 subsidiary, Branch Banking and Trust Company (“Branch Bank”), which has offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. In addition, BB&T’s operations consist of several nonbank subsidiaries, which offer financial services products. 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 assets are all of the issued and outstanding shares of common stock of Branch Bank and its other 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;

 

  ·  

local, state or federal taxing authorities may take tax positions that are adverse to BB&T;

 

  ·  

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 a material adverse impact on 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

 

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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;

 

  ·  

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 apply for fewer mortgage refinancings or purchase mortgages.

 

BB&T faces significant operational risk.

 

BB&T is exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Negative public opinion can result from BB&T’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect BB&T’s ability to attract and keep customers and can expose it to litigation and regulatory action.

 

Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. BB&T’s necessary dependence upon automated systems to record and process its transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. BB&T may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. BB&T is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is BB&T) and to the risk that BB&T’s (or its vendors’) business continuity and data security systems prove to be inadequate.

 

BB&T’s liquidity could be impaired by an inability to access the capital markets or an unforeseen outflow of cash.

 

Liquidity is essential to BB&T’s businesses. Due to circumstances that BB&T may be unable to control, such as a general market disruption or an operational problem that affects third parties or BB&T, BB&T’s liquidity could be impaired by an inability to access the capital markets or an unforeseen outflow of cash. BB&T’s credit

 

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ratings are important to its liquidity. A reduction in BB&T’s credit ratings could adversely affect its liquidity and competitive position, increase its borrowing costs, limit its access to the capital markets or trigger unfavorable contractual obligations.

 

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.

 

Differences in interpretation of tax laws and regulations may adversely impact BB&T’s financial statements.

 

Local, state or federal tax authorities may interpret tax laws and regulations differently than BB&T and challenge tax positions that BB&T has taken on its tax returns. This may result in the disallowance of deductions or differences in the timing of deductions and result in the payment of additional taxes, interest or penalties that could materially affect BB&T’s performance.

 

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 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

 

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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 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.

 

Significant litigation could have a material adverse effect on BB&T.

 

BB&T faces legal risks in its businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against BB&T could have material adverse financial effects or cause significant reputational harm to BB&T, which in turn could seriously harm BB&T’s business prospects.

 

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 the financial services industry is intense. The Company may not be able to hire the best people or retain them.

 

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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, 2006, the principal operating subsidiaries of BB&T included the following:

 

  ·  

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

 

  ·  

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 1,459 offices (as of December 31, 2006) located in North Carolina, South Carolina, Virginia, 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 (effective January 1, 2007 BB&T Leasing Corporation changed its name to BB&T Equipment Finance Corporation), which provides lease financing to commercial and small businesses;

 

  ·  

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;

 

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  ·  

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 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.

 

BB&T Bankcard Corporation is a special purpose bank, which offers revolving credit products.

 

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., a 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, alternative investment products and strategies and fixed income investing.

 

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

 

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  ·  

commercial mortgage lending

 

  ·  

equipment finance

 

  ·  

asset management

 

  ·  

retail and wholesale agency insurance

 

  ·  

institutional trust services

 

  ·  

wealth management / private banking

 

  ·  

investment brokerage services

 

  ·  

capital markets services

 

  ·  

commercial finance

 

  ·  

consumer finance

 

  ·  

international banking services

 

  ·  

treasury services

 

  ·  

venture capital

 

  ·  

bankcard and merchant services

 

  ·  

insurance premium finance

 

  ·  

payroll processing

 

The following table reflects BB&T’s deposit market share and branch locations by state at December 31, 2006.

 

Table 1

BB&T Deposit Market Share and Branch Locations by State

December 31, 2006

 

     % of
BB&T’s
Deposits (2)
    Deposit
Market
Share
Rank (2)
   Number of
Branches

Virginia

   27 %   2nd    399

North Carolina (1)

   26     2nd    341

Georgia

   10     5th    150

Maryland

   8     6th    126

South Carolina

   8     3rd    101

Florida

   5     9th    101

Kentucky

   5     4th    91

West Virginia

   6     1st    78

Tennessee

   2     7th    58

Washington, D.C.

   2     5th    10

  (1)   Excludes home office deposits
  (2)   Source: SNL Financial—data as of June 30, 2006 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 two branches in Indiana. After the completion of the pending acquisition with Coastal Financial Corporation (“Coastal”), BB&T will operate 118 branches in South Carolina and 348 branches in North Carolina. BB&T’s deposit market share in the table above will not change as a result of the pending acquisition with Coastal. Please refer to Note 21 “Operating Segments” in the “Notes to Consolidated Financial Statements” for additional disclosures.

 

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Executive Overview

 

Significant accomplishments in 2006

 

In the opinion of BB&T’s management, the Corporation’s most significant accomplishments during 2006 were as follows (amounts include the impact of acquisitions where applicable):

 

  ·  

Deposit market share increased in every state BB&T operates with the exception of West Virginia where we maintained our No. 1 ranking

 

  ·  

Average loans increased 10.9%

 

  ·  

Average deposits increased 9.8%

 

  ·  

Fee income increased 11.7% and fee income as a percentage of total revenues exceeded 40%

 

  ·  

Asset quality remained excellent

 

  ·  

122,000 net new transaction deposit accounts were added

 

  ·  

Households utilizing 5 or more BB&T services grew to 29.4%

 

  ·  

The number of customers utilizing online banking services increased 26% to over 2 million clients

 

  ·  

51 branch locations were opened, including 39 de novo locations

 

  ·  

Superior service quality was regained, as evidenced by lower client attrition

 

  ·  

A successful advertising campaign was launched

 

  ·  

Acquisitions and conversions of Main Street Banks, Inc., and First Citizens Bancorp were completed, and an agreement to acquire Coastal Financial Corporation was announced

 

  ·  

Acquisitions of several nonbank financial services companies were completed and plans to acquire AFCO/CAFO, a large insurance premium finance company were announced (AFCO/CAFO acquisition was completed on January 2, 2007)

 

  ·  

BB&T’s three bank charters were consolidated

 

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:

 

  ·  

Difficult interest rate environment, including an inverted yield curve, has compressed growth in net interest income

 

  ·  

Cost and risk associated with the current heightened regulatory environment

 

  ·  

Building revenue momentum

 

  ·  

Intense competition within the financial services industry

 

  ·  

Improving efficiency

 

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

 

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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. 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 effectively provide financial products and services to businesses and individuals in its 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 10.7%, 11.2%, and 11.8%, 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 resumed strategic mergers and acquisitions in 2006, including bank and thrift acquisitions primarily within BB&T’s existing footprint. BB&T will continue to pursue economically advantageous acquisitions of insurance agencies, asset managers, consumer and commercial finance companies, and may pursue other strategic opportunities to grow existing businesses or 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 50 community banks and thrifts, 77 insurance agencies and 30 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 mergers and acquisitions. The consideration paid for these acquisitions may be in the form of cash, debt or BB&T common 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.

 

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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,  
     2006     2005     2004     2003     2002  
     (Dollars in millions)  

Commercial, financial and agricultural loans

   $ 10,848     $ 9,532     $ 8,824     $ 8,187     $ 8,035  

Lease receivables

     4,358       4,250       4,170       4,085       4,093  

Real estate—construction and land development loans

     17,553       11,942       8,601       6,477       5,292  

Real estate—mortgage loans

     42,219       41,539       39,257       36,251       30,023  

Consumer loans

     10,389       9,604       9,238       9,208       6,502  
                                        

Total loans and leases held for investment

     85,367       76,867       70,090       64,208       53,945  

Loans held for sale

     680       629       613       725       2,378  
                                        

Total loans and leases

     86,047       77,496       70,703       64,933       56,323  

Less: unearned income

     (2,456 )     (2,473 )     (2,540 )     (2,628 )     (2,805 )
                                        

Net loans and leases

   $ 83,591     $ 75,023     $ 68,163     $ 62,305     $ 53,518  
                                        

 

BB&T’s loan portfolio is approximately 50% commercial and 50% retail by design, and is divided into four major categories—commercial, consumer, mortgage and specialized lending. 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.

 

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.

 

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  ·  

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

 

  ·  

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

 

  ·  

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

 

  ·  

Level of equity invested in the transaction—in general, borrowers are required to contribute or invest a portion of their own funds prior to any loan advances.

 

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—commercial 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 market segments.

 

Commercial and small business loans are primarily originated through BB&T’s banking network. In accordance with the Corporation’s lending policy, each loan undergoes a detailed underwriting process, which incorporates BB&T’s underwriting approach, procedures and evaluations described above. In addition, the Bank has adopted an internal maximum credit exposure lending limit of $235 million for a “best grade” credit, which is considerably below the Bank’s 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”) or a fixed-rate. 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’s commercial leases consist of investments in various types of leveraged lease transactions.

 

Consumer Loan Portfolio

 

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

 

The consumer loan portfolio consists of three primary sub-portfolios—direct retail, revolving credit and sales finance. The direct retail category consists mainly of home equity loans and lines of credit, which are secured by residential real estate. It also includes installment loans and some unsecured lines of credit other than credit cards. The revolving credit category is comprised of the outstanding balances on credit cards and BB&T’s checking account overdraft protection product, Constant Credit. Such balances are generally unsecured and actively managed by BB&T Bankcard Corporation. Finally, the sales finance category primarily includes secured indirect installment loans to consumers for the purchase of automobiles. Such loans are originated through approved franchised and independent automobile dealers throughout the BB&T market area and, to a lesser degree, states outside BB&T’s market area. 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 2006 totaling $9.9 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or

 

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refinancing residential properties. BB&T primarily originates conforming mortgage loans for owner-occupied properties. 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.

 

Specialized Lending Portfolio

 

BB&T’s specialized lending portfolio consist of loans originated through six wholly owned subsidiaries that provide specialty finance alternatives to consumers and businesses including: dealer-based financing of equipment for both small businesses and consumers, equipment leasing, direct and indirect consumer finance, insurance premium finance, indirect sub-prime automobile finance, and full-service commercial mortgage banking. BB&T offers these services to bank clients as well as non-bank clients within and outside BB&T’s primary geographic market area.

 

The specialized lending portfolio carries a higher credit risk profile than BB&T’s other portfolios with a corresponding higher yield on the loan. BB&T’s specialized lending subsidiaries adhere to the same overall underwriting approach as the commercial and consumer lending portfolio and also utilize automated credit scoring to assist with underwriting the credit risk. These loans are relatively homogenous and no single loan is individually significant in terms of its size and potential risk of loss. The majority of the loans are secured by real estate, automobiles or equipment.

 

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,
     2006    2005    2004    2003    2002
     (Dollars in millions)

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

              

Commercial loans

   $ 39,580    $ 34,965    $ 31,968    $ 29,083    $ 27,106

Leveraged leases

     1,720      1,650      1,576      1,500      1,354
                                  

Total commercial loans and leases

     41,300      36,615      33,544      30,583      28,460
                                  

Sales finance

     5,683      5,264      5,176      5,250      2,732

Revolving credit

     1,414      1,347      1,277      1,180      1,051

Direct retail

     15,312      14,453      13,585      11,812      9,116
                                  

Total consumer loans

     22,409      21,064      20,038      18,242      12,899
                                  

Residential mortgage loans

     16,257      14,481      12,305      11,640      10,598

Specialized lending

     3,625      2,863      2,276      1,840      1,561
                                  

Total loans and leases

   $ 83,591    $ 75,023    $ 68,163    $ 62,305    $ 53,518
                                  

(1)   Includes loans held for sale.

 

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

 

Table 4

Selected Loan Maturities and Interest Sensitivity (1)

 

     December 31, 2006
      Commercial,
Financial
and
Agricultural
   Real Estate:
Construction
   Total
     (Dollars in millions)

Fixed rate:

        

1 year or less (2)

   $ 485    $ 662    $ 1,147

1-5 years

     1,521      3,652      5,173

After 5 years

     1,561      974      2,535
                    

Total

     3,567      5,288      8,855
                    

Variable rate:

        

1 year or less (2)

     4,128      7,321      11,449

1-5 years

     2,381      4,263      6,644

After 5 years

     772      681      1,453
                    

Total

     7,281      12,265      19,546
                    

Total loans and leases (3)

   $ 10,848    $ 17,553    $ 28,401
                    

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

 

     (Dollars
in millions)

(3)    The above table excludes:

  

(i)     consumer loans

   $ 10,389

(ii)    real estate mortgage loans

     42,219

(iii)   loans held for sale

     680

(iv)   lease receivables

     4,358
      

Total

   $ 57,646
      

 

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 in 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.

 

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

 

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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, 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.

 

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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. 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,  
     2006     2005     2004     2003     2002  
     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 millions)  

Balances at end of period applicable to:

                   

Commercial, financial and agricultural

  $ 135   12.6 %   $ 138   12.3 %   $ 130   12.5 %   $ 155   12.6 %   $ 164   14.3 %

Real estate:

                   

Construction and land development

    193   20.4       132   15.4       96   12.2       94   10.0       86   9.4  

Mortgage

    360   49.9       381   54.4       403   56.4       382   56.9       332   57.5  
                                                           

Total real estate

    553   70.3       513   69.8       499   68.6       476   66.9       418   66.9  
                                                           

Consumer

    121   12.1       100   12.4       111   13.1       80   14.2       64   11.5  

Lease receivables

    26   5.0       24   5.5       22   5.8       29   6.3       32   7.3  

Unallocated

    53   —         50   —         43   —         45   —         46   —    
                                                           

Total

  $ 888   100.0 %   $ 825   100.0 %   $ 805   100.0 %   $ 785   100.0 %   $ 724   100.0 %
                                                           

 

Investment Activities

 

Investment securities represent a significant portion of BB&T’s assets. Branch Bank invests 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, privately-issued mortgage-backed securities, structured notes, bank eligible corporate obligations, including corporate debentures, commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. Branch Bank 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 Market Risk and Liquidity Committee (“MRLC”), which meets regularly to review the economic environment and establish investment strategies. The MRLC 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.

 

Investment strategies are established by the MRLC 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

 

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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, 2006, these sources of deposits represented approximately 9% 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, 2006:

 

Table 6

Scheduled Maturities of Time Deposits $100,000 and Greater

December 31, 2006

(Dollars in millions)

 

Maturity Schedule   

Three months or less

   $ 5,020

Over three through six months

     3,766

Over six through twelve months

     3,669

Over twelve months

     1,283
      

Total

   $ 13,738
      

 

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.

 

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BB&T also utilizes longer-term borrowings when management determines that the pricing and maturity options available through these sources create cost-effective options for funding asset growth and satisfying capital needs. BB&T’s long-term borrowings include long-term FHLB advances to Branch Bank, 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, 2006, BB&T had approximately 29,300 full-time equivalent employees compared to approximately 27,700 full-time equivalent employees at December 31, 2005.

 

Properties

 

BB&T and its significant subsidiaries occupy headquarter 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, 2006, Branch Bank operated 1,459 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:

 

Name of Executive Officer

  

Title

   Years of Service    Age

John A. Allison IV

   Chairman and Chief Executive Officer    36    58

Ricky K. Brown

   Senior Executive Vice President and Manager of Banking Network    30    51

W. Kendall Chalk

   Senior Executive Vice President and Chief Credit Officer    32    61

Barbara F. Duck

   Senior Executive Vice President and Electronic Delivery Systems Manager    19    40

Donna C. Goodrich

   Senior Executive Vice President and Deposit Services Manager    21    44

Robert E. Greene

   Senior Executive Vice President and Risk Management and Administrative Group Manager    34    56

Christopher L. Henson

   Senior Executive Vice President and Chief Financial Officer    22    45

Kelly S. King

   Chief Operating Officer    35    58

Clarke R. Starnes III

   Senior Executive Vice President and Specialized Lending Group Manager    25    47

Steven B. Wiggs

   Senior Executive Vice President and Chief Marketing Officer    28    49

C. Leon Wilson III

   Senior Executive Vice President and Operations Division Manager    30    51

 

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.BBT.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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PERFORMANCE GRAPH

 

Set forth below is a graph comparing the total returns (assuming reinvestment of dividends) of BB&T Common Stock, the S&P 500 Index, and an Industry Peer Group Index. The graph assumes $100 invested on December 31, 2001 in BB&T Common Stock and in each of the indices. In 2006, the financial holding companies in the Industry Peer Group Index (the “Peer Group”) were Comerica Incorporated, Fifth-Third Bancorp, KeyCorp, M&T Bank Corporation, Marshall & Ilsley Corporation, National City Corporation, PNC Financial Services Group, Inc., Popular, Incorporated, Regions Financial Corporation, SunTrust Banks, Inc., UnionBanCal Corporation and U.S. Bancorp. The Peer Group consists of bank holding companies with assets between approximately $46.9 billion and $217.3 billion.

 

LOGO


*   $100 invested on 12/31/01 in stock or index, including reinvestment of dividends.
       Fiscal year ending December 31.

 

     Cumulative Total Return
         12/01            12/02            12/03            12/04            12/05            12/06    
BB&T CORPORATION    $ 100.00    $ 105.70    $ 114.31    $ 129.01    $ 133.39    $ 145.30
S&P 500      100.00      77.90      100.24      111.15      116.61      135.02
BB&T’s PEER GROUP      100.00      98.02      126.31      136.54      133.55      156.16

 

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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 a state-chartered commercial bank, Branch Bank is subject to regulation, supervision and examination by the North Carolina Commissioner of Banks. 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 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 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 SEC, the National Association of Securities Dealers, Inc. (the “NASD”), 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 and its subsidiaries are 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, a financial holding 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 Board 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 Board can place any limitations on the financial holding company that it believes to be appropriate. Furthermore, if the Federal Reserve Board 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 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

 

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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 SEC 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 holding company or 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 the Deposit Insurance Fund (“DIF”) 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 DIF. 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.

 

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

 

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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 Branch Bank. Branch Bank is subject to laws and regulations that limit the amount of dividends it can pay. In addition, both BB&T and Branch Bank 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 law states that, subject to certain capital requirements, the board of directors of a bank chartered under the laws of North Carolina may declare a dividend of as much of that bank’s undivided profits as the directors deem expedient. BB&T does not expect that these laws, regulations or policies will materially affect the ability of Branch Bank to pay dividends. At December 31, 2006, subject to restrictions imposed by state law, the Board of Directors of Branch Bank could have declared dividends of up to $3.1 billion; however, to remain well-capitalized under federal guidelines, Branch Bank would have limited total additional dividends to $1.1 billion.

 

Capital

 

Each of the federal banking agencies, including the Federal Reserve Board and the FDIC, have issued substantially similar risk-based and leverage capital guidelines applicable to banking organizations they supervise, including bank holding companies and banks. Under the risk-based capital requirements, BB&T and the Banks are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common shareholders’ equity excluding the over- or underfunded status of postretirement benefit obligations, 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 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.

 

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

 

The ratios of Tier 1 capital, total capital to risk-adjusted assets, and leverage capital of BB&T and Branch Bank as of December 31, 2006, are shown in the following table.

 

Table 7

Capital Adequacy Ratios of BB&T Corporation and Branch Bank

December 31, 2006

 

     Regulatory
Minimums
    Regulatory
Minimums
to be Well-
Capitalized
    BB&T     Branch
Bank
 

Risk-based capital ratios:

        

Tier 1 capital (1)

   4.0 %   6.0 %   9.0 %   9.2 %

Total risk-based capital (2)

   8.0     10.0     14.3     11.3  

Tier 1 leverage ratio (3)

   3.0     5.0     7.2     7.3  

(1)   Common shareholders’ equity excluding the over- or underfunded status of postretirement benefit obligations, 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 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.

 

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Deposit Insurance Assessments

 

The deposits of the Banks are insured by the DIF of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. Beginning January 1, 2007, assessments for the DIF can range from 5 to 43 basis points per $100 of assessable deposits, depending on the insured institution’s risk category as described above. This assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed quarterly. The Reform Act also provides for a one-time premium assessment credit for eligible insured depository institutions, including those institutions in existence and paying deposit insurance premiums on December 31, 1996, or certain successors to any such institution. The assessment credit is determined based on the eligible institution’s deposits at December 31, 1996 and is applied automatically to reduce the institution’s quarterly premium assessments to the maximum extent allowed, until the credit is exhausted. In addition, 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.

 

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 Board in connection with any acquisition or merger application.

 

USA Patriot Act

 

The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

 

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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 SEC, the NASD, 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.BBT.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.BBT.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 22, 2006.

 

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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 its subsidiaries for each of the three years in the period ended December 31, 2006, 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 2006 performance.

 

Reclassifications

 

In certain circumstances, reclassifications have been made to prior period information to conform to the 2006 presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income.

 

Mergers and Acquisitions Completed During 2006

 

During 2006, BB&T completed the following mergers and acquisitions.

 

On June 1, 2006, BB&T completed its merger with Main Street Banks, Inc. (“Main Street”), a bank holding company headquartered in Atlanta, Georgia. Main Street’s operations were merged into Branch Bank in September 2006. Main Street had total assets of approximately $2.3 billion, total loans of $1.8 billion and total deposits of $1.7 billion.

 

On August 1, 2006, BB&T completed its merger with First Citizens Bancorp (“First Citizens”), a bank holding company headquartered in Cleveland, Tennessee. First Citizens’ operations were merged into Branch Bank in November 2006. First Citizens had total assets, total loans and total deposits of approximately $700 million, $460 million and $550 million, respectively.

 

In addition to the mergers and acquisitions noted above, BB&T acquired two nonbank financial services companies and an insurance agency during 2006, 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.

 

Mergers Pending as of December 31, 2006

 

On August 24, 2006, BB&T announced plans to acquire insurance premium finance company AFCO Credit Corporation and its Canadian affiliate, CAFO, Inc. The acquisition is expected to significantly strengthen BB&T’s insurance premium finance franchise in the United States, as well as provide entry into Canada—a first for BB&T. The transaction closed on January 2, 2007.

 

On December 21, 2006, BB&T announced plans to acquire Coastal Financial Corporation (“Coastal”), a bank holding company headquartered in Myrtle Beach, South Carolina. At the time of the announcement, Coastal had $1.7 billion in assets and operated 17 branches in the Myrtle Breach area of South Carolina and seven branches in the Wilmington area of North Carolina. Shareholders of Coastal will receive .385 of a share of BB&T common stock in exchange for each share of Coastal common stock. The transaction, which is subject to shareholder and regulatory approval, is expected to close in the second quarter of 2007.

 

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

 

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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 Board of Directors on a periodic basis.

 

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

 

It is the policy of BB&T to maintain an allowance for loan and lease losses and a reserve for unfunded lending commitments that equal 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 has two classes of mortgage servicing rights for which it separately manages the economic risk: residential and commercial. Residential mortgage servicing rights are carried at fair value with changes in fair value recorded as a component of mortgage banking income each period. BB&T uses various derivative instruments to mitigate the income statement effect of changes in fair value, due to change in valuation inputs and assumptions, of its residential mortgage servicing rights. Commercial mortgage servicing rights are carried at lower of cost or market and amortized 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

 

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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.

 

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 14 “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, 2006, BB&T’s average assets totaled $114.3 billion, an increase of $9.7 billion, or 9.3%, compared to the 2005 average of $104.6 billion, primarily reflecting growth in average loans and leases and investment securities. Average loans and leases for 2006 were up $7.8 billion, or 10.9%, from 2005 and average investment securities increased $881 million, or 4.3%, compared to 2005. The growth in average loans and leases was composed of growth in average commercial loans and leases, which increased $4.0 billion, or 11.3%;

 

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average mortgage loans, which increased $2.0 billion, or 15.1%; average consumer loans, which increased $1.1 billion, or 5.4%; and growth in average loans originated by BB&T’s specialized lending subsidiaries, which increased $698 million, or 27.4%. Total earning assets averaged $101.6 billion in 2006, an increase of $8.9 billion, or 9.6%, compared to 2005. These averages and growth rates include the effects of acquisitions.

 

BB&T’s average deposits totaled $77.2 billion, reflecting growth of $6.9 billion, or 9.8%, compared to 2005. The categories of deposits with the highest growth rates were: client certificates of deposit, which increased $4.6 billion, or 25.6%; interest checking, which increased $367 million, or 20.4%; and other client deposits, which increased $1.6 billion, or 5.5%.

 

Shorter-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and treasury tax and loan deposit notes payable. Average shorter-term borrowings totaled $7.0 billion for the year ended December 31, 2006, a decrease of $380 million, or 5.1% from the 2005 average. BB&T has also utilized long-term debt for a significant portion of its funding needs. Long-term debt includes Federal Home Loan Bank (“FHLB”) advances, other secured borrowings by Branch Bank, capital securities issued by unconsolidated trusts and senior and subordinated debt issued by the Corporation and Branch Bank. Average long-term debt totaled $14.6 billion for the year ended December 31, 2006, up $2.7 billion, or 22.3%, compared to 2005.

 

The compound annual rate of growth in average total assets for the five-year period ended December 31, 2006, was 10.7%. Over the same five-year period, average loans and leases increased at a compound annual rate of 11.2%, average securities increased at a compound annual rate of 6.1%, and average deposits grew at a compound annual rate of 11.8%. These balance sheet growth rates 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 11.6% in 2006, to a total of $22.9 billion at the end of the year. As of December 31, 2006, the total securities portfolio included $2.1 billion in trading securities and $20.7 billion of available-for-sale securities. The available-for-sale portfolio comprised 90.6% of total securities at December 31, 2006. 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 available-for-sale securities portfolio is primarily comprised of U.S. government-sponsored entity obligations and mortgage-backed securities issued by U.S. government-sponsored entities. U.S. government-sponsored entity securities comprised 43.6% of the available-for-sale securities portfolio at December 31, 2006. The duration of the U.S. government-sponsored entity portfolio was 2.84 years and 3.43 years at December 31, 2006 and 2005, respectively. Mortgage-backed securities comprised 40.0% of the total available-for-sale securities portfolio at year-end 2006. The duration of the mortgage-backed securities was 3.26 years at December 31, 2006 compared to 3.18 years at December 31, 2005. The duration of the entire available-for-sale portfolio at December 31, 2006 was 3.04 years compared to 3.26 years at December 31, 2005.

 

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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,
     2006    2005    2004
     (Dollars in millions)

Trading securities (at fair value):

   $ 2,147    $ 707    $ 334
                    

Securities available for sale (at fair value):

        

U.S. Treasury securities

     83      112      123

U.S. government-sponsored entity securities

     9,036      11,154      12,640

States and political subdivisions

     571      675      784

Mortgage-backed securities

     8,297      6,611      4,530

Equity and other securities

     2,734      1,231      761
                    

Total securities available for sale

     20,721      19,783      18,838
                    

Total securities

   $ 22,868    $ 20,490    $ 19,172
                    

 

At December 31, 2006, trading securities reflected on BB&T’s consolidated balance sheet totaled $2.1 billion compared to $707 million at December 31, 2005. The majority of the increase in the trading portfolio was the result of a $1.1 billion purchase of municipal securities executed late in 2006.

 

Securities available for sale totaled $20.7 billion at year-end 2006 and are carried at estimated fair value. Securities available for sale at year-end 2005 totaled $19.8 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-sponsored entity securities and mortgage-backed securities issued by U.S. government-sponsored entities, which together composed 83.6% of the portfolio. This portfolio also contains investments in U.S. Treasury securities, which represented less than 1% of the December 31, 2006 balance, obligations of states and municipalities, which represented 2.8% of the available-for-sale portfolio, and equity and other securities, which made up 13.2% of the available-for-sale portfolio.

 

The $938 million increase in securities available for sale was the result of a combination of factors, including an increase in funds allocated to the securities portfolio as a result of the acquisitions of Main Street and First Citizens and the securitization of approximately $51 million in mortgage loans in the fourth quarter of 2006 that were held in BB&T’s loan portfolio and subsequently transferred to the securities portfolio. During the year ended December 31, 2006, BB&T sold approximately $2.8 billion of available-for-sale securities and realized net losses totaling $73 million. These sales included approximately $2.5 billion of sales and $75 million in net losses in connection with an announced restructuring of a portion of the securities portfolio that was undertaken in the fourth quarter of 2006. BB&T replaced substantially all of the assets sold with higher-yielding securities and expects to recover the $75 million loss through higher earnings by the end of 2007.

 

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The following table presents BB&T’s securities portfolio at December 31, 2006, segregated by major category with ranges of maturities and average yields disclosed.

 

Table 9

Securities

 

     December 31, 2006  
    

Carrying

Value

   Weighted
Average Yield (1)
 
     (Dollars in millions)  
U.S. Treasury securities:      

Within one year

   $ 17    3.13 %

One to five years

     61    4.57  

Five to ten years

     5    4.32  

After ten years

     —      —    
             

Total

     83    4.26  
             
U.S. government-sponsored entity securities:      

Within one year

     315    3.50  

One to five years

     5,648    3.84  

Five to ten years

     3,002    4.51  

After ten years

     71    5.94  
             

Total

     9,036    4.07  
             
Mortgage-backed securities (2):      

Within one year

     4    2.99  

One to five years

     196    3.85  

Five to ten years

     69    5.52  

After ten years

     8,028    5.00  
             

Total

     8,297    4.97  
             
Obligations of states and political subdivisions:      

Within one year

     98    5.76  

One to five years

     355    6.78  

Five to ten years

     52    7.22  

After ten years

     66    7.35  
             

Total

     571    6.71  
             
Other securities (3):      

Within one year

     —      —    

One to five years

     141    6.14  

Five to ten years

     529    7.31  

After ten years

     1,472    5.67  
             

Total

     2,142    6.11  
             
Trading securities and securities with no stated maturity (4)      2,739    3.87  
             

Total securities (5)

   $ 22,868    4.63 %
             

(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 $1.6 billion. 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 that totaled $592 million and trading securities that totaled $2.1 billion.
(5)   Includes securities available-for-sale and trading securities carried at estimated fair values of $20.7 billion and $2.1 billion, respectively.

 

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The market value of the available-for-sale portfolio at year-end 2006 was $391 million lower than the amortized cost of these securities. At December 31, 2006, BB&T’s available-for-sale portfolio had net unrealized losses, net of deferred income taxes, of $249 million, which are reported as a component of shareholders’ equity. At December 31, 2005, the available-for-sale portfolio had net unrealized losses of $338 million, net of deferred income taxes.

 

On December 31, 2006, BB&T held certain investment securities having continuous unrealized loss positions for more than 12 months. As of December 31, 2006, the unrealized losses on these securities totaled $445 million. Substantially all of these investments were in U.S. government-sponsored entity securities and mortgage-backed securities, which primarily consist of 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. At December 31, 2006, BB&T had 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 during 2006.

 

The fully taxable equivalent (“FTE”) yield on the total securities portfolio was 4.48% for the year ended December 31, 2006, compared to 4.17% 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 and other higher-yielding securities, which primarily consist of privately-issued mortgage backed securities. The yield on U.S. government sponsored-entity securities increased from 3.78% in 2005 to 4.02% in 2006, while the yield on mortgage-backed securities increased from 4.72% to 4.97% and the FTE yield on state and municipal securities increased from 6.73% last year to 6.89% in the current year. The yield on other securities increased from 4.97% during 2005 to 5.82% in 2006.

 

Loans and Leases

 

BB&T emphasizes commercial lending to small and medium-sized businesses, consumer lending, mortgage lending and specialized 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, comprised 49.1% of the loan portfolio during 2006, compared to 48.9% in 2005. Average consumer loans, which include sales finance, revolving credit and direct retail, comprised 27.3% of average loans in 2006, compared to 28.7% in 2005. Average mortgage loans comprised 19.5% of average total loans for 2006, compared to 18.8% a year ago. Average loans originated by BB&T’s specialized lending subsidiaries represented the remaining 4.1% of average total loans in 2006, compared to 3.6% during the prior year.

 

BB&T’s loan portfolio, excluding loans held for sale, increased $8.5 billion, or 11.4%, as compared to 2005. Average total loans and leases for 2006 increased $7.8 billion, or 10.9%, compared to 2005. In addition to strong internal loan growth, the increase was aided by the addition of loans held by Main Street and First Citizens, which were acquired during 2006. Average loan growth was reduced by the securitization of approximately $51 million and $210 million of residential mortgage loans during the fourth quarter of 2006 and the fourth quarter of 2005, respectively. The resulting mortgage-backed securities were transferred to the available-for-sale securities portfolio. The securitizations completed during 2006 and 2005 were undertaken to provide additional collateral-eligible assets needed to satisfy client demands.

 

Average commercial loans and leases increased $4.0 billion, or 11.3%, in 2006 as compared to 2005. Overall the commercial loan and lease portfolio showed solid growth during 2006. The mix of the commercial loan portfolio has shifted somewhat during the latter part of 2006, as commercial real estate lending has slowed due to a slower real estate market. This has been offset by an increased focus on commercial and industrial loans. Average consumer loans increased $1.1 billion, or 5.4%, as compared to 2005, which was comprised of increases in direct retail loans of 6.2%, sales finance loans of 3.2% and revolving credit loans of 4.6%. The pace of growth in the consumer loan portfolio slowed further in 2006 especially direct retail loans, due to higher interest rates that caused a slowdown in demand for home equity loan products. Sales finance loans grew modestly during 2006,

 

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however the fourth quarter showed substantial improvement as BB&T continues to benefit from expansion into newer markets within the BB&T footprint. BB&T expects to increase its sales finance business during 2007 by continuing to emphasize expansion in newer markets within the BB&T footprint and increasing its focus on the marine finance and recreational vehicle markets. Average mortgage loans increased $2.0 billion, or 15.1%, compared to 2005. 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 2006 was reduced by the securitizations previously discussed. BB&T is a large originator of residential mortgage loans, with 2006 originations of $9.9 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, 2006, BB&T was servicing $28.2 billion in residential mortgages owned by third parties and $17.0 billion of mortgage loans owned by BB&T, including $16.3 billion classified as mortgage loans and $747 million classified as securities available for sale. Average loans originated by BB&T’s specialized lending subsidiaries increased $698 million, or 27.4%, compared to 2005. The growth in the specialized lending portfolio was primarily due to strong internal loan growth as management views these businesses as providing an attractive risk-adjusted return for BB&T and has grown this portfolio at a faster pace than the overall lending portfolio.

 

The average annualized FTE yields on commercial, consumer, mortgage and specialized lending subsidiary loans for 2006 were 7.78%, 7.23%, 5.70% and 15.22%, respectively, resulting in a yield for the total loan portfolio of 7.53%. The FTE yields on commercial, consumer, mortgage and specialized lending subsidiary loans for 2005 were 6.51%, 6.48%, 5.44% and 14.68%, respectively, resulting in a yield for the total loan portfolio of 6.59%. The 94 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. In addition, a portion of the consumer loan portfolio is variable-rate and was repriced as a result of increases in the prime lending rate. 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 average prime rate in effect during 2006 and 2005 was 7.96% and 6.19%, respectively. The prime rate is the basis for pricing many commercial and consumer loans and was 8.25% at year-end 2006. The Federal Reserve Board has left rates unchanged since June 2006. 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. The overall yield in the loan portfolio also benefited from a slight change in the mix of the portfolio as the specialized lending portfolio grew at a faster pace than the overall portfolio, contributing to an increase in the loan portfolio’s yield.

 

Asset Quality and Credit Risk Management

 

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

 

  ·  

limiting the amount of credit that individual lenders may extend;

 

  ·  

establishing a process for credit approval accountability;

 

  ·  

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

 

  ·  

ongoing servicing of individual loans and lending relationships;

 

  ·  

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

 

  ·  

periodically reevaluating the 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.

 

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Asset Quality

 

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

 

Table 10

Asset Quality

 

     December 31,  
     2006     2005     2004     2003     2002  
     (Dollars in millions)  

Nonaccrual loans and leases

   $ 260     $ 229     $ 269     $ 350     $ 375  

Restructured loans

     —         —         —         1       —    

Foreclosed property

     89       71       89       96       77  
                                        

Nonperforming assets

   $ 349     $ 300     $ 358     $ 447     $ 452  
                                        

Loans 90 days or more past due and still accruing

   $ 102     $ 103     $ 100     $ 117     $ 115  
                                        

Asset Quality Ratios: (1)

          

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

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

Nonperforming assets as a percentage of:

          

Total assets

     .29       .27       .36       .49       .56  

Loans and leases plus foreclosed property

     .42       .40       .52       .72       .84  

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

     .27       .30       .36       .43       .48  

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

     1.06       1.10       1.18       1.26       1.35  

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

     1.07       1.11       1.19       1.27       1.42  

Ratio of allowance for loan and leases to:

          

Net charge-offs

     4.12  x     3.84  x     3.42  x     3.17  x     2.94  x

Nonaccrual and restructured loans and leases

     3.41       3.60       2.99       2.24       1.93  

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.

 

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During 2006, BB&T’s credit quality remained solid. BB&T experienced a fourth consecutive year of lower charge-offs as a percentage of average outstanding loans. Nonperforming assets increased slightly from .27% of total assets at December 31, 2005 to .29% at year-end 2006, after three consecutive years of declines.

 

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,  
     2006     2005     2004  
     (Dollars in millions)  

Nonaccrual loans and leases

      

Commercial loans and leases

   $ 129     $ 104     $ 138  

Direct retail

     39       41       38  

Sales finance

     2       5       6  

Revolving credit

     —         —         —    

Mortgage

     53       48       61  

Specialized lending

     37       31       26  
                        

Total nonaccrual loans and leases

   $ 260     $ 229     $ 269  
                        

Foreclosed real estate

   $ 54     $ 48     $ 69  

Other foreclosed assets

     35       23       20  

Restructured loans

     —         —         —    
                        

Total nonperforming assets

   $ 349     $ 300     $ 358  
                        

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

      

Commercial loans and leases

     .16 %     .14 %     .20 %

Direct retail

     .05       .06       .05  

Sales finance

     —         .01       .01  

Revolving credit

     —         —         —    

Mortgage

     .06       .06       .09  

Specialized lending

     .04       .04       .04  
                        

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

     .31 %     .31 %     .39 %
                        

Loans 90 days or more past due and still accruing interest

      

Commercial loans and leases

   $ 14     $ 10     $ 4  

Direct retail

     20       21       20  

Sales finance

     17       21       20  

Revolving credit

     6       5       5  

Mortgage

     37       39       44  

Specialized lending

     8       7       7  
                        

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

   $ 102     $ 103     $ 100  
                        

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 %     .01 %

Direct retail

     .02       .03       .03  

Sales finance

     .02       .03       .03  

Revolving credit

     .01       .01       .01  

Mortgage

     .04       .05       .06  

Specialized lending

     .01       .01       .01  
                        

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

     .12 %     .14 %     .15 %
                        

 

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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 $888 million at December 31, 2006, an increase of 7.0% compared to $830 million at the end of 2005. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.06% at December 31, 2006, compared to 1.10% at year-end 2005. As a percentage of loans held for investment, the ratio of the allowance for loan and lease losses to total loans and leases was 1.07% at December 31, 2006 compared to 1.11% at the end of last year. BB&T’s strong credit history, combined with improvements in BB&T’s relative level of net charge-offs, led to the reduction in the 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,  
         2006             2005             2004             2003             2002      
     (Dollars in millions)  

Balance, beginning of period

   $ 830     $ 828     $ 793     $ 724     $ 645  
                                        

Charge-offs:

          

Commercial, financial and agricultural

     (32 )     (52 )     (60 )     (72 )     (85 )

Real estate

     (46 )     (45 )     (61 )     (78 )     (61 )

Consumer

     (194 )     (174 )     (165 )     (161 )     (145 )

Lease receivables

     (5 )     (6 )     (11 )     (5 )     (6 )
                                        

Total charge-offs

     (277 )     (277 )     (297 )     (316 )     (297 )
                                        

Recoveries:

          

Commercial, financial and agricultural

     12       14       17       25       18  

Real estate

     7       8       10       11       7  

Consumer

     41       39       34       30       25  

Lease receivables

     1       2       1       1       1  
                                        

Total recoveries

     61       63       62       67       51  
                                        

Net charge-offs

     (216 )     (214 )     (235 )     (249 )     (246 )
                                        

Provision charged to expense

     240       217       249       248       263  
                                        

Allowance for loans (sold) acquired, net

     34       (1 )     21       70       62  
                                        

Balance, end of period

   $ 888     $ 830     $ 828     $ 793     $ 724  
                                        

Average loans and leases (1)

   $ 79,313     $ 71,517     $ 66,107     $ 57,857     $ 50,851  
                                        

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

     .27 %     .30 %     .36 %     .43 %     .48 %
                                        

(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 banking network are the largest source of funds used to support asset growth. Total deposits at December 31, 2006, were $81.0 billion, an increase of $6.7 billion, or 9.0%, compared to year-end 2005. The increase in deposits during 2006 was driven by a $5.7 billion, or 29.4% increase in client certificates of deposit (“CDs”), a $3.1 billion, or 10.0% increase in other client deposits, which include money rate savings accounts, investor deposit accounts, savings accounts, individual retirement accounts and other time

 

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deposits. These increases were partially offset by a decline of $1.9 billion, or 21.0% in other interest-bearing deposits. For the year ended December 31, 2006, total deposits averaged $77.2 billion, an increase of $6.9 billion, or 9.8%, compared to 2005. The increase in average deposits was primarily the result of a $4.6 billion, or 25.6% increase in average CDs, and a $1.6 billion, or 5.5% increase in average other client deposits. The overall increases in year-end and average deposits included the impact of the acquisitions of Main Street and First Citizens, which were completed during 2006.

 

Average other client deposits, which include money rate savings accounts, investor deposit accounts, savings accounts, individual retirement accounts and other time deposits represent the largest component of BB&T’s deposits and composed 40.7% of total average deposits for 2006, compared to 42.4% during 2005. CDs are the second largest source and comprised 29.2% of total average deposits for 2006 compared to 25.5% for 2005. The remainder of client deposits is comprised of noninterest-bearing deposits and savings and interest-checking accounts, which comprised 19.9% of total average deposits in the current year, compared to 20.9%, for last year. BB&T also gathers other interest-bearing deposits through wholesale funding products, which include negotiable certificates of deposit and Eurodollar deposits. Average other interest-bearing deposits represented 10.1% of total average deposits for 2006, as compared to 11.2% for 2005. During 2006, management increased its focus on deposit gathering efforts and more aggressively pursued retail deposits through the banking network. This led to the increases in CDs as a percentage of total deposits and the decrease in reliance on other interest-bearing deposits to fund strong loan growth and fuel organic growth initiatives. The decline in other client deposits as a percentage of total average deposits was largely a result of consumers migrating to CDs and other higher-yielding deposit products as interest rates increased during 2005 and 2006.

 

The average rate paid on interest-bearing deposits increased to 3.34% during 2006, from 2.18% in 2005. 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: CDs increased to 4.16% in the current year from 2.91% in 2005; other client deposits increased to 2.43% in the current year from 1.51% in 2005; interest checking increased to 1.87% in 2006 from .80% in 2005; and other interest-bearing deposits increased to 5.04% in 2006 from 3.35% in 2005.

 

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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 and other balance sheet management purposes. Shorter-term borrowings comprised 6.1% of total funding needs on average in 2006 as compared to 7.1% in 2005. 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 comprised 24.8% of total shorter-term borrowings, and securities sold under repurchase agreements, which comprised 25.8% of shorter-term borrowings at year-end 2006. Master notes, U.S. Treasury tax and loan deposit notes, and short-term bank notes are also utilized to meet short-term funding needs and comprised the remaining 49.4% of these types of funding sources as of December 31, 2006. Shorter-term borrowings at the end of 2006 were $8.1 billion, an increase of $1.5 billion, or 23.2% compared to year-end 2005. Average shorter-term borrowings totaled $7.0 billion during 2006 compared to $7.4 billion last year, a decrease of 5.1%. The increase in the year-end balance was primarily associated with funding trading securities purchased at year-end 2006, while the decline in the average balance during 2006 compared to 2005 was the result of strong deposit growth and a migration of some funding requirements to long-term debt. The rates paid on average shorter-term borrowings increased from 3.04% in 2005 to 4.30% during 2006. The increase in the cost of shorter-term borrowings resulted from recent actions by the Federal Reserve Board, which steadily increased the targeted Federal funds rate by 425 basis points starting in the second half of 2004 and ending in June 2006. At December 31, 2006, the targeted federal funds rate was 5.25% as compared to its lowest level of 1.00% 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
December 31,
 
     2006     2005     2004  
     (Dollars in millions)  
Securities Sold Under Agreements to Repurchase       

Maximum outstanding at any month-end during the year

   $ 3,080     $ 4,269     $ 3,690  

Balance outstanding at end of year

     2,090       2,699       2,521  

Average outstanding during the year

     2,608       3,505       3,078  

Average interest rate during the year

     4.35 %     3.04 %     1.38 %

Average interest rate at end of year

     4.24       3.73       2.12  
Federal Funds Purchased and Short-term Borrowed Funds       

Maximum outstanding at any month-end during the year

   $ 6,036     $ 5,447     $ 5,319  

Balance outstanding at end of year

     5,997       3,863       4,167  

Average outstanding during the year

     4,398       3,881       3,513  

Average interest rate during the year

     4.27 %     3.04 %     1.36 %

Average interest rate at end of year

     4.83       3.93       2.03  

 

BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 12.8% of total funding needs on average during 2006 and 11.4% in 2005. See Note 10 “Long-Term Debt” in the “Notes to Consolidated Financial Statements” herein for further disclosure. Long-term debt at December 31, 2006, totaled $15.9 billion, an increase of $2.8 billion, or 21.2%, from year-end 2005. For the year ended December 31, 2006, average long-term debt increased $2.7 billion, or 22.3%, compared to the average for 2005. BB&T’s long-term debt consists primarily of FHLB advances, which composed 41.3% of total outstanding long-term debt at December 31, 2006, and subordinated notes of BB&T Corporation, which composed 21.1% 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 4.22% during 2005 to 5.10% during 2006 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 2006 was primarily related to the issuance of $600 million in capital securities, $500 million in medium term bank notes, $750 million in subordinated bank notes and the receipt of a

 

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$1.0 billion FHLB advance. The issuances of the floating rate medium term bank notes and the FHLB advance were designed to better stratify debt maturities among short, medium and long-term periods. The proceeds from the issuance of the capital securities were used primarily to repurchase shares under BB&T’s share repurchase program. The proceeds from the subordinated bank notes were used to provide for general funding needs of Branch Bank and to provide additional regulatory capital.

 

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 2006 totaled $1.53 billion, which generated basic earnings per share of $2.84 and diluted earnings per share of $2.81. Net income for 2005 was $1.65 billion and net income for 2004 totaled $1.56 billion. Basic earnings per share were $3.02 in 2005 and $2.82 in 2004, while diluted earnings per share were $3.00 and $2.80 for 2005 and 2004, 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 1.34%, 1.58%, and 1.62% for the years ended December 31, 2006, 2005 and 2004, respectively. The returns on average common shareholders’ equity were 13.35%, 14.95%, and 14.71% for the last three years.

 

BB&T’s 2006 net income and returns were negatively affected by an additional tax provision of $139 million after-tax, which is discussed further under the section titled “Provision for Income Taxes” herein and securities losses resulting from a portfolio restructuring of $47 million after-tax, which was mentioned previously under the section titled “Securities” herein.

 

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 pursue any new bank or thrift acquisitions during 2004 and 2005, and instead focus on integrating recent acquisitions and improving internal growth. During 2006, BB&T re-entered the bank acquisition market and completed the acquisitions of Main Street and First Citizens. Please 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, 2006. 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 2006, BB&T recorded net merger-related and restructuring charges of $18 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 write-off of duplicate software in connection with the Main Street acquisition and systems conversion costs related to the acquisitions of Main Street and First Citizens.

 

During 2005, BB&T recorded net merger-related and restructuring credits, or gains of $11 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

 

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personnel-related liabilities in connection with the First Virginia Banks, Inc. (“First Virginia”) and Republic Bancshares, Inc. (“Republic”) acquisitions on terms more beneficial than originally estimated.

 

During 2004, BB&T recorded merger-related and restructuring charges of $6 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, Seibels & Williams, Inc. (“McGriff”) and Republic.

 

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

 

     For the Year Ended
December 31,
 
         2006             2005             2004      
     (Dollars in millions)  

Severance and personnel-related charges

   $ 2     $ (5 )   $ 9  

Occupancy and equipment charges

     (2 )     (5 )     (12 )

Systems conversions and related charges

     4       —         1  

Marketing and public relations

     2       —         4  

Asset write-offs and other merger-related charges

     12       (1 )     4  
                        

Total

   $ 18     $ (11 )   $ 6  
                        

 

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. During 2006, BB&T estimated that 147 positions would be eliminated and receive severance due to mergers and 114 employees did, in fact, receive severance in 2006. Sixty-one former employees will continue to receive merger-related severance payments during 2007. 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 continued to receive severance payments during 2005.

 

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.

 

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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. These tables include costs reflected as expenses, as presented in the table above, and certain accruals recorded through purchase accounting adjustments.

 

    Merger Accrual Activity
    (Dollars in millions)
    Balance
January 1,
2005
  Accrued at
acquisition
  Merger-related
and
restructuring
gains
    Utilized     Purchase
Price
Adjustments
  Other, net     Balance
December 31,
2005

Severance and personnel-related charges

  $ 15   $ —     $ (5 )   $ (4 )   $ —     $ —       $ 6

Occupancy and equipment charges

    16     —       (5 )     (4 )     —       1       8

Other merger-related charges

    3     2     (1 )     (2 )     1     —         3
                                               

Total

  $ 34   $ 2   $ (11 )   $ (10 )   $ 1   $ 1     $ 17
                                               
    Balance
January 1,
2006
  Accrued at
acquisition
  Merger-related
and
restructuring
charges (gains)
    Utilized     Purchase
Price
Adjustments
  Other, net (1)     Balance
December 31,
2006

Severance and personnel-related charges

  $ 6   $ 20   $ 2     $ (19 )   $ 3   $ —       $ 12

Occupancy and equipment charges

    8     —       (2 )     (2 )     —       —         4

Systems conversions and related charges

    —       1     4       (5 )     —       —         —  

Other merger-related charges

    3     —       14       (5 )     —       (10 )     2
                                               

Total

  $ 17   $ 21   $ 18     $ (31 )   $ 3   $ (10 )   $ 18
                                               

(1)   Primarily relates to the write-off of duplicate software related to the Main Street acquisition.

 

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, 2006 are expected to be utilized during 2007, 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.

 

For 2006, net interest income on an FTE-adjusted basis totaled $3.8 billion, compared with $3.6 billion in 2005 and $3.4 billion in 2004. The 5.2% increase in net interest income during 2006 resulted because the benefit from strong average earning asset growth of 9.6% 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.

 

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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 3.74% in 2006, 3.89% in 2005 and 4.04% in 2004. The average yield on interest earning assets increased 84 basis points compared to the average yield during 2005, while the average cost of funds over the same time period increased 114 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 and a change in the mix of funding sources with a higher concentration of deposits in higher-cost products. 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 expects 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, which became inverted in 2006. The inverted yield curve is a significant challenge for financial services companies, like BB&T, who borrow money from clients in the form of deposits and pay short-term rates, and invest in assets with longer-term maturities, which generally produce an interest spread. BB&T’s net interest margin was also negatively impacted by the additional interest expense incurred in connection with BB&T’s share repurchase program. While management expects some volatility in the net interest margin during the quarterly periods in 2007, it currently estimates that the full year 2007 margin will be in the middle of the range between 3.60% and 3.70%. While management believes this estimate is reasonable it is based on a number of factors management does not control, including expectations with regards to future actions by the Federal Reserve Board, changes in the volumes of assets and liabilities and other factors, which may not occur as currently anticipated by management.

 

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Table 15

FTE Net Interest Income and Rate / Volume Analysis

For the Years Ended December 31, 2006, 2005 and 2004

 

                                              2006 vs. 2005     2005 vs. 2004  
    Average Balances   Yield / Rate     Income / Expense  

Increase

(Decrease)

    Change due to    

Increase

(Decrease)

    Change due to  
    2006   2005   2004   2006     2005     2004     2006   2005   2004     Rate     Volume       Rate     Volume  
    (Dollars in millions)  

Assets

                             

Securities, at amortized cost (1):

                             

U.S. Treasury securities

  $ 113   $ 120   $ 132   3.56 %   3.05 %   2.93 %   $ 4   $ 4   $ 4   $ —       $ —       $ —       $ —       $ —       $ —    

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

    11,616     12,299     13,883   4.02     3.78     3.91       467     465     542     2       29       (27 )     (77 )     (17 )     (60 )

Mortgage-backed securities

    6,990     6,106     2,593   4.97     4.72     4.52       347     288     117     59       16       43       171       5       166  

States and political subdivisions

    607     699     827   6.89     6.73     6.51       42     47     54     (5 )     1       (6 )     (7 )     2       (9 )

Other securities

    1,160     696     387   5.82     4.97     3.25       67     35     13     32       7       25       22       9       13  

Trading securities

    862     547     396   3.34     2.64     2.09       29     14     8     15       4       11       6       3       3  
                                                                                                     

Total securities (5)

    21,348     20,467     18,218   4.48     4.17     4.05       956     853     738     103       57       46       115       2       113  

Other earning assets (2)

    911     719     621   5.69     3.06     1.79       52     22     11     30       22       8       11       9       2  

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

    79,313     71,517     66,107   7.53     6.59     5.87       5,973     4,713     3,879     1,260       714       546       834       501       333  
                                                                                                     

Total earning assets

    101,572     92,703     84,946   6.87     6.03     5.45       6,981     5,588     4,628     1,393       793       600       960       512       448  
                                                                                                     

Non-earning assets

    12,756     11,909     11,330                        
                                         

Total assets

  $ 114,328   $ 104,612   $ 96,276                        
                                         

Liabilities and Shareholders’ Equity

                             

Interest-bearing deposits:

                             

Interest-checking

  $ 2,164   $ 1,797   $ 1,609   1.87     0.80     0.33       40     14     5     26       23       3       9       8       1  

Other client deposits

    31,462     29,814     28,623   2.43     1.51     0.96       764     451     275     313       287       26       176       164       12  

Client certificates of deposits

    22,564     17,969     17,526   4.16     2.91     2.14       939     522     375     417       262       155       147       137       10  

Other interest-bearing deposits

    7,822     7,888     5,375   5.04     3.35     1.39       394     265     75     129       131       (2 )     190       143       47  
                                                                                                     

Total interest-bearing deposits

    64,012     57,468     53,133   3.34     2.18     1.37       2,137     1,252     730     885       703       182       522       452       70  

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

    7,006     7,386     6,591   4.30     3.04     1.37       301     224     90     77       90       (13 )     134       122       12  

Long-term debt

    14,628     11,959     10,886   5.10     4.22     3.48       747     505     378     242       117       125       127       87       40  
                                                                                                     

Total interest-bearing liabilities

    85,646     76,813     70,610   3.72     2.58     1.70       3,185     1,981     1,198     1,204       910       294       783       661       122  
                                                                                                     

Noninterest-bearing deposits

    13,218     12,878     11,683                        

Other liabilities

    4,012     3,856     3,386                        

Shareholders’ equity

    11,452     11,065     10,597                        
                                         

Total liabilities and shareholders’ equity

  $ 114,328   $ 104,612   $ 96,276                        
                                         

Average interest rate spread

        3.15 %   3.45 %   3.75 %                  
                                         

Net interest margin

        3.74 %   3.89 %   4.04 %   $ 3,796   $ 3,607   $ 3,430   $ 189     $ (117 )   $ 306     $ 177     $ (149 )   $ 326  
                                                                                         

(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 $88 million, $83 million and $81 million for the three years ended December 31, 2006, 2005 and 2004, 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.

 

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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 2006 was $240 million, compared with $217 million in 2005 and $249 million in 2004.

 

The provision for credit losses increased 10.6% during 2006 while the total loan and lease portfolio increased 11.4% compared to the balance outstanding at the end of 2005. Net charge-offs were .27% of average loans and leases for 2006 compared to .30% of average loans during 2005. The allowance for loan and lease losses was 1.06% of loans and leases outstanding and was 3.41x total nonaccrual and restructured loans and leases at year-end 2006, compared to 1.10% and 3.60x, respectively, at December 31, 2005. The increase in the provision for credit losses during 2006 was primarily the result of growth in the loan portfolio compared to 2005, while the decrease in the provision for credit losses during 2005 compared to 2004 reflected improving credit quality trends.

 

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 commissions and fees derived from other activities. Noninterest income as a percentage of total revenues has steadily increased in recent years, totaling 40.6% for 2006. Exceeding 40% on this measure has been a management objective for several years. Management has established a new goal for noninterest income to exceed 45% of total revenues in the next five years to further reduce BB&T’s reliance on traditional spread-based interest income, as fee-based activities are a relatively stable revenue source during periods of changing interest rates.

 

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

 

Table 16

Noninterest Income

 

                     % Change  
     Years Ended December 31,    2006
v.
2005
    2005
v.
2004
 
     2006     2005    2004     
     (Dollars in millions)  

Insurance commissions

   $ 813     $ 714    $ 619    13.9 %   15.3 %

Service charges on deposits

     548       543      523    .9     3.8  

Investment banking and brokerage fees and commissions

     317       290      265    9.3     9.4  

Other nondeposit fees and commissions

     167       129      116    29.5     11.2  

Checkcard fees

     155       128      101    21.1     26.7  

Trust income

     154       141      119    9.2     18.5  

Bankcard fees and merchant discounts

     122       112      102    8.9     9.8  

Mortgage banking income

     108       104      110    3.8     (5.5 )

Securities gains (losses), net

     (73 )     —        6    NM     NM  

Income from bank-owned life insurance

     93       94      92    (1.1 )   2.2  

Other noninterest income

     117       71      66    64.8     7.6  
                                  

Total noninterest income

   $ 2,521     $ 2,326    $ 2,119    8.4 %   9.8 %
                                  

NM—not meaningful

 

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The 8.4% growth in noninterest income was the result of increased revenues from essentially all of BB&T’s fee-based businesses during 2006. These increases were partially offset by a loss from sales of securities as a result of management’s decision to restructure a portion of the securities portfolio during the fourth quarter of 2006, and a slight decline in income from bank-owned life insurance. The 9.8% growth in noninterest income for 2005 was a 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, checkcard fees 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 major categories of noninterest income and fluctuations in these amounts are discussed in the following paragraphs. These fluctuations reflect the impact of acquisitions.

 

Revenues from BB&T’s extensive insurance agency/brokerage operations were the largest source of noninterest income. Internal growth, combined with the expansion of BB&T’s insurance agency network through acquisitions during the last two years, resulted in growth of 13.9% in 2006 and 15.3% in 2005. Commission income from CRC Insurance Services (“CRC”), BB&T’s wholly owned wholesale insurance broker, contributed approximately $39 million in growth for the current year, while BB&T Insurance Services, Inc. (“BB&T Insurance”) and McGriff contributed an additional $24 million and $30 million of growth, respectively, compared to 2005. These increases were primarily related to property and casualty insurance and employee benefit-related insurance products, which increased $77 million and $10 million, respectively, compared to 2005. The increase in commission income during 2005 was also generated primarily from CRC, BB&T Insurance and McGriff and included increases in property and casualty insurance, employee benefit-related insurance and other insurance fees and commissions of $67 million, $16 million and $15 million, respectively compared to 2004.

 

Service charges on deposit accounts represent BB&T’s second largest category of noninterest revenue. Growth in service charge revenue slowed during 2006, primarily due to management’s decision to offer more free services as a method of attracting and retaining clients. The resulting decline caused by these changes in pricing strategy was more than offset by an increase of $24 million on higher revenues from overdraft items in 2006 compared to 2005. During 2005, BB&T experienced a 3.8% 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 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 million and $11 million, respectively, compared to last year.

 

Investment banking and brokerage fees and commissions increased $27 million, or 9.3%, compared to 2005 primarily as a result of increased revenues of $23 million at Scott & Stringfellow, BB&T’s full-service brokerage and investment banking subsidiary. The increase during 2006 includes the impact from the acquisition of Bergen Capital, Inc., which was completed in January 2006. The 9.4% increase in 2005 compared to 2004 resulted primarily from growth in investment banking and retail brokerage revenues at Scott & Stringfellow. The primary contributor to the 2005 increase was the acquisition of Windsor Group, LLC by Scott and Stringfellow.

 

Other nondeposit fees and commissions, including bankcard fees and merchant discounts and checkcard fees increased $75 million, or 20.3%, during 2006 compared to 2005. During 2005, these categories increased $50 million, or 15.7%, compared to 2004. The increases in 2006 and 2005 included additional checkcard fees and bankcard fees and merchant discounts of $27 million and $10 million, respectively, for each period as clients continued to show a preference for utilizing electronic forms of payment rather than traditional paper checks. This preference by clients transferred into increased volumes in both categories of noninterest revenues for 2006 and 2005. Additionally, during 2006 and 2005 fees from money orders and official checks increased $14 million and $8 million, respectively, compared to the prior year. In addition, the growth in this category was impacted by the acquisitions completed during the last two years.

 

Revenue from corporate and personal trust services 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. During 2006, trust revenues increased by $13 million compared to 2005. The increase during 2006 was the result of a combination of factors, including approximately $4 million related to wealth management fee opportunities that were identified as part of management’s 2004 revenue enhancement initiative, $4 million as a result of increased assets under management and $3 million related to the 2005 acquisition of Sterling Capital Management LLC (“Sterling”). In

 

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2005, trust revenue increased $22 million, or 18.5%, compared to 2004. The increase in trust service income in 2005 was primarily a result of the acquisition of Sterling, which contributed approximately $15 million in growth in 2005. In addition, administrative fees from proprietary mutual funds increased $5 million in 2005 compared to 2004. The value of trust assets under management, including custodial accounts, increased during each of the last three years and was $33.7 billion, $32.9 billion and $28.4 billion at December 31, 2006, 2005 and 2004, respectively. The increase in assets under management during 2005 was primarily a result of the acquisition of Sterling, which added approximately $8.0 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.

 

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 $108 million, $104 million and $110 million during 2006, 2005 and 2004, respectively. 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,

   

2006

v.

    2005    

   

2005

v.

    2004    

 

Mortgage Banking Income

       2006             2005             2004          
     (Dollars in millions)              

Residential mortgage production income

   $ 46     $ 58     $ 62     (20.7 )%   (6.5 )%

Residential Mortgage Servicing:

          

Residential mortgage servicing fees

     102       96       93     6.3     3.2  

Residential mortgage servicing rights increase in fair value due to change in valuation inputs or assumptions

     21       —         —       NM     NM  

Mortgage servicing rights valuation recapture

     —         86       8     NM     NM  

Mortgage servicing rights derivative losses (gains)

     (17 )     (77 )     17     (77.9 )   NM  
                            

Net

     4       9       25     (55.6 )   (64.0 )

Amortization of residential mortgage servicing rights

     —         (84 )     (89 )   NM     (5.6 )

Decrease in fair value of residential mortgage servicing rights

     (80 )     —         —       NM     NM  
                            

Total residential mortgage servicing income

     26       21       29     23.8     (27.6 )
                            

Total residential mortgage banking income

     72       79       91     (8.9 )   (13.2 )
                            

Commercial mortgage banking revenues

     40       27       22     48.1     22.7  

Amortization of commercial mortgage servicing rights

     (4 )     (2 )     (3 )   100.0     (33.3 )
                            

Total commercial banking income

     36       25       19     44.0     31.6  
                            

Total mortgage banking income

   $ 108     $ 104     $ 110     3.8     (5.5 )
                            
          

NM = Not Meaningful

                        
    

As of/ For the Years Ended
December 31,

    % Change  
      

2006

v.

2005

   

2005

v.

2004

 

Mortgage Banking Statistical Information

   2006     2005     2004      
     (Dollars in millions)              

Residential mortgage originations

   $ 9,889     $ 10,528     $ 9,961     (6.1 )%   5.7 %

Residential mortgage loan serviced for others

     28,232       25,844       24,526     9.2     5.4  

Residential mortgage loan sales

     5,282       4,835       5,323     9.2     (9.2 )

Commercial mortgage originations

   $ 2,906     $ 2,038     $ 1,554     42.6     31.1  

Commercial mortgage loans serviced for others

     9,206       8,092       6,706     13.8     20.7  

 

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Mortgage banking income increased $4 million, or 3.8%, during 2006. The increase in 2006 included an increase of $11 million, or 44.0%, from commercial mortgage banking activities which are generated by BB&T’s subsidiary, Laureate Capital LLC (“Laureate”). BB&T’s residential mortgage banking income declined $7 million during 2006 compared to 2005, primarily as a result of lower gains from sales of mortgage loans, which resulted in a decline of $12 million from residential mortgage production revenues. While residential mortgage loan sales increased from $4.8 billion in 2005 to $5.3 billion in 2006 the margins on residential mortgage loan sales were down as a result of increased competition in the marketplace. This decline was partially offset by an increase of $5 million related to residential mortgage servicing activities. The 5.5% decline in mortgage banking income in 2005 compared to 2004 was primarily a result of a decrease in the net impact of the valuation adjustment for mortgage servicing rights and related derivatives, which declined $16 million, or 64.0%, compared to 2004. During 2005, BB&T recorded $86 million of recapture for the valuation of mortgage servicing rights as compared to $8 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 $(77 million) and $17 million, respectively. In addition, mortgage production revenues declined 6.5% 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 retained in the loan portfolio. Commercial mortgage banking revenues generated by Laureate increased $6 million in 2005 compared to 2004. Laureate increased its presence during 2005 with the acquisition of two firms specializing in commercial mortgage banking, which contributed to the increases in revenues for 2006 and 2005.

 

Other income increased $46 million, or 64.8%, in 2006 compared to 2005. The increase during 2006 was primarily the result of increased revenues from investments managed by BB&T Capital Partners, a small business investment company, which contributed $21 million to the growth during 2006. In addition, 2006 includes increases of $8 million in revenues from various financial assets isolated for the purpose of providing post-employee benefits and $8 million related to trading income at Scott & Stringfellow. The 7.6%, or $5 million increase in 2005 compared to 2004 was primarily due to higher income from limited partnership investments, which increased $7 million compared to the prior year. In addition, trading income at Scott & Stringfellow increased $7 million compared to the prior year due to increased activity in the trading portfolio. These increases were 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 million and $3 million, respectively, during 2005 as compared to 2004.

 

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 financial services companies, including 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. As previously mentioned, management has set a goal to increase the contribution of noninterest revenue sources from the current level of 40% to 45% over the next five years.

 

Noninterest Expense

 

Noninterest expense totaled $3.5 billion in 2006, $3.2 billion in 2005 and $2.9 billion in 2004. Noninterest expense includes certain merger-related charges or credits recorded during the years 2006, 2005 and 2004 as noted in Table 18 below. These amounts totaled $18 million in 2006, $(11 million) in 2005 and $6 million in 2004. 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. 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 2006 and 2005.

 

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Table 18

Noninterest Expense

 

          % Change  
     Years Ended December 31,   

2006
v.

2005

   

2005
v.

2004

 
     2006    2005     2004     
     (Dollars in millions)             

Salaries and wages

   $ 1,700    $ 1,474     $ 1,338    15.3 %   10.2 %

Pension and other employee benefits

     377      311       294    21.2     5.8  
                                  

Total personnel expenses

     2,077      1,785       1,632    16.4     9.4  

Net occupancy expense on bank premises

     253      274       213    (7.7 )   28.6  

Furniture and equipment expense

     196      198       203    (1.0 )   (2.5 )
                                  

Total occupancy and equipment expenses

     449      472       416    (4.9 )   13.5  

Professional services

     120      93       76    29.0     22.4  

Amortization of intangibles

     104      112       106    (7.1 )   5.7  

Loan processing expenses

     103      98       84    5.1     16.7  

Software

     58      52       43    11.5     20.9  

Advertising and public relations

     55      48       32    14.6     50.0  

Travel and transportation

     48      38       32    26.3     18.8  

Telephone

     44      43       47    2.3     (8.5 )

Deposit related expense

     38      38       34    —       11.8  

Supplies

     37      38       37    (2.6 )   2.7  

Foreclosed property expense

     18      23       26    (21.7 )   (11.5 )

Regulatory charges

     15      14       15    7.1     (6.7 )

Merger-related and restructuring charges

     18      (11 )     6    NM     NM  

Loss on early extinguishment of debt

     —        3       —      NM     NM  

Other noninterest expenses

     332      321       310    3.4     3.5  
                                  

Total noninterest expense

   $ 3,516    $ 3,167     $ 2,896    11.0 %   9.4 %
                                  

NM—not meaningful

 

The 11.0% increase in total noninterest expense during 2006 compared to 2005 was primarily due to increases in personnel costs and professional services, which was partially offset by a reduction in occupancy expense as a result of the one-time lease adjustment recorded during 2005. The 9.4% 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 increases during 2006 and 2005 were impacted by the acquisitions of Main Street and First Citizens during 2006 and several nonbank financial services companies during 2006 and 2005.

 

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 2006 increase of 16.4% resulted primarily from additional salaries and wages as a result of increased incentive compensation and additional staffing. Total salaries and wages increased $226 million compared to 2005, including higher insurance incentive compensation, investment banking incentive compensation and other annual incentive compensation of $37 million, $17 million and $10 million, respectively. Incentive commissions related to mortgage banking activities declined $7 million in 2006 compared to 2005. In addition, BB&T adopted SFAS 123(R) on January 1, 2006 and recorded compensation expense related to its equity-based awards in 2006 of $58 million. The 21.2% 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 million each compared to 2005. In addition, expense related to post-employment benefits, excluding defined contribution plan expenses, increased $18 million and health care and other welfare expenses increased $14 million compared to 2005. 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 $136 million in 2005 compared to 2004, including higher insurance incentive compensation, investment banking incentive compensation, mortgage loan production incentive compensation and other annual performance compensation, which grew $34 million, $19 million, $8 million and $19 million, respectively, compared to 2004. The 5.8% increase in pension and other employee benefit

 

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costs was also affected by the additional salaries and wages expense, which caused increases in social security taxes and defined contribution plan expenses, of $9 million and $4 million, respectively, compared to 2004. In addition, pension expense increased $2 million and health care expenses increased $6 million compared to 2004. These increases were offset by a $12 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. Additional disclosures relating to BB&T’s benefit plans can be found in Note 14 “Benefit Plans” in the “Notes to Consolidated Financial Statements.”

 

Net occupancy and equipment expense decreased $23 million, or 4.9%, in 2006. The decrease in 2006 was largely a result of the $44 million lease adjustment previously mentioned. This decrease was partially offset by increases as a result of BB&T’s de novo branching strategy, additional rent from new leases and other increases. During 2005 net occupancy and equipment expense increased by $56 million, or 13.5%, in 2005. The increase is primarily the result of the $44 million one-time lease adjustment previously mentioned.

 

The decrease in amortization expense associated with intangible assets in 2006 compared to 2005 primarily resulted from decreases from declining balance amortization methods for past acquisitions. These decreases were offset by additional amortization due to the acquisitions of Main Street and First Citizens during 2006. During 2005 amortization expense for intangibles increased 5.7% due to acquisitions. 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, 2006.

 

Other noninterest expenses, including loan processing expenses and professional services, increased $59 million, or 7.3% compared to 2005, which reflected an increase of $73 million, or 9.9%, compared to 2004. The 2006 increase was primarily the result of increases in professional services, advertising expenses, software expenses and travel and transportation costs. The 2005 increase reflected higher advertising expenses, professional services expenses, loan processing expenses and software expenses. The increases for 2006 and 2005 were impacted by acquisitions completed during the past two years. 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 estimates that through year-end 2006, approximately $140 million of the anticipated revenue enhancements or cost savings had been realized. Management expects that substantially all of the $175 million of annual benefits will be achieved by mid-year 2007.

 

Provision for Income Taxes

 

BB&T’s provision for income taxes totaled $945 million for 2006, an increase of $132 million, or 16.2%, compared to 2005. The provisions for income taxes totaled $813 million in 2005 and $764 million in 2004. BB&T’s effective tax rates for the years ended 2006, 2005 and 2004 were 38.2%, 33.0%, and 32.9%, respectively. The increase in the provision for income taxes and the higher effective tax rate in 2006 were primarily the result of an adjustment of $139 million to BB&T’s tax reserves for leveraged lease transactions as discussed below. The increased provision for income taxes in 2005 was the result of higher pretax income. A reconciliation of the effective tax rate to the statutory tax rate is included in Note 13 “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 2006, 2005 and 2004.

 

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

 

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and regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of current taxing authorities’ examinations of BB&T’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment in relation to tax-advantaged transactions. Accordingly, the results of these examinations may alter the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. In this regard, the Internal Revenue Service (“IRS”) disallowed certain deductions taken by BB&T on leveraged lease transactions during 1997-2002. In 2004, BB&T filed a lawsuit against the IRS to pursue a refund of amounts assessed by the IRS related to a leveraged lease transaction entered into during 1997. On January 4, 2007, the United States Middle District Court of North Carolina issued a summary judgment in favor of the IRS related to BB&T’s lawsuit. Based on a review of the summary judgment by BB&T’s counsel, BB&T’s management disagrees with the decision and currently intends to appeal the matter to the United States Appeals Court for the Fourth Circuit, based in Richmond, Virginia.

 

Due to the timing of the District Court’s ruling and its potential impact on BB&T’s other leveraged lease transactions, BB&T recorded $139 million in additional reserves in the fourth quarter of 2006 and paid $1.2 billion to the IRS during the first quarter of 2007. This payment represented the total tax and interest due on these transactions for all open years. The tax paid relates to differences in the timing of income recognition and deductions for income tax purposes for which deferred taxes had been previously provided.

 

Management has consulted with outside counsel and continues to believe that BB&T’s treatment of its leveraged lease transactions was appropriate and in compliance with the tax laws and regulations applicable to the years examined and intends to continue to pursue legal remedies related to this issue.

 

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 may have on net interest income. This is accomplished through active management of asset and liability portfolios with a focus on the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The goal of these activities is the development of appropriate maturity and repricing opportunities in BB&T’s portfolios of assets and liabilities that will produce consistent net interest income during periods of changing interest rates. BB&T’s Market Risk and Liquidity Committee 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 Market Risk and Liquidity Committee to determine and achieve the most appropriate volume and mix of earning assets and interest-bearing liabilities, as well as to ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The Market Risk and Liquidity Committee also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The Market Risk and Liquidity Committee meets regularly to review BB&T’s interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards.

 

BB&T utilizes a variety of financial instruments to manage various financial risks. These instruments, commonly referred to as derivatives, primarily consist of interest-rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. BB&T uses derivatives primarily to manage risk related to securities, business loans, federal funds purchased, long-term debt, mortgage servicing rights, mortgage banking operations and certificates of deposit. BB&T also uses derivatives to facilitate transactions on behalf of its clients. BB&T’s derivatives resulted in an increase in net interest income of $8 million, $52 million and $155 million in

 

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2006, 2005 and 2004, respectively. The reduction in net interest income benefit from 2004 to 2006 can be attributed to interest rate increases as well as changes in the composition of the derivatives portfolio.

 

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, 2006, BB&T had derivative financial instruments outstanding with notional amounts totaling $23.1 billion. The estimated net fair value of open contracts was $(45 million) at December 31, 2006.

 

See Note 19 “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 Market Risk and Liquidity Committee, management believes that BB&T is positioned to respond to changing needs for liquidity, changes in interest rates and inflationary trends.

 

BB&T’s interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions at December 31, 2006, 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, 2006

 

    

Within One

Year

   

One to

Three Years

  

Three to

Five Years

   After
Five Years
    Total
     (Dollars in millions)
Assets             

Securities and other interest-earning assets (1)

   $ 5,960     $ 6,340    $ 4,204    $ 7,328     $ 23,832

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

     253       —        —        —         253

Loans and leases (2)

     50,648       14,498      7,779      10,666       83,591
                                    
Total interest-earning assets      56,861       20,838      11,983      17,994       107,676
                                    
Liabilities             

Time deposits

     31,683       3,552      663      3       35,901

Other deposits with no stated maturity (3)

     14,644       4,339      2,237      10,457       31,677

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

     7,869       218      —        —         8,087

Long-term debt

     3,273       1,036      1,301      10,294       15,904
                                    
Total interest-bearing liabilities      57,469       9,145      4,201      20,754       91,569
                                    
Asset-liability gap    $ (608 )   $ 11,693    $ 7,782    $ (2,760 )  
                                
Cumulative interest rate sensitivity gap    $ (608 )   $ 11,085    $ 18,867    $ 16,107    
                                

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

 

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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 the 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 management believes that it provides a better illustration of the sensitivity of earnings to changes in interest rates than other analyses such as static or dynamic gap.

 

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

 

The following table shows the effect that the indicated changes in interest rates would have on interest sensitive 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 of 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 interest sensitive income reflects the level of sensitivity that interest sensitive 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,

  

2006

  

2005

  

2006

  

2005

3.00%

   11.25%    10.25%    (3.12)%    1.20%

1.50   

   9.75       8.75       (2.19)       0.76   

No Change

   8.25       7.25       —      —  

(1.50)   

   6.75       5.75       1.58       (1.13)   

(3.00)   

   5.25       4.25       1.96       (1.95)   

 

Management has established parameters for asset/liability management, which prescribe a maximum negative impact on interest sensitive income of 3% for the next 12 months for a linear increase 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 increase of 300 basis points for 12 months.

 

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.

 

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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 Branch Bank, equity investments in subsidiaries, advances to subsidiaries, accounts receivable from subsidiaries, and other miscellaneous assets. The principal obligations of the Parent Company are principal and interest on master notes, long-term debt, and redeemable capital securities. The main sources of funds for the Parent Company are dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from issuance of long-term debt and master notes. The primary uses of funds by the Parent Company are for the retirement of common stock, investments in subsidiaries, advances to subsidiaries, dividend payments to shareholders, and interest and principal payments due on long-term debt and master notes.

 

The primary source of funds used for Parent Company cash requirements has been dividends declared from Branch Bank, which totaled $1.8 billion during 2006, and net proceeds from the issuance of long-term debt, which totaled $599 million in 2006. Funds raised through master note agreements with commercial clients are placed on deposit with Branch Bank primarily for its 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, 2006 and 2005, master note balances totaled $1.4 billion and $1.1 billion, 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 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. In late 2005, the SEC passed major changes to the securities registration process, which especially benefited larger companies who frequently access the capital markets. The changes to the securities registration process allow companies who have met certain eligibility requirements to file a registration statement that immediately becomes effective and permits the company to pay the fees related to the registration of the securities at the time of issuance. This has effectively eliminated the need to periodically file shelf registration statements and estimate the amount of securities that will be needed in the future. The change in regulations also has greatly enhanced the ability of BB&T to access the capital markets. During 2006, BB&T filed an automatic shelf registration statement in accordance with the new regulations to provide for the issuance of capital securities by BB&T Capital Trust II and issued $600 million of capital securities under this registration.

 

The Parent Company had six issues of subordinated notes outstanding totaling $3.4 billion and $3.3 billion at December 31, 2006 and 2005, 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.

 

Branch Bank has several major sources of funding to meet its liquidity requirements, including access to capital markets through issuance of senior or subordinated bank notes and institutional 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 Board, 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 Board 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 15 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements” for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations.

 

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

 

The following table presents, as of December 31, 2006, 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 15 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”

 

Table 21

Contractual Obligations and Other Commitments

December 31, 2006

 

     Total    Less than
One Year
   1 to 3
Years
   3 to 5
Years
   After 5
Years
     (Dollars in millions)
Contractual Cash Obligations               

Long-term debt

   $ 15,904    $ 3,273    $ 1,036    $ 1,301    $ 10,294

Operating leases

     939      121      211      164      443

Commitments to fund affordable housing investments

     183      85      66      31      1

Time deposits

     35,901      31,683      3,552      663      3
                                  

Total contractual cash obligations

   $ 52,927    $ 35,162    $ 4,865    $ 2,159    $ 10,741
                                  

 

BB&T’s significant commitments include certain investments in affordable housing and historic building rehabilitation projects throughout its market area. BB&T enters into such arrangements as a means of supporting local communities and recognizes tax credits relating to these investments. At December 31, 2006, BB&T’s investments in such projects totaled $367 million, which includes outstanding commitments of $183 million. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. Branch Bank typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. BB&T’s risk exposure relating to such commitments is generally limited to the amount of investments and commitments made. Please refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for further discussion of these investments in limited partnerships.

 

In addition, BB&T enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the Consolidated Balance Sheets with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative liabilities recorded on the balance sheet as of December 31, 2006, do not represent the amounts that may ultimately be paid under these contracts. Further discussion of derivative instruments is included in Note 1 “Summary of Significant Accounting Policies” and Note 19 “Derivative Financial Instruments” in the “Notes to Consolidated Financial Statements.”

 

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

 

Merger and acquisition agreements of businesses other than financial institutions occasionally include additional incentives to the acquired entities to offset the loss of future cash flows previously received through ownership positions. Typically, these incentives are based on the acquired entity’s contribution to BB&T’s

 

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earnings compared to agreed-upon amounts. When offered, these incentives are typically issued for terms of three to five years. As certain provision of these agreements do not specify dollar limitations, it is not possible to quantify the maximum exposure resulting from these agreements.

 

In the normal course of business, BB&T is also a party to financial instruments to meet the financing needs of clients and to mitigate exposure to interest rate risk. Such financial instruments include commitments to extend credit and certain contractual agreements, including standby letters of credit and financial guarantee arrangements. Further discussion of these commitments is included in Note 15 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements.”

 

BB&T contracts with an independent third party for the disbursement of official checks. Under the terms of the agreement, BB&T acts as an agent for the third party in the issuance of official checks. Funds received from the buyers of official checks are transferred to the third party issuer to cover the checks when they are ultimately presented for payment. But for this arrangement with the third party, these funds would have remained at BB&T in the form of noninterest-bearing deposits. The official check program is contractually arranged to substantially limit BB&T’s exposure to loss, since the third party is required to invest the funds received and maintain an equal relationship between outstanding checks and the balances available to cover the checks. BB&T monitors this relationship through a reconciliation process. The third party has provided a letter of credit from another bank in favor of BB&T and has access to a revolving line of credit to further mitigate any risk that there would be inadequate funds to cover the outstanding balance of official checks sold. However, in the event that the third party failed to honor official checks BB&T had sold as its agent, it is likely that BB&T would choose to reimburse the purchasers, though not contractually obligated to do so. At December 31, 2006, the third party issuer had outstanding official checks that had been sold by BB&T totaling $441 million.

 

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

 

Table 22

Summary of Significant Commitments

December 31, 2006

(Dollars in millions)

 

Lines of credit

   $ 12,933

Commercial letters of credit

     37

Standby letters of credit and financial guarantees written

     3,185

Other commitments (1)

     20,045
      

Total significant commitments

   $ 36,200
      

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

 

BB&T has from time to time entered into accelerated share repurchase programs (“ASRs”) to facilitate the repurchase of shares of BB&T common stock under share repurchase plans approved by the Board of Directors. As of December 31, 2006, BB&T had a commitment to purchase 701,200 shares to cover its outstanding obligations under an ASR program that was executed in June 2006. BB&T paid the agent executing the transaction $41.76 for each share upon entering the ASR agreement and will be required under the terms of the ASR agreement to ultimately settle the remaining shares either by delivering stock or paying or receiving cash based on the actual price paid by the agent for the remaining shares. As of February 5, 2007, the remaining shares outstanding under the ASR program had been settled and no further commitments were outstanding with respect to the ASR program.

 

Related Party Transactions

 

The Corporation may extend credit to certain officers and directors in the ordinary course of business. These loans are made under substantially the same terms as comparable third-party lending arrangements and are in compliance with applicable banking regulations.

 

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Capital

 

The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. BB&T’s principal goals related to the maintenance of capital are to provide adequate capital to support BB&T’s comprehensive risk profile, to preserve a sufficient capital base from which to support future growth, to provide a competitive return to shareholders, to comply with regulatory standards and to achieve optimal credit ratings for BB&T Corporation and its subsidiaries.

 

Management regularly monitors the capital position of BB&T on a consolidated basis. In this regard, management’s overriding policy is to maintain capital at levels that will result in BB&T being classified as “well-capitalized” for regulatory purposes and to maintain sufficient capital relative to the Corporation’s level of risk. Secondarily, it is management’s intent to maintain consolidated capital levels that result in regulatory risk-based capital ratios that are generally comparable with BB&T’s peers of similar size, complexity and risk profile. Further, management particularly monitors and intends to maintain the following minimum capital ratios:

 

Tier 1 Capital Ratio

   8.50 %

Total Capital Ratio

   12.00 %

Tier 1 Leverage Capital Ratio

   7.00 %

Tangible Capital Ratio

   5.50 %

 

Payments of cash dividends to BB&T’s shareholders, which have generally been in the range of 40.0% to 50.0% of earnings over the last six years, and repurchases of common shares are the methods used to manage any excess capital generated. In addition, management closely monitors the Parent Company’s double leverage ratio (investments in subsidiaries as a percentage of shareholders’ equity) with the intention of maintaining the ratio below 125.0%. The active management of the subsidiaries’ equity capital, as described above, is the process utilized to manage this important driver of Parent Company liquidity and is a key element in the management of BB&T’s capital position.

 

The capital of the subsidiaries is also regularly monitored to determine if the levels that management believes are the most beneficial and efficient for their operations are maintained. Management intends to maintain capital at Branch Bank at levels that will result in Branch Bank being classified as “well-capitalized” for regulatory purposes. Secondarily, it is management’s intent to maintain Branch Bank’s capital at levels that result in regulatory risk-based capital ratios that are generally comparable with peers of similar size, complexity and risk profile. If the capital levels of Branch Bank increase above these guidelines, excess capital may be transferred to the Parent Company, subject to regulatory and other operating considerations, in the form of special dividend payments.

 

While nonrecurring events or management decisions may result in the Corporation temporarily falling below its minimum guidelines for one or more of these ratios, it is management’s intent through capital planning to return to these targeted minimums within a reasonable period of time. Such temporary decreases below these minimums will not be considered an infringement of BB&T’s overall capital policy provided the Corporation and Branch Bank remain “well-capitalized.”

 

Shareholders’ Equity

 

Shareholders’ equity totaled $11.7 billion at December 31, 2006, an increase of $616 million, or 5.5%, from year-end 2005. During 2006, BB&T issued 20.7 million shares in connection with business combinations, the exercise of stock options and other equity-based incentive plans, which increased shareholders’ equity by $848 million. Additionally, growth of $645 million in shareholders’ equity resulted from BB&T’s earnings retained after dividends to shareholders. This growth was partially offset by the repurchase of 22.3 million shares of common stock at a cost of $936 million.

 

Capital Adequacy and Resources

 

Bank holding companies and their subsidiaries are subject to regulatory requirements with respect to risk-based capital adequacy. Capital adequacy is an important indicator of financial stability and performance.

 

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Risk-based capital ratios measure capital as a percentage of a combination of risk-weighted balance sheet and off-balance sheet risk. The risk-weighted values of both balance sheet and off-balance sheet items are determined in accordance with risk factors specified by Federal bank regulatory pronouncements.

 

Tier 1 capital is calculated as common shareholders’ equity, excluding the over- or underfunded status of postretirement benefit obligations, unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets, net of applicable deferred income taxes, and certain nonfinancial equity investments. Tier 2 capital may consist of qualifying subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for credit losses. Tier 1 capital and Tier 2 capital combined are referred to as total regulatory capital. Tier 1 capital is required to be at least 4% of risk-weighted assets, and total capital must be at least 8% of risk-weighted assets, with one half of the minimum consisting of Tier 1 capital.

 

In addition to the risk-based capital measures described above, regulators have also established minimum leverage capital requirements for banking organizations. The minimum required Tier 1 leverage ratio ranges from 3% to 5% depending upon Federal bank regulatory agency evaluations of an organization’s overall safety and soundness. BB&T’s regulatory capital and ratios are set forth in the following table.

 

Table 23

Capital—Components and Ratios

 

     December 31,  
     2006     2005  
     (Dollars in millions)  

Tier 1 capital

   $ 8,226     $ 7,454  

Tier 2 capital

     4,790       4,157  
                

Total regulatory capital

   $ 13,016     $ 11,611  
                

Risk-based capital ratios:

    

Tier 1 capital

     9.0 %     9.3 %

Total regulatory capital

     14.3       14.4  

Tier 1 leverage ratio

     7.2       7.2  

Tangible equity ratio

     5.6       6.1  

 

Common Stock and Dividends

 

BB&T’s ability to pay dividends is primarily dependent on earnings from operations, the adequacy of capital and the availability of liquid assets for distribution. BB&T’s ability to generate liquid assets for distribution is dependent on the ability of Branch Bank to pay dividends to the Parent Company. The payment of cash dividends is an integral part of providing a competitive return on shareholders’ investments. The Corporation’s policy is to accomplish this while retaining sufficient capital to support future growth and to meet regulatory requirements. BB&T’s common dividend payout ratio, computed by dividing dividends paid per common share by basic earnings per common share, was 56.34% in 2006 as compared to 48.34% in 2005. BB&T’s annual cash dividends paid per common share increased 9.6% during 2006 to $1.60 per common share for the year, as compared to $1.46 per common share in 2005. This increase marked the 35th consecutive year that the Corporation’s annual cash dividend paid to shareholders has been increased. A discussion of dividend restrictions is included in Note 16 “Regulatory Requirements and Other Restrictions” in the “Notes to Consolidated Financial Statements” and in the “Regulatory Considerations” section.

 

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BB&T’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “BBT”. BB&T’s common stock was held by approximately 259,000 shareholders at December 31, 2006 compared to approximately 257,000 at December 31, 2005. The accompanying table, “Quarterly Summary of Market Prices and Dividends Paid on Common Stock,” sets forth the quarterly high and low trading prices and closing sales prices for BB&T’s common stock and the dividends paid per share of common stock for each of the last eight quarters.

 

Table 24

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

 

     2006    2005
     Sales Prices   

Cash

Dividends

Paid

   Sales Prices   

Cash

Dividends

Paid

     High    Low    Last       High    Low    Last   

Quarter Ended:

                       

March 31

   $ 42.85    $ 38.24    $ 39.20    $ .38    $ 42.24    $ 37.68    $ 39.08    $ .35

June 30

     43.46      39.09      41.59      .38      40.95      37.04      39.97      .35

September 30

     44.54      39.87      43.78      .42      43.00      38.56      39.05      .38

December 31

     44.74      42.48      43.93      .42      43.92