BB&T Sees Trouble in Loans Tied to CRE

“BB&T bank out with its earnings, came out with $0.23 a share, a penny better than Thomson was looking for. Also talked about revenue of $2.8 billion in line…. Looking for non-performing assets as a percentage of total assets increasing 2.48% as of September 30th.” — CNBC’s Squawk Box 10/19/2009

BB&T (NYSE:BBT) reported third quarter earnings of 23 cents per share or $157 million. The bank’s profits came in one cent above the consensus of analysts’ estimates, but the Street has not greeted the results with enthusiasm as results represent a 58% drop in net income from a year ago. Shares of BB&T have sold off nearly 5% as the indices are soaring higher, and the main reason for this is the increased loan loss reserves set aside by BB&T. The bank set aside $709 million to cushion the shock of future losses, and this is nearly double the amount set aside a year ago. Furthermore, this follows the second quarter where the company added $701 million to reserves.

For much of the last year, BB&T has been regarded as one of the winners of the credit crisis because of their generally conservative practices. They have been one of the few major banks who have yet to report a loss in any recent quarter. However, the company’s debt portfolio is largely exposed to commercial real estate loans primarily in the Southeast region. The bank reported that they are seeing an increase in late payments and charge offs in the quarter.

BB&T’s recent acquisition of Colonial BancGroup’s deposits and assets has increased the risk associated with this bank. Colonial failed under the weight of its exposure to risky loans largely in Florida, an area that prior to the deal BB&T had luckily limited exposure. The deal to acquire these risky assets came with backing from the U.S. government on the first $5 billion in loan losses related to Colonial.

BB&T has increased the percentage of allowed loan losses now covered by reserves to 2.49% (excluding covered loans from FDIC backing) from 2.19% at the end of the second quarter. The buildup of reserves suggests two possibilities; either BB&T believes there is more risk of losses from Colonial than originally thought or that the company’s original book of debt is starting to show signs of weakness. Whether either or both of these scenarios are happening, it is cause for concern in the market as BB&T may lose the mantel of “conservative management.”

We have recently downgraded BB&T to Fairly Valued from Undervalued because the stock has appreciated into a price range that was no longer attractive given the growing risk in real estate. Residential foreclosures and nonperforming loans are still extremely high and many analysts believe will only get worse with the upcoming mortgage reset schedule. Furthermore, banks are just starting to recognize the difficulty that lay ahead in commercial real estate. Time will tell whether the acquisition of Colonial was a risk worth taking, but if the losses can be contained to right around the $5 billion mark then it certainly makes sense. For right now, we are neutral on BB&T as some of the concerns over real estate have been baked into the price, but we do not see enough value to compensate for the risk to recommend these shares.

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