My grandfather used to say, though never to me directly, that "banking is like sex. When it's good, it's great. And when it's bad, it's still pretty good."
While the financial crisis may have led the average investor to question this -- 454 banks have been seized by regulators since the beginning of 2008 -- the industry is back on its feet and growing again -- albeit at a less frenetic pace than before. In its most recent quarterly banking profile, for instance, the FDIC noted that the industry's first-quarter aggregate net income of $35.3 billion is the highest it's been since the second quarter of 2007.
Yet many banks are still trading for fractions of book value. While the average savings and loan institution is selling for an 11% discount, megamoney center banks like Bank of America and Citigroup are trading for less than half of their book values respectively. In this environment, it's become exceedingly important for investors in financial stocks to be able to weed out the winners from the losers. And to do this appropriately, one must look under the proverbial hood.
In this series, I examine six of the most important metrics to assess the quality of a bank's operations. The current bank under the microscope is BB&T (NYSE: BBT ) , the 16th largest bank in the United States operating principally throughout the mid-Atlantic.
|Tier 1 capital ratio
|| approx. 8%
|Net interest margin
|| >= 3.5%
|Provision for loan losses (as a % of net interest income)
|Net noninterest expense (as a % of net interest income)
|Non-performing loans (as a % of total loans)
|Return on equity (TTM)
|| >= 15%
|Price to book ratio
Source: BB&T's Q2 2012 10-Q, S&P Capital IQ, and Yahoo! Finance. TTM = trailing 12 months.
Despite BB&T's size, it's been able to avoid many of the pitfalls that other large banks experienced during and after the financial crisis. How did it do so, you ask? By staying boring. Very boring. In virtually every category I examined, it was neither the best nor the worst, typically falling close to the middle.
Its balance sheet provides a perfect example of the lender's laudable mediocrity. On the asset side, it has an ample loan portfolio constituting 62% of its assets and yielding an above average 5.45%. Approximately 42% of these are associated with individuals, while 43% are commercial in nature. Its total loans have grown an average of 6% a year since 2006.
On the liability side, its average cost of funds comes in at 0.87%. This, too, is diversified between deposits, which make up 62% of its liabilities, and more expensive debt, which accounts for the rest. While its aggregate cost of funds is notably higher than the industry average of 0.59%, it's less than half that of other large competitors like New York Community Bancorp (NYSE: NYB ) , which pays an outlandish 1.9%.
Taken together, then, its net interest margin for the second quarter was 3.95% -- again, above average, but nothing to write home about. And the same can be said about its capital base, illustrated by its good but not great tier 1 capital ratio of 10.2% -- though it should be noted that BB&T performed admirably in the most recent round of bank stress tests.
BB&T's income statement evidences more of the same. Thanks to its impressive net interest margin, it recorded nearly $1.5 billion in net interest income for the second quarter.
Yet, like any bank, these proceeds progressively vanish as you move down the statement. Nearly 19% are consumed by loan-loss provisions. With this in mind, besides its extreme ambivalence, if there is one area where BB&T unceremoniously distinguishes itself, this is it. As I noted in the table above, you ideally don't want to exceed 5% in this regard; even the currently troubled Hudson City Bancorp (Nasdaq: HCBK ) comes in at a comparatively modest 11%. Though, the difference between a bank like Hudson City and one like BB&T is that the latter manages its credit much more conservatively, with total loan-loss provisions equal to 129% of its nonperforming loans, whereas Hudson City's comparable figure is a regrettable 26%.
Beyond this, BB&T has a robust-fee based business which accounts for nearly $1 billion in noninterest income. The majority of this derives from three activities: insurance products, service charges on deposits, and mortgage banking income. These additional proceeds are nevertheless overwhelmed by the bank's $1.4 billion in noninterest expenses, over half of which consist of personnel expenses.
Yet, at the end of the day, through thick and thin, good times and bad, BB&T makes money. I suppose you can't ask for much more than that.
So is BB&T a buy?
Whether BB&T is a buy is a subjective question that individual investors must answer for themselves. What I will say, however, is this: It's consistent and unerringly profitable. It grows reliably both organically and via acquisition. And it pays a 2.5% dividend yield, outpacing the 10-year Treasury by almost a full percentage point. The biggest downfall is the price, as its shares trade for a 20% premium to book value and for more than two times tangible book.
The question of whether an investor should or should not buy BB&T accordingly boils down to this. If you want a high-quality stock and are willing to pay the price for it, then BB&T fits the bill for a legitimate long-term investment. On the other hand, if you prefer shopping in the bargain bin, it's probably best to look elsewhere.
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