We lowered our recommendation on BB&T Corporation (BBT) to Neutral from Outperform despite the fact that it reported better-than-expected first quarter results. The recommendation was downgraded owing to the company’s ever-increasing operating expenses.
BB&T continues to grow in both organic and inorganic front. Overall, the company’s strong liquidity position and steady improvement in capital and profitability ratios are the major positives. Nevertheless, the current protracted economic recovery and various regulatory issues will make it difficult for the company to significantly improve its top line.
One of the primary strengths for BB&T is the continued stability in its net interest margin (NIM). Over the last three years, NIM has been improving as a result of lower deposit and borrowing costs. Additionally, though there could be NIM pressure with the shrinkage of the Colonial-related accretion and low interest rate environment, we expect lower deposit costs and strong loan growth to keep the overall upward momentum intact.
BB&T can be viewed as an asset for yield-seeking investors. The company pays regular dividend as a part of its capital deployment activity. In March, following the release of the Federal Reserve’s stress test results, the company received the approval to hike its quarterly dividend by 25% to 20 cents per share. Over the longer term, the company is targeting a dividend payout ratio in the range of 30–50%.
Further, BB&T continuous to acquire small firms to augment its revenue streams. Last year, the company announced four acquisitions that will enable it to expand its market share in the insurance sector. Going forward, the company intends to pursue more acquisitions that will enhance its banking network, improve top line and client delivery system.
On the flip side is the company’s significant exposure to residential mortgage loans, direct retail residential loans, sales finance and revolving credit loans. Although BB&T has been successful in implementing assets disposition strategy, it still has a large amount of risky loans that could pose a problem if economic conditions continue to deteriorate.
Further, BB&T is severely exposed to risks and uncertainties associated with the integration of its acquisitions. Given the continued market volatility and economic uncertainty, the company may need to take additional markdowns and provide for allowances for loan losses on the assets and loans acquired from the acquisitions that the company has been making.
Moreover, like many other peers including PNC Financial Services Group Inc. (PNC) and SunTrust Banks Inc. (STI), BB&T’s profitability will likely be affected by various financial reform laws due to increased costs and fee restrictions. New capital proposals unveiled by the Fed suggest that big U.S. banks would be required to maintain a total tier 1 ratio of 7% to risk-weighted assets.
All these factors are expected to lower the company’s flexibility with respect to its business investments to some extent in the medium term. Currently, BB&T retains a Zacks #3 Rank, which translates into a short-term Hold rating.
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