BB&T 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended:
December 31, 2004
Commission File Number: 1-10853
(Exact name of Registrant as specified in its Charter)
(Registrants telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Securities Exchange Act of 1934:
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 an accelerated filer (as defined in Rule 12b-2 of the Act). YES þ NO ¨
At February 28, 2005, the Corporation had 548,455,745 shares of its Common Stock, $5 par value, outstanding. The aggregate market value of voting stock held by nonaffiliates of the Corporation is approximately $20.2 billion (based on the closing price of such stock as of June 30, 2004.)
Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 26, 2005, are incorporated by reference in Part III of this report.
CROSS REFERENCE INDEX
The information required by Item 11 is incorporated herein by reference to the information that appears under the headings Compensation of Executive Officers, Retirement Plans and Compensation Committee Report on Executive Compensation in the Registrants Proxy Statement for the 2005 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 Section 16(a) Beneficial Ownership Reporting Compliance in the Registrants Proxy Statement for the 2005 Annual Meeting of Shareholders.
The information required by Item 13 is incorporated herein by reference to the information that appears under the headings Compensation Committee Interlocks and Insider Participation and Transactions with Executive Officers and Directors in the Registrants Proxy Statement for the 2005 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 MattersAudit Committee Pre-Approval Policy in the Registrants Proxy Statement for the 2005 Annual Meeting of Shareholders.
BB&T Corporation (BB&T, the Company or the Corporation), headquartered in Winston-Salem, North Carolina, is a bank holding company and a financial holding company providing a wide variety of banking and financial services. BB&T conducts its business operations primarily through its commercial banking subsidiaries, which have offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, Indiana and Washington, D.C. In addition, BB&T offers various lending products, insurance and other financial services products nationwide through other subsidiaries.
BB&Ts principal commercial bank subsidiaries are Branch Banking and Trust Company (Branch Bank), Branch Banking and Trust Company of South Carolina (BB&T-SC), Branch Banking and Trust Company of Virginia (BB&T-VA) collectively the (Subsidiary Banks), and BB&T Bankcard Corporation. Branch Bank, BB&Ts largest subsidiary, was chartered in 1872 and is the oldest bank headquartered in North Carolina.
This Annual Report on Form 10-K contains forward-looking statements with respect to the financial condition, results of operations and business 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 on 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 possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) 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; (3) 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; (4) legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which BB&T is engaged; (5) costs or difficulties related to the integration of the businesses of BB&T and its merger partners may be greater than expected; (6) expected cost savings associated with recently completed mergers may not be fully realized or realized within the expected time frame; (7) deposit attrition, customer loss or revenue loss following recently completed mergers may be greater than expected; (8) competitors of BB&T may have greater financial resources and develop products that enable such competitors to compete more successfully than BB&T; and (9) adverse changes may occur in the securities markets.
Primary Subsidiaries of BB&T Corporation
At December 31, 2004, the principal operating subsidiaries of BB&T included the following:
Branch Bank, BB&Ts largest subsidiary, operated 905 banking offices at December 31, 2004, which were primarily located in North Carolina, Georgia, Kentucky, Maryland, Florida and West Virginia. Branch Bank is the largest bank in West Virginia and, excluding home office deposits, is the second largest bank in North Carolina in terms of deposit market share. Branch Banks principal operating subsidiaries include:
BB&T-SC operated 98 banking offices at December 31, 2004 and is the third largest bank in South Carolina in terms of deposit market share.
BB&T-VA operated 410 banking offices at December 31, 2004 and is the second largest bank in Virginia in terms of deposit market share.
Scott & Stringfellow, Inc. (Scott & Stringfellow) is an investment banking and full-service brokerage firm located in Richmond, Virginia. At December 31, 2004, Scott & Stringfellow operated 41 full-service retail brokerage offices; 21 in Virginia, 12 in North Carolina, 7 in South Carolina, and 1 office in West Virginia. Scott & Stringfellow specializes in the origination, trading and distribution of fixed-income securities and equity products in both the public and private capital markets. Scott & Stringfellow also has a public finance department that provides investment banking, financial advisory services and debt underwriting services to a variety of regional tax-exempt issuers. Scott & Stringfellows investment banking and corporate and public finance areas do business as BB&T Capital Markets.
The primary services offered by BB&Ts subsidiaries include:
The following table reflects BB&Ts deposit market share and branch locations by state at December 31, 2004.
BB&T Deposit Market Share and Branch Locations by State
December 31, 2004
In addition to the markets described in the table above, BB&T operates two branches in Alabama and one branch in Indiana. Please refer to Note 20 Operating Segments in the Notes to Consolidated Financial Statements for additional disclosures.
Significant accomplishments in 2004
In the opinion of BB&Ts management, the Corporations most significant accomplishments during 2004 were as follows (amounts include the impact of acquisitions where applicable):
BB&T has grown at a rapid pace since its merger of equals with Southern National Corporation in 1995, and BB&Ts business has become more dynamic and complex in recent years. Consequently, management has annually evaluated and, as necessary, adjusted the Corporations 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&Ts key strategic objectives and established long-term financial goals is subject to many uncertainties and challenges. The challenges, which in the opinion of management, are most relevant and likely to have a near term impact on performance, are presented below:
The financial services industry is highly competitive and dramatic change continues to occur in all aspects of the Companys business. The ability of nonbank financial entities to provide services previously reserved for commercial banks has intensified competition. BB&Ts subsidiaries compete actively with national, regional and local financial services providers, including banks, thrifts, securities dealers, mortgage bankers, finance companies and insurance companies. Competition among providers of financial products and services continues to increase with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to consolidate, which affects competition by eliminating some regional and
local institutions, while strengthening the franchises of acquirers. For additional information concerning markets, BB&Ts competitive position and business strategies, see Market Area and General Business Development below.
BB&Ts primary market area consists of North and South Carolina, Virginia, Maryland, Georgia, eastern Tennessee, West Virginia, Kentucky, Florida and Washington, D.C. This areas employment base is diverse and primarily consists of manufacturing, general services, agricultural, wholesale/retail trade, technology and financial services. BB&T believes its current market area is economically strong and will support consistent growth in assets and deposits in the future. Even so, management intends to continue expanding and diversifying the BB&T franchise, although at a slower pace than in recent years. Management strongly believes that BB&Ts community bank approach to providing client service is a competitive advantage which strengthens the Corporations ability to enter new markets and effectively provide financial products and services to businesses and individuals in these markets.
General Business Development
BB&T is a regional financial holding company. The core of its business and franchise was created by the merger-of-equals between BB&T and Southern National Corporation in 1995 and the acquisition of United Carolina Bancshares in 1997. BB&T has maintained a long-term focus on a strategy that includes expanding and diversifying the BB&T franchise both 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 at compound annual rates of 11.0%, 11.8%, and 10.8%, respectively, over the last five years.
BB&Ts 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 any bank or thrift acquisitions during 2004 or 2005, instead focusing on fully integrating recent mergers. Management intends to resume strategic mergers and acquisitions, including bank and thrift acquisitions primarily within BB&Ts existing footprint in 2006. BB&T will continue to pursue economically advantageous acquisitions of insurance agencies, asset managers and other consumer and commercial finance companies to grow existing product lines and expand into related financial businesses. BB&Ts acquisition strategy is focused on three primary objectives:
BB&T consummated acquisitions of 58 community banks and thrifts, 73 insurance agencies and 24 nonbank financial services providers over the last fifteen years. BB&T expects, in the long-term, 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 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&Ts 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.
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&Ts lending process incorporates the standards of a consistent company-wide credit culture and an in-depth local market knowledge. Furthermore, the Company 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 Corporations community bank operating model, with lending decisions made as close to the client as practicable.
The following table summarizes BB&Ts loan portfolio based on the regulatory classification of the portfolio, which focuses on the underlying loan collateral, and differs from internal classifications presented herein which focus on the primary purpose of the loan.
Composition of Loan and Lease Portfolio
BB&Ts loan portfolio is approximately 50% business and 50% retail by design, and is divided into three major categoriesbusiness, consumer and mortgage. Loans from BB&Ts specialized lending segment, as discussed in Note 20, Operating Segments of the Notes to Consolidated Financial Statements, are included in the applicable categories. BB&T lends to a diverse customer base that is substantially located within the Companys primary market area. At the same time, the loan portfolio is geographically dispersed throughout BB&Ts 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&Ts lending function. The relative risk of each loan portfolio is presented in the Asset Quality section of Managements Discussion and Analysis of Financial Condition and Results of Operations herein.
Recognizing that the loan portfolio is a primary source of profitability, proper loan underwriting is critical to long-term financial success. BB&Ts underwriting approach is designed to define acceptable combinations of specific risk-mitigating features that ensure credit relationships conform to BB&Ts risk philosophy. Provided below is a summary of the most significant underwriting criteria used to evaluate new loans and loan renewals:
Business Loan and Lease Portfolio
The business loan and lease portfolio represents the largest category of the Companys total loan portfolio and is segmented as followscommercial loans, generally defined as client relationships with total credit exposure above $500,000, small business loans, and leases. BB&Ts 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&Ts strongest markets.
Business loans are primarily originated through BB&Ts banking network. In accordance with the Corporations lending policy, each loan undergoes a detailed underwriting process, which incorporates BB&Ts underwriting approach, procedures and evaluations described above. In addition, the bank has adopted an internal maximum credit exposure lending limit of $215 million for a best grade credit, which is considerably below the Banks maximum legal lending limit. Commercial loans are typically priced with an interest rate tied to market indexes, such as the prime rate and the London Interbank Offered Rate (LIBOR). Business loans are individually monitored and reviewed for any possible deterioration in the ability of the client to repay the loan. Approximately 95% of BB&Ts commercial loans are secured by real estate, business equipment, inventories, and other types of collateral.
BB&T provides commercial leasing services through BB&T Leasing Corp. (Leasing), a subsidiary of Branch Bank. Leasing provides three primary products: finance or capital leases, true leases (as defined under the Internal Revenue Code) and other operating leases for vehicles, rolling stock and tangible personal property. Leasing also provides lease-related services for small to medium-sized commercial customers. In addition to the services offered by Leasing, other BB&T subsidiaries provide leases to municipalities and invest in various types of leveraged lease transactions. Substantially all of BB&Ts leases are secured.
Consumer Loan Portfolio
BB&T offers a wide variety of consumer loan products. Various types of secured and unsecured loans are marketed to qualifying existing clients and to other creditworthy candidates in BB&Ts 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 Corporations 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-portfoliosdirect 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&Ts 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 limited adjoining states. On a very limited basis, sales finance loans are also originated through qualified non-automotive dealers for the purchase of boats, recreational vehicles and other consumer equipment. Substantially all consumer loans, excluding the revolving credit portfolio, are secured.
Mortgage Loan Portfolio
BB&T is a large originator of residential mortgage loans, with originations in 2004 totaling $10.0 billion. The bank offers various types of fixed- and adjustable-rate loans for the purpose of constructing, purchasing or refinancing owner-occupied properties. BB&T primarily originates conforming mortgage loans. These are loans that are underwritten in accordance with the underwriting standards set forth by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). They are generally collateralized by one-to-four-family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing.
Risks associated with the mortgage lending function include interest rate risk, which is mitigated through the sale of substantially all conforming fixed-rate loans in the secondary mortgage market, and default risk by the borrower, which 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 managements strategy to establish profitable long-term customer relationships and offer high quality client service. Branch Bank also purchases residential mortgage loans from correspondent originators. The loans purchased from third-party originators are subject to the same underwriting and risk-management criteria as loans originated internally.
The following table presents BB&Ts total loan portfolio based upon the primary purpose of the loan, as discussed herein, rather than upon regulatory reporting classifications:
Composition of Loan and Lease Portfolio Based on Loan Purpose
The following table reflects the scheduled maturities of commercial, financial and agricultural loans, as well as real estate construction loans:
Selected Loan Maturities and Interest Sensitivity (1)
Scheduled repayments are reported in the maturity category in which the payment is due. Determinations of maturities are based upon contract terms. BB&Ts credit policy typically does not permit automatic renewals 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 a new note 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 managements best estimate of probable losses that are inherent in the portfolio at the balance sheet date. BB&Ts allowance is driven by existing conditions and observations, and reflects losses already incurred, even if not yet identifiable.
The Company determines the allowance based on an ongoing evaluation of the loan and lease portfolios. This evaluation is inherently subjective because it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Increases to the allowance are made by charges to the provision for credit losses, which is reflected on the Consolidated Statements of Income. Loans or leases deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance.
In addition to the allowance for loan and lease losses, BB&T also estimates probable losses related to binding unfunded lending commitments. The methodology to determine such losses is inherently similar to the methodology utilized in calculating the allowance for commercial loans, adjusted for factors specific to binding commitments, including the probability of funding and exposure at funding. The reserve for unfunded lending commitments is included in accounts payable and other liabilities on the Consolidated Balance Sheets. Changes to the reserve for unfunded lending commitments are made by changes 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 contractual agreement. The amount of impairment is based on the present value of expected cash flows discounted at the loans 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&Ts 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&Ts established loan review committee process. Loans are assigned risk grades based on an assessment of conditions that affect the borrowers 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 $500,000 or more on an annual basis or at any point management becomes aware of information affecting the borrowers 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 Corporations allowance for loan and lease losses is not allocated to any specific category of loans. This unallocated portion of the allowance reflects managements 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 managements 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.
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. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.
The following table presents an estimated allocation of the allowance for loan and lease losses at the end of each of the past five years. This table is presented based on the regulatory reporting classifications of the loans. Amounts applicable to years prior to 2002 reflect acquisitions accounted for as poolings of interests. This allocation of the allowance for loan and lease losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.
Allocation of Allowance for Loan and Lease Losses by Category
Investment securities represent a significant portion of BB&Ts assets. BB&Ts subsidiary banks invest in securities as allowable under bank regulations. These securities include obligations of the U.S. Treasury, agencies and corporations of the U.S. government, including mortgage-backed securities, bank eligible obligations of any state or political subdivision, bank eligible corporate obligations, including commercial paper, negotiable certificates of deposit, bankers acceptances, mutual funds and limited types of equity securities. BB&Ts bank subsidiaries may also deal in securities subject to the provisions of the Gramm-Leach-Bliley Act. Scott & Stringfellow, Inc., BB&Ts 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&Ts investment activities are governed internally by a written, board-approved policy. The investment policy is carried out by the Corporations Asset / Liability Management Committee (ALCO), which meets regularly to review the economic environment and establish investment strategies. The ALCO also has much broader responsibilities, which are discussed in the Market Risk Management section in Managements Discussion and Analysis of Financial Condition and Results of Operations herein.
Investment strategies are established by ALCO in consideration of the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of the Corporation. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits as prescribed by law and other borrowings; and (iii) to earn the maximum return on funds invested that is commensurate with meeting the requirements of (i) and (ii).
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&Ts funding activities are monitored and governed through BB&Ts overall asset/liability management process, which is further discussed in the Market Risk Management section in Managements 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 Managements Discussion and Analysis of Financial Condition and Results of Operations herein.
Deposits are attracted principally from clients within BB&Ts 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.
The following table provides information regarding the scheduled maturities of time deposits that are $100,000 and greater at December 31, 2004:
Scheduled Maturities of Time Deposits $100,000 and Greater
December 31, 2004
(Dollars in thousands)
BB&Ts ability to borrow funds from nondeposit sources provides additional flexibility in meeting the liquidity needs of customers and the Company. Short-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term FHLB advances, and U.S. Treasury tax and loan depository note accounts. See Note 9 Federal Funds Purchased, Securities Sold Under Agreements to Repurchase, and Short-Term Borrowed Funds in the Notes to Consolidated Financial Statements herein for additional disclosures related to these types of borrowings.
BB&T also utilizes longer-term borrowings when management determines that the pricing and maturity options available through these sources create cost-effective options for funding asset growth and satisfying capital needs. BB&Ts long-term borrowings include long-term FHLB advances to the Subsidiary Banks, 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.
At December 31, 2004, BB&T had approximately 26,100 full-time equivalent employees compared to approximately 26,300 full-time equivalent employees at December 31, 2003.
BB&T and its significant subsidiaries occupy headquarters offices that are either owned or operated under long-term leases, and also own 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 Corporations headquarters in Winston-Salem, North Carolina. At December 31, 2004, BB&Ts subsidiary banks operated 1,413 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 variously 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&Ts properties and other fixed assets.
Executive Officers of BB&T
The following table lists the members of BB&Ts executive management team as of December 31, 2004:
Web Site Access to BB&Ts Filings with the Securities and Exchange Commission
All BB&Ts 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 Corporations web site, www.BBandT.com, through the Investor Relations link as soon as reasonably practicable after BB&T files such material with, or furnishes it to, the SEC. BB&Ts SEC filings are also available through the SECs web site at www.sec.gov.
As a bank holding company and a financial holding company under federal law, BB&T is subject to regulation under the Bank Holding Company Act of 1956, as amended, (the BHCA) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the Federal Reserve Board). As state-chartered commercial banks, Branch Bank, BB&T-SC and BB&T-VA are subject to regulation, supervision and examination by state bank regulatory authorities in their respective home states. These authorities include the North Carolina Commissioner of Banks, in the case of Branch Bank, the South Carolina Commissioner of Banking, in the case of BB&T-SC, and the Virginia State Corporation Commissions Bureau of Financial Institutions, in the case of BB&T-VA. In addition, BB&T Bankcard Corporation is a special-purpose Georgia bank, subject to regulation, supervision and examination by the Georgia Department of Banking and Finance. Branch Bank, BB&T-SC, BB&T-VA and BB&T Bankcard Corporation are collectively referred to as the Banks. Each of the Banks is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the FDIC). State and Federal law also govern the activities in which the Banks engage, the investments they make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks operations.
In addition to federal and state banking laws and regulations, BB&T and certain of its subsidiaries and affiliates, including those that engage in securities underwriting, dealing, brokerage, investment advisory activities and insurance activities, are subject to other federal and state laws and regulations, and supervision and examination by other state and federal regulatory agencies, including the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state insurance and securities regulators.
The earnings of BB&Ts subsidiaries, and therefore the earnings of BB&T, are affected by general economic conditions, management policies, changes in state and federal laws and regulations and actions of various regulatory authorities, including those referred to above. Proposals to change the laws and regulations to which BB&T is subject are frequently introduced at both the federal and state levels. The likelihood and timing of any such changes and the impact such changes might have on BB&T and its subsidiaries are impossible to determine with any certainty. The following description summarizes the significant state and federal laws to which BB&T and the Banks currently are subject. To the extent statutory or regulatory provisions are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions.
Financial Holding Company Regulation
Under current federal law, as amended by the Gramm-Leach-Bliley Act of 1999 (GLBA), a bank holding company, such as BB&T, may elect to become a financial holding company, which allows the holding company to offer customers virtually any type of service that is financial in nature or incidental thereto, including banking and activities closely related thereto, securities underwriting, insurance (both underwriting and agency) and merchant banking. In order to become and maintain its status as a financial holding company, the company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act of 1977 (CRA) rating. If the Federal Reserve determines that a financial holding company is not well-capitalized or well-managed, the company has a period of time to come into compliance, but during the period of noncompliance, the Federal Reserve can place any limitations on the financial holding company that it believes to be appropriate. Furthermore, if the Federal Reserve determines that a financial holding company has not maintained a satisfactory rating under the CRA test, 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 banks financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion; the bank must have at least a satisfactory CRA rating; and if that bank is one of the 100 largest national banks, it must meet certain financial rating or other comparable requirements.
Current federal law also establishes a system of functional regulation under which the Federal Reserve Board is the umbrella regulator for bank holding companies, but bank holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. Certain specific activities, including traditional bank trust and fiduciary activities, may be conducted in the bank without the bank being deemed a broker or a dealer in securities for purposes of functional regulation. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain identifiable areas.
As an active acquirer, BB&T complies with numerous laws related to its acquisition activity. Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. Current Federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Furthermore, a bank headquartered in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states have opted out of such interstate merger authority prior to such date, and subject to any state requirement that the target bank shall have been in existence and operating for a minimum period of time, not to exceed five years; and subject to certain deposit market-share limitations. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable Federal or state law.
Other Safety and Soundness Regulations
The Federal Reserve Board has enforcement powers over bank holding companies and their non-banking subsidiaries. The Federal Reserve Board has authority to prohibit activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative order or written agreement with a federal regulator. These powers may be exercised through the issuance of cease and desist orders, civil money penalties or other actions.
There also are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution is insolvent or is in danger of becoming insolvent. For example, under requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit financial resources to support such institutions in circumstances where it might not do so otherwise. In addition, the cross-guarantee provisions of Federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund (SAIF) or the Bank Insurance Fund (BIF) as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the SAIF or the BIF or both. The FDICs 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 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&Ts revenue is from dividends paid to BB&T by the Banks. The Banks are subject to laws and regulations that limit the amount of dividends they can pay. In addition, both BB&T and its Banks are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain well-capitalized under the prompt corrective action regulations summarized elsewhere in this section. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organizations 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 organizations capital needs, asset quality and overall financial condition. North Carolina and Virginia laws state that, subject to certain capital requirements, the board of directors of a bank chartered under their laws may declare a dividend of as much of that banks undivided profits as the directors deem expedient. South Carolina allows for the payment of dividends by a state-chartered bank with the prior approval of the Commissioner of Banking. BB&T does not expect that any of these laws, regulations or policies will materially affect the ability of the Banks to pay dividends. During the year ended December 31, 2004, the Banks declared $977.1 million in dividends payable to BB&T. At December 31, 2004, subject to restrictions imposed by state law, the Boards of Directors of the Banks could have declared dividends from their retained earnings up to $2.9 billion; however, to remain well-capitalized under federal guidelines, the Banks would have limited total additional dividends to $1.3 billion.
Each of the federal banking agencies, including the Federal Reserve Board and the FDIC, have issued substantially similar risk-based and leverage capital guidelines applicable to banking organizations they supervise, including bank holding companies and banks. Under the risk-based capital requirements, BB&T and the Banks are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common shareholders equity excluding unrealized gains or losses on debt securities available for sale, unrealized gains on equity securities available for sale and unrealized gains or losses on cash flow hedges, net of deferred income taxes; plus certain mandatorily redeemable capital securities, less nonqualifying intangible assets net of applicable deferred income taxes, and certain nonfinancial equity investments. This is called Tier 1 capital. The remainder may consist of qualifying subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for credit losses. This is called Tier 2 capital. Tier 1 capital and Tier 2 capital combined are referred to as total regulatory capital.
The Federal Reserve requires bank holding companies that engage in trading activities to adjust their risk-based capital ratios to take into consideration market risks that may result from movements in market prices of covered trading positions in trading accounts, or from foreign exchange or commodity positions, whether or not in trading accounts, including changes in interest rates, equity prices, foreign exchange rates or commodity prices. Any capital required to be maintained under these provisions may consist of a new Tier 3 capital consisting of forms of short-term subordinated debt.
Each of the federal bank regulatory agencies, including the Federal Reserve, also has established minimum leverage capital requirements for banking organizations. These requirements provide that banking organizations that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and that have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total
adjusted average assets of at least 3%. Institutions not meeting these criteria, as well as institutions with supervisory, financial or operational weaknesses, are expected to maintain a minimum Tier 1 capital to total adjusted average assets ratio equal to 100 to 200 basis points above that stated minimum. Holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve also continues to consider a tangible Tier 1 capital leverage ratio (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activity.
In addition, each of the Federal Reserve Board and the FDIC has adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institutions ability to manage these risks, as important factors to be taken into account by each agency in assessing an institutions overall capital adequacy. The capital guidelines also provide that an institutions 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 organizations capital adequacy. The agencies also require banks and bank holding companies to adjust their regulatory capital to take into considerations 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 the leverage capital ratios of BB&T and the Subsidiary Banks as of December 31, 2004, are shown in the following table.
Capital Adequacy Ratios of BB&T Corporation and Principal Banking Subsidiaries
December 31, 2004
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 can 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 can subject a banking organization to a variety of other enforcement remedies, including additional substantial restrictions on its operations and activities, termination of deposit insurance by the FDIC and, under certain conditions, the appointment of a conservator or receiver.
Deposit Insurance Assessments
The deposits of the Banks are insured by the FDIC up to the limits set forth under applicable law. A majority of the deposits of the Banks are subject to the deposit insurance assessments of the BIF of the FDIC. However, a portion of the Banks deposits (relating to the acquisitions of various savings associations) are subject to assessments imposed by the SAIF of the FDIC. The assessments imposed in BIF-insured and SAIF-insured deposits have been equalized.
The FDIC imposes a risk-based deposit premium assessment system, based in part on an insured institutions capital classification under the prompt corrective action provisions, and whether that institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. The assessments are set forth in schedules issued by the FDIC that specify, at semi-annual intervals, target reserve ratios designed to maintain the reserve ratio of each of the funds at 1.25% of their estimated insured deposits. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of assessable deposits, depending on the institutions capital position and other supervisory factors. In addition, both SAIF-insured and BIF-insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (FICO) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2004, the FDIC assessed BIF-insured and SAIF-insured deposits 1.46 basis points per $100 of deposits to cover those obligations. At December 31, 2004, BB&Ts assessment was limited to that 1.46 basis point obligation.
Consumer Protection Laws
In connection with their lending and leasing activities, the Banks are each subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and 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 institutions 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 banks record in meeting the credit needs of the communities served by each Bank, including low- and moderate-income neighborhoods and persons. Institutions are assigned one of four ratings: Outstanding, Satisfactory, Needs to Improve or Substantial Noncompliance. This assessment is reviewed for any bank that applies to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. The CRA record of each subsidiary bank of a financial holding company, such as BB&T, also is assessed by the Federal Reserve in connection with any acquisition or merger application.
USA Patriot Act
The USA Patriot Act of 2001 (the Patriot Act) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such 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 institutions anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions. Compliance with the Patriot Act by BB&T has not had a material impact on BB&Ts or the Banks results of operations or financial condition.
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) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (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 securities laws.
The American Jobs Creation Act of 2004
The American Jobs Creation Act of 2004 (the Act) was signed into law by the President on October 22, 2004. The Act includes a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. Under the provisions of the Act, BB&T would receive a tax deduction of 85% of certain foreign earnings if repatriated during 2005 pursuant to a domestic reinvestment plan. BB&T is currently evaluating the potential income tax effects of these provisions. Upon the completion of such evaluation, BB&T expects to make a determination concerning repatriation of these foreign earnings.
Information with respect to BB&Ts corporate governance policies and principles is presented on BB&Ts web site, www.BBandT.com, and includes:
BB&T intends to disclose any substantive amendments or waivers to the Code of Ethics for Directors or Senior Financial Officers on our web site at www.BBandT.com/Investor.
The annual certification of BB&Ts 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 18, 2004.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition and consolidated results of operations of BB&T Corporation and subsidiaries (BB&T or the Corporation) for each of the three years in the period ended December 31, 2004, and related financial information, are presented in conjunction with the consolidated financial statements and related notes to assist in the evaluation of BB&Ts 2004 performance.
In certain circumstances, reclassifications have been made to prior period information to conform to the 2004 presentation. Such reclassifications had no effect on previously reported shareholders equity or net income.
Mergers and Acquisitions Completed During 2004
During 2004, BB&T completed the following mergers and acquisitions.
On February 1, 2004, BB&T Insurance Services completed its acquisition of McGriff, Seibels & Williams, Inc., of Birmingham, Alabama (McGriff). BB&T issued 8.2 million shares of common stock valued at $300.5 million and paid $50 million in cash to complete the acquisition. The transaction also allows for an additional payment to McGriffs shareholders of up to $127.9 million in cash over a five-year period if McGriffs performance exceeds certain targets. BB&T recorded $396.0 million in goodwill and other intangible assets in connection with the acquisition, including subsequent reallocations of purchase price.
On April 14, 2004, BB&T completed its acquisition of Republic Bancshares Inc. (Republic), headquartered in St. Petersburg, Florida. BB&T issued 6.5 million shares of common stock valued at $262.3 million and paid $171.1 million in cash in exchange for all of the outstanding common shares of Republic. Republics assets totaled $2.9 billion at the time of acquisition and BB&T recorded $260.5 million in goodwill and other intangible assets in connection with the acquisition, including subsequent reallocations of purchase price.
In addition to the mergers and acquisitions noted above, BB&T acquired a number of nonbank financial services companies and insurance agencies during 2004, 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.
On February 16, 2005, BB&T announced plans to acquire a 70% ownership interest in Charlotte, North Carolina-based Sterling Capital Management LLC, a provider of investment management services with more than $8.0 billion in assets under management. Pending regulatory approval, the transaction is expected to be completed in the second quarter of 2005.
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&Ts financial position and results of operations are affected by managements 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&Ts consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting and reporting policies include BB&Ts accounting for the allowance for loan and lease losses and reserve for unfunded lending commitments, valuation of mortgage servicing rights, intangible assets associated with mergers and acquisitions, costs and benefit obligations associated with BB&Ts pension and postretirement benefit plans, and income taxes.
Understanding BB&Ts accounting policies is fundamental to understanding BB&Ts consolidated financial position and consolidated results of operations. Accordingly, BB&Ts 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&Ts critical accounting policies that are highly dependent on estimates, assumptions and judgments. These critical accounting policies are reviewed with the Audit Committee of BB&Ts Corporate 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 equals managements 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 managements estimates for loan and lease losses are considerations with respect to the impact of current economic events, the outcome of which is 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 BusinessAllowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments.
Valuation of Mortgage Servicing Rights
BB&T has a significant mortgage loan servicing portfolio and related mortgage servicing rights. Mortgage servicing rights represent the present value of the future net servicing fees from servicing mortgage loans acquired or originated by BB&T. The methodology used to determine the fair value of mortgage servicing rights is subjective and requires the development of a number of assumptions, including anticipated prepayments of loan principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining interest rates, the value of mortgage servicing assets declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. BB&T amortizes mortgage servicing rights over the estimated period that servicing income is expected to be received based on projections of the amount and timing of estimated future cash flows. The amount and timing of servicing asset amortization is updated based on actual results and updated projections. Please refer to Note 8 Loan Servicing in the Notes to Consolidated Financial Statements for quantitative disclosures reflecting the effect that changes in managements assumptions would have on the fair value of mortgage servicing rights.
BB&Ts growth in business, profitability and market share over the past several years has been enhanced significantly by mergers and acquisitions. BB&Ts mergers and acquisitions are accounted for using the purchase method of accounting. Under the purchase method, BB&T is required to record the assets acquired, including identified intangible assets and liabilities assumed at their fair value, which often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. The amortization of identified intangible assets is based upon the estimated economic benefits to be received, which is also subjective. These estimates also include the establishment of various accruals and allowances based on planned facility dispositions and employee severance considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in
goodwill, which is subject to ongoing periodic impairment tests based on the fair value of net assets acquired compared to the carrying value of goodwill. Please refer to Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of our 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 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. Please refer to Note 13 Benefit Plans in the Notes to Consolidated Financial Statements for disclosures related to BB&Ts benefit plans, including quantitative disclosures reflecting the impact that changes in certain assumptions would have on service and interest costs and benefit obligations.
The calculation of BB&Ts income tax provision is complex and requires the use of estimates and judgments. As part of the Companys 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 Companys 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, 2004, BB&Ts average assets totaled $96.3 billion, an increase of $10.9 billion, or 12.8%, compared to the 2003 average primarily reflecting growth in average loans and leases. Average loans and leases for 2004 were up $8.3 billion, or 14.3%, from 2003. The primary components of the growth in average loans and leases were consumer loans, which increased $4.0 billion, or 23.8%; commercial loans and leases, which increased $3.1 billion, or 10.2%; and mortgage loans, which increased $1.2 billion, or 10.9%. Total earning assets averaged $84.9 billion in 2004, an increase of $9.5 billion, or 12.6%, compared to 2003. These averages and growth rates include the effects of acquisitions.
BB&Ts average deposits totaled $64.8 billion, reflecting growth of $7.9 billion, or 13.8%, compared to 2003. The categories of deposits with the highest growth rates were: money rate savings, which increased $3.7 billion, or 20.2%; noninterest-bearing deposits, which increased $2.2 billion, or 22.8%; and savings and interest checking, which increased $892.8 million, or 22.9%.
Shorter-term borrowings include Federal funds purchased, securities sold under repurchase agreements, master notes, short-term bank notes and short-term Federal Home Loan Bank (FHLB) advances. Average shorter-term borrowings totaled $6.6 billion for the year ended December 31, 2004, an increase of $1.4 billion, or 28.2%, from the 2003 average. BB&T has also utilized long-term debt for a significant portion of its funding needs. Long-term debt includes FHLB advances, other secured borrowings by Subsidiary Banks and subordinated debt issued by the Corporation and Branch Bank. Average long-term debt totaled $10.9 billion for the year ended December 31, 2004, down $824.1 million, or 7.0%, compared to 2003.
The compound annual rate of growth in average total assets for the five-year period ended December 31, 2004, was 11.0%. Over the same five-year period, average loans and leases increased at a compound annual rate of 11.8%, average securities increased at a compound annual rate of 4.2%, and average deposits grew at a compound
annual rate of 10.8%. All balance sheet growth rates referred to include the effect of acquisitions accounted for as purchases, as well as internal growth.
For more detailed discussions concerning the causes of these fluctuations, please refer to the sections that follow.
The securities portfolios provide earnings and liquidity, and are 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 durations of five years or less to provide flexibility in managing the balance sheet in changing interest rate environments. Total securities increased 17.5% in 2004, to a total of $19.2 billion at the end of the year. The quality of the investment portfolio continues to be strong with 66.6% of the total portfolios fair market value at December 31, 2004 comprised of U.S. Treasury securities and U.S. government entity securities, excluding mortgage-backed securities. The combined duration of the U.S. Treasury and U.S. government entity portfolios was 3.23 years and 3.19 years at December 31, 2004 and 2003, respectively. Mortgage-backed securities composed 23.6% of the total investment portfolio at year-end 2004. The duration of the mortgage-backed securities was 2.78 years at December 31, 2004 compared to 2.71 years at December 31, 2003. The duration of the total portfolio at December 31, 2004 was 3.13 years compared to 3.19 years at December 31, 2003.
The following table provides information regarding the composition of BB&Ts securities portfolio for the years presented:
Composition of Securities Portfolio
At December 31, 2004, trading securities reflected on BB&Ts Consolidated Balance Sheets totaled $334.3 million compared to $693.8 million at December 31, 2003. The decrease in trading securities primarily resulted from managements decision to liquidate a portion of the trading portfolio being used as an economic risk management strategy in connection with BB&Ts mortgage servicing rights. In addition, approximately half of the trading portfolio is held by BB&Ts full-service brokerage subsidiary as a normal part of its operations and, as a result, is subject to significant fluctuations. Market valuation gains and losses in the trading portfolio are reflected in current earnings.
Securities held to maturity are composed of investments in U.S. Treasury securities and made up less than 1% of the total portfolio at December 31, 2004. Securities held to maturity are carried at amortized cost and totaled $125 thousand at December 31, 2004, compared to $60.1 million outstanding at the end of 2003. This
decrease resulted primarily from the maturity of these securities and the decision to classify the reinvestment of the proceeds as trading securities. Unrealized market valuation gains and losses on securities in the Corporations held-to-maturity category affect neither earnings nor shareholders equity.
Securities available for sale totaled $18.8 billion at year-end 2004 and are carried at estimated fair value. Securities available for sale at year-end 2003 totaled $15.6 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 entities and mortgage-backed securities, which composed 91.8% of the portfolio. This portfolio also contains investments in U.S. Treasury securities, which represented less than 1% of the December 31, 2004 balance, obligations of states and municipalities, which represented 4.2% of the available-for-sale portfolio, and equity and other securities, which made up 4.0% of the available-for-sale portfolio.
The $3.3 billion increase in securities available for sale was the result of a combination of factors including the securitization of approximately $1.0 billion in mortgage loans, the acquisition of Republic and the investment of funds generated by strong deposit growth. During the year ended December 31, 2004, BB&T sold $2.3 billion of available-for-sale securities and realized net gains totaling $6.1 million.
The following table presents BB&Ts securities portfolio at December 31, 2004, segregated by major category with ranges of maturities and average yields disclosed.
Securities Maturities and Yields
The available-for-sale portfolio comprised 98.3% of total securities at December 31, 2004. Management believes that the high concentration of securities in the available-for-sale portfolio allows flexibility in the day-to-day management of the overall investment portfolio, consistent with the objective of optimizing profitability and mitigating interest rate risk.
The market value of the available-for-sale portfolio at year-end 2004 was $139.5 million lower than the amortized cost of these securities. At December 31, 2004, BB&Ts available-for-sale portfolio had net unrealized depreciation, net of deferred income taxes, of $87.5 million, which is reported as a component of shareholders equity. At December 31, 2003, the available-for-sale portfolio had net unrealized appreciation of $11.4 million, net of deferred income taxes.
On December 31, 2004, BB&T held certain investments having continuous unrealized loss positions for more than 12 months totaling $131.0 million. The vast majority of these investments were in U.S. government entity securities and it is expected that the securities would not be settled at a price less than their amortized cost. Because the decline in market value was caused by interest rate increases and not credit quality, and because BB&T has the ability to hold these investments until a recovery of fair value, which may be maturity, BB&T has not recognized any other-than-temporary impairment in connection with these investments.
The fully taxable equivalent (FTE) yield on the total securities portfolio was 4.05% for the year ended December 31, 2004, compared to 4.81% for the prior year. The decrease in FTE yield resulted principally from the prolonged historically low interest rate environment and purchases of lower-yielding securities. As BB&Ts higher-yielding securities matured or were called or were rapidly prepaid, in the case of mortgage-backed securities, the resulting cash flows were reinvested in lower-yielding securities paying then-current market interest rates. The yield on U.S. Treasuries and U.S. government entities decreased from 4.65% in 2003 to 3.88% in 2004, while the yield on mortgage-backed securities decreased from 5.09% to 4.52% and the FTE yield on state and municipal securities decreased from 6.83% last year to 6.51% in the current year.
Loans and Leases
Management emphasizes commercial lending to small and medium-sized businesses, consumer lending and mortgage lending with an overall goal of maximizing the profitability of the loan portfolio while maintaining strong asset quality. The various categories of loan products offered by BB&T are discussed under Lending Activities in the Overview and Description of Business section herein. BB&T is a full-service lender with approximately one-half of its loan portfolio composed of loans to businesses and one-half composed of loans to individual consumers. Average commercial loans, including lease receivables, increased $3.1 billion, or 10.2%, in 2004 as compared to 2003, and now compose 50.0% of the loan portfolio, compared to 51.8% in 2003. Average consumer loans, which include sales finance, revolving credit and direct retail, increased $4.0 billion, or 23.8%, for the year ended December 31, 2004 as compared to the same period in 2003, and compose 31.1% of average loans, compared to 28.7% in 2003. Average mortgage loans increased $1.2 billion, or 10.9%, in 2004 as compared to 2003, and represented the remaining 18.9% of average total loans for 2004, compared to 19.5% a year ago. BB&T is a large originator of residential mortgage loans, with 2004 originations of $10.0 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. However, in late 2003, BB&T began retaining a portion of the originated mortgage loans as part of a balance sheet restructuring initiative. The total amount of fixed-rate mortgage loans retained pursuant to this initiative was approximately $3.6 billion. At December 31, 2004, BB&T was servicing $24.5 billion in residential mortgages owned by third parties and $13.4 billion of mortgage loans owned by BB&T, including $1.1 billion classified as securities available for sale.
BB&Ts loan portfolio, excluding loans held for sale, increased $6.0 billion, or 9.7%, as compared to 2003. Average total loans and leases for 2004 increased $8.3 billion, or 14.3%, compared to 2003. In addition to strong internal loan growth, these increases were aided by the addition of loans held by Republic, which was acquired on April 14, 2004, and had loans of $1.7 billion. During the third quarter of 2004, BB&T securitized $1.0 billion in residential mortgage loans and transferred the related mortgage-backed securities to the available-for-sale securities portfolio. The securitization was undertaken to rebalance the loan portfolio which had grown significantly as a result of strong mortgage loan originations over the last two years and the retention of approximately $3.6 billion in fixed-rate mortgage loans.
While the mix of the consolidated loan portfolio in 2004 was very similar to that of one year ago, the fluctuation reflects certain trends in the composition of the loan portfolio caused by improving general economic conditions across BB&Ts footprint and the mortgage loan securitization mentioned earlier. During 2004, commercial loan activity in the markets served by BB&T improved. BB&T expects these positive trends to continue into 2005 as BB&Ts commercial customers utilize liquid assets accumulated in recent years and their needs for funds increase.
The pace of commercial loan growth during 2004 was complemented by stronger trends in the consumer loan portfolio. During the past two years, the low interest rate environment combined with appreciating home values and the purchase of First Virginia has led to more advances under home equity and revolving lines of credit, and the resulting increase in average direct retail loans, which were up $2.5 billion, or 23.5%, compared to the average balance in 2003. Average sales finance loans increased $1.3 billion, or 27.3%, from the prior year primarily as a result of the purchase of First Virginia, which had a loan portfolio concentrated in sales finance. However, sales finance loans were up only $169.1 million, or 2.7%, at December 31, 2004 compared to year-end 2003. Following the merger, BB&T began to reposition the sales finance portfolio by ceasing origination of certain components of the First Virginia business, in particular the segment with very high quality but low-priced loans, which management views as having a lower risk-adjusted return than the existing BB&T portfolio. Furthermore, management believes that such loans do not fit the potential niches and pricing goals of automobile dealers serviced by BB&T. In addition, during 2004, the sales finance business continued to be highly competitive as many finance subsidiaries of automobile manufacturers were offering large financing discounts and rebates to consumers. Based on current market conditions, historical results and projected portfolio liquidation, BB&T expects slow growth in the sales finance loan portfolio.
Mortgage loans comprised 18.0% of the loan portfolio at December 31, 2004 compared to 18.7% at the end of 2003. 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&Ts relationship-based credit culture. The decrease in the percentage of mortgage loans in the total loan portfolio was the result of slower mortgage origination activity compared to 2003 when interest rates were at historically low levels, the growth in commercial and consumer loans, and the securitization of $1.0 billion of mortgage loans. During 2004, BB&T securitized approximately $1.0 billion in residential mortgage loans and transferred the related mortgage-backed securities to the available-for-sale securities portfolio. The securitization was undertaken to rebalance the loan portfolio which had grown significantly as a result of strong mortgage loan originations over the last two years and the retention, rather than sale, of approximately $3.6 billion in fixed-rate mortgage loans as part of a balance sheet restructuring largely completed during 2003.
The average annualized FTE yields on commercial, consumer and mortgage loans for 2004 were 5.41%, 6.79% and 5.57%, respectively, resulting in a yield for the total loan portfolio of 5.87%, compared to 6.06% for the total portfolio in 2003. The 19 basis point decrease in the average yield on loans resulted primarily from the runoff of higher-yielding fixed-rate loans and leases and more intense competition in loan pricing. During the second half of 2004, the Federal Reserve started to gradually increase the intended Federal funds rate in response to an increase in economic activity. As a result of the Federal Reserve Boards actions, the prime rate, which is the basis for pricing many commercial and consumer loans, was 5.25% at year-end 2004, compared to 4.00% at both year-end 2003 and during the first half of 2004. Therefore, as loans gradually reprice at higher rates or mature and are replaced with higher-yielding loans, the annualized interest yield of the loan portfolio is expected to increase. Evidence of this trend is visible from the changes in the quarterly annualized interest yield of the loan portfolio, which improved from its low of 5.72% during the second quarter to 6.00% during the fourth quarter of 2004.
Asset Quality and Credit Risk Management
BB&T utilizes the following general practices to manage credit risk:
BB&Ts 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&Ts asset quality has remained significantly better than published industry averages.
The following table summarizes asset quality information for BB&T for the past five years.
During 2004, BB&Ts credit quality continued to improve. The improving economic conditions combined with BB&Ts careful loan underwriting process and active monitoring of past due loans resulted in a reduction in total nonperforming assets and relative levels of nonperforming assets and net charge-offs, the second year of these trends.
The following table summarizes nonperforming assets and past due loans by loan type for the past three years.
Summary of Nonperforming Assets and Past Due Loans
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&Ts allowance for credit losses. The allowance for credit losses totaled $828.3 million at December 31, 2004, compared to $793.4 million at the end of 2003, an increase of 4.4%. The allowance for loan and lease losses, as a percentage of loans and leases, was 1.18% at December 31, 2004, compared to 1.26% at year-end 2003. As a percentage of loans held for investment, the ratio of the allowance for loan and lease losses to total loans and leases was 1.19% at December 31, 2004 compared to 1.27% at the end of last year. BB&Ts strong credit history and recent trends, combined with improvements in BB&Ts relative levels of net charge-offs and nonperforming assets, led to the
reduction in the allowance as a percentage of outstanding loans and leases for a third 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&Ts allowance for credit losses for the last five years is presented in the following table. The table is presented using regulatory classifications.
Analysis of Allowance for Credit Losses
Deposits and Other Borrowings
Client deposits generated through the BB&T branch network are the largest source of funds used to support asset growth. Total deposits at December 31, 2004, were $67.7 billion, an increase of $8.3 billion, or 14.1%, compared to year-end 2003. The increase in deposits was driven by a $3.9 billion, or 16.7% increase in certificates of deposit (CDs) and other time deposits, a $3.1 billion, or 15.1% increase in money rate savings accounts, and a $1.1 billion, or 10.3% increase in noninterest-bearing deposits. For the year ended December 31, 2004, total deposits averaged $64.8 billion, an increase of $7.9 billion, or 13.8%, compared to 2003. The increase in average deposits was the result of a $2.2 billion, or 22.8% increase in average noninterest-bearing deposits, and a $3.7 billion, or 20.2% increase in average money rate savings accounts. Average certificates of deposit and other time deposits increased $1.1 billion, or 4.4%, during 2004 compared to 2003. Other time deposits, including individual retirement accounts and certificates of deposit, remain BB&Ts largest category of deposits, comprising 40.8% of average total deposits for the year, down from 44.4% last year. The primary drivers of the overall increase in average deposits were the purchases of First Virginia at the beginning of the third quarter of 2003 and Republic during the second quarter of 2004, which added deposits of $9.5 billion and $2.5 billion, respectively, and significant internal deposit growth.
Together with the positive growth trends in client deposits over the last two years, there has been a noticeable shift in the overall deposit mix from certificates of deposit and other time deposits to lower-cost transaction accounts such as noninterest bearing deposits and money rate savings accounts. This shift reflects the reduced attractiveness of time deposits and client preferences for more liquid investments in a low interest rate environment. Another contributing factor, in light of the low interest environment, has been the tendency by many commercial customers to concentrate their deposit balances in noninterest bearing accounts, which allows them to minimize commercial account service charges. Furthermore, in recent years BB&T has intentionally not replaced many of the high-rate certificates of deposit that matured, instead focusing on core deposit growth in noninterest-bearing deposits due to their low cost and their potential for generating service fee income.
The average rate paid on interest-bearing deposits decreased to 1.37% during 2004, from 1.59% in 2003. This decrease resulted primarily from the shift in deposit mix from certificates of deposit and higher-cost time deposits to lower-cost savings and transaction accounts. The average rates paid on the various categories of interest-bearing deposits also decreased as follows: other time deposits, including individual retirement accounts and certificates of deposit, decreased to 2.11% in the current year from 2.39% in 2003; money rate savings accounts decreased to .74% in the current year from .76% in 2003; interest checking decreased from .42% in 2003 to .33% in the current year; and savings deposits decreased to .17% in 2004 from .28% in 2003. Recent actions by the Federal Reserve Board during the second half of 2004 to raise the targeted Federal funds rate are beginning to cause increases in the above rates paid on interest-bearing deposits.
BB&T also uses various types of shorter-term borrowings in meeting funding needs. While client deposits remain the primary source for funding loan originations, management uses shorter-term borrowings as a supplementary funding source for loan growth. Shorter-term borrowings comprised 6.8% of total funding needs on average in 2004 as compared to 6.0% in 2003. See Note 9 Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Short-Term Borrowed Funds in the Notes to Consolidated Financial Statements herein for further disclosure. The types of shorter-term borrowings utilized by the Corporation include Federal funds purchased, which composed 42.9% of total shorter-term borrowings, and securities sold under repurchase agreements, which comprised 37.7% of shorter-term borrowings at year-end 2004. Master notes, U.S. Treasury tax and loan deposit notes, short-term bank notes and short-term Federal Home Loan Bank (FHLB) advances are also utilized to meet short-term funding needs. Shorter-term borrowings at the end of 2004 were $6.7 billion, down $647.0 million, or 8.8%, compared to year-end 2003. The decrease in average shorter-term borrowings was primarily a result of healthy deposit growth during 2004, which provided sufficient resources for funding loan and other balance sheet growth. The rates paid on average shorter-term borrowings increased from 1.13% in 2003 to 1.37% during 2004. The increase in the cost of shorter-term borrowings resulted from recent actions by the Federal Reserve Board, which increased the targeted Federal funds rate by 125 basis points during the second half of 2004 to 2.25% from its lowest level of 1.00% set in June 2003. The following table summarizes certain pertinent information for the past three years with respect to BB&Ts shorter-term borrowings:
Federal Funds Purchased, Securities Sold Under Agreements to Repurchase and Other Borrowings
BB&T also utilizes long-term debt to provide both funding and, to a lesser extent, regulatory capital. Long-term debt comprised 11.3% of total funding needs on average during 2004 and 13.7% in 2003. See Note 10 Long-Term Debt in the Notes to Consolidated Financial Statements herein for further disclosure. Long-term debt at December 31, 2004 totaled $11.4 billion, an increase of $611.9 million, or 5.7%, from year-end 2003. For the year ended December 31, 2004, average long-term debt decreased $824.1 million, or 7.0%, compared to the average for 2003. BB&Ts long-term debt consists primarily of FHLB advances, which composed 48.8% of total outstanding long-term debt at December 31, 2004, and subordinated notes of BB&T Corporation, which composed 29.2% 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 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 decreased from 3.87% during 2003 to 3.48% during 2004 primarily because of the balance sheet restructuring completed during 2003, which was intended to improve net interest income and the net interest margin.
During the third quarter of 2004, Branch Bank issued $500 million of senior floating rate debt maturing in June 2007. The proceeds from the offering are being used for general bank funding purposes. On October 27, 2004, BB&T Corporation also issued $600 million of subordinated global notes maturing in November 2019. The proceeds from this offering are being used to fund repurchases of BB&Ts common stock, acquisitions of other companies or their assets, extending credit to or funding investments in BB&Ts subsidiaries and for other general corporate purposes.
During 2003, BB&T completed a balance sheet restructuring. In connection with the restructuring, BB&T refinanced $3.0 billion of FHLB advances, lowering the annual interest rate paid on these advances during the next four years, after which the FHLB has the option to increase the interest rate paid on such advances. Because the refinancing gave rise to substantially similar debt, the transaction resulted in no immediate gain or loss. BB&T also prepaid $2.9 billion in FHLB advances using funds obtained from the reduction of the securities portfolio. The transaction resulted in prepayment penalties totaling $384.9 million that reduced 2003 after-tax earnings by $248.5 million. The prepayment penalties are reflected in BB&Ts Consolidated Statements of Income as a separate category of noninterest expenses. Management estimates that these long-term debt transactions contributed approximately 18 basis points to the net interest margin during 2004 and 12 basis points during 2003.
Liquidity needs are a primary consideration in evaluating funding sources. BB&Ts 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 2004 totaled $1.56 billion, which generated basic earnings per share of $2.82 and diluted earnings per share of $2.80. Net income for 2003 was $1.06 billion and net income for 2002 totaled $1.30 billion. Basic earnings per share were $2.09 in 2003 and $2.75 in 2002, while diluted earnings per share were $2.07 and $2.72 for 2003 and 2002, 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&Ts returns on average assets were 1.62%, 1.25% and 1.72% for the years ended December 31, 2004, 2003 and 2002, respectively. The returns on average common shareholders equity were 14.71%, 11.97% and 18.32% for the last three years.
Merger-Related and Restructuring Charges
Mergers and acquisitions have played an important role in the development of BB&Ts franchise. BB&T has been an active acquirer of financial institutions, insurance agencies and other nonbank fee income producing businesses for many years. 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,
2004. 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&Ts automation platform. Merger-related charges also include professional fees, advertising and asset write-offs incurred in connection with the mergers.
During 2004, BB&T recorded merger-related and restructuring charges of $5.5 million, which are reflected in BB&Ts Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of McGriff and Republic.
During 2003, BB&T recorded merger-related and restructuring charges of $89.8 million, which are reflected in BB&Ts Consolidated Statements of Income as noninterest expenses. These expenses were recorded primarily in connection with the acquisitions and systems conversions of Equitable Bank and First Virginia.
During 2002, BB&T recorded merger-related and restructuring charges of $39.3 million, which are reflected in BB&Ts Consolidated Statements of Income as noninterest expenses. These expenses were recorded in connection with the first quarter systems conversion of F&M National Corporation, the second quarter systems conversion of Community First Banking Company, and the mergers with MidAmerica Bancorp (MidAmerica), Area Bancshares (AREA), and Regional Financial Corp. (Regional).
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, travel and other costs.
Summary of Merger-Related and Restructuring Charges
(Dollars in thousands)
Severance and personnel-related costs include severance, employee retention, payments related to change-in-control provisions of employment contracts, outplacement services and other benefits associated with employee termination, which typically occur in corporate support and data processing functions. 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 will continue to receive severance payments during 2005. During 2003, BB&T estimated that 1,918 positions would be eliminated and receive severance and 980 employees did, in fact, receive severance during 2003. Substantially all of the remaining positions involved employees who voluntarily resigned or were offered positions elsewhere within BB&T. These former employees did not receive severance. Approximately 551 of the employees whose jobs were eliminated received severance payments during 2004. During 2002, BB&T estimated that 372 positions would be eliminated and receive severance and 370 employees did, in fact, receive severance during 2002. Approximately 90 of these former employees continued to receive severance payments during 2003.
Occupancy and equipment charges or credits represent merger-related costs or gains associated with lease terminations, obsolete equipment write-offs, and the sale of duplicate facilities and equipment. Credits may result when obsolete properties or equipment are sold for more than originally estimated. Systems conversions and related charges include expenses necessary to convert and combine the acquired branches and operations of merged companies. Marketing and public relations costs represent direct media advertising related to the acquisitions. The other merger-related charges are composed of asset and supply inventory write-offs, litigation accruals and other similar charges.
In conjunction with the consummation of an acquisition and the completion of other requirements, BB&T typically accrues certain merger-related expenses related to estimated severance and other personnel costs, costs to terminate lease contracts, costs related to the disposal of duplicate facilities and equipment, costs to terminate data processing contracts and other costs associated with an acquisition. The following tables present a summary of activity with respect to BB&Ts merger and restructuring accruals related to the mergers listed above, with the more significant merger (First Virginia) presented separately. These tables include costs reflected as expenses, as presented in the table above, and certain accruals recorded through purchase accounting adjustments.
The remaining accruals at December 31, 2004 for First Virginia are related primarily to costs related to severance payments for certain executive officers and costs to exit certain leases and to dispose of excess facilities and equipment. These liabilities will be utilized in the future because they relate to specific contracts or legal obligations that expire in later years, or they relate to the disposal of duplicate facilities and equipment, which may take longer to complete.
Activity with respect to the merger and restructuring accruals for all other mergers, which are discussed above, is presented in the accompanying table:
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&Ts 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. Liabilities associated with systems conversions relate to termination penalties on contracts with information technology service providers. These liabilities will be utilized as the contracts are paid out and expire. The other merger-related liabilities relate to litigation and other similar charges.
Because BB&T has often had multiple merger integrations in process, and, due to limited resources, has had to schedule in advance significant events in the merger conversion and integration process, BB&Ts merger process and utilization of merger accruals has typically covered an extended period of time. 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, 2004 are expected to be utilized during 2005, unless they relate to specific contracts that expire in later years.
Net Interest Income
Net interest income is BB&Ts 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.
FTE Net Interest Income and Rate/Volume Analysis
For the Years Ended December 31, 2004, 2003 and 2002