BB&T 10-Q 2006
Quarterly Report Pursuant to Section 13 or 15(d)
For the quarterly period ended:
March 31, 2006
Commission file number: 1-10853
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 [Ö ] NO [__]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer [ Ö ] Accelerated filer [__] Non-accelerated filer [__]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [Ö]
At April 30, 2006, 535,773,565 shares of the registrant's common stock, $5 par value, were outstanding.
March 31, 2006
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BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
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BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
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BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
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BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
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CORPORATION AND SUBSIDIARIES
NOTE 1. Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated balance sheets, consolidated statements of income, consolidated statements of changes in shareholders equity, and consolidated statements of cash flows of BB&T Corporation and subsidiaries (referred to herein as BB&T, the Corporation or the Company), present fairly, in all material respects, BB&Ts financial position at March 31, 2006 and December 31, 2005; BB&Ts results of operations for the three months ended March 31, 2006 and 2005; and BB&Ts cash flows for the three months ended March 31, 2006 and 2005. In the opinion of management, all adjustments necessary to fairly present the consolidated financial position and consolidated results of operations have been made. All adjustments during the first three months of 2006 were of a normal recurring nature.
These consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q. The information contained in the footnotes included in BB&Ts 2005 Annual Report on Form 10-K should be referred to in connection with these unaudited interim consolidated financial statements.
Nature of Operations
BB&T is a financial holding company headquartered in Winston-Salem, North Carolina. BB&T conducts its operations primarily through its subsidiary banks, which have branches in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Florida, Alabama, Indiana and Washington, D.C. BB&Ts subsidiary banks provide a wide range of banking services to individuals and businesses. BB&Ts subsidiary banks offer a variety of loans to businesses and consumers. Such loans are made primarily to individuals residing in the market areas described above or to businesses located within BB&Ts geographic footprint. BB&Ts subsidiary banks also market a wide range of deposit services to individuals and businesses. BB&Ts subsidiary banks offer, either directly, or through their subsidiaries, lease financing to businesses and municipal governments; factoring; discount brokerage services, annuities and mutual funds; life insurance, property and casualty insurance, health insurance and commercial general liability insurance on an agency basis and through a wholesale insurance brokerage operation; insurance premium financing; permanent financing arrangements for commercial real estate; loan servicing for third-party investors; direct consumer finance loans to individuals; and trust services. The direct nonbank subsidiaries of BB&T provide a variety of financial services including automobile lending, equipment financing, full-service securities brokerage, payroll processing, asset management and capital markets services.
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Principles of Consolidation
The consolidated financial statements of BB&T include the accounts of BB&T Corporation and those subsidiaries that are majority-owned by BB&T and over which BB&T exercises control. In consolidation, all significant intercompany accounts and transactions are eliminated. The results of operations of companies acquired are included only from the dates of acquisition. All material wholly owned and majority-owned subsidiaries are consolidated unless accounting principles generally accepted in the United States of America require otherwise.
BB&T evaluates variable interests in entities for which voting interests are not an effective means of identifying controlling financial interests. Variable interests are those in which the value of the interest changes with the fair value of the net assets of the entity exclusive of variable interests. If the results of the evaluation indicate the existence of a primary beneficiary and the entity does not effectively disperse risks among the parties involved, that primary beneficiary is required to consolidate the entity. Likewise, if the evaluation indicates that the requirements for consolidation are not met and the entity has previously been consolidated, then the entity would be deconsolidated.
BB&T has variable interests in certain entities that were not required to be consolidated, including affordable housing partnership interests, historic tax credit partnerships, other partnership interests and trusts that have issued capital securities.
BB&T accounts for unconsolidated partnership investments using the equity method of accounting. In addition to affordable housing partnerships, which represent the majority of unconsolidated investments in variable interest entities, BB&T also has investments and future funding commitments to venture capital and other entities. The maximum potential exposure to losses relative to investments in variable interest entities is generally limited to the sum of the outstanding balance, future funding commitments and any related loans to the entity. Loans to these entities are underwritten in substantially the same manner as are other loans and are generally secured.
BB&T has investments in certain entities for which BB&T does not have controlling interest. For these investments, the Company records its interest using the equity method with its portion of income or loss being recorded in other noninterest income on the Consolidated Statements of Income. BB&T periodically evaluates these investments for impairment.
In certain instances, amounts reported in prior periods consolidated financial statements have been reclassified to conform to the current presentation. Such reclassifications had no effect on previously reported shareholders equity or net income.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses and the reserve for unfunded lending commitments, valuation of mortgage servicing rights, valuation of goodwill, intangible assets and other purchase accounting related adjustments, benefit plan obligations and expenses, and tax assets, liabilities and expense.
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BB&T maintains various equity-based compensation plans. These plans provide for the granting of stock options (incentive and nonqualified), stock appreciation rights, restricted stock, restricted stock units, performance units and performance shares to selected BB&T employees and directors. BB&T adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS No. 123(R)), on January 1, 2006, using the modified-prospective method, which requires the recognition of compensation costs beginning with the effective date based on (a) the requirements of SFAS No. 123(R) for all share-based awards granted after the effective date and (b) the requirements of SFAS No. 123 , Accounting for Stock-Based Compensation (SFAS No. 123), for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date. The adoption of SFAS No. 123(R) reduced BB&Ts income before income taxes and net income for the three months ended March 31, 2006, by $26.0 million and $16.1 million, respectively, while basic earnings per share and diluted earnings per share for the same period were reduced by $.03 per share. The adoption of SFAS No. 123(R) also required that excess tax benefits from the exercise of equity-based awards be recorded as a financing cash flow, rather than an operating cash flow. This requirement reduced cash provided by operating activities and increased cash provided by financing activities for the three months ended March 31, 2006, by $4.4 million. Additional disclosures required by SFAS No. 123(R) are included in Note 11 to the consolidated financial statements herein.
As permitted by SFAS No. 123, BB&T accounted for share-based awards granted to employees prior to January 1, 2006 using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and related interpretations. Since the option price equaled the market price on the date of the grant for options awarded by BB&T, compensation cost was not recognized for any of the periods presented, except with respect to restricted stock awards and awards that were modified.
The following table presents BB&Ts net income, basic earnings per share and diluted earnings per share as reported, and pro forma net income and pro forma earnings per share for periods ended prior to January 1, 2006, assuming compensation cost for BB&Ts stock option plans had been determined based on the fair value at the grant dates for awards under those plans granted after December 31, 1994, consistent with the method prescribed by SFAS No. 123. BB&Ts equity-based awards generally contain a provision that accelerates vesting of awards for holders who retire and have met all retirement eligibility requirements. Prior to the adoption of SFAS No. 123(R), BB&T reported the expense in the pro forma disclosure based on the vesting cycle in the grant agreement and reported an acceleration of the expense for the unrecognized compensation cost in the period that the accelerated vesting occurred. BB&T will continue to account for awards granted prior to the adoption of SFAS No. 123(R) in this manner, with the exception that the unrecognized compensation cost on the date of adoption will be recognized as personnel expense in future periods. For awards granted after January 1, 2006, BB&T has recognized compensation expense based on retirement eligibility dates for all equity-based compensation awards. Therefore, the information presented in the following table is not comparable to the amounts recognized by BB&T in the first quarter of 2006.
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Changes in Accounting Principles and Effects of New AccountingPronouncements
In July 2005, the Financial Accounting Standards Board (FASB) issued Proposed FASB Staff Position (FSP) FAS 13-a Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease, which proposes to amend SFAS No. 13, Accounting for Leases. The proposed FSP would require recalculations of leveraged leases for changes that affect the timing of cash flows, even if the total amount of cash flows is not affected. If the FSP is finalized as currently proposed, it would require a one-time non-cash charge to be recorded as a cumulative effect of a change in accounting principle. The amount of the charge related to the previously recognized lease income, if any, would then be recognized as income over the remaining lives of the respective leases. While BB&T has entered into leveraged lease transactions in prior years that may require recalculations, any impact on BB&Ts consolidated financial position or consolidated results of operations cannot currently be predicted with certainty, because the final timing and provisions of the proposal have yet to be determined.
In July 2005, the FASB issued a Proposed Interpretation of SFAS No. 109 Accounting for Income Taxes entitled Accounting for Uncertain Tax Positions. The proposed Interpretation would clarify the criteria under which tax benefits could be recognized under SFAS No. 109. If the proposed Interpretation is finalized as currently proposed it would require a one-time non-cash charge to be recorded as a cumulative effect of a change in accounting principle. While BB&T is currently evaluating the potential impact of this proposed Interpretation, any impact on BB&Ts consolidated financial position or consolidated results of operations cannot currently be predicted with certainty, because the final timing and provisions of the proposal have yet to be determined.
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In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, (SFAS No. 155), which permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities and FASB No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement is effective for financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. BB&T adopted the provisions of SFAS No. 155 on January 1, 2006. The adoption did not have an impact on BB&Ts consolidated financial position, results of operations or cash flows.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, (SFAS No. 156), which was issued to simplify the accounting for servicing rights and reduce the volatility resulting from the use of different measurement attributes for servicing rights and the related financial instruments used to economically hedge risks associated with those servicing rights. SFAS No. 156 requires separately recognized servicing rights to be initially measured at fair value, and provides the irrevocable option to subsequently account for those servicing rights (by class) at either fair value or under the amortization method previously required under FASB Statement No. 140. BB&T adopted the provisions of SFAS No. 156 effective January 1, 2006. The initial application of the provisions of SFAS No. 156 was immaterial to BB&Ts consolidated financial position, results of operations and cash flows. The disclosures required by SFAS No. 156 are included in Note 12 to the consolidated financial statements herein.
NOTE 2. Business Combinations
Insurance and Other Nonbank Acquisitions
During the first three months of 2006, BB&T acquired two nonbank financial services companies. In conjunction with these transactions, BB&T issued approximately 189 thousand shares of common stock and paid $35.0 million in cash. Approximately $17.4 million in goodwill and $16.8 million of identifiable intangibles were recorded in connection with these transactions, pending final valuations. During 2005, BB&T acquired five insurance businesses and four nonbank financial services companies, including the acquisition of a 70% ownership interest in Sterling Capital Management LLC, an investment management services company based in Charlotte, North Carolina. In conjunction with these transactions, BB&T issued approximately 1.2 million shares of common stock and paid approximately $136.4 million in cash. Including subsequent adjustments, approximately $104.4 million in goodwill and $85.2 million of identifiable intangible assets were recorded in connection with these transactions. BB&T also acquires client relationships, primarily from insurance companies. Such acquisitions have not been material to BB&Ts financial condition or results of operations.
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Merger-Related and Restructuring Activities
BB&T has incurred certain expenses in connection with business combinations. The following table presents the components of merger-related and restructuring charges included in noninterest expenses. This table includes increases to previously recorded merger-related accruals and period expenses for merger-related items that must be expensed as incurred. Items that are required to be expensed as incurred include certain expenses associated with systems conversions, data processing, training, and other costs.
Summary of Merger-Related and Restructuring Charges (Gains)
In conjunction with the consummation of an acquisition and completion of other requirements, BB&T typically accrues certain merger-related expenses related to estimated severance and other personnel-related 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 the acquisition. The costs related to the acquired entity are accrued in accordance with the guidance in EITF 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, and generally recorded as adjustments to the purchase price unless they are required to be expensed as incurred. The costs related to existing BB&T facilities and personnel are recorded in accordance with the guidance in SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities and SFAS 112, Employers Accounting for Postemployment Benefits, as appropriate, and reflected as merger-related and restructuring charges on the Consolidated Statements of Income. The following table presents a summary of BB&Ts merger accrual activity for 2006:
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The following table provides a summary of BB&Ts merger accrual activity, by acquisition, for 2006:
NOTE 3. Securities
The amortized cost and approximate fair values of securities available for sale were as follows:
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On March 31, 2006, BB&T held certain investment securities having continuous unrealized loss positions for more than 12 months. As of March 31, 2006, the unrealized loss on these securities totaled $620.1 million. Substantially all of these investments were in U.S. government-sponsored entity securities and mortgage-backed securities, which primarily consist of securities issued by the Federal Farm Credit Bureau, the Federal Home Loan Bank System, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These agencies are rated AAA and the unrealized losses are the result of increases in market interest rates rather than the credit quality of the issuers. BB&T has the ability and intent to retain these securities for a period of time sufficient to recover all unrealized losses. Accordingly, BB&T has not recognized other-than-temporary impairment in connection with these securities.
The following tables reflect the gross unrealized losses and fair values of BB&Ts investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates presented.
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NOTE 4. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill attributable to each of BB&Ts operating segments for the three months ended March 31, 2006 and the year ended December 31, 2005 are as follows:
The adjustments to goodwill recorded during the first three months of 2006 include $26.3 million of contingent consideration paid subsequent to the dates of acquisition based on the terms of the purchase agreements. The adjustments to goodwill recorded during 2005 include $23.2 million of contingent consideration paid subsequent to the dates of acquisition based on the terms of the purchase agreements and $3.1 million related to the accounting for property and equipment leases of acquired companies.
The following table presents the gross carrying amounts and accumulated amortization for BB&Ts identifiable intangible assets subject to amortization at the dates presented:
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(1) Other amortizing identifiable intangibles are primarily composed of customer relationship intangibles.
The following table presents estimated amortization expense for the full year 2006 and each of the next four years:
Estimated Amortization Expense
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Note 5. Long-Term Debt
Long-term debt is summarized as follows:
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Contractual Obligations, Commitments, Contingent Liabilities, and Off-Balance
BB&T utilizes a variety of financial instruments to meet the financing needs of clients and to reduce exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees, and derivatives. BB&T also has commitments to fund certain affordable housing investments and contingent liabilities of certain sold loans.
Standby letters of credit and financial guarantees written are unconditional commitments issued by BB&T to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper issuance, bond financing and similar transactions. The credit risk involved in the issuance of these guarantees is essentially the same as that involved in extending loans to clients and as such, the instruments are collateralized when necessary. As of March 31, 2006, BB&T had issued a total of $2.8 billion in standby letters of credit. The carrying amount of the liability for such guarantees was $5.9 million at March 31, 2006.
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest-rate swaps, caps, floors, collars, financial forwards and futures contracts, swaptions, when-issued securities, foreign exchange contracts and options written and purchased. BB&T uses derivatives primarily to manage economic risk related to securities, business loans, mortgage servicing rights and mortgage banking operations, Federal funds purchased, other time deposits, long-term debt and institutional certificates of deposit. BB&T also uses derivatives to facilitate transactions on behalf of its clients. BB&T held a variety of derivative financial instruments with notional values of $21.1 billion and $23.7 billion, at March 31, 2006 and December 31, 2005, respectively. The fair value of the instruments was $(134.6 million) and $(10.6 million), at March 31, 2006 and December 31, 2005, respectively.
BB&T invests in certain affordable housing and historic building rehabilitation projects throughout its market area as a means of supporting local communities and receives tax credits related to these investments. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. BB&Ts subsidiary banks typically provide financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. BB&Ts outstanding commitments to fund affordable housing investments totaled $159.0 million and $172.4 million at March 31, 2006 and December 31, 2005, respectively. At March 31, 2006, BB&Ts maximum exposure to loss associated with these investments totaled $262.7 million.
In the ordinary course of business, BB&T indemnifies its officers and directors to the fullest extent permitted by law against liabilities arising from pending litigation. BB&T also issues standard representation warranties in underwriting agreements, merger and acquisition agreements, loan sales, brokerage activities and other similar arrangements. Counterparties in many of these indemnification arrangements provide similar indemnifications to BB&T. Although these agreements often do not specify limitations, BB&T has not been required to act on the guarantees and does not believe that any payments pursuant to them would materially change the financial condition or results of operations of the company.
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Merger and acquisition agreements of businesses other than financial institutions occasionally include additional incentives to the acquired entities to offset the loss of future cash flows previously received through ownership positions. Typically, these incentives are based on the acquired entitys contribution to BB&Ts earnings compared to agreed-upon amounts. When offered, these incentives are typically issued for terms of three to eight years. As certain provisions of these agreements do not specify dollar limitations, it is not possible to quantify the maximum exposure resulting from these agreements.
NOTE 7. Benefit Plans
BB&T provides various benefit plans to substantially all employees, including employees of acquired entities. Employees of acquired entities generally participate in existing BB&T plans after consummation of the business combinations. The plans of acquired institutions are typically merged into the BB&T plans after consummation of the mergers, and, under these circumstances, credit is usually given to these employees for years of service at the acquired institution for vesting and eligibility purposes. Please refer to BB&Ts Annual Report on Form 10-K for the year ended December 31, 2005 for descriptions and disclosures about the various benefit plans offered by BB&T.
The following table summarizes the components of net periodic benefit cost recognized for the three-month periods ended March 31, 2006 and 2005, respectively:
Management elected to make a discretionary contribution of $80.0 million to the qualified pension plan in the first quarter of 2006, and may make additional contributions in 2006 if determined appropriate.
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NOTE 8. Computation of Earnings per Share
BB&Ts basic and diluted earnings per share amounts for the three month periods ended March 31, 2006 and 2005, respectively, were calculated as follows:
For the three months ended March 31, 2006 and 2005, respectively, antidilutive options to purchase 121 thousand shares and 108 thousand shares of common stock were outstanding. Antidilutive options outstanding were not included in the computation of diluted earnings per share.
NOTE 9. Comprehensive Income (Loss)
The balances in accumulated other comprehensive loss for the periods indicated are shown in the following tables:
Accumulated Other Comprehensive Loss
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Accumulated Other Comprehensive Loss
NOTE 10. Operating Segments
BB&Ts operations are divided into seven reportable business segments: the Banking Network, Residential Mortgage Banking, Trust Services, Insurance Services, Specialized Lending, Investment Banking and Brokerage, and Treasury. These operating segments have been identified based on BB&Ts organizational structure. The segments require unique technology and marketing strategies and offer different products and services. While BB&T is managed as an integrated organization, individual executive managers are held accountable for the operations of these business segments.
BB&T emphasizes revenue growth by focusing on client service, sales effectiveness and relationship management. The segment results contained herein are presented based on internal management accounting policies that are designed to support these strategic objectives. Unlike financial accounting, there is no comprehensive authoritative body of guidance for management accounting equivalent to generally accepted accounting principles. The performance of the segments is not comparable with BB&Ts consolidated results or with similar information presented by any other financial institution. Additionally, because of the interrelationships of the various segments, the information presented is not indicative of how the segments would perform if they operated as independent entities.
Please refer to BB&Ts Annual Report on Form 10-K for the year ended December 31, 2005, for a description of internal accounting policies and the basis of segmentation, including a description of the segments presented in the accompanying tables.
The following tables disclose selected financial information with respect to BB&Ts reportable business segments for the periods indicated:
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The following table presents a reconciliation of segment results to consolidated results:
(1) Other net interest income (expense), other net income (loss) and other,
net, include amounts applicable to BB&Ts support functions that are not
allocated to the reported segments.
NOTE 11. Equity-Based Compensation Plans
At March 31, 2006, BB&T had options, restricted shares and restricted share units outstanding from the following equity-based compensation plans: the 2004 Stock Incentive Plan (2004 Plan), the 1995 Omnibus Stock Incentive Plan (Omnibus Plan), the Non-Employee Directors Stock Option Plan (Directors Plan), and plans assumed from acquired entities, which are described below. All plans generally allow for accelerated vesting of options, restricted shares or restricted share units for holders who retire and have met all retirement eligibility requirements and in connection with certain other events. BB&Ts shareholders have approved all plans that award incentive stock options, non-qualified stock options, shares of restricted stock, performance shares and stock appreciation rights with the exception of plans assumed from acquired companies. As of March 31, 2006, the 2004 Plan is the only plan that has shares available for future grants.
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BB&Ts 2004 Plan is intended to assist the Corporation in recruiting and retaining employees, directors and independent contractors and to associate the interests of eligible participants with those of BB&T and its shareholders. At March 31, 2006 there were 6.4 million nonqualified stock options at prices ranging from $38.64 to $42.25 and 2.5 million restricted shares or restricted share units outstanding under the 2004 Plan. The options outstanding under the 2004 Plan generally vest ratably over five years and have a ten-year term. The restricted shares and restricted share units generally vest five years from the date of grant. At March 31, 2006, there were 16.1 million shares remaining available to grant under the 2004 Plan.
BB&Ts Omnibus Plan was intended to allow BB&T to recruit and retain employees with ability and initiative and to associate the employees interests with those of BB&T and its shareholders. At March 31, 2006, 8.0 million qualified stock options at prices ranging from $10.73 to $48.01 and 22.9 million non-qualified stock options at prices ranging from $9.52 to $53.10 were outstanding. The stock options generally vest over 3 to 5 years and have a 10-year term.
The Directors Plan was intended to provide incentives to non-employee directors to remain on the Board of Directors and share in the profitability of BB&T. In 2005, the Directors Plan was amended and no future grants will be awarded in connection with this Plan. At March 31, 2006, options to purchase 616 thousand shares of common stock at prices ranging from $11.04 to $31.80 were outstanding pursuant to the Directors Plan.
BB&T also has equity-based plans outstanding as the result of assuming the plans of acquired companies. At March 31, 2006, there were 428 thousand stock options outstanding in connection with these plans, with option prices ranging from $16.53 to $29.54.
BB&T changed its practices regarding equity-based awards in the first quarter of 2006 and began issuing a combination of restricted share units and nonqualified stock options in connection with its incentive plans. Formerly, the Company had issued substantially all of its equity-based awards in the form of stock options.
BB&T measures the fair value of each option award on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants awarded in the first three months of 2006 and 2005, respectively:
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BB&T determines the assumptions used in the Black-Scholes option pricing model as follows: the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant; the dividend yield is based on the historical dividend yield of BB&Ts stock, adjusted to reflect the expected dividend yield over the expected life of the option; the volatility factor is based on the historical volatility of BB&Ts stock, adjusted to reflect the ways in which current information indicates that the future is reasonably expected to differ from the past; the weighted-average expected life is based on the historical behavior of employees related to exercises, forfeitures and cancellations.
BB&T measures the fair value of restricted shares based on the price of BB&Ts stock on the grant date and restricted share units based on the price of BB&Ts stock on the grant date less the present value of expected dividends that are foregone during the vesting period.
BB&T recorded $26.5 million and $45 thousand in equity-based compensation during the first quarters of 2006 and 2005, respectively. In connection with this compensation expense, BB&T also recorded $10.2 million and $18 thousand as an income tax benefit during the first quarters of 2006 and 2005, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2006 and 2005 was $9.1 million and $10.0 million, respectively. The total fair value of options vested during the three months ended March 31, 2006 was $27.5 million. As of March 31, 2006, there was $131.0 million of unrecognized compensation costs related to BB&Ts equity-based awards that is expected to be recognized over a weighted-average life of 4.0 years.
The following table details the activity during the first three months of 2006 related to stock options awarded by BB&T:
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The following tables summarize information about BB&Ts stock option awards as of March 31, 2006:
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The following table details the activity during the first three months of 2006 related to restricted shares and restricted share units awarded by BB&T:
At March 31, 2006, BB&Ts restricted shares and restricted share units had a weighted-average life of 4.8 years. At March 31, 2006, management estimates that 2,052,715 restricted shares or restricted share units will vest over a weighted-average life of 4.8 years.
NOTE 12. Loan Servicing
BB&T has two classes of mortgage servicing rights for which it separately manages the economic risks: residential and commercial. Commercial mortgage servicing rights are recorded as other assets on the Consolidated Balance Sheets at lower of cost or market and amortized in proportion to and over the estimated period that net servicing income is expected to be received based on projections of the amount and timing of estimated future net cash flows. Commercial mortgage servicing rights were $22.4 million and $20.1 million at March 31, 2006 and December 31, 2005, respectively. Residential mortgage servicing rights are recorded on the Consolidated Balance Sheets at fair value with changes in fair value recorded as a component of mortgage banking income on the Consolidated Statements of Income for each period. BB&T uses various derivative instruments to mitigate the income statement effect of changes in fair value, due to change in valuation inputs and assumptions, of its residential mortgage servicing rights. The following is an analysis of BB&Ts residential mortgage servicing rights:
(1) Represents economic amortization associated with the collection and realization of expected net servicing cash flows, expected borrower payments and the passage of time.
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The unpaid principal balances of BB&Ts total residential mortgage servicing portfolio were $41.8 billion and $41.1 billion at March 31, 2006 and December 31, 2005, respectively. The unpaid principal balances of residential mortgage loans serviced for others is comprised primarily of agency conforming fixed-rate mortgage loans and totaled $26.0 billion and $25.8 billion at March 31, 2006 and December 31, 2005, respectively. Mortgage loans serviced for others are not included in loans on the accompanying Consolidated Balance Sheets. BB&T recognized servicing fees of $25.1 million and $23.3 million in the first quarter of 2006 and 2005, respectively, as a component of mortgage banking income.
During the first quarters of 2006 and 2005, BB&T sold residential mortgage loans with unpaid principal balances of $1.1 billion and $1.2 billion, respectively and recognized pretax gains of $8.0 million and $9.8 million, respectively, which were recorded in noninterest income as a component of mortgage banking income. BB&T retained the related mortgage servicing rights and receives servicing fees. At March 31, 2006 and December 31, 2005, the approximate weighted average servicing fee was .35% of the outstanding balance of residential mortgage loans. The weighted average coupon interest rate on the portfolio of mortgage loans serviced for others was 5.84% and 5.83% at March 31, 2006 and December 31, 2005, respectively.
At March 31, 2006, BB&T had $259.6 million of residential mortgage loans sold with limited recourse liability. In the event of nonperformance by the borrower, BB&T has maximum recourse exposure of approximately $78.3 million on these mortgage loans.
BB&T uses assumptions and estimates in determining the fair value of capitalized mortgage servicing rights. These assumptions include prepayment speeds, net charge-off experience and discount rates commensurate with the risks involved and comparable to assumptions used by market participants to value and bid servicing rights available for sale in the market. At March 31, 2006 the sensitivity of the current fair value of the residential mortgage servicing rights to immediate 10% and 20% adverse changes in key economic assumptions are included in the accompanying table, which excludes commercial mortgage servicing rights.
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The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the mortgage servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the effect of the change.
This report on Form 10-Q contains forward-looking statements with respect to the financial condition, results of operations and businesses of BB&T. These forward-looking statements involve certain risks and uncertainties and are based on the beliefs and assumptions of the management of BB&T and the information available to management at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following: