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We are maintaining our ‘Neutral’ recommendation on BB&T Corporation (BBT - Analyst Report) based on its sound organic growth strategy and stable net interest margin (NIM). However, elevated operating expenses, significant exposure to perilous loans, sluggish economic recovery along with stringent regulatory landscape remain the causes of concern.

BB&T is focused on its organic growth strategy, which is evident from the growth in client deposits and increase in net interest income (NII) over the last few quarters along with significant improvement in deposits as well as loans and leases. Further, the company is planning to open about 30 new branches in Texas by the end of 2013. All these are expected to lead to gradual improvement in the top line.

Moreover, one of the primary strengths for BB&T is the continued NIM stability. Over the last few years, NIM has been improving due to lower deposit and borrowing costs. Though there could be NIM pressure with the shrinkage of the Colonial-related accretion and low interest rate environment, we expect lower deposit costs and strong loan growth to keep the overall upward momentum intact.

BB&T can be viewed as an asset for yield-seeking investors. The company pays regular dividend as a part of its capital deployment activity. In March 2012, following the release of the Federal Reserve’s stress test results, the company received the approval to hike its quarterly dividend by 25% to 20 cents per share. Over the longer term, the company is targeting a dividend payout ratio in the range of 30%–50%.

On the flip side is the company’s significant exposure to residential mortgage loans, direct retail residential loans, sales finance and revolving credit loans. Although BB&T has been successful in implementing assets disposition strategy, it still has a large amount of risky loans that could pose a problem if economic conditions continue to deteriorate.

Operating expenses continue to rise at BB&T. Though decline in foreclosed property cost, amortization of intangibles as well as merger and restructuring charges were impressive, total non-interest expenses inched up nearly 4% year over year in the first nine months of 2012. Additional hiring and branch-building are expected to keep operating expenses elevated in the upcoming quarters.

Also, like many other peers including PNC Financial Services Group Inc. (PNC - Analyst Report) and SunTrust Banks Inc. (STI - Analyst Report), BB&T’s profitability will likely be affected by various financial reform laws leading to increased costs and fee restrictions. Moreover, new capital proposals unveiled by the Fed suggest that big U.S. banks would be required to maintain a total tier 1 ratio of 7% to risk-weighted assets. All these factors are expected to lower the company’s flexibility with respect to its business investments to some extent in the medium term.

Currently, BB&T retains a Zacks #3 Rank, which translates into a short-term Hold rating.

 

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