Table of Contents
Exhibit 99.1
Selected Financial Data | Huntington Bancshares Incorporated |
Table 1 — Selected Financial Data(1)
Year Ended December 31, | ||||||||||||||||||||
(in thousands, except per share amounts) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Interest income | $ | 2,798,322 | $ | 2,742,963 | $ | 2,070,519 | $ | 1,641,765 | $ | 1,347,315 | ||||||||||
Interest expense | 1,266,631 | 1,441,451 | 1,051,342 | 679,354 | 435,941 | |||||||||||||||
Net interest income | 1,531,691 | 1,301,512 | 1,019,177 | 962,411 | 911,374 | |||||||||||||||
Provision for credit losses | 1,057,463 | 643,628 | 65,191 | 81,299 | 55,062 | |||||||||||||||
Net interest income after provision for credit losses | 474,228 | 657,884 | 953,986 | 881,112 | 856,312 | |||||||||||||||
Service charges on deposit accounts | 308,053 | 254,193 | 185,713 | 167,834 | 171,115 | |||||||||||||||
Automobile operating lease income | 39,851 | 7,810 | 43,115 | 133,015 | 285,431 | |||||||||||||||
Securities (losses) gains | (197,370 | ) | (29,738 | ) | (73,191 | ) | (8,055 | ) | 15,763 | |||||||||||
Other non-interest income | 556,604 | 444,338 | 405,432 | 339,488 | 346,289 | |||||||||||||||
Total noninterest income | 707,138 | 676,603 | 561,069 | 632,282 | 818,598 | |||||||||||||||
Personnel costs | 783,546 | 686,828 | 541,228 | 481,658 | 485,806 | |||||||||||||||
Automobile operating lease expense | 31,282 | 5,161 | 31,286 | 103,850 | 235,080 | |||||||||||||||
Other non-interest expense | 662,546 | 619,855 | 428,480 | 384,312 | 401,358 | |||||||||||||||
Total noninterest expense | 1,477,374 | 1,311,844 | 1,000,994 | 969,820 | 1,122,244 | |||||||||||||||
(Loss) Income before income taxes | (296,008 | ) | 22,643 | 514,061 | 543,574 | 552,666 | ||||||||||||||
(Benefit) provision for income taxes | (182,202 | ) | (52,526 | ) | 52,840 | 131,483 | 153,741 | |||||||||||||
Net (loss) income | $ | (113,806 | ) | $ | 75,169 | $ | 461,221 | $ | 412,091 | $ | 398,925 | |||||||||
Dividends on preferred shares | 46,400 | — | — | — | — | |||||||||||||||
Net (loss) income applicable to common shares | $ | (160,206 | ) | $ | 75,169 | $ | 461,221 | $ | 412,091 | $ | 398,925 | |||||||||
Net (loss) income per common share — basic | $(0.44 | ) | $0.25 | $1.95 | $1.79 | $1.74 | ||||||||||||||
Net (loss) income per common share — diluted | (0.44 | ) | 0.25 | 1.92 | 1.77 | 1.71 | ||||||||||||||
Cash dividends declared per common share | 0.6625 | 1.060 | 1.000 | 0.845 | 0.750 | |||||||||||||||
Balance sheet highlights | ||||||||||||||||||||
Total assets (period end) | $ | 54,352,859 | $ | 54,697,468 | $ | 35,329,019 | $ | 32,764,805 | $ | 32,565,497 | ||||||||||
Total long-term debt (period end)(2) | 6,870,705 | 6,954,909 | 4,512,618 | 4,597,437 | 6,326,885 | |||||||||||||||
Total shareholders’ equity (period end) | 7,227,141 | 5,949,140 | 3,014,326 | 2,557,501 | 2,537,638 | |||||||||||||||
Average long-term debt(2) | 7,374,681 | 5,714,572 | 4,942,671 | 5,168,959 | 6,650,367 | |||||||||||||||
Average shareholders’ equity | 6,393,788 | 4,631,912 | 2,945,597 | 2,582,721 | 2,374,137 | |||||||||||||||
Average total assets | 54,921,419 | 44,711,676 | 35,111,236 | 32,639,011 | 31,432,746 | |||||||||||||||
Key ratios and statistics | ||||||||||||||||||||
Margin analysis — as a % of average earnings assets | ||||||||||||||||||||
Interest income(3) | 5.90 | % | 7.02 | % | 6.63 | % | 5.65 | % | 4.89 | % | ||||||||||
Interest expense | 2.65 | 3.66 | 3.34 | 2.32 | 1.56 | |||||||||||||||
Net interest margin(3) | 3.25 | % | 3.36 | % | 3.29 | % | 3.33 | % | 3.33 | % | ||||||||||
Return on average total assets | (0.21 | )% | 0.17 | % | 1.31 | % | 1.26 | % | 1.27 | % | ||||||||||
Return on average total shareholders’ equity | (1.8 | ) | 1.6 | 15.7 | 16.0 | 16.8 | ||||||||||||||
Return on average tangible shareholders’ equity(4) | (2.1 | ) | 3.9 | 19.5 | 17.4 | 18.5 | ||||||||||||||
Efficiency ratio(5) | 57.0 | 62.5 | 59.4 | 60.0 | 65.0 | |||||||||||||||
Dividend payout ratio | N.M. | N.M. | 52.1 | 47.7 | 43.9 | |||||||||||||||
Average shareholders’ equity to average assets | 11.64 | 10.36 | 8.39 | 7.91 | 7.55 | |||||||||||||||
Effective tax rate | N.M. | N.M. | 10.3 | 24.2 | 27.8 | |||||||||||||||
Tangible common equity to tangible assets (period end)(6) | 4.04 | 5.08 | 6.93 | 7.19 | 7.18 | |||||||||||||||
Tangible equity to tangible assets (period end)(7) | 7.72 | 5.08 | 6.93 | 7.19 | 7.18 | |||||||||||||||
Tier 1 leverage ratio (period end) | 9.82 | 6.77 | 8.00 | 8.34 | 8.42 | |||||||||||||||
Tier 1 risk-based capital ratio (period end) | 10.72 | 7.51 | 8.93 | 9.13 | 9.08 | |||||||||||||||
Total risk-based capital ratio (period end) | 13.91 | 10.85 | 12.79 | 12.42 | 12.48 | |||||||||||||||
Other data | ||||||||||||||||||||
Full-time equivalent employees (period end) | 10,951 | 11,925 | 8,081 | 7,602 | 7,812 | |||||||||||||||
Domestic banking offices (period end) | 613 | 625 | 381 | 344 | 342 |
N.M., not a meaningful value.
(1) | Comparisons for presented periods are impacted by a number of factors. Refer to the “Significant Items” for additional discussion regarding these key factors. |
(2) | Includes Federal Home Loan Bank advances, subordinated notes, and other long-term debt. |
(3) | On a fully taxable equivalent (FTE) basis assuming a 35% tax rate. |
(4) | Net (loss) income less expense excluding amortization of intangibles for the period divided by average tangible shareholders’ equity. Average tangible shareholders’ equity equals average total shareholders’ equity less average intangible assets and goodwill. Expense for amortization of intangibles and average intangible assets are net of deferred tax liability, and calculated assuming a 35% tax rate. |
(5) | Noninterest expense less amortization of intangibles divided by the sum of FTE net interest income and noninterest income excluding securities gains. |
(6) | Tangible common equity (total common equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
(7) | Tangible equity (total equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
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Table of Contents
Management’s Discussion and Analysis of Financial Condition | Huntington Bancshares Incorporated |
and Results of Operations
INTRODUCTION
Huntington Bancshares Incorporated (we or our) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through our subsidiaries, including our bank subsidiary, The Huntington National Bank (the Bank), organized in 1866, we provide full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, brokerage services, customized insurance service programs, and other financial products and services. Our banking offices are located in Ohio, Michigan, Pennsylvania, Indiana, West Virginia, and Kentucky. Selected financial service activities are also conducted in other states including: Auto Finance and Dealer Services (AFDS) offices in Arizona, Florida, Tennessee, Texas, and Virginia; Private Financial, Capital Markets, and Insurance Group (PFCMIG) offices in Florida; and Mortgage Banking offices in Maryland and New Jersey. International banking services are available through the headquarters office in Columbus and a limited purpose office located in both the Cayman Islands and Hong Kong.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) provides you with information we believe necessary for understanding our financial condition, changes in financial condition, results of operations, and cash flows and should be read in conjunction with the financial statements, notes, and other information contained in this report.
Our discussion is divided into key segments:
– | Introduction — Provides overview comments on important matters including risk factors, acquisitions, and other items. These are essential for understanding our performance and prospects. | |
– | Discussion of Results of Operations — Reviews financial performance from a consolidated company perspective. It also includes a “Significant Items” section that summarizes key issues helpful for understanding performance trends. Key consolidated average balance sheet and income statement trends are also discussed in this section. | |
– | Risk Management and Capital — Discusses credit, market, liquidity, and operational risks, including how these are managed, as well as performance trends. It also includes a discussion of liquidity policies, how we obtain funding, and related performance. In addition, there is a discussion of guaranteesand/or commitments made for items such as standby letters of credit and commitments to sell loans, and a discussion that reviews the adequacy of capital, including regulatory capital requirements. | |
– | Lines of Business Discussion — Provides an overview of financial performance for each of our major lines of business and provides additional discussion of trends underlying consolidated financial performance. | |
– | Results for the Fourth Quarter — Provides a discussion of results for the 2008 fourth quarter compared with the 2007 fourth quarter. |
A reading of each section is important to understand fully the nature of our financial performance and prospects.
Forward-Looking Statements
This report, including MD&A, contains certain forward-looking statements, including certain plans, expectations, goals, projections, and statements, which are subject to numerous assumptions, risks, and uncertainties. Statements that do not describe historical or current facts, including statements about beliefs and expectations, are forward-looking statements. The forward-looking statements are intended to be subject to the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Actual results could differ materially from those contained or implied by such statements for a variety of factors including: (a) deterioration in the loan portfolio could be worse than expected due to a number of factors such as the underlying value of the collateral could prove less valuable than otherwise assumed and assumed cash flows may be worse than expected; (b) changes in economic conditions; (c) movements in interest rates and spreads; (d) competitive pressures on product pricing and services; (e) success and timing of other business strategies; (f) the nature, extent, and timing of governmental actions and reforms, including the rules of participation for the Trouble Asset Relief Program voluntary Capital Purchase Plan under the Emergency Economic Stabilization Act of 2008, which may be changed unilaterally and retroactively by legislative or regulatory actions; and (g) extended disruption of vital infrastructure. Additional factors that could cause results to differ materially from those described above can be found in Huntington’s 2008 Form 10-K.
All forward-looking statements speak only as of the date they are made and are based on information available at that time. We assume no obligation to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made or to reflect the occurrence of unanticipated events except as required by federal securities laws. As forward-looking statements involve significant risks and uncertainties, caution should be exercised against placing undue reliance on such statements.
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Risk Factors
We, like other financial companies, are subject to a number of risks that may adversely affect our financial condition or results of operation, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (1)credit risk, which is the risk of loss due to loan and lease customers or other counterparties not being able to meet their financial obligations under agreed upon terms, (2)market risk, which is the risk of loss due to changes in the market value of assets and liabilities due to changes in market interest rates, foreign exchange rates, equity prices, and credit spreads, (3)liquidity risk, which is the risk of loss due to the possibility that funds may not be available to satisfy current or future obligations based on external macro market issues, investor and customer perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues, and (4)operational risk, which is the risk of loss due to human error, inadequate or failed internal systems and controls, violations of, or noncompliance with, laws, rules, regulations, prescribed practices, or ethical standards, and external influences such as market conditions, fraudulent activities, disasters, and security risks.
Throughout 2008, we operated in what is now being labeled by many industry observers as the most difficult environment for financial institutions in many decades. What began as a subprime lending crises in 2007, turned into a widespread housing, banking, and capital markets crisis in 2008. As a result, 2008 represented a year of tremendous capital markets turmoil as capital markets ceased to function and credit markets were largely closed to businesses and consumers. The unavailability of credit to many borrowers and lack of credit flow, even between banks, contributed to the weakening of the economy, especially in the second half of 2008, and the 2008 fourth quarter in particular.
Concurrent with and reflecting this environment, the weakness that had been centered primarily in the housing and capital markets segments, spilled over into other segments of the economy. The most visible sector negatively impacted was manufacturing, and most notably, the automobile industry. As 2008 ended, it was estimated that the United States economy had lost 3.6 million jobs, with approximately 50% of those losses occurring in the fourth quarter. According to the United States Labor Department, nationwide unemployment at 2008 year-end was 7.6%.
While the United States government took several actions in 2008 and into 2009, such as the largest stimulus plan in United States’ history, and is considering even further actions, no assurances can be given regarding their effectiveness in strengthening the capital markets and improving the economy. Therefore, for the foreseeable future, we believe we will be operating in a heightened risk environment. Of the major risk factors, those most likely to affect us are credit risk, market risk, and liquidity risk.
As related tocredit risk, we anticipate continued pressure on credit quality performance, including higher loan delinquencies, net charge-offs, and the level of nonaccrual loans. All loan portfolios are expected to be impacted, although we believe the impact will be more concentrated in our commercial loan portfolio. Until unemployment levels decline, and the economic outlook improves, we anticipate that we will continue to build our allowance for credit losses in both absolute and relative terms.
With regard tomarket risk, the continuation of volatile capital markets is likely to be reflected in wide fluctuations in the valuation of certain assets, most notably mortgage asset-backed investment securities. Such fluctuations may result in additional asset value write-downs and other-than-temporary impairment (OTTI) charges.
We believe that actions taken by regulatory agencies and government bodies in late 2008 have been effective in reducing systemicliquidity risk. Specific actions included the FDIC raising the deposit insurance limit to $250,000 and providing full guarantees on noninterest bearing deposits at all FDIC-insured financial institutions. Among other actions, the most significant was the passage in October 2008 of the $700 billion Emergency Economic Stabilization Act; the cornerstone of which was the Troubled Asset Relief Program (TARP). The TARP’s voluntary Capital Purchase Plan (CPP) made available $350 billion of funds to banks and other financial institutions. We participated in TARP, which increased capital by $1.4 billion, as well as other such programs.
More information on risk is set forth below, and under the heading “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008. Additional information regarding risk factors can also be found in the “Risk Management and Capital” discussion.
Critical Accounting Policies and Use of Significant Estimates
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with GAAP requires us to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in our financial statements. Note 1 of the Notes to Consolidated Financial Statements lists significant accounting policies we use in the development and presentation of our financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors necessary for an understanding and evaluation of our company, financial position, results of operations, and cash flows.
An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates were used or if estimates changed from period to period. Estimates are made
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under facts and circumstances at a point in time, and changes in those facts and circumstances could produce results that differ from when those estimates were made. The most significant accounting estimates and their related application are discussed below. This analysis is included to emphasize that estimates are used in connection with the critical and other accounting policies and to illustrate the potential effect on the financial statements if the actual amount were different from the estimated amount.
– | Total Allowances for Credit Losses — The allowance for credit losses (ACL) is the sum of the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). At December 31, 2008, the ACL was $944.4 million. The amount of the ACL was determined by judgments regarding the quality of the loan portfolio and loan commitments. All known relevant internal and external factors that affected loan collectibility were considered. The ACL represents the estimate of the level of reserves appropriate to absorb inherent credit losses in the loan and lease portfolio, as well as unfunded loan commitments. We believe the process for determining the ACL considers all of the potential factors that could result in credit losses. However, the process includes judgmental and quantitative elements that may be subject to significant change. To the extent actual outcomes differ from our estimates, additional provision for credit losses could be required, which could adversely affect earnings or financial performance in future periods. |
At December 31, 2008, the ACL as a percent of total loans and leases was 2.30%. To illustrate the potential effect on the financial statements of our estimates of the ACL, a 10 basis point, or 4%, increase would have required $41.1 million in additional reserves (funded by additional provision for credit losses), which would have negatively impacted 2008 net income by approximately $26.7 million, or $0.07 per common share.
Additionally, in 2007, we established a specific reserve of $115.3 million associated with our loans to Franklin Credit Management Corporation (Franklin). At December 31, 2008, our specific ALLL for Franklin loans increased to $130.0 million, and represented approximately 20% of the remaining loans outstanding. Table 21 details our probability-of-default and recovery-after-default performance assumptions for estimating anticipated cash flows from the Franklin loans that were used to determine the appropriate amount of specific ALLL for the Franklin loans. The calculation of our specific ALLL for the Franklin portfolio is dependent, among other factors, on the assumptions provided in the table, as well as the current one-month LIBOR rate on the underlying loans to Franklin. As the one-month LIBOR rate increases, the specific ALLL for the Franklin portfolio could also increase. Our relationship with Franklin is discussed in greater detail in the “Commercial Credit” section of this report.
– | Fair Value Measurements — The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. We estimate the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, we estimate fair value. Our valuation methods consider factors such as liquidity and concentration concerns and, for the derivatives portfolio, counterparty credit risk. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded. |
Many of our assets are carried at fair value, including securities, mortgage loans held-for-sale, derivatives, mortgage servicing rights (MSRs), and trading assets. At December 31, 2008, approximately $5.1 billion of our assets were recorded at fair value. In addition to the above mentioned ongoing fair value measurements, fair value is also the unit of measure for recording business combinations.
FASB Statement No. 157,Fair Value Measurements, establishes a framework for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:
– | Level 1 — quoted prices (unadjusted) for identical assets or liabilities in active markets. | |
– | Level 2 — inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. | |
– | Level 3 — inputs that are unobservable and significant to the fair value measurement. |
At the end of each quarter, we assess the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period.
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The table below provides a description and the valuation methodologies used for financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy. The fair values measured at each level of the fair value hierarchy can be found in Note 19 of the Notes to the Consolidated Financial Statements.
Table 2 — Fair Value Measurement of Financial Instruments
Financial Instrument(1) | Hierarchy | Valuation methodology | ||
Loans held-for-sale | Level 2 | Loans held-for-sale are estimated using security prices for similar product types. | ||
Investment Securities & TradingAccount Securities(2) | Level 1 | Consist of U.S. Treasury and other federal agency securities, and money market mutual funds which generally have quoted prices. | ||
Level 2 | Consist of U.S. Government and agency mortgage-backed securities and municipal securities for which an active market is not available. Third-party pricing services provide a fair value estimate based upon trades of similar financial instruments. | |||
Level 3 | Consist of asset-backed securities and certain private label CMOs, for which we estimate the fair value. Assumptions used to determine the fair value of these securities have greater subjectivity due to the lack of observable market transactions. Generally, there are only limited trades of similar instruments and a discounted cash flow approach is used to determine fair value. | |||
Mortgage Servicing Rights (MSRs)(3) | Level 3 | MSRs do not trade in an active, open market with readily observable prices. Although sales of MSRs do occur, the precise terms and conditions typically are not readily available. Fair value is based upon the final month-end valuation, which utilizes the month-end rate curve and prepayment assumptions. | ||
Derivatives(4) | Level 1 | Consist of exchange traded options and forward commitments to deliver mortgage-backed securities which have quoted prices. | ||
Level 2 | Consist of basic asset and liability conversion swaps and options, and interest rate caps. These derivative positions are valued using internally developed models that use readily observable market parameters. | |||
Level 3 | Consist of interest rate lock agreements related to mortgage loan commitments. The determinination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. | |||
Equity Investments(5) | Level 3 | Consist of equity investments via equity funds (holding both private and publicly-traded equity securities), directly in companies as a minority interest investor, and directly in companies in conjunction with our mezzanine lending activities. These investments do not have readily observable prices. Fair value is based upon a variety of factors, including but not limited to, current operating performance and future expectations of the particular investment, industry valuations of comparable public companies, and changes in market outlook. |
(1) | Refer to Notes 1 and 19 of the Notes to the Consolidated Financial Statements for additional information. |
(2) | Refer to Note 4 of the Notes to the Consolidated Financial Statements for additional information. |
(3) | Refer to Note 6 of the Notes to the Consolidated Financial Statements for additional information. |
(4) | Refer to Note 20 of the Notes to the Consolidated Financial Statements for additional information. |
(5) | Certain equity investments are accounted for under the equity method and, therefore, are not subject to the fair value disclosure requirements. |
Alt-A mortgage-backed / Private-label collateralized mortgage obligation (CMO) securities, included within our Level 3 investment securities portfolio, represent mortgage-backed securities collateralized by first-lien residential mortgage loans. As the lowest level input that is significant to the fair value measurement in its entirety is Level 3, we classify all securities within this portfolio as Level 3. The securities are priced with the assistance of an outside third-party consultant using a discounted cash flow approach
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using the third-party’s proprietary pricing model. The model uses inputs such as estimated prepayment speeds, losses, recoveries, default rates that are implied by the underlying performance of collateral in the structure or similar structures, discount rates that are implied by market prices for similar securities, and collateral structure types and house price depreciation and appreciation that are based upon macroeconomic forecasts.
We analyzed both our Alt-A mortgage-backed and private-label CMO securities portfolios to determine if the impairment in these portfolios was other-than-temporary. We performed this analysis, with the assistance of third-party consultants with knowledge of the structures of these securities and expertise in the analysis and pricing of mortgage-backed securities, and using the guidance in FSP EITF 99-20-1, to determine whether we believed it probable that we would have a loss of principal on a security within the portfolio in the future. All securities in these portfolios remained current with respect to interest and principal at December 31, 2008.(See Note 2 of the Notes to the Consolidated Financial Statements for additional information regarding FSP EITF 99-20-1.)
For each security with any indication of impairment, we analyzed nine reasonably possible scenarios, based around the scenario that we considered most likely. To develop these nine scenarios, we analyzed the amount of principal loss that we would expect to have if the expected default rate of the loans underlying the security were 10% higher and 10% lower than the most likely default scenario, a range we believe covers the reasonably possible scenarios for these securities. We also analyzed, for each of these default scenarios, the amount of principal loss that we would expect to have if the severity of the losses that we experienced at default were both 10% higher and 10% lower than the most likely severity-of-loss scenario, a range we believe covers the reasonably possible scenarios for these securities.
For each security subject to this additional review, we analyzed all nine of these scenarios to determine whether principal loss was probable. As a result of this analysis, we believe that we will experience a loss of principal on 19 Alt-A mortgage-backed securities and one private-label CMO security. The analysis indicated future expected losses of principal on these other-than-temporarily impaired securities ranged from 0.5% to 75.2% of the par value of the securities in our most-likely scenario. The average amount of expected principal loss was 9.6% of the par value of the securities. These losses were projected to occur beginning anywhere from 25 months to as many as 151 months in the future. We measured the amount of impairment on these securities using the fair value of the security in the scenario we considered to be most likely, using discount rates ranging from 14% to 23%, depending on both the potential variability of outcomes for each security and the expected duration of cash flows for each security. As a result, we recorded $176.9 million of OTTI for our Alt-A mortgage-backed securities and $5.7 million of OTTI for our private-label CMO security.
Recognition of additional OTTI could be required for our Alt-A mortgage-backed and private-label CMO securities. To estimate potential impairment losses, we perform stress testing under which we increase probability-of-default and loss-given-default performance assumptions related to the underlying collateral mortgages. Increasing probability-of-default and loss-given-default estimates to 150% and 125%, respectively, of our current most-likely case estimates would result in: (a) the recognition of additional OTTI of $74.3 million, or $0.13 per common share, and (b) a reduction to our equity position of $17.1 million, as most of the decline in fair value would already be reflected in our equity.
Pooled-trust-preferred securities, also included within our Level 3 investment securities portfolio, represent collateralized debt obligations (CDOs) backed by a pool of debt securities issued by financial institutions. As the lowest level input that is significant to the fair value measurement in its entirety is Level 3, we classify all securities within this portfolio as Level 3. The collateral is generally trust preferred securities and subordinated debt securities issued by banks, bank holding companies, and insurance companies. The first and second-tier bank trust preferred securities, which comprise 80% of the pooled-trust-preferred securities portfolio, are priced with the assistance of an outside third-party consultant using a discounted cash flow approach, and the independent third-party’s proprietary pricing models. The model uses inputs such as estimated default and deferral rates that are implied from the underlying performance of the issuers in the structure, and discount rates that are implied by market prices for similar securities and collateral structure types. Insurance company securities, which comprise 20% of the pooled-trust-preferred securities portfolio, are priced by utilizing a third-party pricing service that determines the fair value based upon trades of similar financial instruments.
Cash flow analyses of the first and second-tier bank trust preferred securities issued by banks and bank holding companies were conducted to test for any OTTI, and in accordance with FSP EITF 99-20-1, OTTI was recorded in certain securities within these portfolios as we concluded it was probable that all cash flows would not be collected. The discount rate used to calculate the cash flows ranged from11%-15%, and was heavily impacted by an illiquidity premium due to the lack of an active market for these securities. We assumed that all issuers deferring interest payments would ultimately default, and we assumed a 10% recovery rate on such defaults. In addition, future defaults were estimated based upon an analysis of the financial strength of the issuers. As a result of this testing, we recognized OTTI of $14.5 million in the pooled-trust-preferred securities portfolio during 2008.
Recognition of additional OTTI could be required for our pooled-trust-preferred securities. Our estimates of potential OTTI are performed on a security-by-security basis. The significant variable in estimating OTTI on these securities is the probability of default by banks issuing underlying collateral securities. Tripling the default assumptions we used to evaluate these securities at December 31, 2008,
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would result in: (a) the recognition of additional OTTI of $64.3 million, or $0.11 per common share, and (b) a reduction to our equity position of only $5.1 million as most of the decline in fair value would already be reflected in our equity.
Certain other assets and liabilities which are not financial instruments also involve fair value measurements. A description of these assets and liabilities, and the methodologies utilized to determine fair value are discussed below:
Goodwill
Goodwill is tested for impairment annually, as of October 1, based upon reporting units, to determine whether any impairment exists. Goodwill is also tested for impairment on an interim basis if an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Impairment losses, if any, would be reflected in noninterest expense. For 2008, we performed interim evaluations of our goodwill balances at June 30, 2008 and December 31, 2008 as well as our annual goodwill impairment assessment as of October 1, 2008. Based on our analyses, we concluded that the fair value of our reporting units exceeded the fair value of our assets and liabilities and therefore goodwill was not considered impaired at any of those dates.
Huntington identified four reporting units: Regional Banking, Private Financial & Capital Markets Group, Insurance, and AFDS. The reporting units were identified after establishing Huntington’s operating segments. Components of the regional banking segment have been aggregated as one reporting unit based upon the similar economic and operating characteristics of the components. Although Insurance is included within the Private Financial & Capital Markets Group segment for 2008, it is evaluated as a separate reporting unit since the nature of the products and services differ from the rest of the Private Financial & Capital Markets Group segment. The AFDS unit does not have goodwill, and therefore, is not subject to goodwill impairment testing.
The first step of impairment testing required a comparison of each reporting unit’s fair value to carrying value to identify potential impairment. An independent third party was engaged to assist with the impairment assessment.
To determine the fair value of the Private Financial & Capital Markets Group and Insurance reporting units, a market approach was utilized. Revenue, earnings and market capitalization multiples of comparable public companies were selected and applied to the reporting units’ results to calculate fair value. Using this approach, the Private Financial & Capital Markets Group and Insurance reporting units passed the first step, and as a result, no further impairment testing was required and goodwill was determined to not be impaired for these reporting units.
At December 31, 2008, our goodwill totaled $3.1 billion. Of this $3.1 billion, $2.9 billion, or 95%, was allocated to Regional Banking. To determine the fair value of the Regional Banking reporting unit, both an income (discounted cash flows) and market approach were utilized. The income approach is based on discounted cash flows derived from assumptions of balance sheet and income statement activity. It also factors in costs of equity and weighted-average costs of capital to determine an appropriate discount rate. The market approach is similar to the method for the Private Financial & Capital Markets Group and Insurance units as described above. The results of the income and market approach were weighted to arrive at the final calculation of fair value. As market capitalization has declined across the banking industry, we believed that a heavier weighting on the income approach was more representative of a market participant’s view. The Regional Banking unit did not pass the first step of the impairment test, and therefore, we conducted the second step of the impairment testing. The second step required a comparison of the implied fair value of goodwill to the carrying amount of goodwill.
The aggregate fair values were compared to market capitalization as an assessment of the appropriateness of the fair value measurements. As our stock price fluctuated greatly during 2008, we used our average stock price for the 30 days preceding the valuation date to determine market capitalization. The comparison between the aggregate fair values and market capitalization indicates an implied premium. A control premium analysis indicated that the implied premium was within range of the overall premiums observed in the market place.
To determine the implied fair value of goodwill, the fair value of Regional Banking (as determined in step one) is allocated to all assets and liabilities of the reporting unit including any recognized or unrecognized intangible assets. The allocation is done as if the reporting unit had been acquired in a business combination, and the fair value of the reporting unit was the price paid to acquire the reporting unit. Key valuations were the assessment of core deposit intangibles, the mark-to-fair value of outstanding debt, and discount on the loan portfolio. The mark adjustment on our outstanding debt is based upon observable trades or modeled prices using current yield curves and market spreads. The valuation of the loan portfolio indicated discounts that we believe were consistent with transactions occurring in the marketplace.
The results of this allocation indicated the implied fair value of Regional Banking’s goodwill exceeded the carrying amount of goodwill for Regional Banking, and therefore, goodwill was not impaired.
It is possible that our assumptions and conclusions regarding the valuation of our reporting units could change adversely and could result in impairment of our goodwill. Such impairment could have a material effect on our financial position and results of operations.
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Pension
Pension plan assets consist of mutual funds and Huntington common stock. Investments are accounted for at cost on the trade date and are reported at fair value. Mutual funds are valued at quoted redemption value. Huntington common stock is traded on a national securities exchange and is valued at the last reported sales price.
The discount rate and expected return on plan assets used to determine the benefit obligation and pension expense for December 31, 2008 are both assumptions. Any deviation from these assumptions could cause actual results to change.
Other Real Estate Owned (OREO)
OREO obtained in satisfaction of a loan is recorded at its estimated fair value less anticipated selling costs based upon the property’s appraised value at the date of transfer, with any difference between the fair value of the property and the carrying value of the loan charged to the ALLL. Subsequent declines in value are reported as adjustments to the carrying amount, and are charged to noninterest expense. Gains or losses not previously recognized resulting from the sale of OREO are recognized in noninterest expense on the date of sale.
– | Income Taxes — The calculation of our provision for federal income taxes is complex and requires the use of estimates and judgments. We have two accruals for income taxes: Our income tax receivable represents the estimated amount currently due from the federal government, net of any reserve for potential audit issues, and is reported as a component of “accrued income and other assets” in our consolidated balance sheet; our deferred federal income tax asset or liability represents the estimated impact of temporary differences between how we recognize our assets and liabilities under GAAP, and how such assets and liabilities are recognized under the federal tax code. |
In the ordinary course of business, we operate in various taxing jurisdictions and are subject to income and nonincome taxes. The effective tax rate is based in part on our interpretation of the relevant current tax laws. We believe the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. We review the appropriate tax treatment of all transactions taking into consideration statutory, judicial, and regulatory guidance in the context of our tax positions. In addition, we rely on various tax opinions, recent tax audits, and historical experience.
From time to time, we engage in business transactions that may have an effect on our tax liabilities. Where appropriate, we have obtained opinions of outside experts and have assessed the relative merits and risks of the appropriate tax treatment of business transactions taking into account statutory, judicial, and regulatory guidance in the context of the tax position. However, changes to our estimates of accrued taxes can occur due to changes in tax rates, implementation of new business strategies, resolution of issues with taxing authorities regarding previously taken tax positions and newly enacted statutory, judicial, and regulatory guidance. Such changes could affect the amount of our accrued taxes and could be material to our financial positionand/or results of operations.(See Note 17 of the Notes to the Consolidated Financial Statements.)
Recent Accounting Pronouncements and Developments
Note 2 to the Consolidated Financial Statements discusses new accounting pronouncements adopted during 2008 and the expected impact of accounting pronouncements recently issued but not yet required to be adopted. To the extent the adoption of new accounting standards materially affect financial condition, results of operations, or liquidity, the impacts are discussed in the applicable section of this MD&A and the Notes to the Consolidated Financial Statements.
Acquisitions
Sky Financial Group, Inc. (Sky Financial)
The merger with Sky Financial was completed on July 1, 2007. At the time of acquisition, Sky Financial had assets of $16.8 billion, including $13.3 billion of loans, and total deposits of $12.9 billion. The impact of this acquisition was included in our consolidated results for the last six months of 2007. Additionally, in September 2007, Sky Bank and Sky Trust, National Association (Sky Trust), merged into the Bank and systems integration was completed. As a result, performance comparisons between 2008 and 2007, and 2007 and 2006, are affected.
As a result of this acquisition, we have a significant loan relationship with Franklin. This relationship is discussed in greater detail in the “Commercial Credit” section of this report.
Unizan Financial Corp. (Unizan)
The merger with Unizan was completed on March 1, 2006. At the time of acquisition, Unizan had assets of $2.5 billion, including $1.6 billion of loans and core deposits of $1.5 billion. The impact of this acquisition was included in our consolidated results for the last ten months of 2006. As a result, performance comparisons between 2007 and 2006, and 2006 and 2005, are affected.
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Impact Methodology
For both the Sky Financial and Unizan acquisitions, comparisons of the reported results are impacted as follows:
– | Increased the absolute level of reported average balance sheet, revenue, expense, and the absolute level of certain credit quality results. | |
– | Increased the absolute level of reported noninterest expense items because of costs incurred as part of merger integration activities, most notably employee retention bonuses, outside programming services related to systems conversions, occupancy expenses, and marketing expenses related to customer retention initiatives. |
Given the significant impact of the mergers on reported results, we believe that an understanding of the impacts of each merger is necessary to understand better underlying performance trends. When comparing post-merger period results to premerger periods, we use the following terms when discussing financial performance:
– | “Merger-related” refers to amounts and percentage changes representing the impact attributable to the merger. | |
– | “Merger costs” represent noninterest expenses primarily associated with merger integration activities, including severance expense for key executive personnel. | |
– | “Non-merger-related” refers to performance not attributable to the merger, and includes “merger efficiencies”, which represent noninterest expense reductions realized as a result of the merger. |
After completion of our mergers, we combine the acquired companies’ operations with ours, and do not monitor the subsequent individual results of the acquired companies. As a result, the following methodologies were implemented to estimate the approximate effect of the mergers used to determine “merger-related” impacts.
Balance Sheet Items
Sky Financial
For average loans and leases, as well as total average deposits, Sky Financial’s balances as of June 30, 2007, adjusted for purchase accounting adjustments, and transfers of loans to loans held-for-sale, were used in the comparison. To estimate the impact on 2007 average balances, it was assumed that the June 30, 2007 balances, as adjusted, remained constant over time.
Unizan
For average loans and leases, as well as core average deposits, balances as of the acquisition date were pro-rated to the post-merger period being used in the comparison. For example, to estimate the impact on 2006 first quarter average balances, one-third of the closing date balance was used as those balances were in reported results for only one month of the quarter. Quarterly estimated impacts for the 2006 second, third, and fourth quarter results were developed using this same pro-rata methodology. Full-year 2006 estimated results represent the annual average of each quarter’s estimate. This methodology assumed acquired balances remained constant over time.
Income Statement Items
Sky Financial
Sky Financial’s actual results for the first six months of 2007, adjusted for the impact of unusual items and purchase accounting adjustments, were determined. This six-month adjusted amount was multiplied by two to estimate an annual impact. This methodology does not adjust for any market-related changes, or seasonal factors in Sky Financial’s 2007 six-month results. Nor does it consider any revenue or expense synergies realized since the merger date. The one exception to this methodology of holding the estimated annual impact constant relates to the amortization of intangibles expense where the amount is known and is therefore used.
Unizan
Unizan’s actual full-year 2005 results were used for pro-rating the impact on post-merger periods. For example, to estimate the 2006 first quarter impact of the merger on personnel costs, one-twelfth of Unizan’s full-year 2005 personnel costs was used. Full quarter and year-to-date estimated impacts for subsequent periods were developed using this same pro-rata methodology. This results in an approximate impact since the methodology does not adjust for any unusual items or seasonal factors in Unizan’s 2005 reported results, or synergies realized since the merger date. The one exception to this methodology relates to the amortization of intangibles expense where the amount is known and is therefore used.
Certain tables and comments contained within our discussion and analysis provide detail of changes to reported results to quantify the estimated impact of the Sky Financial merger using this methodology.
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Table 3 — Selected Annual Income Statements(1)
Year Ended December 31, | ||||||||||||||||||||||||||||||||||||
Change from 2007 | Change from 2006 | |||||||||||||||||||||||||||||||||||
(in thousands, except per share amounts) | 2008 | Amount | Percent | 2007 | Amount | Percent | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||
Interest income | $ | 2,798,322 | $ | 55,359 | 2.0 | % | $ | 2,742,963 | $ | 672,444 | 32.5 | % | $ | 2,070,519 | $ | 1,641,765 | $ | 1,347,315 | ||||||||||||||||||
Interest expense | 1,266,631 | (174,820 | ) | (12.1 | ) | 1,441,451 | 390,109 | 37.1 | 1,051,342 | 679,354 | 435,941 | |||||||||||||||||||||||||
Net interest income | 1,531,691 | 230,179 | 17.7 | 1,301,512 | 282,335 | 27.7 | 1,019,177 | 962,411 | 911,374 | |||||||||||||||||||||||||||
Provision for credit losses | 1,057,463 | 413,835 | 64.3 | 643,628 | 578,437 | N.M. | 65,191 | 81,299 | 55,062 | |||||||||||||||||||||||||||
Net interest income after provision for credit losses | 474,228 | (183,656 | ) | (27.9 | ) | 657,884 | (296,102 | ) | (31.0 | ) | 953,986 | 881,112 | 856,312 | |||||||||||||||||||||||
Service charges on deposit accounts | 308,053 | 53,860 | 21.2 | 254,193 | 68,480 | 36.9 | 185,713 | 167,834 | 171,115 | |||||||||||||||||||||||||||
Brokerage and insurance income | 137,796 | 45,421 | 49.2 | 92,375 | 33,540 | 57.0 | 58,835 | 53,619 | 54,799 | |||||||||||||||||||||||||||
Trust services | 125,980 | 4,562 | 3.8 | 121,418 | 31,463 | 35.0 | 89,955 | 77,405 | 67,410 | |||||||||||||||||||||||||||
Electronic banking | 90,267 | 19,200 | 27.0 | 71,067 | 19,713 | 38.4 | 51,354 | 44,348 | 41,574 | |||||||||||||||||||||||||||
Bank owned life insurance income | 54,776 | 4,921 | 9.9 | 49,855 | 6,080 | 13.9 | 43,775 | 40,736 | 42,297 | |||||||||||||||||||||||||||
Automobile operating lease income | 39,851 | 32,041 | N.M. | 7,810 | (35,305 | ) | (81.9 | ) | 43,115 | 133,015 | 285,431 | |||||||||||||||||||||||||
Mortgage banking | 8,994 | (20,810 | ) | (69.8 | ) | 29,804 | (11,687 | ) | (28.2 | ) | 41,491 | 28,333 | 26,786 | |||||||||||||||||||||||
Securities (losses) gains | (197,370 | ) | (167,632 | ) | N.M. | (29,738 | ) | 43,453 | (59.4 | ) | (73,191 | ) | (8,055 | ) | 15,763 | |||||||||||||||||||||
Other | 138,791 | 58,972 | 73.9 | 79,819 | (40,203 | ) | (33.5 | ) | 120,022 | 95,047 | 113,423 | |||||||||||||||||||||||||
Total noninterest income | 707,138 | 30,535 | 4.5 | 676,603 | 115,534 | 20.6 | 561,069 | 632,282 | 818,598 | |||||||||||||||||||||||||||
Personnel costs | 783,546 | 96,718 | 14.1 | 686,828 | 145,600 | 26.9 | 541,228 | 481,658 | 485,806 | |||||||||||||||||||||||||||
Outside data processing and other services | 128,163 | 918 | 0.7 | 127,245 | 48,466 | 61.5 | 78,779 | 74,638 | 72,115 | |||||||||||||||||||||||||||
Net occupancy | 108,428 | 9,055 | 9.1 | 99,373 | 28,092 | 39.4 | 71,281 | 71,092 | 75,941 | |||||||||||||||||||||||||||
Equipment | 93,965 | 12,483 | 15.3 | 81,482 | 11,570 | 16.5 | 69,912 | 63,124 | 63,342 | |||||||||||||||||||||||||||
Amortization of intangibles | 76,894 | 31,743 | 70.3 | 45,151 | 35,189 | N.M. | 9,962 | 829 | 817 | |||||||||||||||||||||||||||
Professional services | 53,667 | 13,347 | 33.1 | 40,320 | 13,267 | 49.0 | 27,053 | 34,569 | 36,876 | |||||||||||||||||||||||||||
Marketing | 32,664 | (13,379 | ) | (29.1 | ) | 46,043 | 14,315 | 45.1 | 31,728 | 26,279 | 24,600 | |||||||||||||||||||||||||
Automobile operating lease expense | 31,282 | 26,121 | N.M. | 5,161 | (26,125 | ) | (83.5 | ) | 31,286 | 103,850 | 235,080 | |||||||||||||||||||||||||
Telecommunications | 25,008 | 506 | 2.1 | 24,502 | 5,250 | 27.3 | 19,252 | 18,648 | 19,787 | |||||||||||||||||||||||||||
Printing and supplies | 18,870 | 619 | 3.4 | 18,251 | 4,387 | 31.6 | 13,864 | 12,573 | 12,463 | |||||||||||||||||||||||||||
Other | 124,887 | (12,601 | ) | (9.2 | ) | 137,488 | 30,839 | 28.9 | 106,649 | 82,560 | 95,417 | |||||||||||||||||||||||||
Total noninterest expense | 1,477,374 | 165,530 | 12.6 | 1,311,844 | 310,850 | 31.1 | 1,000,994 | 969,820 | 1,122,244 | |||||||||||||||||||||||||||
(Loss) Income before income taxes | (296,008 | ) | (318,651 | ) | N.M. | 22,643 | (491,418 | ) | (95.6 | ) | 514,061 | 543,574 | 552,666 | |||||||||||||||||||||||
(Benefit) provision for income taxes | (182,202 | ) | (129,676 | ) | N.M. | (52,526 | ) | (105,366 | ) | N.M. | 52,840 | 131,483 | 153,741 | |||||||||||||||||||||||
Net (Loss) Income | (113,806 | ) | (188,975 | ) | N.M. | 75,169 | (386,052 | ) | (83.7 | ) | 461,221 | 412,091 | 398,925 | |||||||||||||||||||||||
Dividends on preferred shares | 46,400 | 46,400 | N.M. | — | — | — | — | — | — | |||||||||||||||||||||||||||
Net (loss) income applicable to common shares | $ | (160,206 | ) | $ | (235,375 | ) | N.M. | % | $ | 75,169 | $ | (386,052 | ) | (83.7 | )% | $ | 461,221 | $ | 412,091 | $ | 398,925 | |||||||||||||||
Average common shares — basic | 366,155 | 65,247 | 21.7 | % | 300,908 | 64,209 | 27.1 | % | 236,699 | 230,142 | 229,913 | |||||||||||||||||||||||||
Average common shares — diluted(2) | 366,155 | 62,700 | 20.7 | 303,455 | 63,535 | 26.5 | 239,920 | 233,475 | 233,856 | |||||||||||||||||||||||||||
Per common share: | ||||||||||||||||||||||||||||||||||||
Net income — basic | $ | (0.44 | ) | $ | (0.69 | ) | N.M. | % | $ | 0.25 | $ | (1.70 | ) | (87.2 | )% | $ | 1.95 | $ | 1.79 | $ | 1.74 | |||||||||||||||
Net income — diluted | (0.44 | ) | (0.69 | ) | N.M. | 0.25 | (1.67 | ) | (87.0 | ) | 1.92 | 1.77 | 1.71 | |||||||||||||||||||||||
Cash dividends declared | 0.6625 | (0.40 | ) | (37.5 | ) | 1.060 | 0.06 | 6.0 | 1.000 | 0.845 | 0.750 | |||||||||||||||||||||||||
Revenue — fully taxable equivalent (FTE) | ||||||||||||||||||||||||||||||||||||
Net interest income | $ | 1,531,691 | $ | 230,179 | 17.7 | % | $ | 1,301,512 | $ | 282,335 | 27.7 | % | $ | 1,019,177 | $ | 962,411 | $ | 911,374 | ||||||||||||||||||
FTE adjustment | 20,218 | 969 | 5.0 | 19,249 | 3,224 | 20.1 | 16,025 | 13,393 | 11,653 | |||||||||||||||||||||||||||
Net interest income(3) | 1,551,909 | 231,148 | 17.5 | 1,320,761 | 285,559 | 27.6 | 1,035,202 | 975,804 | 923,027 | |||||||||||||||||||||||||||
Noninterest income | 707,138 | 30,535 | 4.5 | 676,603 | 115,534 | 20.6 | 561,069 | 632,282 | 818,598 | |||||||||||||||||||||||||||
Total revenue(3) | $ | 2,259,047 | $ | 261,683 | 13.1 | % | $ | 1,997,364 | $ | 401,093 | 25.1 | % | $ | 1,596,271 | $ | 1,608,086 | $ | 1,741,625 | ||||||||||||||||||
N.M., not a meaningful value.
(1) | Comparisons for presented periods are impacted by a number of factors. Refer to “Significant Factors” for additional discussion regarding these key factors. |
(2) | For the year ended December 31, 2008, the impact of the convertible preferred stock issued in April of 2008 was excluded from the diluted share calculation. It was excluded because the result would have been higher than basic earnings per common share (anti-dilutive) for the year. |
(3) | On a fully taxable equivalent (FTE) basis assuming a 35% tax rate. |
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Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
DISCUSSION OF RESULTS OF OPERATIONS
This section provides a review of financial performance from a consolidated perspective. It also includes a “Significant Items” section that summarizes key issues important for a complete understanding of performance trends. Key consolidated balance sheet and income statement trends are discussed. All earnings per share data are reported on a diluted basis. For additional insight on financial performance, please read this section in conjunction with the “Lines of Business” discussion.
Summary
2008 versus 2007
We reported a net loss of $113.8 million in 2008, representing a loss per common share of $0.44. These results compared unfavorably with net income of $75.2 million, or $0.25 per common share, in 2007. Comparisons with the prior year were significantly impacted by a number of factors that are discussed later in the “Significant Items” section.
During 2008, the primary focus within our industry continued to be credit quality. The economy deteriorated substantially throughout the year in our regions, and continued to put stress on our borrowers. Our expectation is that the economy will remain under stress, and that no improvement will be seen through at least the end of 2009.
The largest setback to 2008 performance was the credit quality deterioration of the Franklin relationship that occurred in the 2008 fourth quarter resulting in a negative impact of $454.3 million, or $0.81 per common share. The loan restructuring associated with our relationship with Franklin, completed during the 2007 fourth quarter, continued to perform consistent with the terms of the restructuring agreement through the 2008 third quarter. However, cash flows that we received deteriorated significantly during the 2008 fourth quarter, reflecting a more severe than expected deterioration in the overall economy. This, and other factors discussed in the “Franklin relationship” section, resulted in a significant partial charge-off of the loans to Franklin. Although disappointing, and while we can give no further assurances, this charge represents our best estimate of the inherent loss within this credit relationship.
Non-Franklin-related net charge-offs (NCOs) and provision levels increased substantially compared with 2007. During 2008, the non-Franklin-related allowance for credit losses (ACL) as a percentage of total loans and leases increased to 2.01% compared with 1.36% at the prior year-end. Non-Franklin-related nonaccrual loans (NALs) also significantly increased to $851.9 million, compared with $319.8 million at the prior year-end, reflecting increased NALs in our commercial real estate (CRE) loans, particularly the single family home builder and retail properties segments, and within our commercial and industrial (C&I) portfolio related to businesses that support residential development. We expect to see continued levels of elevated charge-offs and provision expense during 2009.
Our year-end regulatory capital levels were strong. Our tangible equity ratio improved 264 basis points to 7.72% compared with the prior year-end, reflecting the benefits of a $0.6 billion preferred stock issuance in the 2008 second quarter and a $1.4 billion preferred stock issuance in the 2008 fourth quarter as a result of our participation in the Troubled Assets Relief Program (TARP) voluntary Capital Purchase Plan (CPP)(see “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008). However, our tangible common equity ratio declined 104 basis points compared with the prior year-end, and we believe that it is important that we begin rebuilding our common equity. To that end, we reduced our quarterly common stock dividend to $0.01 per common share, effective with the dividend declared on January 22, 2009. Our period-end liquidity position was sound, as we have conservatively managed our liquidity position at both the parent company and bank levels. At December 31, 2008, the parent company had sufficient cash for operations and does not have any debt maturities for several years. Further, the Bank has a manageable level of debt maturities during the next12-month period. In the 2008 fourth quarter, the FDIC introduced the Temporary Liquidity Guarantee Program (TLGP). One component of this program guarantees certain newly issued senior unsecured debt. In the 2009 first quarter, the Bank issued $600 million of debt as part of the TLGP.
Fully taxable net interest income in 2008 increased $231.1 million, or 18%, compared with 2007. The prior year reflected only six months of net interest income attributable to the acquisition of Sky Financial compared with twelve months for 2008. The Sky Financial acquisition added $13.3 billion of loans and $12.9 billion of deposits at July 1, 2007. There was good non-merger-related growth in total average commercial loans, partially offset by a decline in total average residential mortgages reflecting the continued slowdown in the housing market, as well as loan sales. Fully taxable net interest income in 2008 was negatively impacted by an 11 basis point decline in the net interest margin compared with 2007, primarily due to the interest accrual reversals resulting from loans being placed on nonaccrual status, as well as deposit pricing. We anticipate the net interest margin will remain under modest pressure during 2009 resulting from the absolute low-level of current interest rates and expected continued aggressive deposit pricing in our markets.
Noninterest income in 2008 increased $30.5 million, or 5%, compared with 2007. Comparisons with the prior year were affected by: (a) $153.2 million of lower noninterest income resulting from Significant Items(see “Significant Items” discussion),and (b) $137.4 million increase resulting from the Sky Financial acquisition. Considering the impact of both of these items, the remaining components of noninterest income increased $45.0 million, or 6%. The increase primarily reflects automobile operating
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lease income, and a 9% increase in brokerage and insurance income reflecting growth in annuity sales. These increases were partially offset by a 7% decline in trust services income reflecting the impact of lower market values on asset management revenues.
Expenses were well controlled, with our efficiency ratio improving to 57.0% in 2008 compared with 62.5% in 2007. Noninterest expense in 2008 increased $165.5 million, or 13%, compared with 2007. Comparisons with the prior year were affected by: (a) $62.4 million of net lower expenses resulting from Significant Items(see “Significant Items” discussion), and (b) $208.1 million increase resulting from the Sky Financial acquisition, including the impact of restructuring and merger costs. Considering the impact of both of these items, the remaining components of noninterest expense increased $20.4 million, or 1%. The increase primarily reflected increased collection and OREO expenses as the economy continues to weaken, as well as increased insurance expense and automobile operating lease expense. These increases are partially offset by a decline in personnel expense, as well as other expense categories, due to merger/restructuring efficiencies.
2007 versus 2006
We reported 2007 net income of $75.2 million and earnings per common share of $0.25. These results compared unfavorably with net income of $461.2 million and earnings per common share of $1.92 in 2006. Comparisons with the prior year were significantly impacted by: (a) our acquisition of Sky Financial, which closed on July 1, 2007, as well as the credit deterioration of the Franklin relationship that was also acquired with Sky Financial, (b) a 2006 reduction in the provision for income taxes as a result of the favorable resolution to certain federal income tax audits, and (c) balance sheet restructuring charges taken in 2006.
The credit deterioration of the Franklin relationship late in 2007 was the largest setback to 2007 performance. A negative impact of $423.6 million pretax ($275.4 million after-tax, or $0.91 per common share based upon the annual average outstanding diluted common shares) related to this relationship. Other factors negatively impacting our 2007 performance included: (a) the building of the non-Franklin-related allowance for loan losses due to continued weakness in the residential real estate development markets and (b) the volatility of the financial markets resulting in net market-related losses.
The negative factors discussed above were partially offset by the $47.5 million, or 4%, decline in non-merger-related expenses, representing the realization of most of the merger efficiencies that were targeted from the acquisition. Also, commercial loans showed good non-merger-related growth, and there was also strong non-merger-related growth in several key noninterest income activities, including deposit service charges, trust services, and electronic banking income.
Fully taxable net interest income for 2007 increased $285.6 million, or 28%, from 2006. Six months of net interest income attributable to the acquisition of Sky Financial was included in 2007. There was good non-merger-related growth in total average commercial loans. However, total average automobile loans and leases declined, as expected, due to lower consumer demand and competitive pricing. Additionally, the non-merger-related declines in total average residential mortgages, as well as the lack of growth in non-merger-related total average home equity loans, reflected the continued softness in the real estate markets, as well as loan sales. Growth in non-merger-related average total deposits was good in 2007, driven by strong growth in interest-bearing demand deposits. Our net interest margin increased seven basis points to 3.36% from 3.29% in 2006.
In addition to the Franklin credit deterioration discussed previously, credit quality generally weakened in 2007 compared with 2006. The ALLL increased to 1.44% in 2007 from 1.04% in the prior year. The ALLL coverage of NALs decreased to 181% at December 31, 2007, from 189% at December 31, 2006. Nonperforming assets (NPAs) also increased from the prior year, including the NPAs acquired from Sky Financial. The deterioration of all of these measures reflected the continued economic weakness in our Midwest markets, most notably among our borrowers in eastern Michigan and northern Ohio, and within the residential real estate development portfolio.
Significant Items
Definition of Significant Items
Certain components of the income statement are naturally subject to more volatility than others. As a result, readers of this report may view such items differently in their assessment of “underlying” or “core” earnings performance compared with their expectationsand/or any implications resulting from them on their assessment of future performance trends.
Therefore, we believe the disclosure of certain “Significant Items” affecting current and prior period results aids readers of this report in better understanding corporate performance so that they can ascertain for themselves what, if any, items they may wish to include or exclude from their analysis of performance, within the context of determining how that performance differed from their expectations, as well as how, if at all, to adjust their estimates of future performance accordingly.
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To this end, we have adopted a practice of listing as “Significant Items”, individualand/or particularly volatile items that impact the current period results by $0.01 per share or more. Such “Significant Items” generally fall within the categories discussed below:
Timing Differences
Parts of our regular business activities are naturally volatile, including capital markets income and sales of loans. While such items may generally be expected to occur within a full-year reporting period, they may vary significantly from period to period. Such items are also typically a component of an income statement line item and not, therefore, readily discernable. By specifically disclosing such items, analysts/investors can better assess how, if at all, to adjust their estimates of future performance.
Other Items
From time to time, an event or transaction might significantly impact revenues or expenses in a particular reporting period that is judged to be infrequent, short-term in nature,and/or materially outside typically expected performance. Examples would be (1) merger costs as they typically impact expenses for only a few quarters during the period of transition; including related restructuring charges and asset valuation adjustments; (2) changes in an accounting principle; (3) large and infrequent tax assessments/refunds; (4) a large gain/loss on the sale of an asset; and (5) outsized commercial loan net charge-offs related to fraud. In addition, for the periods covered by this report, the impact of the Franklin relationship is deemed to be a significant item due to its unusually large size and because it was acquired in the Sky Financial merger and thus it is not representative of our typical underwriting criteria. By disclosing such items, analysts/investors can better assess how, if at all, to adjust their estimates of future performance.
Provision for Credit Losses
While the provision for credit losses may vary significantly among periods, and often exceeds $0.01 per share, we typically exclude it from the list of “Significant Items” unless, in our view, there is a significant, specific credit (or multiple significant, specific credits) affecting comparability among periods. In determining whether any portion of the provision for credit losses should be included as a significant item, we consider, among other things, that the provision is a major income statement caption rather than a component of another caption and, therefore, the period-to-period variance can be readily determined. We also consider the additional historical volatility of the provision for credit losses.
Other Exclusions
“Significant Items” for any particular period are not intended to be a complete list of items that may significantly impact future periods. A number of factors, including those described in Huntington’s 2008 Annual Report onForm 10-K and other factors described from time to time in Huntington’s other filings with the SEC, could also significantly impact future periods.
Significant Items Influencing Financial Performance Comparisons
Earnings comparisons among the three years ended December 31, 2008, 2007, and 2006 were impacted by a number of significant items summarized below.
1. | Sky Financial Acquisition. The merger with Sky Financial was completed on July 1, 2007. The impacts of Sky Financial on the 2008 reported results compared with the 2007 reported results are as follows: |
– | Increased the absolute level of reported average balance sheet, revenue, expense, and credit quality results (e.g., NCOs). | |
– | Increased reported noninterest expense items as a result of costs incurred as part of merger integration and post- merger restructuring activities, most notably employee retention bonuses, outside programming services related to systems conversions, and marketing expenses related to customer retention initiatives. These net merger costs were $21.8 million ($0.04 per common share) in 2008 and $85.1 million ($0.18 per common share) in 2007. |
2. | Franklin Relationship. Our relationship with Franklin was acquired in the Sky Financial acquisition. The impacts of the Franklin relationship on the 2008 reported results compared with the 2007 reported results are as follows: |
– | Performance for 2008 included a $454.3 million ($0.81 per common share) negative impact. In the 2008 fourth quarter, the cash flow from Franklin’s mortgages, which represent the collateral for our loans, deteriorated significantly. This deterioration resulted in a $438.0 million provision for credit losses, $9.0 million reduction of net interest income as the loans were placed on nonaccrual status, and $7.3 million of interest-rate swap losses recorded to noninterest income. |
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– | Performance for 2007 included a $423.6 million ($0.91 per common share) negative impact. On December 28, 2007, the loans associated with Franklin were restructured, resulting in a $405.8 million provision for credit losses and a $17.9 million reduction of net interest income. |
3. | Visa® Initial Public Offering (IPO). Prior to the Visa® IPO occurring in March 2008, Visa® was owned by its member banks, which included the Bank. Impacts related to the Visa® IPO included a positive impact of $42.1 million ($0.07 per common share) in 2008, and a negative impact of $24.9 million ($0.04 per common share) in 2007. The impacts included: |
– | In 2007, we recorded a $24.9 million ($0.05 per common share) for our pro-rata portion of an indemnification charge provided to Visa® by its member banks for various litigation filed against Visa®. Subsequently, in 2008, we reversed $17.0 million ($0.03 per common share) of the $24.9 million, as an escrow account was established by Visa® using a portion of the proceeds received from the IPO. This escrow account was established for the potential settlements relating to this litigation thereby mitigating our potential liability from the indemnification. The accrual, and subsequent reversal, was recorded to noninterest expense. | |
– | In 2008, a $25.1 million gain ($0.04 per common share), was recorded in other noninterest income resulting from the proceeds of the IPO in 2008 relating to the sale of a portion of our ownership interest in Visa®. |
4. | Mortgage Servicing Rights (MSRs) and Related Hedging. Included in total net market-related losses are net losses or gains from our MSRs and the related hedging.(See “Mortgage Servicing Rights” located within the “Market Risk” section).Net income included the following net impact of MSR hedging activity(see Table 10): |
(in thousands, except per share amounts) | ||||||||||||||||||||
Per | ||||||||||||||||||||
Net interest | Noninterest | Pretax | Net | common | ||||||||||||||||
Period | income | income | (loss) income | (loss) income | share | |||||||||||||||
2008 | $ | 33,139 | $ | (63,955 | ) | $ | (30,816 | ) | $ | (20,030 | ) | $ | (0.05 | ) | ||||||
2007 | 5,797 | (24,784 | ) | (18,987 | ) | (12,342 | ) | (0.04 | ) | |||||||||||
2006 | 36 | 3,586 | (1) | 3,622 | 2,354 | 0.01 |
(1) Includes $5.1 million related to the positive impact of adopting SFAS No 156.
5. | Other Net Market-Related Gains or Losses. Other net market-related gains or losses included gains and losses related to the following market-driven activities: net securities gains and losses, gains and losses from public and private equity investments included in other noninterest income, net losses from the sale of loans included primarily in other noninterest income (except as otherwise noted), and the impact from the extinguishment of debt included in other noninterest expense. Total net market-related losses also include the net impact of MSRs and related hedging(see item 4 above). Net income included the following impact from other net market-related losses: |
(in thousands, except per share amounts) | ||||||||||||||||||||||||||||
Debt | Per | |||||||||||||||||||||||||||
Securities | Equity | Net loss on | extinguish- | Pretax | Net | common | ||||||||||||||||||||||
Period | losses | investments | loans sold | ment | (loss) income | (loss) income | share | |||||||||||||||||||||
2008 | $ | (197,370 | ) | $ | (5,892 | ) | $ | (5,131 | )(1) | $ | 23,541 | $ | (184,852 | ) | $ | (120,154 | ) | $ | (0.33 | ) | ||||||||
2007(2) | (30,486 | ) | (20,009 | ) | (34,003 | ) | 8,058 | (76,440 | ) | (49,686 | ) | (0.16 | ) | |||||||||||||||
2006 | (73,191 | ) | 7,436 | (859 | )(3) | — | (66,614 | ) | (43,299 | ) | (0.18 | ) |
(1) This amount included a $2.1 million gain reflected in mortgage banking income.
(2) $748 thousand of securities losses related to debt extinguishment, therefore, this amount is reflected as debt extinguishment in the above table.
(3) This amount is reflected entirely in mortgage banking income.
The 2008 securities losses total included OTTI adjustments of $176.9 million in our Alt-A mortgage-backed securities portfolio(see “Investment Portfolio” discussion within the “Credit Risk” section).
6. | Other Significant Items Influencing Earnings Performance Comparisons. In addition to the items discussed separately in this section, a number of other items impacted financial results. These included: |
2008
– | $12.4 million ($0.02 per common share) of asset impairment, including (a) $5.9 million venture capital loss included in other noninterest income, (b) $4.0 million charge off of a receivable included in other noninterest expense, and (c) $2.5 million write-down of leasehold improvements in our Cleveland main office included in net occupancy expense. | |
– | $7.9 million ($0.02 per common share) benefit to provision for income taxes, representing a reduction to the previously established capital loss carryforward valuation allowance as a result of the 2008 first quarter Visa® IPO. |
2007
– | $10.8 million ($0.02 per common share) pretax negative impact primarily due to increases in litigation reserves on existing cases. |
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2006
– | $84.5 million ($0.35 per common share) reduction of provision for income taxes from the release of tax reserves as a result of the resolution of the federal income tax audit for 2002 and 2003, and recognition of a federal tax loss carryback. | |
– | $10.0 million ($0.03 per common share) pretax contribution to the Huntington Foundation. | |
– | $4.8 million ($0.01 per common share) in severance and consolidation pretax expenses. This reflected fourth quarter severance-related expenses associated with a reduction of 75 Regional Banking staff positions, as well as costs associated with the retirements of a vice chairman and an executive vice president. | |
– | $3.7 million ($0.01 per common share) of Unizan pretax merger costs, primarily associated with systems conversion expenses. | |
– | $3.5 million ($0.01 per common share) pretax negative impact associated with the refinancing of Federal Home Loan Bank (FHLB) funding. | |
– | $3.3 million ($0.01 per common share) pretax gain on the sale of MasterCard® stock. | |
– | $3.2 million ($0.01 per common share) pretax negative impact associated with the write-down of equity method investments. | |
– | $2.3 million ($0.01 per common share) pretax unfavorable impact due to a cumulative adjustment to defer home equity annual fees. |
Table 4 reflects the earnings impact of the above-mentioned significant items for periods affected by this Results of Operations discussion:
Table 4 — Significant Items Influencing Earnings Performance Comparison (1)
2008 | 2007 | 2006 | ||||||||||||||||||||||
(in thousands) | After-tax | EPS | After-tax | EPS | After-tax | EPS | ||||||||||||||||||
Net income — GAAP | $ | (113,806 | ) | $ | 75,169 | $ | 461,221 | |||||||||||||||||
Earnings per share, after tax | $ | (0.44 | ) | $ | 0.25 | $ | 1.92 | |||||||||||||||||
Change from prior year — $ | (0.69 | ) | (1.67 | ) | 0.15 | |||||||||||||||||||
Change from prior year — % | N.M. | % | (87.0 | )% | 8.5 | % | ||||||||||||||||||
Significant items — favorable (unfavorable) impact: | Earnings(2) | EPS(3) | Earnings(2) | EPS(3) | Earnings(2) | EPS(3) | ||||||||||||||||||
Aggegate impact of Visa IPO | $ | 25,087 | $ | 0.04 | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Visa® anti-trust indemnification | 16,995 | 0.03 | (24,870 | ) | (0.05 | ) | — | — | ||||||||||||||||
Deferred tax valuation allowance benefit(4) | 7,892 | 0.02 | — | — | — | — | ||||||||||||||||||
Franklin Credit relationship | (454,278 | ) | (0.81 | ) | (423,645 | ) | (0.91 | ) | — | — | ||||||||||||||
Net market-related losses | (215,667 | ) | (0.38 | ) | (95,427 | ) | (0.10 | ) | (62,992 | ) | (0.17 | ) | ||||||||||||
Merger/Restructuring costs | (21,830 | ) | (0.04 | ) | (85,084 | ) | (0.18 | ) | (3,749 | ) | (0.01 | ) | ||||||||||||
Asset impairment | (12,400 | ) | (0.02 | ) | — | — | — | — | ||||||||||||||||
Litigation losses | — | — | (10,767 | ) | (0.02 | ) | — | — | ||||||||||||||||
Reduction to federal income tax expense(4) | — | — | — | — | 84,541 | 0.35 | ||||||||||||||||||
Gain on sale of MasterCard® stock | — | — | — | — | 3,341 | 0.01 | ||||||||||||||||||
Huntington Foundation contribution | — | — | — | — | (10,000 | ) | (0.03 | ) | ||||||||||||||||
Severance and consolidation expenses | — | — | — | — | (4,750 | ) | (0.01 | ) | ||||||||||||||||
FHLB refinancing | — | — | — | — | (3,530 | ) | (0.01 | ) | ||||||||||||||||
Accounting adjustment for certain equity investments | — | — | — | — | (3,240 | ) | (0.01 | ) | ||||||||||||||||
Adjustment to defer home equity annual fees | — | — | — | — | (2,254 | ) | (0.01 | ) |
N.M., not a meaningful value.
(1) | See Significant Factors Influencing Financial Performance discussion. |
(2) | Pre-tax unless otherwise noted. |
(3) | Based upon the annual average outstanding diluted common shares. |
(4) | After-tax. |
Net Interest Income / Average Balance Sheet
(This section should be read in conjunction with Significant Items 1, 2, and 4.)
Our primary source of revenue is net interest income, which is the difference between interest income from earning assets (primarily loans, direct financing leases, and securities), and interest expense of funding sources (primarily interest bearing deposits and borrowings). Earning asset balances and related funding, as well as changes in the levels of interest rates, impact net interest income. The difference between the average yield on earning assets and the average rate paid for interest-bearing liabilities is the
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net interest spread. Noninterest bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest bearing sources of funds, often referred to as “free” funds, is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Given the “free” nature of noninterest bearing sources of funds, the net interest margin is generally higher than the net interest spread. Both the net interest spread and net interest margin are presented on a fully taxable equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax equivalent income, assuming a 35% tax rate.
The table below shows changes in fully taxable equivalent interest income, interest expense, and net interest income due to volume and rate variances for major categories of earning assets and interest bearing liabilities.
Table 5 — Change in Net Interest Income Due to Changes in Average Volume and Interest Rates(1)
2008 | 2007 | |||||||||||||||||||||||
Increase (Decrease) From | Increase (Decrease) From | |||||||||||||||||||||||
Previous Year Due To | Previous Year Due To | |||||||||||||||||||||||
Fully-taxable equivalent basis(2) | Yield/ | Yield/ | ||||||||||||||||||||||
(in millions) | Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
Loans and direct financing leases | $ | 504.7 | $ | (449.6 | ) | $ | 55.1 | $ | 519.8 | $ | 97.8 | $ | 617.6 | |||||||||||
Securities | 17.0 | (16.2 | ) | 0.8 | (27.7 | ) | 23.2 | (4.5 | ) | |||||||||||||||
Other earning assets | 19.1 | (18.7 | ) | 0.4 | 60.2 | 2.4 | 62.6 | |||||||||||||||||
Total interest income from earning assets | 540.8 | (484.5 | ) | 56.3 | 552.3 | 123.4 | 675.7 | |||||||||||||||||
Deposits | 206.8 | (301.5 | ) | (94.7) | 224.0 | 85.2 | 309.2 | |||||||||||||||||
Short-term borrowings | 5.1 | (55.6 | ) | (50.5) | 18.3 | 2.3 | 20.6 | |||||||||||||||||
Federal Home Loan Bank advances | 49.3 | (44.1 | ) | 5.2 | 32.2 | 10.4 | 42.6 | |||||||||||||||||
Subordinated notes and other long-term debt, including capital securities | 22.3 | (57.1 | ) | (34.8) | 6.6 | 11.1 | 17.7 | |||||||||||||||||
Total interest expense of interest-bearing liabilities | 283.5 | (458.3 | ) | (174.8) | 281.1 | 109.0 | 390.1 | |||||||||||||||||
Net interest income | $ | 257.3 | $ | (26.2 | ) | $ | 231.1 | $ | 271.2 | $ | 14.4 | $ | 285.6 | |||||||||||
(1) The change in interest rates due to both rate and volume has been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.
(2) | Calculated assuming a 35% tax rate. |
2008 versus 2007
Fully taxable equivalent net interest income for 2008 increased $231.1 million, or 18%, from 2007. This reflected the favorable impact of a $8.4 billion, or 21%, increase in average earning assets, of which $7.8 billion represented an increase in average loans and leases, partially offset by a decrease in the fully-taxable net interest margin of 11 basis points to 3.25%. The increase to average earning assets, and to average loans and leases, reflected the Sky Financial acquisition.
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The following table details the estimated merger-related impacts on our reported loans and deposits:
Table 6 — Average Loans/Leases and Deposits — Estimated Merger-Related Impacts — 2008 vs. 2007
Change Attributable to: | ||||||||||||||||||||||||||||
Twelve Months Ended | ||||||||||||||||||||||||||||
December 31, | Change | Non-merger-related | ||||||||||||||||||||||||||
Merger- | ||||||||||||||||||||||||||||
(in millions) | 2008 | 2007 | Amount | Percent | Related | Amount | Percent(1) | |||||||||||||||||||||
Loans/Leases | ||||||||||||||||||||||||||||
Commercial and industrial | $ | 13,588 | $ | 10,636 | $ | 2,952 | 27.8 | % | $ | 2,388 | $ | 564 | 4.3 | % | ||||||||||||||
Commerical real estate | 9,732 | 6,807 | 2,925 | 43.0 | 1,986 | 939 | 10.7 | |||||||||||||||||||||
Total commercial | $ | 23,320 | $ | 17,443 | $ | 5,877 | 33.7 | % | $ | 4,374 | $ | 1,503 | 6.9 | % | ||||||||||||||
Automobile loans and leases | 4,527 | 4,118 | 409 | 9.9 | 216 | 193 | 4.5 | |||||||||||||||||||||
Home equity | 7,404 | 6,173 | 1,231 | 19.9 | 1,193 | 38 | 0.5 | |||||||||||||||||||||
Residential mortgage | 5,018 | 4,939 | 79 | 1.6 | 556 | (477 | ) | (8.7 | ) | |||||||||||||||||||
Other consumer | 691 | 529 | 162 | 30.6 | 72 | 90 | 15.0 | |||||||||||||||||||||
Total consumer | 17,640 | 15,759 | 1,881 | 11.9 | 2,037 | (156 | ) | (0.9 | ) | |||||||||||||||||||
Total loans and leases | $ | 40,960 | $ | 33,202 | $ | 7,758 | 23.4 | % | $ | 6,411 | $ | 1,347 | 3.4 | % | ||||||||||||||
Deposits | ||||||||||||||||||||||||||||
Demand deposits — noninterest bearing | $ | 5,095 | $ | 4,438 | $ | 657 | 14.8 | % | $ | 915 | $ | (258 | ) | (4.8 | )% | |||||||||||||
Demand deposits — interest bearing | 4,003 | 3,129 | 874 | 27.9 | 730 | 144 | 3.7 | |||||||||||||||||||||
Money market deposits | 6,093 | 6,173 | (80 | ) | (1.3 | ) | 498 | (578 | ) | (8.7 | ) | |||||||||||||||||
Savings and other domestic time deposits | 4,949 | 4,001 | 948 | 23.7 | 1,297 | (349 | ) | (6.6 | ) | |||||||||||||||||||
Core certificates of deposit | 11,527 | 8,057 | 3,470 | 43.1 | 2,315 | 1,155 | 11.1 | |||||||||||||||||||||
Total core deposits | 31,667 | 25,798 | 5,869 | 22.7 | 5,755 | 114 | 0.4 | |||||||||||||||||||||
Other deposits | 6,169 | 5,268 | 901 | 17.1 | 672 | 229 | 3.9 | |||||||||||||||||||||
Total deposits | $ | 37,836 | $ | 31,066 | $ | 6,770 | 21.8 | % | $ | 6,427 | $ | 343 | 0.9 | % | ||||||||||||||
(1) Calculated as non-merger related / (prior period + merger-related)
The $1.3 billion, or 3%, non-merger-related increase in average total loans and leases primarily reflected:
– | $1.5 billion, or 7%, growth in average total commercial loans, with growth reflected in both the C&I and CRE portfolios. The growth in CRE loans was primarily to existing borrowers with a focus on traditional income producing property types and was not related to the single family home builder segment. The growth in C&I loans reflected a combination of draws associated with existing commitments, new loans to existing borrowers, and some originations to new high quality borrowers. |
Partially offset by:
– | $0.2 billion, or 1%, decline in total average consumer loans reflecting a $0.5 billion, or 9%, decline in residential mortgages due to loan sales, as well as the continued slowdown in the housing markets. This decrease was partially offset by a $0.2 billion, or 4%, increase in average automobile loans and leases reflecting higher automobile loan originations, although automobile loan origination volumes have declined throughout 2008 due to the industry wide decline in sales. Automobile lease origination volumes have also declined throughout 2008. During the 2008 fourth quarter, we exited the automobile leasing business. |
Average other earning assets increased $0.6 billion, primarily reflecting the increase in average trading account securities. The increase in these assets reflected a change in our strategy to use trading account securities to hedge the change in fair value of our MSRs, however, the practice of hedging the change in fair value of our MSRs using on-balance sheet trading assets ceased at the end of 2008.
The $0.3 billion, or 1%, increase in average total deposits reflected growth in other deposits. These deposits were primarily other domestic time deposits of $100,000 or more reflecting increases in commercial and public fund deposits. Changes from the prior year also reflected customers transferring funds from lower rate to higher rate accounts such as certificates of deposit as short-term rates had fallen.
2007 versus 2006
Fully taxable equivalent net interest income for 2007 increased $285.6 million, or 28%, from 2006. This reflected the favorable impact of a $7.9 billion, or 25%, increase in average earning assets, of which $7.3 billion represented an increase in average loans and leases, as well as the benefit of an increase in the fully-taxable net interest margin of seven basis points to 3.36%. The increase to average earning assets, and to average loans and leases, was primarily merger-related.
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The following table details the estimated merger-related impacts on our reported loans and deposits:
Table 7 — Average Loans/Leases and Deposits — Estimated Merger-Related Impacts
Twelve Months Ended | ||||||||||||||||||||||||||||
December 31, | Change | Non-merger-related | ||||||||||||||||||||||||||
Merger- | ||||||||||||||||||||||||||||
(in millions) | 2007 | 2006 | Amount | Percent | Related | Amount | Percent(1) | |||||||||||||||||||||
Loans/Leases | ||||||||||||||||||||||||||||
Commercial and industrial | $ | 10,636 | $ | 7,323 | $ | 3,313 | 45.2 | % | $ | 2,388 | $ | 925 | 9.5 | % | ||||||||||||||
Commercial real estate | 6,807 | 4,542 | 2,265 | 49.9 | 1,986 | 279 | 4.3 | |||||||||||||||||||||
Total commercial | 17,443 | 11,865 | 5,578 | 47.0 | 4,374 | 1,204 | 7.4 | |||||||||||||||||||||
Automobile loans and leases | 4,118 | 4,088 | 30 | 0.7 | 216 | (186 | ) | (4.3 | ) | |||||||||||||||||||
Home equity | 6,173 | 4,970 | 1,203 | 24.2 | 1,193 | 10 | 0.2 | |||||||||||||||||||||
Residential mortgage | 4,939 | 4,581 | 358 | 7.8 | 556 | (198 | ) | (3.9 | ) | |||||||||||||||||||
Other consumer | 529 | 439 | 90 | 20.5 | 72 | 18 | 3.5 | |||||||||||||||||||||
Total consumer | 15,759 | 14,078 | 1,681 | 11.9 | 2,037 | (356 | ) | (2.2 | ) | |||||||||||||||||||
Total loans and leases | $ | 33,202 | $ | 25,943 | $ | 7,259 | 28.0 | % | $ | 6,411 | $ | 848 | 2.6 | % | ||||||||||||||
Deposits | ||||||||||||||||||||||||||||
Demand deposits — noninterest bearing | $ | 4,438 | $ | 3,530 | $ | 908 | 25.7 | % | $ | 915 | $ | (7 | ) | (0.2 | )% | |||||||||||||
Demand deposits — interest bearing | 3,129 | 2,138 | 991 | 46.4 | 730 | 261 | 9.1 | |||||||||||||||||||||
Money market deposits | 6,173 | 5,604 | 569 | 10.2 | 498 | 71 | 1.2 | |||||||||||||||||||||
Savings and other domestic time deposits | 4,001 | 3,060 | 941 | 30.8 | 1,297 | (356 | ) | (8.2 | ) | |||||||||||||||||||
Core certificates of deposit | 8,057 | 5,050 | 3,007 | 59.5 | 2,315 | 692 | 9.4 | |||||||||||||||||||||
Total core deposits | 25,798 | 19,382 | 6,416 | 33.1 | 5,755 | 661 | 2.6 | |||||||||||||||||||||
Other deposits | 5,268 | 4,802 | 466 | 9.7 | 672 | (206 | ) | (3.8 | ) | |||||||||||||||||||
Total deposits | $ | 31,066 | $ | 24,184 | $ | 6,882 | 28.5 | % | $ | 6,427 | $ | 455 | 1.5 | % | ||||||||||||||
(1) | Calculated as non-merger related / (prior period + merger-related) |
The $0.8 billion, or 3%, non-merger-related increase in total average loans compared with the prior year primarily reflected a $1.2 billion, or 7%, increase in average total commercial loans. This increase was the result of strong growth in both C&I loans and CRE loans across substantially all regions. This was partially offset by a $0.4 billion, or 2%, decrease in average total consumer loans reflecting declines in automobile loans and leases and residential mortgages. These declines reflect weaker demand, a softer economy, as well as the continued impact of competitive pricing. In addition to these factors, loan sales contributed to the decline in residential mortgages.
Average other earning assets increased $0.6 billion, primarily reflecting the increase in average trading account securities. The increase in these assets reflected a change in our strategy to use trading account securities to hedge the change in fair value of our MSRs.
The $0.5 billion, or 1%, increase in total non-merger-related average deposits primarily reflected a $0.7 billion, or 3%, increase in average total core deposits as interest bearing demand deposits grew $0.3 billion, or 9%. While there was also strong growth in core certificates of deposit, this was partially offset by the decline in savings and other domestic deposits, as customers transferred funds from lower rate to higher rate accounts. In 2007, we reduced our dependence on noncore funds (total liabilities less core deposits and accrued expenses and other liabilities) to 30% of total assets, down from 33% in 2006.
Table 8 shows average annual balance sheets and fully taxable equivalent net interest margin analysis for the last five years. It details average balances for total assets and liabilities, as well as shareholders’ equity, and their various components, most notably loans and leases, deposits, and borrowings. It also shows the corresponding interest income or interest expense associated with each earning asset and interest bearing liability category along with the average rate with the difference resulting in the net interest spread. The net interest spread plus the positive impact from the noninterest bearing funds represents the net interest margin.
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Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Table 8 — Consolidated Average Balance Sheet and Net Interest Margin Analysis
Average Balances | ||||||||||||||||||||||||||||||||||||
Change from | ||||||||||||||||||||||||||||||||||||
Change from 2007 | 2006 | |||||||||||||||||||||||||||||||||||
Fully-taxable equivalent basis(1) | ||||||||||||||||||||||||||||||||||||
(in millions) | 2008 | Amount | Percent | 2007 | Amount | Percent | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||||||
Interest bearing deposits in banks | $ | 303 | $ | 43 | 16.5 | % | $ | 260 | $ | 207 | N.M. | % | $ | 53 | $ | 53 | $ | 66 | ||||||||||||||||||
Trading account securities | 1,090 | 448 | 69.8 | 642 | 550 | N.M. | 92 | 207 | 105 | |||||||||||||||||||||||||||
Federal funds sold and securities purchased under resale agreement | 435 | (156 | ) | (26.4 | ) | 591 | 270 | 84.1 | 321 | 262 | 319 | |||||||||||||||||||||||||
Loans held for sale | 416 | 54 | 14.9 | 362 | 87 | 31.6 | 275 | 318 | 243 | |||||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||||||||||
Taxable | 3,878 | 225 | 6.2 | 3,653 | (544 | ) | (13.0 | ) | 4,197 | 3,683 | 4,425 | |||||||||||||||||||||||||
Tax-exempt | 705 | 59 | 9.1 | 646 | 76 | 13.3 | 570 | 475 | 412 | |||||||||||||||||||||||||||
Total investment securities | 4,583 | 284 | 6.6 | 4,299 | (468 | ) | (9.8 | ) | 4,767 | 4,158 | 4,837 | |||||||||||||||||||||||||
Loans and leases:(3) Commercial: | ||||||||||||||||||||||||||||||||||||
Commercial and industrial | 13,588 | 2,953 | 27.8 | 10,636 | 3,308 | 45.1 | 7,327 | 6,171 | 5,466 | |||||||||||||||||||||||||||
Construction | 2,061 | 527 | 34.4 | 1,533 | 275 | 21.8 | 1,259 | 1,738 | 1,468 | |||||||||||||||||||||||||||
Commercial | 7,671 | 2,397 | 45.4 | 5,274 | 1,995 | 60.8 | 3,279 | 2,718 | 2,867 | |||||||||||||||||||||||||||
Commercial real estate | 9,732 | 2,924 | 42.9 | 6,807 | 2,270 | 50.0 | 4,538 | 4,456 | 4,335 | |||||||||||||||||||||||||||
Total commercial | 23,320 | 5,877 | 33.7 | 17,443 | 5,578 | 47.0 | 11,865 | 10,627 | 9,801 | |||||||||||||||||||||||||||
Consumer: | ||||||||||||||||||||||||||||||||||||
Automobile loans | 3,676 | 1,043 | 39.6 | 2,633 | 576 | 28.0 | 2,057 | 2,043 | 2,285 | |||||||||||||||||||||||||||
Automobile leases | 851 | (634 | ) | (42.7 | ) | 1,485 | (546 | ) | (26.9 | ) | 2,031 | 2,422 | 2,192 | |||||||||||||||||||||||
Automobile loans and leases | 4,527 | 409 | 9.9 | 4,118 | 30 | 0.7 | 4,088 | 4,465 | 4,477 | |||||||||||||||||||||||||||
Home equity | 7,404 | 1,231 | 19.9 | 6,173 | 1,203 | 24.2 | 4,970 | 4,752 | 4,244 | |||||||||||||||||||||||||||
Residential mortgage | 5,018 | 79 | 1.6 | 4,939 | 358 | 7.8 | 4,581 | 4,081 | 3,212 | |||||||||||||||||||||||||||
Other loans | 691 | 162 | 30.6 | 529 | 90 | 20.5 | 439 | 385 | 393 | |||||||||||||||||||||||||||
Total consumer | 17,640 | 1,881 | 11.9 | 15,759 | 1,681 | 11.9 | 14,078 | 13,683 | 12,326 | |||||||||||||||||||||||||||
Total loans and leases | 40,960 | 7,758 | 23.4 | 33,202 | 7,259 | 28.0 | 25,943 | 24,310 | 22,127 | |||||||||||||||||||||||||||
Allowance for loan and lease losses | (695 | ) | (313 | ) | 81.9 | (382 | ) | (95 | ) | 33.1 | (287 | ) | (268 | ) | (298 | ) | ||||||||||||||||||||
Net loans and leases | 40,265 | 7,445 | 22.7 | 32,820 | 7,164 | 27.9 | 25,656 | 24,042 | 21,829 | |||||||||||||||||||||||||||
Total earning assets | 47,787 | 8,431 | 21.4 | 39,356 | 7,905 | 25.1 | 31,451 | 29,308 | 27,697 | |||||||||||||||||||||||||||
Automobile operating lease assets | 180 | 163 | N.M. | 17 | (76 | ) | (81.7 | ) | 93 | 351 | 891 | |||||||||||||||||||||||||
Cash and due from banks | 958 | 28 | 3.0 | 930 | 105 | 12.7 | 825 | 845 | 843 | |||||||||||||||||||||||||||
Intangible assets | 3,446 | 1,427 | 70.7 | 2,019 | 1,452 | N.M. | 567 | 218 | 216 | |||||||||||||||||||||||||||
All other assets | 3,245 | 473 | 17.1 | 2,772 | 309 | 12.5 | 2,462 | 2,185 | 2,084 | |||||||||||||||||||||||||||
Total Assets | $ | 54,921 | $ | 10,209 | 22.8 | % | $ | 44,712 | $ | 9,600 | 27.3 | % | $ | 35,111 | $ | 32,639 | $ | 31,433 | ||||||||||||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||||||||||||
Demand deposits — noninterest bearing | $ | 5,095 | $ | 657 | 14.8 | % | $ | 4,438 | $ | 908 | 25.7 | % | $ | 3,530 | $ | 3,379 | $ | 3,230 | ||||||||||||||||||
Demand deposits — interest bearing | 4,003 | 874 | 27.9 | 3,129 | 991 | 46.4 | 2,138 | 1,920 | 1,953 | |||||||||||||||||||||||||||
Money market deposits | 6,093 | (80 | ) | (1.3 | ) | 6,173 | 569 | 10.2 | 5,604 | 5,738 | 5,254 | |||||||||||||||||||||||||
Savings and other domestic time deposits | 4,949 | 948 | 23.7 | 4,001 | 941 | 30.8 | 3,060 | 3,206 | 3,434 | |||||||||||||||||||||||||||
Core certificates of deposit | 11,527 | 3,470 | 43.1 | 8,057 | 3,007 | 59.5 | 5,050 | 3,334 | 2,689 | |||||||||||||||||||||||||||
Total core deposits | 31,667 | 5,869 | 22.7 | 25,798 | 6,416 | 33.1 | 19,382 | 17,577 | 16,560 | |||||||||||||||||||||||||||
Other domestic time deposits of $100,000 or more | 1,951 | 563 | 40.6 | 1,388 | 343 | 32.8 | 1,045 | 859 | 590 | |||||||||||||||||||||||||||
Brokered time deposits and negotiable CDs | 3,243 | 4 | 0.1 | 3,239 | (3 | ) | (0.1 | ) | 3,242 | 3,119 | 1,837 | |||||||||||||||||||||||||
Deposits in foreign offices | 975 | 334 | 52.1 | 641 | 126 | 24.5 | 515 | 457 | 508 | |||||||||||||||||||||||||||
Total deposits | 37,836 | 6,770 | 21.8 | 31,066 | 6,882 | 28.5 | 24,184 | 22,012 | 19,495 | |||||||||||||||||||||||||||
Short-term borrowings | 2,374 | 129 | 5.7 | 2,245 | 445 | 24.7 | 1,800 | 1,379 | 1,410 | |||||||||||||||||||||||||||
Federal Home Loan Bank advances | 3,281 | 1,254 | 61.9 | 2,027 | 658 | 48.1 | 1,369 | 1,105 | 1,271 | |||||||||||||||||||||||||||
Subordinated notes and other long-term debt | 4,094 | 406 | 11.0 | 3,688 | 114 | 3.2 | 3,574 | 4,064 | 5,379 | |||||||||||||||||||||||||||
Total interest bearing liabilities | 42,490 | 7,902 | 22.8 | 34,588 | 7,191 | 26.2 | 27,397 | 25,181 | 24,325 | |||||||||||||||||||||||||||
All other liabilities | 942 | (112 | ) | (10.6 | ) | 1,054 | (185 | ) | (14.9 | ) | 1,239 | 1,496 | 1,504 | |||||||||||||||||||||||
Shareholders’ equity | 6,394 | 1,762 | 38.0 | 4,632 | 1,686 | 57.2 | 2,945 | 2,583 | 2,374 | |||||||||||||||||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 54,921 | $ | 10,209 | 22.8 | % | $ | 44,712 | $ | 9,600 | 27.3 | % | $ | 35,111 | $ | 32,639 | $ | 31,433 | ||||||||||||||||||
Net interest income | ||||||||||||||||||||||||||||||||||||
Net interest rate spread | ||||||||||||||||||||||||||||||||||||
Impact of noninterest bearing funds on margin | ||||||||||||||||||||||||||||||||||||
Net Interest Margin | ||||||||||||||||||||||||||||||||||||
N.M., not a meaningful value.
(1) | Fully-taxable equivalent (FTE) yields are calculated assuming a 35% tax rate. |
(2) | Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees. |
(3) | For purposes of this analysis, non-accrual loans are reflected in the average balances of loans. |
30
Table of Contents
Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Interest Income/Expense | Average Rate(2) | |||||||||||||||||||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||
$ | 7.7 | $ | 12.5 | $ | 3.2 | $ | 1.1 | $ | 0.7 | 2.53 | % | 4.80 | % | 6.00 | % | 2.16 | % | 1.05 | % | |||||||||||||||||||
57.5 | 37.5 | 3.8 | 8.5 | 4.4 | 5.28 | 5.84 | 4.19 | 4.08 | 4.15 | |||||||||||||||||||||||||||||
10.7 | 29.9 | 16.1 | 6.0 | 5.5 | 2.46 | 5.05 | 5.00 | 2.27 | 1.73 | |||||||||||||||||||||||||||||
25.0 | 20.6 | 16.8 | 17.9 | 13.0 | 6.01 | 5.69 | 6.10 | 5.64 | 5.35 | |||||||||||||||||||||||||||||
217.9 | 221.9 | 229.4 | 158.7 | 171.7 | 5.62 | 6.07 | 5.47 | 4.31 | 3.88 | |||||||||||||||||||||||||||||
48.2 | 43.4 | 38.5 | 31.9 | 28.8 | 6.83 | 6.72 | 6.75 | 6.71 | 6.98 | |||||||||||||||||||||||||||||
266.1 | 265.3 | 267.9 | 190.6 | 200.5 | 5.81 | 6.17 | 5.62 | 4.58 | 4.14 | |||||||||||||||||||||||||||||
770.2 | 791.0 | 536.3 | 362.9 | 250.6 | 5.67 | 7.44 | 7.32 | 5.88 | 4.58 | |||||||||||||||||||||||||||||
104.2 | 119.4 | 101.5 | 111.7 | 66.9 | 5.05 | 7.80 | 8.07 | 6.42 | 4.55 | |||||||||||||||||||||||||||||
430.1 | 395.8 | 244.3 | 162.9 | 141.5 | 5.61 | 7.50 | 7.45 | 5.99 | 4.95 | |||||||||||||||||||||||||||||
534.3 | 515.2 | 345.8 | 274.6 | 208.4 | 5.49 | 7.57 | 7.61 | 6.16 | 4.81 | |||||||||||||||||||||||||||||
1,304.5 | 1,306.2 | 882.1 | 637.5 | 459.0 | 5.59 | 7.49 | 7.43 | 6.00 | 4.68 | |||||||||||||||||||||||||||||
263.4 | 188.7 | 135.1 | 133.3 | 165.1 | 7.17 | 7.17 | 6.57 | 6.52 | 7.22 | |||||||||||||||||||||||||||||
48.1 | 80.3 | 102.9 | 119.6 | 109.6 | 5.65 | 5.41 | 5.07 | 4.94 | 5.00 | |||||||||||||||||||||||||||||
311.5 | 269.0 | 238.0 | 252.9 | 274.7 | 6.88 | 6.53 | 5.82 | 5.66 | 6.14 | |||||||||||||||||||||||||||||
475.2 | 479.8 | 369.7 | 288.6 | 208.6 | 6.42 | 7.77 | 7.44 | 6.07 | 4.92 | |||||||||||||||||||||||||||||
292.4 | 285.9 | 249.1 | 212.9 | 163.0 | 5.83 | 5.79 | 5.44 | 5.22 | 5.07 | |||||||||||||||||||||||||||||
68.0 | 55.5 | 39.8 | 39.2 | 29.5 | 9.85 | 10.51 | 9.07 | 10.23 | 7.51 | |||||||||||||||||||||||||||||
1,147.1 | 1,090.2 | 896.6 | 793.6 | 675.8 | 6.50 | 6.92 | 6.37 | 5.80 | 5.48 | |||||||||||||||||||||||||||||
2,451.6 | 2,396.4 | 1,778.7 | 1,431.1 | 1,134.8 | 5.99 | 7.22 | 6.86 | 5.89 | 5.13 | |||||||||||||||||||||||||||||
�� | ||||||||||||||||||||||||||||||||||||||
2,818.6 | 2,762.2 | 2,086.5 | 1,655.2 | 1,358.9 | 5.90 | 7.02 | 6.63 | 5.65 | 4.89 | |||||||||||||||||||||||||||||
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||
22.2 | 40.3 | 19.3 | 10.6 | 8.3 | 0.55 | 1.29 | 0.90 | 0.55 | 0.42 | |||||||||||||||||||||||||||||
117.5 | 232.5 | 193.1 | 124.9 | 65.8 | 1.93 | 3.77 | 3.45 | 2.18 | 1.25 | |||||||||||||||||||||||||||||
92.9 | 96.1 | 53.5 | 45.2 | 44.2 | 1.88 | 2.40 | 1.75 | 1.41 | 1.29 | |||||||||||||||||||||||||||||
491.6 | 391.1 | 214.8 | 118.7 | 90.4 | 4.27 | 4.85 | 4.25 | 3.56 | 3.36 | |||||||||||||||||||||||||||||
724.2 | 760.0 | 480.7 | 299.4 | 208.7 | 2.73 | 3.55 | 3.02 | 2.10 | 1.56 | |||||||||||||||||||||||||||||
73.6 | 70.5 | 52.3 | 28.5 | 11.2 | 3.76 | 5.08 | 5.00 | 3.32 | 1.88 | |||||||||||||||||||||||||||||
118.8 | 175.4 | 169.1 | 109.4 | 33.1 | 3.66 | 5.41 | 5.22 | 3.51 | 1.80 | |||||||||||||||||||||||||||||
15.2 | 20.5 | 15.1 | 9.6 | 4.1 | 1.56 | 3.19 | 2.93 | 2.10 | 0.82 | |||||||||||||||||||||||||||||
931.8 | 1,026.4 | 717.2 | 446.9 | 257.1 | 2.85 | 3.85 | 3.47 | 2.40 | 1.58 | |||||||||||||||||||||||||||||
42.3 | 92.8 | 72.2 | 34.3 | 13.0 | 1.78 | 4.13 | 4.01 | 2.49 | 0.93 | |||||||||||||||||||||||||||||
107.8 | 102.6 | 60.0 | 34.7 | 33.3 | 3.29 | 5.06 | 4.38 | 3.13 | 2.62 | |||||||||||||||||||||||||||||
184.8 | 219.6 | 201.9 | 163.5 | 132.5 | 4.51 | 5.96 | 5.65 | 4.02 | 2.46 | |||||||||||||||||||||||||||||
1,266.7 | 1,441.4 | 1,051.3 | 679.4 | 435.9 | 2.98 | 4.17 | 3.84 | 2.70 | 1.79 | |||||||||||||||||||||||||||||
$ | 1,551.9 | $ | 1,320.8 | $ | 1,035.2 | $ | 975.8 | $ | 923.0 | |||||||||||||||||||||||||||||
2.92 | 2.85 | 2.79 | 2.95 | 3.10 | ||||||||||||||||||||||||||||||||||
0.33 | 0.51 | 0.50 | 0.38 | 0.23 | ||||||||||||||||||||||||||||||||||
3.25 | % | 3.36 | % | 3.29 | % | 3.33 | % | 3.33 | % | |||||||||||||||||||||||||||||
31
Table of Contents
Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Provision for Credit Losses
(This section should be read in conjunction with Significant Item 1, 2, and the Credit Risk section.)
The provision for credit losses is the expense necessary to maintain the ALLL and the allowance for AULC at levels adequate to absorb our estimate of probable inherent credit losses in the loan and lease portfolio and the portfolio of unfunded loan commitments and letters of credit.
The provision for credit losses in 2008 was $1,057.5 million, up $413.8 million from 2007, and exceeded NCOs by $299.4 million. The $413.8 million increase reflects $32.2 million of higher provision related to Franklin ($438.0 million in 2008 compared with $405.8 million in 2007). The remaining increase in 2008 from 2007 primarily reflected the continued economic weakness across all our regions and within the single family home builder segment of our CRE portfolio.
The provision for credit losses in 2007 was $643.6 million, up from $65.2 million in 2006, primarily reflecting a $405.8 million increase in the 2007 fourth-quarter provision related to Franklin. The remainder of the increase reflected the continued weakness across all our regions, most notably among our borrowers in eastern Michigan and northern Ohio, and within the single family home builder segment of our CRE portfolio.
Noninterest Income
(This section should be read in conjunction with Significant Items 1, 2, 3, 4, 5, and 6.)
Table 9 reflects noninterest income for the three years ended December 31, 2008:
Table 9 — Noninterest Income
Twelve Months Ended December 31, | ||||||||||||||||||||||||||||
Change from 2007 | Change from 2006 | |||||||||||||||||||||||||||
(in thousands) | 2008 | Amount | Percent | 2007 | Amount | Percent | 2006 | |||||||||||||||||||||
Service charges on deposit accounts | $ | 308,053 | $ | 53,860 | 21.2 | % | $ | 254,193 | $ | 68,480 | 36.9 | % | $ | 185,713 | ||||||||||||||
Brokerage and insurance income | 137,796 | 45,421 | 49.2 | 92,375 | 33,540 | 57.0 | 58,835 | |||||||||||||||||||||
Trust services | 125,980 | 4,562 | 3.8 | 121,418 | 31,463 | 35.0 | 89,955 | |||||||||||||||||||||
Electronic banking | 90,267 | 19,200 | 27.0 | 71,067 | 19,713 | 38.4 | 51,354 | |||||||||||||||||||||
Bank owned life insurance income | 54,776 | 4,921 | 9.9 | 49,855 | 6,080 | 13.9 | 43,775 | |||||||||||||||||||||
Mortgage banking | 8,994 | (20,810 | ) | (69.8 | ) | 29,804 | (11,687 | ) | (28.2 | ) | 41,491 | |||||||||||||||||
Securities losses | (197,370 | ) | (167,632 | ) | N.M. | (29,738 | ) | 43,453 | (59.4 | ) | (73,191 | ) | ||||||||||||||||
Other income | 138,791 | 58,972 | 73.9 | 79,819 | (40,203 | ) | (33.5 | ) | 120,022 | |||||||||||||||||||
Sub-total | 667,287 | (1,506 | ) | (0.2 | ) | 668,793 | 150,839 | 29.1 | 517,954 | |||||||||||||||||||
Automobile operating lease income | 39,851 | 32,041 | N.M. | 7,810 | (35,305 | ) | (81.9 | ) | 43,115 | |||||||||||||||||||
Total noninterest income | $ | 707,138 | $ | 30,535 | 4.5 | % | $ | 676,603 | $ | 115,534 | 20.6 | % | $ | 561,069 | ||||||||||||||
N.M., not a meaningful value.
32
Table of Contents
Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Table 10 details mortgage banking income and the net impact of MSR hedging activity for the three years ended December 31, 2008:
Table 10 — Mortgage Banking Income
Twelve Months Ended December 31, | ||||||||||||||||||||||||||||
Change from 2007 | Change from 2006 | |||||||||||||||||||||||||||
(in thousands) | 2008 | Amount | Percent | 2007 | Amount | Percent | 2006 | |||||||||||||||||||||
Mortgage Banking Income | ||||||||||||||||||||||||||||
Origination and secondary marketing | $ | 37,257 | $ | 11,292 | 43.5 | % | $ | 25,965 | $ | 7,748 | 42.5 | % | $ | 18,217 | ||||||||||||||
Servicing fees | 45,558 | 9,546 | 26.5 | 36,012 | 11,353 | 46.0 | 24,659 | |||||||||||||||||||||
Amortization of capitalized servicing(1) | (26,634 | ) | (6,047 | ) | 29.4 | (20,587 | ) | (5,443 | ) | 35.9 | (15,144 | ) | ||||||||||||||||
Other mortgage banking income | 16,768 | 3,570 | 27.0 | 13,198 | 3,025 | 29.7 | 10,173 | |||||||||||||||||||||
Sub-total | 72,949 | 18,361 | 33.6 | 54,588 | 16,683 | 44.0 | 37,905 | |||||||||||||||||||||
MSR valuation adjustment(1) | (52,668 | ) | (36,537 | ) | N.M. | (16,131 | ) | (21,002 | ) | N.M. | 4,871 | |||||||||||||||||
Net trading losses related to MSR hedging | (11,287 | ) | (2,634 | ) | 30.4 | (8,653 | ) | (7,368 | ) | N.M. | (1,285 | ) | ||||||||||||||||
Total mortgage banking income | $ | 8,994 | $ | (20,810 | ) | (69.8 | )% | $ | 29,804 | $ | (11,687 | ) | (28.2 | )% | $ | 41,491 | ||||||||||||
Average trading account securities used to hedge MSRs(in millions) | $ | 1,031 | $ | 437 | 73.6 | % | $ | 594 | $ | 568 | N.M. | % | $ | 26 | ||||||||||||||
Capitalized mortgage servicing rights(2) | 167,438 | (40,456 | ) | (19.5 | ) | 207,894 | 76,790 | 58.6 | 131,104 | |||||||||||||||||||
Total mortgages serviced for others(in millions)(2) | 15,754 | 666 | 4.4 | 15,088 | 6,836 | 82.8 | 8,252 | |||||||||||||||||||||
MSR % of investor servicing portfolio | 1.06 | % | (0.32 | ) | (23.2 | )% | 1.38% | (0.21 | ) | (13.2 | )% | 1.59 | % | |||||||||||||||
Net Impact of MSR Hedging | ||||||||||||||||||||||||||||
MSR valuation adjustment(1) | $ | (52,668 | ) | $ | (36,537 | ) | N.M. | % | $ | (16,131 | ) | $ | (21,002 | ) | N.M. | % | $ | 4,871 | ||||||||||
Net trading losses related to MSR hedging | (11,287 | ) | (2,634 | ) | 30.4 | (8,653 | ) | (7,368 | ) | N.M. | (1,285 | ) | ||||||||||||||||
Net interest income related to MSR hedging | 33,139 | 27,342 | N.M. | 5,797 | 5,761 | N.M. | 36 | |||||||||||||||||||||
Net impact of MSR hedging | $ | (30,816 | ) | $ | (11,829 | ) | 62.3 | % | $ | (18,987 | ) | $ | (22,609 | ) | N.M. | % | $ | 3,622 | ||||||||||
N.M., not a meaningful value.
(1) | The change in fair value for the period represents the MSR valuation adjustment, net of amortization of capitalized servicing. |
(2) | At period end. |
2008 versus 2007
Noninterest income increased $30.5 million, or 5%, from a year ago.
Table 11 — Noninterest Income — Estimated Merger-Related Impact — 2008 vs. 2007
Change attributable to: | ||||||||||||||||||||||||||||||||
Twelve Months Ended | ||||||||||||||||||||||||||||||||
December 31, | Change | Other | ||||||||||||||||||||||||||||||
Merger- | Significant | |||||||||||||||||||||||||||||||
(in thousands) | 2008 | 2007 | Amount | Percent | Related | Items | Amount | Percent(1) | ||||||||||||||||||||||||
Service charges on deposit accounts | $ | 308,053 | $ | 254,193 | $ | 53,860 | 21.2 | % | $ | 48,220 | $ | — | $ | 5,640 | 1.9 | % | ||||||||||||||||
Brokerage and insurance income | 137,796 | 92,375 | 45,421 | 49.2 | 34,122 | — | 11,299 | 8.9 | ||||||||||||||||||||||||
Trust services | 125,980 | 121,418 | 4,562 | 3.8 | 14,018 | — | (9,456 | ) | (7.0 | ) | ||||||||||||||||||||||
Electronic banking | 90,267 | 71,067 | 19,200 | 27.0 | 11,600 | — | 7,600 | 9.2 | ||||||||||||||||||||||||
Bank owned life insurance income | 54,776 | 49,855 | 4,921 | 9.9 | 3,614 | — | 1,307 | 2.4 | ||||||||||||||||||||||||
Mortgage banking income | 8,994 | 29,804 | (20,810 | ) | (69.8 | ) | 12,512 | (37,102 | )(2) | 3,780 | 8.9 | |||||||||||||||||||||
Securities losses | (197,370 | ) | (29,738 | ) | (167,632 | ) | N.M. | 566 | (168,198 | )(3) | — | — | ||||||||||||||||||||
Other income | 138,791 | 79,819 | 58,972 | 73.9 | 12,780 | 52,065 | (4) | (5,873 | ) | (6.3 | ) | |||||||||||||||||||||
Sub-total | 667,287 | 668,793 | (1,506 | ) | (0.2 | ) | 137,432 | (153,235 | ) | 14,297 | 1.8 | |||||||||||||||||||||
Automobile operating lease income | 39,851 | 7,810 | 32,041 | N.M. | — | — | 32,041 | N.M. | ||||||||||||||||||||||||
Total noninterest income | $ | 707,138 | $ | 676,603 | $ | 30,535 | 4.5 | % | $ | 137,432 | $ | (153,235 | ) | $ | 46,338 | 5.7 | % | |||||||||||||||
N.M., not a meaningful value.
(1) | Calculated as other / (prior period + merger-related). |
(2) | Refer to Significant Items 4 and 5 of the “Significant Items” discussion. |
(3) | Refer to Significant Item 5 of the “Significant Items” discussion. |
(4) | Refer to Significant Items 2, 3, 5 and 6 of the “Significant Items” discussion. |
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The $30.5 million increase in total noninterest income reflected $137.4 million of merger-related impacts, and the net change of $153.2 million from Significant Items(see “Significant Items” discussion). After adjusting for these factors, total noninterest income increased $46.3 million, or 6%, reflecting:
– | $32.0 million increase in automobile operating lease income as all leases originated since the 2007 fourth quarter were recorded as operating leases. During the 2008 fourth quarter, we exited the automobile leasing business. | |
– | $11.3 million, or 9%, increase in brokerage and insurance income reflecting growth in annuity sales and the 2007 fourth quarter acquisition of an insurance company. | |
– | $7.6 million, or 9%, increase in electronic banking income reflecting increased debit card transaction volumes. |
Partially offset by:
– | $9.5 million, or 7%, decline in trust services income reflecting the impact of lower market values on asset management revenues. | |
– | $5.9 million, or 6%, decline in other noninterest income, primarily reflecting lower derivatives revenue. |
2007 versus 2006
Noninterest income increased $115.5 million, or 21%, from a year ago.
Table 12 — Noninterest Income — Estimated Merger-Related Impact — 2007 vs. 2006
Change attributable to: | ||||||||||||||||||||||||||||||||
Twelve Months Ended | ||||||||||||||||||||||||||||||||
December 31, | Change | Other | ||||||||||||||||||||||||||||||
Merger- | Significant | |||||||||||||||||||||||||||||||
(in thousands) | 2007 | 2006 | Amount | Percent | Related | Items | Amount | Percent(1) | ||||||||||||||||||||||||
Service charges on deposit accounts | $ | 254,193 | $ | 185,713 | $ | 68,480 | 36.9 | % | $ | 48,220 | $ | — | $ | 20,260 | 8.7 | % | ||||||||||||||||
Trust services | 121,418 | 89,955 | 31,463 | 35.0 | 14,018 | — | 17,445 | 16.8 | ||||||||||||||||||||||||
Brokerage and insurance income | 92,375 | 58,835 | 33,540 | 57.0 | 34,122 | — | (582 | ) | (0.6 | ) | ||||||||||||||||||||||
Electronic banking | 71,067 | 51,354 | 19,713 | 38.4 | 11,600 | — | 8,113 | 12.9 | ||||||||||||||||||||||||
Bank owned life insurance income | 49,855 | 43,775 | 6,080 | 13.9 | 3,614 | — | 2,466 | 5.2 | ||||||||||||||||||||||||
Mortgage banking income | 29,804 | 41,491 | (11,687 | ) | (28.2 | ) | 12,512 | (27,511 | )(2) | 3,312 | 6.1 | |||||||||||||||||||||
Securities losses | (29,738 | ) | (73,191 | ) | 43,453 | (59.4 | ) | 566 | 42,887 | (3) | — | — | ||||||||||||||||||||
Other income | 79,819 | 120,022 | (40,203 | ) | (33.5 | ) | 12,780 | (58,547 | )(4) | 5,564 | 4.2 | |||||||||||||||||||||
Sub-total | 668,793 | 517,954 | 150,839 | 29.1 | 137,432 | (43,171 | ) | 56,578 | 8.6 | |||||||||||||||||||||||
Automobile operating lease income | 7,810 | 43,115 | (35,305 | ) | (81.9 | ) | — | — | (35,305 | ) | (81.9 | ) | ||||||||||||||||||||
Total noninterest income | $ | 676,603 | $ | 561,069 | $ | 115,534 | 20.6 | % | $ | 137,432 | $ | (43,171 | ) | $ | 21,273 | 3.0 | % | |||||||||||||||
(1) | Calculated as other / (prior period + merger-related). |
(2) | Refer to Significant Items 4 and 5 of the “Significant Items” discussion. |
(3) | Refer to Significant Item 5 of the “Signficant Items” discussion. |
(4) | Refer to Significant Items 5 and 6 of the “Signficant Items” discussion. |
The $115.5 million increase in total noninterest income reflected the $137.4 million of merger-related noninterest income, and the net charge of $43.2 million from Significant Items (see “Significant Items” discussion). The remaining $21.3 million, or 3%, increase in non-merger-related noninterest income primarily reflected:
– | $20.3 million, or 9%, increase in service charges on deposit accounts, primarily reflecting higher personal and commercial service charge income. | |
– | $17.4 million, or 17%, increase in trust services income. This increase reflected: (a) $9.7 million of revenues associated with the acquisition of Unified Fund Services, and (b) $4.8 million increase in Huntington Fund fees due to growth in Huntington Funds’ managed assets. | |
– | $8.1 million, or 13%, increase in electronic banking income primarily reflecting increased debit card fees due to higher volume. | |
– | $5.6 million, or 4%, increase in other income. This increase primarily reflected higher derivatives revenue. | |
– | $4.2 million, or 8%, increase in mortgage banking income primarily reflecting increased fees due to higher origination volumes. |
Partially offset by:
– | $35.3 million, or 82%, decline in automobile operating lease income. |
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Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Noninterest Expense
(This section should be read in conjunction with Significant Items 1, 3, 5, and 6.)
Table 13 reflects noninterest expense for the three years ended December 31, 2008:
Table 13 — Noninterest Expense
Twelve Months Ended December 31, | ||||||||||||||||||||||||||||
Change from 2007 | Change from 2006 | |||||||||||||||||||||||||||
(in thousands) | 2008 | Amount | Percent | 2007 | Amount | Percent | 2006 | |||||||||||||||||||||
Salaries | $ | 634,881 | $ | 77,627 | 13.9 | % | $ | 557,254 | $ | 131,597 | 30.9 | % | $ | 425,657 | ||||||||||||||
Benefits | 148,665 | 19,091 | 14.7 | 129,574 | 14,003 | 12.1 | 115,571 | |||||||||||||||||||||
Personnel costs | 783,546 | 96,718 | 14.1 | 686,828 | 145,600 | 26.9 | 541,228 | |||||||||||||||||||||
Outside data processing and other services | 128,163 | 918 | 0.7 | 127,245 | 48,466 | 61.5 | 78,779 | |||||||||||||||||||||
Net occupancy | 108,428 | 9,055 | 9.1 | 99,373 | 28,092 | 39.4 | 71,281 | |||||||||||||||||||||
Equipment | 93,965 | 12,483 | 15.3 | 81,482 | 11,570 | 16.5 | 69,912 | |||||||||||||||||||||
Amortization of intangibles | 76,894 | 31,743 | 70.3 | 45,151 | 35,189 | N.M. | 9,962 | |||||||||||||||||||||
Professional services | 53,667 | 13,347 | 33.1 | 40,320 | 13,267 | 49.0 | 27,053 | |||||||||||||||||||||
Marketing | 32,664 | (13,379 | ) | (29.1 | ) | 46,043 | 14,315 | 45.1 | 31,728 | |||||||||||||||||||
Telecommunications | 25,008 | 506 | 2.1 | 24,502 | 5,250 | 27.3 | 19,252 | |||||||||||||||||||||
Printing and supplies | 18,870 | 619 | 3.4 | 18,251 | 4,387 | 31.6 | 13,864 | |||||||||||||||||||||
Other | 124,887 | (12,601 | ) | (9.2 | ) | 137,488 | 30,839 | 28.9 | 106,649 | |||||||||||||||||||
Sub-total | 1,446,092 | 139,409 | 10.7 | 1,306,683 | 336,975 | 34.8 | 969,708 | |||||||||||||||||||||
Automobile operating lease expense | 31,282 | 26,121 | N.M. | 5,161 | (26,125 | ) | (83.5 | ) | 31,286 | |||||||||||||||||||
Total noninterest expense | $ | 1,477,374 | $ | 165,530 | 12.6 | % | $ | 1,311,844 | $ | 310,850 | 31.1 | % | $ | 1,000,994 | ||||||||||||||
N.M., not a meaningful value.
2008 versus 2007
Table 14 — Noninterest Expense — Estimated Merger-Related Impact — 2008 vs. 2007
Change attributable to: | ||||||||||||||||||||||||||||||||||||
Twelve Months Ended | ||||||||||||||||||||||||||||||||||||
December 31, | Change | Other | ||||||||||||||||||||||||||||||||||
Merger- | Restructuring/ | Significant | ||||||||||||||||||||||||||||||||||
(in thousands) | 2008 | 2007 | Amount | Percent | Related | Merger Costs | Items | Amount | Percent(1) | |||||||||||||||||||||||||||
Personnel costs | $ | 783,546 | $ | 686,828 | $ | 96,718 | 14.1 | % | $ | 136,500 | $ | (17,633 | ) | $ | — | $ | (22,149 | ) | (2.7 | )% | ||||||||||||||||
Outside data processing and other services | 128,163 | 127,245 | 918 | 0.7 | 24,524 | (16,017 | ) | — | (7,589 | ) | (5.6 | ) | ||||||||||||||||||||||||
Net occupancy | 108,428 | 99,373 | 9,055 | 9.1 | 20,368 | (6,487 | ) | 2,500 | (2) | (7,326 | ) | (6.5 | ) | |||||||||||||||||||||||
Equipment | 93,965 | 81,482 | 12,483 | 15.3 | 9,598 | 942 | — | 1,943 | 2.1 | |||||||||||||||||||||||||||
Amortization of intangibles | 76,894 | 45,151 | 31,743 | 70.3 | 32,962 | — | — | (1,219 | ) | (1.6 | ) | |||||||||||||||||||||||||
Professional services | 53,667 | 40,320 | 13,347 | 33.1 | 5,414 | (6,399 | ) | — | 14,332 | 36.4 | ||||||||||||||||||||||||||
Marketing | 32,664 | 46,043 | (13,379 | ) | (29.1 | ) | 8,722 | (13,410 | ) | — | (8,691 | ) | (21.0 | ) | ||||||||||||||||||||||
Telecommunications | 25,008 | 24,502 | 506 | 2.1 | 4,448 | (550 | ) | — | (3,392 | ) | (11.9 | ) | ||||||||||||||||||||||||
Printing and supplies | 18,870 | 18,251 | 619 | 3.4 | 2,748 | (1,433 | ) | — | (696 | ) | (3.6 | ) | ||||||||||||||||||||||||
Other expense | 124,887 | 137,488 | (12,601 | ) | (9.2 | ) | 26,096 | (2,267 | ) | (64,863 | )(3) | 28,433 | 17.6 | |||||||||||||||||||||||
Sub-total | 1,446,092 | 1,306,683 | 139,409 | 10.7 | 271,380 | (63,254 | ) | (62,363 | ) | (6,354 | ) | (0.4 | ) | |||||||||||||||||||||||
Automobile operating lease expense | 31,282 | 5,161 | 26,121 | N.M. | — | — | — | 26,121 | N.M. | |||||||||||||||||||||||||||
Total noninterest expense | $ | 1,477,374 | $ | 1,311,844 | $ | 165,530 | 12.6 | % | $ | 271,380 | $ | (63,254 | ) | $ | (62,363 | ) | $ | 19,767 | 1.3 | % | ||||||||||||||||
N.M., not a meaningful value.
(1) | Calculated as other / (prior period + merger-related + restructuring/merger costs). |
(2) | Refer to Significant Item 6 of the “Significant Items” discussion. |
(3) | Refer to Significant Items 3, 5, and 6 of the “Significant Items” discussion. |
As shown in the above table, noninterest expense increased $165.5 million, or 13%, from a year ago. Of the $165.5 million increase, $271.4 million pertained to merger-related expenses, partially offset by $63.3 million of lower merger/restructuring costs and $62.4 million lower expenses related to Significant Items(see “Significant Items” discussion). After adjusting for these factors, total noninterest expense increased $19.8 million, or 1%, reflecting:
– | $28.4 million, or 18%, increase in other expense primarily reflecting higher Federal Deposit Insurance Corporation (FDIC) insurance expense(discussed below)and OREO losses. | |
– | $26.1 million increase in automobile operating lease expense as all leases originated since the 2007 fourth quarter were recorded as operating leases. During the 2008 fourth quarter, we exited the automobile leasing business. |
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– | $14.3 million, or 36%, increase in professional services, reflecting increased legal and collection costs. We expect that collection costs will remain at higher levels throughout 2009. |
Partially offset by:
– | $22.1 million, or 3%, decline in personnel expense reflecting the benefit of merger and restructuring efficiencies. | |
– | $8.7 million, or 21%, decline in marketing expense. | |
– | $7.6 million, or 6%, decline in outside data processing and other services reflecting merger efficiencies. | |
– | $7.3 million, or 6%, decline in net occupancy expense, reflecting merger efficiencies. |
As a participating FDIC insured bank, we were assessed quarterly deposit insurance premiums totaling $24.1 million during 2008. However, we received a one-time assessment credit from the FDIC which substantially offset our 2008 deposit insurance premium and, therefore, only $7.9 million of deposit insurance premium expense was recognized during 2008. In late 2008, the FDIC raised assessment rates for the first quarter of 2009 by a uniform 7 basis points, resulting in a range between 12 and 50 basis points, depending upon the risk category of the institution. At the same time, the FDIC proposed further changes in the assessment system beginning in the 2009 second quarter. The final rule, expected to be issued in early 2009, could result in adjustments to the proposed changes. Based on these proposed changes, as well as the full consumption of the one-time assessment credit prior to 2009 (discussed above), our full-year 2009 deposit insurance premium expense will increase compared with our full-year 2008 deposit insurance premium expense. We anticipate this increase will negatively impact our earnings per common share by $0.07-$0.09.See “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008 for additional discussion.
In the 2009 first quarter, details of an expense reduction initiative were announced. We anticipate this initiative will reduce expenses approximately $100 million, net of one-time expenses in 2009, compared with 2008 levels.
2007 versus 2006
Noninterest expense increased $310.9 million, or 31%, from 2006.
Table 15 — Noninterest Expense — Estimated Merger-Related Impact-2007 vs. 2006
Change Attributable to: | ||||||||||||||||||||||||||||||||||||
Twelve Months Ended | ||||||||||||||||||||||||||||||||||||
December 31, | Change | Other | ||||||||||||||||||||||||||||||||||
Merger- | Restructuring/ | Significant | ||||||||||||||||||||||||||||||||||
(in thousands) | 2007 | 2006 | Amount | Percent | Related | Merger Costs | Items | Amount | Percent(1) | |||||||||||||||||||||||||||
Personnel costs | $ | 686,828 | $ | 541,228 | $ | 145,600 | 26.9 | % | $ | 136,500 | $ | 30,487 | $ | (4,750 | )(2) | $ | (16,637 | ) | (2.3 | )% | ||||||||||||||||
Outside data processing and other services | 127,245 | 78,779 | 48,466 | 61.5 | 24,524 | 16,996 | — | 6,946 | 5.8 | |||||||||||||||||||||||||||
Net occupancy | 99,373 | 71,281 | 28,092 | 39.4 | 20,368 | 8,495 | — | (771 | ) | (0.8 | ) | |||||||||||||||||||||||||
Equipment | 81,482 | 69,912 | 11,570 | 16.5 | 9,598 | 1,936 | — | 36 | 0.0 | |||||||||||||||||||||||||||
Amortization of intangibles | 45,151 | 9,962 | 35,189 | N.M. | 34,862 | — | — | 327 | 0.7 | |||||||||||||||||||||||||||
Marketing | 46,043 | 31,728 | 14,315 | 45.1 | 8,722 | 12,789 | — | (7,196 | ) | (13.5 | ) | |||||||||||||||||||||||||
Professional services | 40,320 | 27,053 | 13,267 | 49.0 | 5,414 | 6,046 | — | 1,807 | 4.7 | |||||||||||||||||||||||||||
Telecommunications | 24,502 | 19,252 | 5,250 | 27.3 | 4,448 | 1,002 | — | (200 | ) | (0.8 | ) | |||||||||||||||||||||||||
Printing and supplies | 18,251 | 13,864 | 4,387 | 31.6 | 2,748 | 1,332 | — | 307 | 1.7 | |||||||||||||||||||||||||||
Other expense | 137,488 | 106,649 | 30,839 | 28.9 | 26,096 | 2,252 | 14,797 | (3) | (12,306 | ) | (9.1 | ) | ||||||||||||||||||||||||
Sub-total | 1,306,683 | 969,708 | 336,975 | 34.8 | 273,280 | 81,335 | 10,047 | (27,687 | ) | (2.1 | ) | |||||||||||||||||||||||||
Automobile operating lease expense | 5,161 | 31,286 | (26,125 | ) | (83.5 | ) | — | — | — | (26,125 | ) | (83.5 | ) | |||||||||||||||||||||||
Total noninterest expense | $ | 1,311,844 | $ | 1,000,994 | $ | 310,850 | 31.1 | % | $ | 273,280 | $ | 81,335 | $ | 10,047 | $ | (53,812 | ) | (4.0 | )% | |||||||||||||||||
N.M., not a meaningful value.
(1) | Calculated as other / (prior period + merger-related + restructuring/merger costs). |
(2) | Refer to Significant Item 6 of the “Significant Items” discussion. |
(3) | Refer to Significant Items 3, 5, and 6 of the “Significant Items” discussion. |
Of the $310.9 million increase, $273.3 million reflected merger-related expenses, $81.3 million reflected merger costs related to merger/integration activities, and $10.0 million reflected the net change related to Significant Items(see “Significant Items” discussion). Considering the impact of these items, noninterest expense declined $53.8 million, or 4%, reflecting:
– | $26.1 million, or 84%, decline in automobile operating lease expense. | |
– | $16.6 million, or 2%, decline in personnel costs reflecting merger efficiencies including the impact of the reductions to full-time equivalent staff during 2007. |
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– | $12.3 million, or 9%, decline in other noninterest expense primarily reflecting lower lease residual value expenses. | |
– | $7.2 million, or 14%, decline in marketing expense. |
Partially offset by:
– | $6.9 million, or 6%, increase in outside data processing and other services expenses related to: (a) higher debit card transaction volume, and (b) additional expenditures related to technology-related initiatives. |
Provision for Income Taxes
(This section should be read in conjunction with Significant Items 1, 2, and 6.)
The provision for income taxes was a benefit of $182.2 million for 2008 compared with a benefit of $52.5 million in 2007 and a $52.8 million provision in 2006. The tax benefit in 2008 was a result of a pretax loss combined with the favorable impact of the decrease to the capital loss valuation reserve, tax exempt income, bank owned life insurance, asset securitization activities, and general business credits from investments in low income housing and historic property partnerships. The tax benefit in 2007 was a result of lower pretax income combined with the favorable impact of tax exempt income, bank owned life insurance, asset securitization activities, and general business credits from investments in low income housing and historic property partnerships. The 2006 provision for income taxes included a release of previously established federal income tax reserves due to the resolution of a federal income tax audit covering tax years 2002 and 2003, as well as the recognition of a federal tax loss carryback.
During 2008, the Internal Revenue Service (IRS) completed the audit of our consolidated federal income tax returns for tax years 2004 and 2005. In addition, we are subject to ongoing tax examinations in various state and local jurisdictions. Both the IRS and state tax officials have proposed adjustments to the Company’s previously filed tax returns. Management believes that the tax positions taken by the Company related to such proposed adjustments were correct and supported by applicable statutes, regulations, and judicial authority, and intends to vigorously defend them. It is possible that the ultimate resolution of the proposed adjustments, if unfavorable, may be material to the results of operations in the period it occurs. However, although no assurances can be given, we believe that the resolution of these examinations will not, individually or in the aggregate, have a material adverse impact on our consolidated financial position.
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Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
RISK MANAGEMENT AND CAPITAL
Risk identification and monitoring are key elements in overall risk management. We believe our primary risk exposures are credit, market, liquidity, and operational risk.Credit risk is the risk of loss due to adverse changes in the borrower’s ability to meet its financial obligations under agreed upon terms.Market risk represents the risk of loss due to changes in the market value of assets and liabilities due to changes in interest rates, exchange rates, and equity prices. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future obligations based on external macro market issues, investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues.Operational risk arises from the inherent day-to-day operations of the company that could result in losses due to human error, inadequate or failed internal systems and controls, and external events.
We follow a formal policy to identify, measure, and document the key risks facing the company, how those risks can be controlled or mitigated, and how we monitor the controls to ensure that they are effective. Our chief risk officer is responsible for ensuring that appropriate systems of controls are in place for managing and monitoring risk across the company. Potential risk concerns are shared with the board of directors, as appropriate. Our internal audit department performs ongoing independent reviews of the risk management process and ensures the adequacy of documentation. The results of these reviews are reported regularly to the audit committee of the board of directors.
Some of the more significant processes used to manage and control credit, market, liquidity, and operational risks are described in the following paragraphs.
Credit Risk
Credit risk is the risk of loss due to our counterparties not being able to meet their financial obligations under agreed upon terms. We are subject to credit risk in our lending, trading, and investment activities. The nature and degree of credit risk is a function of the types of transactions, the structure of those transactions, and the parties involved. The majority of our credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. We also have credit risk associated with our investment and derivatives activities. Credit risk is incidental to trading activities and represents a significant risk that is associated with our investment securities portfolio(see “Investment Securities Portfolio” discussion). Credit risk is mitigated through a combination of credit policies and processes, market risk management activities, and portfolio diversification.
The maximum level of credit exposure to individual commercial borrowers is limited by policy guidelines based on each borrower or related group of borrowers. All authority to grant commitments is delegated through the independent credit administration function and is monitored and regularly updated. Concentration risk is managed via limits on loan type, geography, industry, loan quality factors, and country limits. We continue to focus predominantly on extending credit to retail and commercial customers with existing or expandable relationships within our primary banking markets. Also, we continue to add new borrowers that meet our targeted risk and profitability profile.
The checks and balances in the credit process and the independence of the credit administration and risk management functions are designed to appropriately assess the level of credit risk being accepted, facilitate the early recognition of credit problems when they do occur, and to provide for effective problem asset management and resolution.
Counterparty Risk
In the normal course of business, we engage with other financial counterparties for a variety of purposes including investing, asset and liability management, mortgage banking, and for trading activities. As a result, we are exposed to credit risk, or the risk of loss if the counterparty fails to perform according to the terms of our contract or agreement.
We minimize counterparty risk through credit approvals, limits, and monitoring procedures similar to those used for our commercial portfolio(see “Commercial Credit” discussion), generally entering into transactions only with counterparties that carry high quality ratings, and obtain collateral when appropriate.
The majority of the financial institutions with whom we are exposed to counterparty risk are large commercial banks. The potential amount of loss, which would have been recognized at December 31, 2008, if a counterparty defaulted, did not exceed $20 million for any individual counterparty.
Credit Exposure Mix
(This section should be read in conjunction with Significant Items 1 and 2.)
As shown in Table 16, at December 31, 2008, commercial loans totaled $23.6 billion, and represented 57% of our total credit exposure. This portfolio was diversified between C&I and CRE loans (see “Commercial Credit” discussion).
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Total consumer loans were $17.5 billion at December 31, 2008, and represented 42% of our total credit exposure. The consumer portfolio was diversified among home equity loans, residential mortgages, and automobile loans and leases(see “Consumer Credit” discussion). Our home equity and residential mortgages portfolios represented $12.3 billion, or 30%, of our total loans and leases. These portfolios are discussed in greater detail below in the “Consumer Credit” section.
Table 16 — Loan and Lease Portfolio Composition
At December 31, | ||||||||||||||||||||||||||||||||||||||||
(in millions) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||
Commercial (1) | ||||||||||||||||||||||||||||||||||||||||
Commercial and industrial | $ | 12,891 | 31.2 | % | $ | 11,939 | 29.8 | % | $ | 7,850 | 30.0 | % | $ | 6,809 | 27.6 | % | $ | 5,830 | 24.1 | % | ||||||||||||||||||||
Franklin Credit Management Corporation | 650 | 1.6 | 1,187 | 3.0 | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Construction | 2,080 | 5.0 | 1,962 | 4.9 | 1,229 | 4.7 | 1,538 | 6.2 | 1,663 | 6.9 | ||||||||||||||||||||||||||||||
Commercial | 8,018 | 19.4 | 7,221 | 18.0 | 3,275 | 12.5 | 2,498 | 10.1 | 2,810 | 11.6 | ||||||||||||||||||||||||||||||
Total commercial real estate | 10,098 | 24.4 | 9,183 | 22.9 | 4,504 | 17.2 | 4,036 | 16.3 | 4,473 | 18.5 | ||||||||||||||||||||||||||||||
Total commercial | 23,639 | 57.2 | 22,309 | 55.7 | 12,354 | 47.2 | 10,845 | 43.9 | 10,303 | 42.6 | ||||||||||||||||||||||||||||||
Consumer: | ||||||||||||||||||||||||||||||||||||||||
Automobile loans | 3,901 | 9.4 | 3,114 | 7.8 | 2,126 | 8.2 | 1,985 | 8.0 | 1,949 | 8.1 | ||||||||||||||||||||||||||||||
Automobile leases | 563 | 1.4 | 1,180 | 2.9 | 1,769 | 6.8 | 2,289 | 9.3 | 2,443 | 10.1 | ||||||||||||||||||||||||||||||
Home equity | 7,557 | 18.3 | 7,290 | 18.2 | 4,927 | 18.8 | 4,763 | 19.3 | 4,647 | 19.2 | ||||||||||||||||||||||||||||||
Residential mortgage | 4,761 | 11.5 | 5,447 | 13.6 | 4,549 | 17.4 | 4,193 | 17.0 | 3,829 | 15.9 | ||||||||||||||||||||||||||||||
Other loans | 671 | 1.6 | 715 | 1.6 | 428 | 1.5 | 397 | 1.7 | 389 | 1.7 | ||||||||||||||||||||||||||||||
Total consumer | 17,453 | 42.2 | 17,746 | 44.1 | 13,799 | 52.7 | 13,627 | 55.3 | 13,257 | 55.0 | ||||||||||||||||||||||||||||||
Total loans and direct financing leases | 41,092 | 99.4 | 40,055 | 99.8 | 26,153 | 99.9 | 24,472 | 99.2 | 23,560 | 97.6 | ||||||||||||||||||||||||||||||
Automobile operating lease assets | 243 | 0.6 | 68 | 0.2 | 28 | 0.1 | 189 | 0.8 | 587 | 2.4 | ||||||||||||||||||||||||||||||
Total credit exposure | $ | 41,335 | 100.0 | % | $ | 40,123 | 100.0 | % | $ | 26,181 | 100.0 | % | $ | 24,661 | 100.0 | % | $ | 24,147 | 100.0 | % | ||||||||||||||||||||
Total automobile exposure (2) | $ | 4,707 | 11.4 | % | $ | 4,362 | 10.9 | % | $ | 3,923 | 15.0 | % | $ | 4,463 | 18.1 | % | $ | 4,979 | 20.6 | % | ||||||||||||||||||||
By Business Segment(3) | ||||||||||||||||||||||||||||||||||||||||
Retail and Business Banking | $ | 16,537 | 40.2 | % | $ | 16,831 | 42.0 | % | ||||||||||||||||||||||||||||||||
Commercial Banking | 8,532 | 20.8 | 8,035 | 20.1 | ||||||||||||||||||||||||||||||||||||
Commercial Real Estate | 7,126 | 17.3 | 6,151 | 15.4 | ||||||||||||||||||||||||||||||||||||
Dealer Sales | 5,949 | 14.5 | 5,621 | 14.0 | ||||||||||||||||||||||||||||||||||||
Private Financial and Capital Markets Group | 2,298 | 5.6 | 2,226 | 5.6 | ||||||||||||||||||||||||||||||||||||
Treasury/Other(4) | 650 | 1.6 | 1,191 | 2.9 | ||||||||||||||||||||||||||||||||||||
Total loans and direct financing leases | $ | 41,092 | 100.0 | % | $ | 40,055 | 100.0 | % | ||||||||||||||||||||||||||||||||
(1) | There were no commercial loans outstanding that would be considered a concentration of lending to a particular industry or group of industries. | |
(2) | Total automobile loans and leases, operating lease assets, and securitized loans. | |
(3) | Prior period amounts have been reclassified to conform to the current period business segment structure. | |
(4) | 2008 and 2007 included loans to Franklin. |
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Commercial Credit
(This section should be read in conjunction with Significant Items 1 and 2.)
Our commercial loan portfolio is diversified by C&I and CRE loans as shown in the table below:
Table 17 — Commercial & Industrial and Commercial Real Estate Loan and Lease Detail
At December 31, | ||||||||||||||||||||
(in millions) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Commercial and industrial loans | $ | 10,902 | $ | 10,786 | $ | 6,632 | $ | 5,723 | $ | 4,796 | ||||||||||
Franklin Credit Management Corporation | 650 | 1,187 | — | — | — | |||||||||||||||
Dealer floor plan loans | 960 | 795 | 631 | 615 | 645 | |||||||||||||||
Equipment direct financing leases | 1,029 | 895 | 587 | 471 | 389 | |||||||||||||||
Commercial and industrial loans and leases | 13,541 | 13,126 | 7,850 | 6,809 | 5,830 | |||||||||||||||
Commercial real estate loans | 10,098 | 9,183 | 4,504 | 4,036 | 4,473 | |||||||||||||||
Total commercial loans and leases | $ | 23,639 | $ | 22,309 | $ | 12,354 | $ | 10,845 | $ | 10,303 | ||||||||||
Commercial credit approvals are based on, among other factors, the financial strength of the borrower, assessment of the borrower’s management capabilities, industry sector trends, type of exposure, transaction structure, and the general economic outlook. While these are the primary factors considered, there are a number of other factors that may be considered in the decision process. There are two processes for approving credit risk exposures. The first, and more prevalent approach, involves individual approval of exposures. These approvals are consistent with the authority delegated to officers located in the geographic regions who are experienced in the industries and loan structures over which they have responsibility. The second involves a centralized loan approval process for the standard products and structures utilized in small business banking. In this centralized decision environment, Where the above primary factors are the basis for approval, individual credit authority is granted to certain individuals on a regional basis to preserve our local decision-making focus. In addition to disciplined, consistent, and judgmental factors, a primary credit evaluation tool is a sophisticated credit scoring process. To provide consistent oversight, a centralized portfolio management team monitors and reports on the performance of the small business banking loans.
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All commercial credit extensions are assigned internal risk ratings reflecting the borrower’s probability-of-default and loss-given-default. This two-dimensional rating methodology, which results in 192 individual loan grades, provides granularity in the portfolio management process. The probability-of-default is rated on a scale of 1-12 and is applied at the borrower level. The loss-given-default is rated on a 1-16 scale and is associated with each individual credit exposure based on the type of credit extension and the underlying collateral.
In commercial lending, ongoing credit management is dependent on the type and nature of the loan. We monitor all significant exposures on a periodic basis. The internal risk ratings are assessed and updated with each periodic monitoring event. There is also extensive macro portfolio management analysis on an ongoing basis. We continually review and adjust our risk rating criteria based on actual experience, which may result in further changes to such criteria, in future periods. The continuous analysis and review process results in a determination of an appropriate ALLL amount for our commercial loan portfolio.
In addition to the initial credit analysis initiated during the underwriting process, the loan review group performs credit analyses to provide an independent review and assessment of the qualityand/or exposure of the loan. The loan review group reviews individual loans and credit processes and conducts a portfolio review at each of the regions on a15-month cycle. The loan review group validates the risk grades on approximately 70% of the portfolio exposure each calendar year.
Borrower exposures may be designated as monitored credits when warranted by individual company performance, or by industry and environmental factors. Such accounts are subjected to additional quarterly reviews by the business line management, the loan review group, and credit administration in order to adequately assess the borrower’s credit status and to take appropriate action.
A specialized credit workout group is involved in the management of all monitored credits, and handles commercial recoveries, workouts, and problem loan sales, as well as the day-to-day management of relationships rated substandard or lower. This group is responsible for developing an action plan, assessing the risk rating, and determining the adequacy of the reserve, the accrual status, and the ultimate collectibility of the credits managed.
C&I loan and lease commitments and balances outstanding by industry classification at December 31, 2008, were as follows:
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Table 18 — Commercial and Industrial Loans and Leases by Industry Classification
At December 31, 2008 | ||||||||||||||||
Commitments | Loans Outstanding | |||||||||||||||
(in millions) | Amount | Percent | Amount | Percent | ||||||||||||
Industry Classification: | ||||||||||||||||
Services | $ | 5,005 | 25.0 | % | $ | 3,363 | 24.8 | % | ||||||||
Manufacturing | 3,806 | 19.0 | 2,423 | 17.9 | ||||||||||||
Finance, insurance, and real estate | 2,721 | 13.6 | 1,953 | 14.4 | ||||||||||||
Retail trade — Auto Dealers | 1,488 | 7.4 | 1,306 | 9.6 | ||||||||||||
Retail trade — Other than Auto Dealers | 1,521 | 7.6 | 810 | 6.0 | ||||||||||||
Contractors and construction | 1,504 | 7.5 | 948 | 7.0 | ||||||||||||
Transportation, communications, and utilities | 1,105 | 5.5 | 767 | 5.7 | ||||||||||||
Franklin Credit Management Corporation | 650 | 3.2 | 650 | 4.8 | ||||||||||||
Wholesale trade | 1,135 | 5.7 | 536 | 4.0 | ||||||||||||
Agriculture and forestry | 574 | 2.9 | 411 | 3.0 | ||||||||||||
Energy | 302 | 1.5 | 207 | 1.5 | ||||||||||||
Public administration | 123 | 0.6 | 100 | 0.7 | ||||||||||||
Other | 88 | 0.5 | 67 | 0.6 | ||||||||||||
Total | $ | 20,022 | 100.0 | % | $ | 13,541 | 100.0 | % | ||||||||
C&I loan credit quality data regarding NCOs, nonaccrual loans, and accruing loans past due 90 days or more by industry classification for 2008 and 2007 are presented in the table below:
Table 19 — Commercial and Industrial Credit Quality Data by Industry Classification
Year Ended December 31, | At December 31, | |||||||||||||||||||||||||||||||||||||||
2007 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||||
2008 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||||
Net Charge-offs | ||||||||||||||||||||||||||||||||||||||||
Nonaccrual Loans | Accruing loans past due | |||||||||||||||||||||||||||||||||||||||
(in millions) | Amount | Percentage | Amount | Percentage | 90 days or more | |||||||||||||||||||||||||||||||||||
Industry Classification: | ||||||||||||||||||||||||||||||||||||||||
Services | $ | 18.6 | 0.57 | % | $ | 5.5 | 0.21 | % | $ | 73.9 | $ | 24.0 | $ | 3.2 | $ | 2.4 | ||||||||||||||||||||||||
Manufacturing | 16.4 | 0.73 | 14.5 | 0.86 | 67.5 | 12.2 | 1.5 | 0.2 | ||||||||||||||||||||||||||||||||
Finance, insurance, and real estate | 13.5 | 0.75 | 4.4 | 0.48 | 46.6 | 15.3 | 2.0 | 1.4 | ||||||||||||||||||||||||||||||||
Retail trade — Auto Dealers | 2.2 | 0.20 | — | — | 6.2 | 1.9 | 0.5 | 1.3 | ||||||||||||||||||||||||||||||||
Retail trade — Other than Auto Dealers | 23.1 | 2.66 | 2.5 | 0.30 | 28.6 | 14.5 | 0.9 | 1.1 | ||||||||||||||||||||||||||||||||
Contractors and construction | 10.7 | 1.87 | 3.6 | 0.62 | 13.5 | 5.9 | 0.7 | 1.1 | ||||||||||||||||||||||||||||||||
Transportation, communications, and utilities | 4.5 | 0.67 | 2.0 | 0.38 | 11.4 | 3.2 | 1.6 | 0.4 | ||||||||||||||||||||||||||||||||
Franklin Credit Management Corporation | 423.3 | 39.01 | 308.5 | 20.27 | 650.2 | — | — | — | ||||||||||||||||||||||||||||||||
Wholesale trade | 12.3 | 1.24 | 4.1 | 0.91 | 19.6 | 3.9 | 0.1 | 2.2 | ||||||||||||||||||||||||||||||||
Agriculture and forestry | 0.7 | 0.32 | — | — | 2.3 | 5.6 | 0.3 | 0.4 | ||||||||||||||||||||||||||||||||
Energy | 0.1 | 0.02 | — | — | 9.6 | 0.2 | — | — | ||||||||||||||||||||||||||||||||
Public administration | 0.5 | 0.42 | 0.1 | 0.13 | 0.6 | 0.6 | — | — | ||||||||||||||||||||||||||||||||
Other | 0.2 | 0.06 | 0.4 | 1.03 | 2.7 | 0.3 | 0.1 | 0.0 | ||||||||||||||||||||||||||||||||
Total(1) | $ | 526.2 | 3.87 | % | $ | 345.8 | 3.25 | % | $ | 932.6 | $ | 87.7 | $ | 10.9 | $ | 10.5 | ||||||||||||||||||||||||
(1) | Excluding the Franklin Credit Management Corporation charge-offs in 2008 and 2007, the net charge-off percentages were 0.83% and 0.41%, respectively. |
Our commercial loan portfolio, including CRE, is diversified by customer size, as well as throughout our geographic footprint. However, the following segments are noteworthy:
Franklin Relationship
(This section should be read in conjunction with Significant Items 1 and 2.)
Franklin is a specialty consumer finance company primarily engaged in the servicing and resolution of performing, reperforming, and nonperforming residential mortgage loans. Franklin’s portfolio consists of loans secured by 1-4 family residential real estate that generally fall outside the underwriting standards of the Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) and involve elevated credit risk as a result of the nature or absence of income documentation, limited credit histories, and higher levels of consumer debt, or past credit difficulties. Through the 2007 fourth quarter, Franklin purchased these loan portfolios at a discount to the unpaid principal balance and originated loans with interest rates and fees calculated to provide a rate of return adjusted to reflect the elevated credit risk
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inherent in these types of loans. Franklin originated nonprime loans through its wholly owned subsidiary, Tribeca Lending Corp., and has generally held for investment the loans acquired and a significant portion of the loans originated.
Loans to Franklin are funded by a bank group, of which we are the lead bank and largest participant. The loans participated to other banks have no recourse to Huntington. The term debt exposure is secured by approximately 30,000 individual first- and second-priority lien residential mortgages. In addition, pursuant to an exclusive lockbox arrangement, we receive substantially all payments made to Franklin on these individual mortgages.
Through the 2008 third quarter, the Franklin relationship continued to perform and accrue interest. While the cash flow generated by the underlying collateral declined slightly, it continued to exceed the requirements of the restructuring agreement. However, during the 2008 fourth quarter, the cash flows deteriorated significantly, reflecting a much more rapid than expected deterioration in the economy. Principal payments continued to contract in the Franklin first mortgage portfolios. In addition, interest collections declined in the Franklin second mortgage portfolios as delinquencies increased, and proceeds from the sale of foreclosed properties decreased. These factors, coupled with the fact that the severity of the economic downturn increased in the 2008 fourth quarter and the likelihood that these trends will continue for the foreseeable future, resulted in a significant deterioration in our expectations of future cash flows from Franklin’s mortgage loans, which represent the collateral for our loans. As such, the change in our estimates of the future expected cash flows resulted in the following actions taken during the 2008 fourth quarter: (a) $423.3 million of our loans to Franklin were charged-off, (b) $9.0 million of interest was reversed as the remaining $650.2 million of loans were placed on nonaccrual status, (c) $7.3 million of interest swap exposure was written off, and (d) $438.0 million of provision expense was taken to replenish and increase the remaining specific loan loss reserve.
As a result of these actions, at December 31, 2008, our total loans outstanding to Franklin were $650.2 million, down $538.2 million from $1,188.4 million at December 31, 2007. As mentioned previously, the outstanding $650.2 million was placed on nonaccrual status at the end of 2008.
The following table details our loan relationship with Franklin as of December 31, 2008, and changes from December 31, 2007:
Table 20 — Commercial Loans to Franklin
At December 31, 2008 | ||||||||||||||||||||||||
Participated | Previously | Huntington | ||||||||||||||||||||||
(in thousands) | Franklin | Tribeca | Subtotal | to others | charged off(1) | Total | ||||||||||||||||||
Variable rate, term loan (Facility A) | $ | 502,436 | $ | 355,451 | $ | 857,887 | $ | (144,789 | ) | $ | (62,873 | ) | $ | 650,225 | ||||||||||
Variable rate, subordinated term loan (Facility B) | 314,013 | 96,226 | 410,239 | (68,149 | ) | (342,090 | ) | — | ||||||||||||||||
Fixed rate, junior subordinated term loan (Facility C) | 125,000 | — | 125,000 | (8,224 | ) | (116,776 | ) | — | ||||||||||||||||
Line of credit facility | 1,958 | — | 1,958 | — | (1,958 | ) | — | |||||||||||||||||
Other variable rate term loans | 40,937 | — | 40,937 | (20,468 | ) | (20,469 | ) | — | ||||||||||||||||
Subtotal | 984,344 | 451,677 | 1,436,021 | $ | (241,630 | ) | $ | (544,166 | ) | $ | 650,225 | |||||||||||||
Participated to others | (150,271 | ) | (91,359 | ) | (241,630 | ) | ||||||||||||||||||
Total principal owed to Huntington | 834,073 | 360,318 | 1,194,391 | |||||||||||||||||||||
Previously charged off(1) | (435,097 | ) | (109,069 | ) | (544,166 | ) | ||||||||||||||||||
Total book value of loans | $ | 398,976 | $ | 251,249 | $ | 650,225 | ||||||||||||||||||
(1) | Includes $4.1 million of interest payments received and applied to reduce the recorded balance. |
Our specific ALLL for the Franklin portfolio was $130.0 million, up from $115.3 million at December 31, 2007, and represented 20% of the loan’s book value. Subtracting the specific reserve from total loans outstanding, our total net exposure to Franklin at December 31, 2008, was $520.2 million. The table below details our probability-of-default and recovery-after-default performance assumptions for estimating anticipated cash flows from the Franklin loans that were used to determine the appropriate amount of specific ALLL for the Franklin loans. The calculation of our specific ALLL for the Franklin portfolio is dependent, among other factors, on the assumptions provided in the table, as well as the current one-month LIBOR rate on the underlying loans to Franklin. As the one-month LIBOR rate increases, the specific ALLL for the Franklin portfolio could also increase.
Table 21 — Franklin Performance Assumptions
Huntington collateral performance assumptions | |||||||||||||
December 31, 2008 | |||||||||||||
UPB (1) | Probability of Default | Recovery After Default | |||||||||||
Purchased 2nd mortgages | $ | 808 million | 90 | % | 2 | % | |||||||
Purchased 1st mortgages | 449 million | 75 | 45 | ||||||||||
Tribeca originated 1st mortgages | 448 million | 80 | 60 | ||||||||||
Total underlying collateral | $ | 1,705 million |
(1) | As of September 30, 2008, unpaid principal balance (“UPB”) of mortgage collateral supporting total bank debt, including OREO. Data was obtained from the September 30, 2008,10-Q filing of Franklin. |
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As another assessment of the adequacy of our specific ALLL for Franklin, during the 2008 fourth quarter, we obtained updated estimates of the fair values on all residential properties securing the Franklin first-lien mortgage loans, which included OREO. Our share of the updated first-mortgage collateral, net of the other participants within the bank group, totaled $898 million at December 31, 2008. We analyzed this value assuming a 40% discount to the fair value estimates to determine costs to sell the underlying collateral and potential declines in the estimated values. We also included $23 million of other collateral, primarily cash, that we have supporting these loans. Using the collateral values, we have collateral coverage of 108% against the exposure that we have from the loan, net of its specific ALLL. In this analysis, we assigned no value to the portfolio of second-lien mortgage loans, even though the portfolio is currently generating approximately $5 million per month of cash flow that is applied directly to the recorded balance.
The U.S. government recently announced an industry-wide, six-month moratorium on mortgage foreclosures. While this will likely have some impact on the performance of the mortgages representing the collateral for our loans to Franklin, we believe that its short-term nature will not materially impact the cash flow assumptions used in our analysis supporting our 2008 fourth quarter actions. Cash collections through mid-February 2009 remained consistent with our valuation analysis expectations.
Automotive Industry
The table below provides a summary of loans outstanding and total exposure from loans, unused commitments, and standby letters of credit to companies related to the automotive industry.
Table 22 — Automotive Industry Exposure(1)
December 31, | ||||||||||||||||||||||||
2008 | 2007 | |||||||||||||||||||||||
Loans | % of Total | Total | Loans | % of Total | Total | |||||||||||||||||||
(in millions) | Outstanding | Loans | Exposure | Outstanding | Loans | Exposure | ||||||||||||||||||
Suppliers: | ||||||||||||||||||||||||
Domestic | $ | 182 | $ | 331 | $ | 235 | $ | 351 | ||||||||||||||||
Foreign | 33 | 46 | 27 | 38 | ||||||||||||||||||||
Total Suppliers | 215 | 0.52 | % | 377 | 261 | 0.64 | % | 389 | ||||||||||||||||
Dealer: | ||||||||||||||||||||||||
Floor plan — domestic | 553 | 747 | 432 | 604 | ||||||||||||||||||||
Floor plan — foreign | 408 | 544 | 363 | 498 | ||||||||||||||||||||
Other | 346 | 464 | 286 | 395 | ||||||||||||||||||||
Total Dealer | 1,306 | 3.18 | 1,755 | 1,081 | 2.63 | 1,496 | ||||||||||||||||||
Total Automotive | $ | 1,521 | 3.70 | % | $ | 2,131 | $ | 1,342 | 3.27 | % | $ | 1,885 | ||||||||||||
(1) | Companies with > 25% of revenue derived from the automotive industry. |
We do not have any direct exposure to any automobile manufacturing companies, including companies that currently have significant operations within our geographic regions. However, we do have $377 million of exposure to companies that derive more than 25% of their revenues from contracts with the automobile manufacturing companies. This low level of exposure is reflective of our industry-level risk-limits approach. Our floorplan exposure is centered in large, multi-dealership entities. Client selection is a primary focus for us in this industry.
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Commercial Real Estate Portfolio
As shown in Table 23, commercial real estate loans totaled $10.1 billion and represented 25% of our total loan exposure at December 31, 2008.
Table 23 — Commercial Real Estate Loans by Property Type and Borrower Location
At December 31, 2008 | ||||||||||||||||||||||||||||||||
Total | % of | |||||||||||||||||||||||||||||||
(in millions) | Ohio | Michigan | Pennsylvania | Indiana | West Virginia | Other | Amount | portfolio | ||||||||||||||||||||||||
Retail properties | $ | 1,610 | $ | 228 | $ | 222 | $ | 148 | $ | 54 | $ | 3 | $ | 2,265 | 22.4 | % | ||||||||||||||||
Single family home builders | 1,127 | 246 | 97 | 73 | 33 | 13 | 1,589 | 15.7 | ||||||||||||||||||||||||
Office | 728 | 209 | 171 | 56 | 53 | 5 | 1,222 | 12.1 | ||||||||||||||||||||||||
Multi family | 845 | 83 | 106 | 116 | 29 | 9 | 1,188 | 11.8 | ||||||||||||||||||||||||
Industrial and warehouse | 719 | 198 | 39 | 72 | 24 | 2 | 1,054 | 10.4 | ||||||||||||||||||||||||
Lines to real estate companies | 771 | 172 | 39 | 16 | 31 | 1 | 1,030 | 10.2 | ||||||||||||||||||||||||
Raw land and other land uses | 512 | 111 | 87 | 42 | 14 | — | 766 | 7.6 | ||||||||||||||||||||||||
Health care | 283 | 63 | 59 | 3 | 3 | — | 411 | 4.1 | ||||||||||||||||||||||||
Hotel | 193 | 64 | 20 | 12 | 15 | — | 304 | 3.0 | ||||||||||||||||||||||||
Other | 214 | 12 | 16 | 12 | 6 | 9 | 269 | 2.7 | ||||||||||||||||||||||||
Total | $ | 7,002 | $ | 1,386 | $ | 856 | $ | 550 | $ | 262 | $ | 42 | $ | 10,098 | 100.0 | % | ||||||||||||||||
Net charge-offs | $ | 40.2 | $ | 17.1 | $ | 0.6 | $ | 5.6 | $ | 2.3 | $ | 2.9 | $ | 68.7 | ||||||||||||||||||
Net charge-offs — annualized percentage | 0.65 | % | 1.34 | % | 0.09 | % | 1.06 | % | 1.07 | % | 0.36 | % | 0.71 | % | ||||||||||||||||||
Non-accrual loans | $ | 276.9 | $ | 124.3 | $ | 10.2 | $ | 23.1 | $ | 0.1 | $ | 11.1 | $ | 445.7 | ||||||||||||||||||
% of portfolio | 3.95 | % | 8.97 | % | 1.19 | % | 4.20 | % | 0.04 | % | 26.43 | % | 4.41 | % | ||||||||||||||||||
Accruing loans past due 90 days or more | $ | 47.2 | $ | 6.9 | $ | 2.0 | $ | 0.4 | $ | — | $ | 2.9 | $ | 59.4 | ||||||||||||||||||
% of portfolio | 0.67 | % | 0.50 | % | 0.23 | % | 0.07 | % | — | % | 6.90 | % | 0.59 | % |
CRE loan credit quality data regarding NCOs, NALs, and accruing loans past due 90 days or more by industry classification code for 2008 and 2007 are presented in the table below:
Table 24 — Commercial Real Estate Loans Credit Quality Data by Property Type
Year Ended December 31, | At December 31, | |||||||||||||||||||||||||||||||||||||||
2007 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||||
2008 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||||
Net charge-offs | ||||||||||||||||||||||||||||||||||||||||
Nonaccrual Loans | Accruing loans past due | |||||||||||||||||||||||||||||||||||||||
(in millions) | Amount | Percentage | Amount | Percentage | 90 days or more | |||||||||||||||||||||||||||||||||||
Retail properties | $ | 7.0 | 0.38 | % | $ | 4.0 | 0.35 | % | $ | 78.3 | $ | 8.2 | $ | 4.2 | $ | 8.3 | ||||||||||||||||||||||||
Single family home builder | 35.0 | 2.87 | 23.2 | 2.19 | 200.4 | 65.1 | 8.6 | 6.4 | ||||||||||||||||||||||||||||||||
Office | 1.7 | 0.15 | 0.9 | 0.11 | 19.9 | 5.7 | 0.3 | 1.9 | ||||||||||||||||||||||||||||||||
Multi family | 9.5 | 0.84 | 2.0 | 0.24 | 42.9 | 23.3 | 12.3 | 0.4 | ||||||||||||||||||||||||||||||||
Industrial and warehouse | 2.3 | 0.24 | 2.8 | 0.44 | 20.4 | 8.6 | 2.1 | 0.2 | ||||||||||||||||||||||||||||||||
Lines to real estate companies | 4.6 | 0.46 | — | — | 26.3 | 16.0 | 5.2 | 0.6 | ||||||||||||||||||||||||||||||||
Raw land and other land uses | 5.1 | 0.34 | 5.3 | 0.48 | 33.5 | 15.5 | 7.9 | 6.2 | ||||||||||||||||||||||||||||||||
Health care | 1.0 | 0.27 | 0.6 | 0.24 | 6.2 | 1.3 | 3.7 | 0.0 | ||||||||||||||||||||||||||||||||
Hotel | — | — | 0.2 | 0.11 | 0.8 | 0.2 | 14.5 | 0.6 | ||||||||||||||||||||||||||||||||
Other | 2.4 | 0.97 | 0.1 | 0.05 | 16.9 | 4.5 | 0.4 | — | ||||||||||||||||||||||||||||||||
Total | $ | 68.7 | 0.71 | % | $ | 39.1 | 0.57 | % | $ | 445.7 | $ | 148.5 | $ | 59.4 | $ | 24.6 | ||||||||||||||||||||||||
We manage the risks inherent in this portfolio through origination policies, concentration limits, on-going loan level reviews, recourse requirements, and continuous portfolio risk management activities. Our origination policies for this portfolio include loan product-type specific policies such as loan-to-value (LTV), debt service coverage ratios, and pre-leasing requirements, as applicable. Except for our mezzanine portfolio, we generally: (a) limit our loans to 80% of the appraised value of the commercial real estate, (b) require net operating cash flows to be 125% of required interest and principal payments, and (c) if the commercial real estate is non-owner occupied, require that at least 50% of the space of the project be pre-leased. We also may require more conservative loan terms, depending on the project.
Dedicated commercial real estate professionals located in our banking regions originated the majority of this portfolio. Appraisals from approved vendors are reviewed by an appraisal review group within Huntington to ensure the quality of the valuation used in the underwriting process. The portfolio is diversified by project type and loan size. This diversification is a significant piece of the credit risk management strategies employed for this portfolio. Our loan review staff provides an assessment of the quality of the underwriting and structure and confirms that an appropriate internal risk rating has been assigned to the loan.
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Appraisal values are updated as needed, in conformity with regulatory requirements. Given the stressed environment for some loan types, we have initiated on-going portfolio level reviews of segments such as single family home builders and retail properties(see “Single Family Home Builders” and “Retail properties” discussions). These reviews often generate an updated appraisal based on the current occupancy or sales volume associated with the project being reviewed.
At the portfolio level, we actively monitor the concentrations and performance metrics of all loan types, with a focus on higher risk segments. Macro-level stress-test scenarios based on home-price depreciation trends for the builder segment are embedded in our performance expectations. An intense credit quality review of this portfolio was conducted during 2008. As a result of this review, we anticipate the current stress within this portfolio will continue throughout 2009, leading to elevated charge-offs, NALs, and ALLL levels.
Table 24 provides certain performance metrics for the CRE loan portfolio by state. Michigan and Ohio have experienced the most stress historically as measured by delinquency and loss rates.
Single Family Home Builders
At December 31, 2008, we had $1.6 billion of loans to single family home builders, which also includes mobile home parks, condominium construction, land held for development, etc. Such loans represented 4% of total loans and leases. Of this portfolio, 69% were to finance projects currently under construction, 15% to finance land under development, and 16% to finance land held for development. The $1.6 billion represented a $91 million, or 6%, increase compared with the December 31, 2007 balance. The increase primarily reflects reclassifications during the 2008 first quarter from other CRE segments, primarily associated with smaller loans acquired during the Sky Financial acquisition. This portfolio is included within our CRE portfolio, discussed above.
The housing market across our geographic footprint remained stressed, reflecting relatively lower sales activity, declining prices, and excess inventories of houses to be sold, particularly impacting borrowers in our East Michigan and northern Ohio regions. Further, a portion of the loans extended to borrowers located within our geographic regions was to finance projects outside of our geographic regions. We anticipate the residential developer market will continue to be depressed, and anticipate continued pressure on the single family home builder segment in 2009. As previously mentioned, all significant exposures are monitored on a periodic basis. This monthly process includes: (a) all loans greater than $50 thousand within this portfolio have been reviewed continuously over the past 18 months and continue to be monitored, (b) credit valuation adjustments have been made when appropriate based on the current condition of each relationship, and (c) reserves have been increased based on proactive risk identification and thorough borrower analysis.
Retail Properties
Our portfolio of commercial real estate loans secured by retail properties totaled $2.3 billion, or approximately 6% of total loans and leases, at December 31, 2008. Loans to this borrower segment increased from $1.8 billion at December 31, 2007. Credit approval in this loan segment is generally dependant on pre-leasing requirements, and net operating income from the project must cover interest expense by specified percentages when the loan is fully funded.
The weakness of the economic environment in our geographic regions significantly impacted the projects that secure the loans in this portfolio segment. Increased unemployment levels compared with recent years, and the expectation that these levels will continue to increase for the foreseeable future, are expected to adversely affect our borrowers’ ability to repay of these loans. We have increased the level of credit risk management scrutiny that we exert over this portfolio, and analyze our retail property loans at a much more detailed level, combining property type, geographic location, tenants, and other data, to assess and manage our credit concentration risks within this portfolio.
Consumer Credit
(This section should be read in conjunction with Significant Item 1.)
Consumer credit approvals are based on, among other factors, the financial strength and payment history of the borrower, type of exposure, and the transaction structure. Consumer credit decisions are generally made in a centralized environment utilizing decision models. There is also individual credit authority granted to certain individuals on a regional basis to preserve our local decision-making focus. Each credit extension is assigned a specific probability-of-default and loss-given-default. The probability-of-default is generally a function of the borrower’s most recent credit bureau score (FICO), which we update quarterly, while the loss-given-default is related to the type of collateral and the loan-to-value ratio associated with the credit extension.
In consumer lending, credit risk is managed from a loan type and vintage performance analysis. All portfolio segments are continuously monitored for changes in delinquency trends and other asset quality indicators. We make extensive use of portfolio assessment models to continuously monitor the quality of the portfolio, which may result in changes to future origination strategies. The continuous analysis and review process results in a determination of an appropriate ALLL amount for our consumer loan portfolio. The independent risk management group has a consumer process review component to ensure the effectiveness and efficiency of the consumer credit processes.
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Collection action is initiated on an “as needed” basis through a centrally managed collection and recovery function. The collection group employs a series of collection methodologies designed to maintain a high level of effectiveness while maximizing efficiency. In addition to the retained consumer loan portfolio, the collection group is responsible for collection activity on all sold and securitized consumer loans and leases.Please refer to the “Nonperforming Assets” discussion for further information regarding the placement of consumer loans on nonaccrual status and the charging off of balances to the ALLL.
Our consumer loan portfolio is primarily comprised of traditional residential mortgages, home equity loans and lines of credit, and automobile loans and leases. The residential mortgage and home equity portfolios are diversified throughout our geographic footprint.
As the performance of our automobile loan and lease portfolio changed during 2007, adjustments were made to our underwriting processes and modeling approach that resulted in increased average FICO score and lower LTV ratios. The positive effects have continued into 2008 as originations have shown lower levels of cumulative risk compared with 2007 originations. Our automobile loan and lease portfolio is primarily located within our banking footprint, with no out-of-footprint state representing more than 10% of our 2008 originations. Florida, an out-of-footprint state that we have consistently operated in for over 10 years, represented 10% of our automobile loan and lease originations during 2008.
The general slowdown in the housing market has impacted the performance of our residential mortgage and home equity portfolios over the past year. While the degree of price depreciation varies across our markets, all regions throughout our footprint have been affected.
Given the market conditions in our markets as described above in the single family home builder section, the home equity and residential mortgage portfolios are particularly noteworthy, and are discussed below:
Table 25 — Selected Home Equity and Residential Mortgage Portfolio Data
Home Equity Loans | Home Equity Lines of Credit | Residential Mortgages | ||||||||||||||||||||||||
12/31/08 | 12/31/07 | 12/31/08 | 12/31/07 | 12/31/08 | 12/31/07 | |||||||||||||||||||||
Ending Balance | $ | 3.1 billion | $ | 3.4 billion | $ | 4.4 billion | $ | 3.9 billion | $ | 4.8 billion | $ | 5.4 billion | ||||||||||||||
Portfolio Weighted Average LTV ratio(1) | 70 | % | 69 | % | 78 | % | 78 | % | 76 | % | 76 | % | ||||||||||||||
Portfolio Weighted Average FICO(2) | 725 | 732 | 720 | 724 | 707 | 709 | ||||||||||||||||||||
Year Ended December 31, 2008 | ||||||||||||||||||||||||||
Home Equity Loans | Home Equity Lines of Credit | Residential Mortgages | ||||||||||||||||||||||||
Originations | $ | 501 million | $ | 1,939 million | $ | 607 million | ||||||||||||||||||||
Origination Weighted Average LTV ratio(1) | 66 | % | 74 | % | 74 | % | ||||||||||||||||||||
Origination Weighted Average FICO(2) | 741 | 755 | 735 |
(1) | The loan-to-value (LTV) ratios for home equity loans and home equity lines of credit are cumulative LTVs reflecting the balance of any senior loans. |
(2) | Portfolio Weighted Average FICO reflects currently updated customer credit scores whereas Origination Weighted Average FICO reflects the customer credit scores at the time of loan origination. |
Home Equity Portfolio
Our home equity portfolio (loans and lines of credit) consists of both first and second mortgage loans with underwriting criteria based on minimum FICO credit scores, debt-to-income ratios, and LTV ratios. Included in our home equity loan portfolio are $1.5 billion of loans where the loan is secured by a first-mortgage lien on the property. We offer closed-end home equity loans with a fixed interest rate and level monthly payments and a variable-rate, interest-only home equity line of credit. The weighted average cumulative LTV ratio at origination of our home equity portfolio was 75% at December 31, 2008, unchanged from December 31, 2007.
We believe we have granted credit conservatively within this portfolio. We have not originated home equity loans or lines of credit that allow negative amortization. Also, we have not originated home equity loans or lines of credit with an LTV ratio at origination greater than 100%, except for infrequent situations with high quality borrowers. Home equity loans are generally fixed-rate with periodic principal and interest payments. Home equity lines of credit generally have variable-rates of interest and do not require payment of principal during the10-year revolving period of the line.
We have taken several actions to mitigate the risk profile of this portfolio. We reduced, and in 2007, ultimately stopped originating new production through brokers, a culmination of our strategy begun in early 2005 to diminish our exposure to the broker channel. Reducing our reliance on brokers also lowers the risk profile as this channel typically included a higher-risk borrower profile, as well as the risks associated with a third party sourcing arrangement. Also, we have focused production within our banking footprint. In 2008, a home-equity line-of-credit management program was initiated to reduce our exposure to higher-risk customers including, but not limited to, the reduction of line-of-credit limits.
We continue to make appropriate origination policy adjustments based on our own assessment of an appropriate risk profile as well as industry actions. As an example, the significant changes made in 2008 by Fannie Mae and Freddie Mac resulted in the reduction of our maximum LTV ratio on second-mortgage loans, even for customers with high FICO scores. While it is still too early to make any
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declarative statements regarding the impact of these actions, our more recent originations have shown consistent, or lower, levels of cumulative risk during the first twelve months of the loan or line of credit term compared with earlier originations.
Residential Mortgages
We focus on higher quality borrowers, and underwrite all applications centrally, or through the use of an automated underwriting system. We do not originate residential mortgage loans that allow negative amortization or are “payment option adjustable-rate mortgages.” Additionally, we generally do not originate residential mortgage loans that have an LTV ratio greater than 95%, although such loans with an LTV ratio of up to 100% are originated in certain limited situations. Also, our residential mortgage portfolio has immaterial loan balances with teaser-rates, that is, loans with a lower introductory interest rates that generally increase after the introductory period has expired.
A majority of the loans in our loan portfolio have adjustable rates. Our adjustable-rate mortgages (ARMs) are primarily residential mortgages that have a fixed-rate for the first 3 to 5 years and then adjust annually. These loans comprised approximately 63% of our total residential mortgage loan portfolio at December 31, 2008. At December 31, 2008, ARM loans that were expected to have rates reset in 2009 and 2010 totaled $889 million and $486 million, respectively. Given the quality of our borrowers and the decline in interest rates during 2008, we believe that we have a relatively limited exposure to ARM reset risk. Nonetheless, we have taken actions to mitigate our risk exposure. We initiate borrower contact at least six months prior to the interest rate resetting, and have been successful in converting many ARMs to fixed-rate loans through this process. Additionally, where borrowers are experiencing payment difficulties, loans may be re-underwritten based on the borrower’s ability to repay the loan.
We had $445.4 million of Alt-A mortgage loans in the residential mortgage loan portfolio at December 31, 2008, compared with $531.4 million at December 31, 2007. These loans have a higher risk profile than the rest of the portfolio as a result of origination policies including stated income, stated assets, and higher acceptable LTV ratios. At December 31, 2008, borrowers for Alt-A mortgages had an average current FICO score of 671 and the loans had an average LTV ratio of 88%, essentially unchanged from December 31, 2007. Total Alt-A NCOs were an annualized 1.80% for 2008, compared with an annualized 0.81% for 2007. Our exposure related to this product will decline in the future as we stopped originating these loans in 2007.
Interest-only loans comprised $691.9 million, or 15%, of residential real estate loans at December 31, 2008, compared with $856.4 million, or 16%, at December 31, 2007. Interest-only loans are underwritten to specific standards including minimum FICO credit scores, stressed debt-to-income ratios, and extensive collateral evaluation. At December 31, 2008, borrowers for interest-only loans had an average current FICO score of 724 and the loans had an average LTV ratio of 78%, compared with 729 and 79%, respectively, at December 31, 2007. Total interest-only NCOs were an annualized 0.21% for 2008, compared with an annualized 0.05% for 2007. We continue to believe that we have mitigated the risk of such loans by matching this product with appropriate borrowers.
Credit Quality
We believe the most meaningful way to assess overall credit quality performance for 2008 is through an analysis of credit quality performance ratios. This approach forms the basis of most of the discussion in the three sections immediately following: NALs and NPAs, ACL, and NCOs.
Credit quality performance in 2008 was negatively impacted by the deterioration of the Franklin portfolio(see “Franklin Relationship” discussion), as well as the continued economic weakness across our Midwest markets. These economic factors influenced the performance of NCOs and NALs, as well as an expected commensurate significant increase in the provision for credit losses(see “Provision for Credit Losses” located within the “Discussion of Results of Operations section)that increased the absolute and relative levels of our ACL. We anticipate a challenging full-year in 2009 with regards to credit quality, resulting in continued levels of elevated NCOs, NALs, NPAs, and ACL across all of our loan portfolios.
Nonaccruing Loans (NAL/NALs) and Nonperforming Assets (NPA/NPAs)
(This section should be read in conjunction with Significant Items 1 and 2.)
NPAs consist of (a) NALs, which represent loans and leases that are no longer accruing interest, (b) NALs held-for-sale, (c) OREO, and (d) other NPAs. C&I and CRE loans are generally placed on nonaccrual status when collection of principal or interest is in doubt or when the loan is90-days past due. When interest accruals are suspended, accrued interest income is reversed with current year accruals charged to earnings and prior-year amounts generally charged-off as a credit loss.
Consumer loans and leases, excluding residential mortgages and home equity lines and loans, are not placed on nonaccrual status but are charged-off in accordance with regulatory statutes, which is generally no more than120-days past due. Residential mortgages and home equity loans and lines are placed on nonaccrual status within180-days past due as to principal and210-days past due as to interest, regardless of collateral. A charge-off on a residential mortgage loan is recorded when the loan has been foreclosed and the loan balance exceeds the fair value of the real estate. The fair value of the collateral, less the cost to sell, is then recorded as OREO.
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When we believe the borrower’s ability and intent to make periodic interest and principal payments has resumed, and collectibility is no longer in doubt, the loan is returned to accrual status.
Table 26 reflects period-end NALs, NPAs, accruing restructured loans (ARLs), and past due loans and leases detail for each of the last five years.
Table 26 — Nonaccrual Loans (NALs), Nonperforming Assets (NPAs) and Past Due Loans and Leases
At December 31, | ||||||||||||||||||||
(in thousands) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Nonaccrual loans and leases (NALs): | ||||||||||||||||||||
Commercial and industrial | $ | 282,423 | $ | 87,679 | $ | 58,393 | $ | 55,273 | $ | 34,692 | ||||||||||
Franklin Credit Management Corporation | 650,225 | — | — | — | — | |||||||||||||||
Commercial real estate | 445,717 | 148,467 | 37,947 | 18,309 | 8,670 | |||||||||||||||
Residential mortgage | 98,951 | 59,557 | 32,527 | 17,613 | 13,545 | |||||||||||||||
Home equity | 24,831 | 24,068 | 15,266 | 10,720 | 7,055 | |||||||||||||||
Total nonaccrual loans and leases | 1,502,147 | 319,771 | 144,133 | 101,915 | 63,962 | |||||||||||||||
Other real estate, net: | ||||||||||||||||||||
Residential(1) | 63,058 | 60,804 | 47,898 | 14,214 | 8,762 | |||||||||||||||
Commercial | 59,440 | 14,467 | 1,589 | 1,026 | 35,844 | |||||||||||||||
Total other real estate, net | 122,498 | 75,271 | 49,487 | 15,240 | 44,606 | |||||||||||||||
Impaired loans held-for-sale(2) | 12,001 | 73,481 | — | — | — | |||||||||||||||
Other nonperforming assets(3) | — | 4,379 | — | — | — | |||||||||||||||
Total nonperforming assets (NPAs) | 1,636,646 | 472,902 | 193,620 | 117,155 | 108,568 | |||||||||||||||
Accruing restructured loans (ARLs): | ||||||||||||||||||||
Franklin | — | 1,187,368 | — | — | — | |||||||||||||||
Other | 306,417 | — | — | — | — | |||||||||||||||
Total ARLs(4) | 306,417 | 1,187,368 | — | — | — | |||||||||||||||
Total NPAs and ARLs | $ | 1,943,063 | $ | 1,660,270 | $ | 193,620 | $ | 117,155 | $ | 108,568 | ||||||||||
Nonaccrual loans and leases as a % of total loans and leases | 3.66 | % | 0.80 | % | 0.55 | % | 0.42 | % | 0.27 | % | ||||||||||
NPA ratio(5) | 3.97 | 1.18 | 0.74 | 0.48 | 0.46 | |||||||||||||||
NPA and ARL ratio(6) | 4.71 | 4.13 | 0.74 | 0.48 | 0.46 | |||||||||||||||
Accruing loans and leases past due 90 days or more | $ | 203,985 | $ | 140,977 | $ | 59,114 | $ | 56,138 | $ | 54,283 | ||||||||||
Accruing loans and leases past due 90 days or more as a percent of total loans and leases | 0.50 | % | 0.35 | % | 0.23 | % | 0.23 | % | 0.23 | % | ||||||||||
Total allowances for credit losses (ACL) as% of: | ||||||||||||||||||||
Total loans and leases | 2.30 | 1.61 | 1.19 | 1.25 | 1.29 | |||||||||||||||
Nonaccrual loans and leases | 63 | 202 | 217 | 300 | 476 | |||||||||||||||
NPAs | 58 | 136 | 161 | 261 | 280 | |||||||||||||||
NPAs and ARLs | 49 | 39 | 161 | 261 | 280 |
(1) | Beginning in 2006, OREO includes balances of loans in foreclosure that are serviced for others and, which are fully guaranteed by the U.S. Government, that were reported in 90 day past due loans and leases in prior periods. |
(2) | Impaired loans held-for-sale are carried at the lower of cost or fair value less costs to sell. |
(3) | Other nonperforming assets represent certain investment securities backed by mortgage loans to borrowers with lower FICO scores. |
(4) | Represents accruing loans that have been restructured. 2007 includes only Tranche A and B of the Franklin relationship. In 2008, Tranche B of the Franklin relationship was charged off, and Tranche A was placed on nonaccrual status. In addition, 2008 includes only other commercial loans and residential mortgage loans that have been restructured. |
(5) | NPAs divided by the sum of loans and leases, impaired loans held-for-sale, net other real estate, and other NPAs. |
(6) | NPAs and ARLs divided by the sum of loans and leases, impaired loans held-for-sale, net other real estate, and other NPAs. |
NPAs, which include NALs, were $1,636.6 million at December 31, 2008, and represented 3.97% of related assets. This compared with $472.9 million, or 1.18%, at December 31, 2007. The $1,163.7 million increase reflected:
– | $1,182.4 million increase to NALs, discussed below. | |
– | $47.2 million increase to OREO, primarily reflecting two foreclosures during the 2008 fourth quarter. |
Partially offset by:
– | $61.5 million decrease in impaired loans held-for-sale, primarily reflecting loan sales and payments. |
NALs were $1,502.1 million at December 31, 2008, compared with $319.8 million at December 31, 2007. The increase of $1,182.4 million primarily reflected:
– | $650.2 million increase related to the placing of the Franklin portfolio on nonaccrual status(see “Franklin relationship” discussion). | |
– | $297.3 million increase in CRE NALs reflecting the continued softness in the residential real estate development markets and overall economic weakness in our markets. The increase was spread across all regions, but was more concentrated to our borrowers in the Greater Cleveland, Northwest Ohio, and East Michigan regions. |
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– | $194.7 million increase in non-Franklin-related C&I NALs reflecting the overall economic weakness in our markets. The increase was spread across all regions. |
As part of our loss mitigation process, we increased our efforts in 2008 to re-underwrite, modify, or restructure loans when borrowers are experiencing payment difficulties, and these loan restructurings are based on the borrower’s ability to repay the loan.
NPA activity for each of the past five years was as follows:
Table 27 — Nonperforming Asset Activity
Year Ended December 31, | ||||||||||||||||||||
(in thousands) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Nonperforming assets, beginning of year | $ | 472,902 | $ | 193,620 | $ | 117,155 | $ | 108,568 | $ | 87,386 | ||||||||||
New nonperforming assets | 1,082,063 | 468,056 | 222,043 | 171,150 | 137,359 | |||||||||||||||
Franklin Credit Management Corporation(1) | 650,225 | — | — | — | — | |||||||||||||||
Acquired nonperforming assets | — | 144,492 | 33,843 | — | — | |||||||||||||||
Returns to accruing status | (42,161 | ) | (24,952 | ) | (43,999 | ) | (7,547 | ) | (3,795 | ) | ||||||||||
Loan and lease losses | (221,831 | ) | (126,754 | ) | (46,191 | ) | (38,819 | ) | (37,337 | ) | ||||||||||
Payments | (194,692 | ) | (86,093 | ) | (59,469 | ) | (64,861 | ) | (43,319 | ) | ||||||||||
Sales | (109,860 | ) | (95,467 | ) | (29,762 | ) | (51,336 | ) | (31,726 | ) | ||||||||||
Nonperforming assets, end of year | $ | 1,636,646 | $ | 472,902 | $ | 193,620 | $ | 117,155 | $ | 108,568 | ||||||||||
(1) | The activity above excludes the 2007 impact of the placement of the loans to Franklin on nonaccrual status and their return to accrual status upon the restructuring of these loans. At 2007 year-end, the loans to Franklin were not included in the nonperforming assets total. |
Allowances for Credit Losses (ACL)
(This section should be read in conjunction with Significant Items 1 and 2.)
We maintain two reserves, both of which are available to absorb credit losses: the ALLL and the AULC. When summed together, these reserves constitute the total ACL. Our credit administration group is responsible for developing the methodology and determining the adequacy of the ACL.
The ALLL represents the estimate of probable losses inherent in the loan portfolio at the balance sheet date. Additions to the ALLL result from recording provision expense for loan losses or recoveries, while reductions reflect charge-offs, net of recoveries, or the sale of loans. The AULC is determined by applying the transaction reserve process, which is described later in this section, to the unfunded portion of the portfolio adjusted by an applicable funding expectation.
We have an established monthly process to determine the adequacy of the ACL that relies on a number of analytical tools and benchmarks. No single statistic or measurement, in itself, determines the adequacy of the allowance. The allowance is comprised of two components: the transaction reserve and the economic reserve. Changes to the transaction reserve component of the ALLL are impacted by changes in the estimated loss inherent in our loan portfolios. For example, our process requires increasingly higher level of reserves as a loan’s internal classification moves from higher quality rankings to lower, and vice versa. This movement across the credit scale is called migration.
The transaction reserve component of the ACL includes both (a) an estimate of loss based on pools of commercial and consumer loans and leases with similar characteristics, and (b) an estimate of loss based on an impairment review of each loan greater than $1 million for business-banking loans, and $500,000 for all other loans, that is considered to be impaired. For commercial loans, the estimate of loss based on pools of loans and leases with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The reserve factors applied to these portfolios were developed based on internal credit migration models that track historical movements of loans between loan ratings over time and a combination of long-term average loss experience of our own portfolio and external industry data. In the case of more homogeneous portfolios, such as consumer loans and leases, the determination of the transaction reserve is based on reserve factors that include the use of forecasting models to measure inherent loss in these portfolios. We update the models and analyses frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in the loss mitigation or credit origination strategies. Adjustments to the reserve factors are made, as needed, based on observed results of the portfolio analytics.
The general economic reserve incorporates our determination of the impact of risks associated with the general economic environment on the portfolio. The reserve is designed to address economic uncertainties and is determined based on economic indices as well as a variety of other economic factors that are correlated to the historical performance of the loan portfolio. Currently, two national and two regionally focused indices are utilized. The two national indices are: (1) Real Consumer Spending, and (2) Consumer Confidence. The two regionally focused indices are: (1) Institute for Supply Management Manufacturing, and
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(2) Non-agriculture Job Creation. Because of this approach to recognizing risks in the general economy, the general economic reserve may fluctuate from period to period, subject to a minimum level specified by policy.
The estimated loss factors assigned to credit exposures across our portfolios are updated from time to time based on changes in actual performance. During the 2008 first quarter, we updated the expected loss factors used to estimate the AULC. The lower expected loss factors were based on our observations of how unfunded loan commitments have historically become funded loans.
As shown in the following tables, the ALLL increased to $900.2 million at December 31, 2008, from $578.4 million at December 31, 2007. Expressed as a percent of period-end loans and leases, the ALLL ratio increased to 2.19% at December 31, 2008, from 1.44% at December 31, 2007. This $321.8 million increase primarily reflected the impact of the continued economic weakness across our Midwest markets. Also contributing to the increase, albeit to a lesser degree, was the reclassification of the $12.1 million economic reserve component of the AULC to the economic reserve component of the ALLL, resulting in the entire economic reserve component of the ACL residing in the ALLL. This action also contributed to the decrease in the AULC to $44.1 million at December 31, 2008, from $66.5 million at December 31, 2007. Expressed as a percent of total period end loans and leases, the AULC ratio decreased to 0.11% at December 31, 2008, from 0.17% at December 31, 2008. At December 31, 2008, the specific ALLL related to Franklin was $130.0 million, an increase from $115.3 million at December 31, 2007.
The ALLL as a percentage of NALs decreased to 60% from 181%. As new nonaccruals are identified, we conduct formal impairment testing that may result in an increase to our ALLL. A significant portion of the increases in the ALLL has been a result of this impairment testing process. As such, we are comfortable that we have taken appropriate action regarding NALs.
Table 28 — Allocation of Allowances for Credit Losses(1)
At December 31, | ||||||||||||||||||||||||||||||||||||||||
(in thousands) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||||||||||||||||||
Commercial and industrial | $ | 282,201 | 31.4 | % | $ | 180,286 | 29.8 | % | $ | 117,481 | 30.0 | % | $ | 116,016 | 27.8 | % | $ | 108,892 | 24.7 | % | ||||||||||||||||||||
Franklin Credit Management Corporation | 130,000 | 1.6 | 115,269 | 3.0 | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Commercial real estate | 322,681 | 24.6 | 172,998 | 22.9 | 72,272 | 17.2 | 67,670 | 16.5 | 65,529 | 19.0 | ||||||||||||||||||||||||||||||
Total commercial | 734,882 | 57.6 | 468,553 | 55.7 | 189,753 | 47.2 | 183,686 | 44.3 | 174,421 | 43.7 | ||||||||||||||||||||||||||||||
Consumer: | ||||||||||||||||||||||||||||||||||||||||
Automobile loans and leases | 44,712 | 10.9 | 28,635 | 10.7 | 28,400 | 14.9 | 33,870 | 17.5 | 41,273 | 18.6 | ||||||||||||||||||||||||||||||
Home equity | 63,538 | 18.3 | 45,957 | 18.2 | 32,572 | 18.8 | 30,245 | 19.5 | 29,275 | 19.7 | ||||||||||||||||||||||||||||||
Residential mortgage | 44,463 | 11.6 | 20,746 | 13.6 | 13,349 | 17.4 | 13,172 | 17.1 | 18,995 | 16.3 | ||||||||||||||||||||||||||||||
Other loans | 12,632 | 1.6 | 14,551 | 1.8 | 7,994 | 1.7 | 7,374 | 1.6 | 7,247 | 1.7 | ||||||||||||||||||||||||||||||
Total consumer | 165,345 | 42.4 | 109,889 | 44.3 | 82,315 | 52.8 | 84,661 | 55.7 | 96,790 | 56.3 | ||||||||||||||||||||||||||||||
Total allowance for loan and lease losses | $ | 900,227 | 100.0 | % | $ | 578,442 | 100.0 | % | $ | 272,068 | 100.0 | % | $ | 268,347 | 100.0 | % | $ | 271,211 | 100.0 | % | ||||||||||||||||||||
Allowance for unfunded loan commitments and letters of credit | 44,139 | 66,528 | 40,161 | 36,957 | 33,187 | |||||||||||||||||||||||||||||||||||
Total allowances for credit losses | $ | 944,366 | $ | 644,970 | $ | 312,229 | $ | 305,304 | $ | 304,398 | ||||||||||||||||||||||||||||||
(1) | Percentages represent the percentage of each loan and lease category to total loans and leases. |
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Table 29 — Summary of Allowances for Credit Losses and Related Statistics
Year Ended December 31, | ||||||||||||||||||||
(in thousands) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Allowance for loan and lease losses, beginning of year | $ | 578,442 | $ | 272,068 | $ | 268,347 | $ | 271,211 | $ | 299,732 | ||||||||||
Acquired allowance for loan and lease losses | — | 188,128 | 23,785 | — | — | |||||||||||||||
Loan and lease charge-offs | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
Franklin Credit Management Corporation | (423,269 | ) | (308,496 | ) | — | — | — | |||||||||||||
Other commecial and industrial | (115,165 | ) | (50,961 | ) | (33,244 | ) | (37,731 | ) | (30,212 | ) | ||||||||||
Commercial and industrial | (538,434 | ) | (359,457 | ) | (33,244 | ) | (37,731 | ) | (30,212 | ) | ||||||||||
Construction | (6,631 | ) | (11,902 | ) | (4,156 | ) | (534 | ) | (2,500 | ) | ||||||||||
Commercial | (65,565 | ) | (29,152 | ) | (4,393 | ) | (5,534 | ) | (6,780 | ) | ||||||||||
Commercial real estate | (72,196 | ) | (41,054 | ) | (8,549 | ) | (6,068 | ) | (9,280 | ) | ||||||||||
Total commercial | (610,630 | ) | (400,511 | ) | (41,793 | ) | (43,799 | ) | (39,492 | ) | ||||||||||
Consumer: | ||||||||||||||||||||
Automobile loans | (56,217 | ) | (28,607 | ) | (20,262 | ) | (25,780 | ) | (45,336 | ) | ||||||||||
Automobile leases | (15,891 | ) | (12,634 | ) | (13,527 | ) | (12,966 | ) | (11,689 | ) | ||||||||||
Automobile loans and leases | (72,108 | ) | (41,241 | ) | (33,789 | ) | (38,746 | ) | (57,025 | ) | ||||||||||
Home equity | (70,457 | ) | (37,221 | ) | (24,950 | ) | (20,129 | ) | (17,514 | ) | ||||||||||
Residential mortgage | (23,012 | ) | (12,196 | ) | (4,767 | ) | (2,561 | ) | (1,975 | ) | ||||||||||
Other loans | (30,122 | ) | (26,773 | ) | (14,393 | ) | (10,613 | ) | (10,109 | ) | ||||||||||
Total consumer | (195,699 | ) | (117,431 | ) | (77,899 | ) | (72,049 | ) | (86,623 | ) | ||||||||||
Total charge-offs | (806,330 | ) | (517,942 | ) | (119,692 | ) | (115,848 | ) | (126,115 | ) | ||||||||||
Recoveries of loan and lease charge-offs | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
Franklin Credit Management Corporation | — | — | — | — | — | |||||||||||||||
Other commecial and industrial | 12,269 | 13,617 | 12,376 | 12,731 | 23,639 | |||||||||||||||
Commercial and industrial | 12,269 | 13,617 | 12,376 | 12,731 | 23,639 | |||||||||||||||
Construction | 5 | 48 | 602 | 399 | 75 | |||||||||||||||
Commercial | 3,451 | 1,902 | 1,163 | 1,095 | 321 | |||||||||||||||
Commercial real estate | 3,456 | 1,950 | 1,765 | 1,494 | 396 | |||||||||||||||
Total commercial | 15,725 | 15,567 | 14,141 | 14,225 | 24,035 | |||||||||||||||
Consumer: | ||||||||||||||||||||
Automobile loans | 14,989 | 11,422 | 11,932 | 13,792 | 16,761 | |||||||||||||||
Automobile leases | 2,554 | 2,127 | 3,082 | 1,302 | 853 | |||||||||||||||
Automobile loans and leases | 17,543 | 13,549 | 15,014 | 15,094 | 17,614 | |||||||||||||||
Home equity | 2,901 | 2,795 | 3,096 | 2,510 | 2,440 | |||||||||||||||
Residential mortgage | 1,765 | 825 | 262 | 229 | 215 | |||||||||||||||
Other loans | 10,328 | 7,575 | 4,803 | 3,733 | 3,276 | |||||||||||||||
Total consumer | 32,537 | 24,744 | 23,175 | 21,566 | 23,545 | |||||||||||||||
Total recoveries | 48,263 | 40,311 | 37,316 | 35,791 | 47,580 | |||||||||||||||
Net loan and lease charge-offs | (758,067 | ) | (477,631 | ) | (82,376 | ) | (80,057 | ) | (78,535 | ) | ||||||||||
Provision for loan and lease losses | 1,067,789 | 628,802 | 62,312 | 83,782 | 57,397 | |||||||||||||||
Economic reserve transfer | 12,063 | — | — | (6,253 | ) | — | ||||||||||||||
Allowance for assets sold and securitized | — | — | — | (336 | ) | (7,383 | ) | |||||||||||||
Allowance for loans transferred to held for sale | — | (32,925 | ) | — | — | — | ||||||||||||||
Allowance for loan and lease losses, end of year | $ | 900,227 | $ | 578,442 | $ | 272,068 | $ | 268,347 | $ | 271,211 | ||||||||||
Allowance for unfunded loan commitments and letters of credit, beginning of year | $ | 66,528 | $ | 40,161 | $ | 36,957 | $ | 33,187 | $ | 35,522 | ||||||||||
Acquired allowance for unfunded loan commitments and letters of credit | — | 11,541 | 325 | — | — | |||||||||||||||
Provision for unfunded loan commitments and letters of credit losses | (10,326 | ) | 14,826 | 2,879 | (2,483 | ) | (2,335 | ) | ||||||||||||
Economic reserve transfer | (12,063 | ) | — | — | 6,253 | — | ||||||||||||||
Allowance for unfunded loan commitments and letters of credit, end of year | $ | 44,139 | $ | 66,528 | $ | 40,161 | $ | 36,957 | $ | 33,187 | ||||||||||
Allowance for credit losses, end of year | $ | 944,366 | $ | 644,970 | $ | 312,229 | $ | 305,304 | $ | 304,398 | ||||||||||
Allowance for loan and lease losses as a % of total period end loans and leases | 2.19 | % | 1.44 | % | 1.04 | % | 1.10 | % | 1.15 | % | ||||||||||
Allowance for unfunded loan commitments and letters of credit as a % of total period end loans and leases | 0.11 | 0.17 | 0.15 | 0.15 | 0.14 | |||||||||||||||
Allowance for credit losses as a % of total period end loans and leases | 2.30 | % | 1.61 | % | 1.19 | % | 1.25 | % | 1.29 | % |
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Net Charge-offs (NCOs)
(This section should be read in conjunction with Significant Items 1 and 2.)
Table 30 reflects NCO detail for each of the last five years.
Table 30 — Net Loan and Lease Charge-offs
Year Ended December 31, | ||||||||||||||||||||
(in thousands) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Net charge-offs by loan and lease type: | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
Franklin Credit Management Corporation | $ | 423,269 | $ | 308,496 | (1) | $ | — | $ | — | $ | — | |||||||||
Other commercial and industrial | 102,896 | 37,344 | 20,868 | 25,000 | 6,573 | |||||||||||||||
Commercial and industrial | 526,165 | 345,840 | 20,868 | 25,000 | 6,573 | |||||||||||||||
Construction | 6,626 | 11,854 | 3,553 | 135 | 2,425 | |||||||||||||||
Commercial | 62,114 | 27,250 | 3,230 | 4,439 | 6,459 | |||||||||||||||
Commercial real estate | 68,740 | 39,104 | 6,783 | 4,574 | 8,884 | |||||||||||||||
Total commercial | 594,905 | 384,944 | 27,651 | 29,574 | 15,457 | |||||||||||||||
Consumer: | ||||||||||||||||||||
Automobile loans | 41,228 | 17,185 | 8,330 | 11,988 | 28,574 | |||||||||||||||
Automobile leases | 13,337 | 10,507 | 10,445 | 11,664 | 10,837 | |||||||||||||||
Automobile loans and leases | 54,565 | 27,692 | 18,775 | 23,652 | 39,411 | |||||||||||||||
Home equity | 67,556 | 34,426 | 21,854 | 17,619 | 15,074 | |||||||||||||||
Residential mortgage | 21,247 | 11,371 | 4,505 | 2,332 | 1,760 | |||||||||||||||
Other loans | 19,794 | 19,198 | 9,591 | 6,880 | 6,833 | |||||||||||||||
Total consumer | 163,162 | 92,687 | 54,725 | 50,483 | 63,078 | |||||||||||||||
Total net charge-offs | $ | 758,067 | $ | 477,631 | $ | 82,376 | $ | 80,057 | $ | 78,535 | ||||||||||
Net charge-offs — annualized percentages: | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
Franklin Credit Management Corporation | 39.01 | % | 20.27 | % | — | % | — | % | — | % | ||||||||||
Other commercial and industrial | 0.82 | 0.41 | 0.28 | 0.41 | 0.12 | |||||||||||||||
Commercial and industrial | 3.87 | 3.25 | 0.28 | 0.41 | 0.12 | |||||||||||||||
Construction | 0.32 | 0.77 | 0.28 | 0.01 | 0.17 | |||||||||||||||
Commercial | 0.81 | 0.52 | 0.10 | 0.16 | 0.23 | |||||||||||||||
Commercial real estate | 0.71 | 0.57 | 0.15 | 0.10 | 0.20 | |||||||||||||||
Total commercial | 2.55 | 2.21 | 0.23 | 0.28 | 0.16 | |||||||||||||||
Consumer: | ||||||||||||||||||||
Automobile loans | 1.12 | 0.65 | 0.40 | 0.59 | 1.25 | |||||||||||||||
Automobile leases | 1.57 | 0.71 | 0.51 | 0.48 | 0.49 | |||||||||||||||
Automobile loans and leases | 1.21 | 0.67 | 0.46 | 0.53 | 0.88 | |||||||||||||||
Home equity | 0.91 | 0.56 | 0.44 | 0.37 | 0.36 | |||||||||||||||
Residential mortgage | 0.42 | 0.23 | 0.10 | 0.06 | 0.05 | |||||||||||||||
Other loans | 2.86 | 3.63 | 2.18 | 1.79 | 1.74 | |||||||||||||||
Total consumer | 0.92 | 0.59 | 0.39 | 0.37 | 0.51 | |||||||||||||||
Net charge-offs as a % of average loans | 1.85 | % | 1.44 | % | 0.32 | % | 0.33 | % | 0.35 | % | ||||||||||
(1) | 2007 includes charge-offs totaling $397.0 million associated with the Franklin restructuring. These charge-offs were reduced by the unamortized discount associated with the loans, and by other amounts received by Franklin totaling $88.5 million, resulting in net charge-offs totaling $308.5 million. |
Total commercial NCOs during 2008 were $594.9 million, or an annualized 2.55% of average related balances, compared with $384.9 million or an annualized 2.21% in 2007. Both 2008 and 2007 included Franklin relationship-related NCOs of $423.3 million and $308.5 million, respectively. Non-Franklin-related NCOs in 2008 were $102.9, compared with non-Franklin-related NCOs in 2007 of $37.3 million. The non-Franklin-related increase of $65.6 million in C&I NCOs reflected the continued economic weakness in our regions as the increase was spread across all regions and consisted primarily of smaller loans, as well as the impact of the Sky Financial acquisition. The $29.6 million increase in CRE NCOs was centered in the single family home builder portfolio spread across our regions.
In reviewing commercial NCOs trends, it is helpful to understand that reserves for such loans are usually established in periods prior to that in which any related NCOs are typically recognized. As the quality of a commercial credit deteriorates, it migrates from a higher quality loan classification to a lower quality classification. As a part of our normal process, the credit is reviewed and reserves are established or increased as warranted. It is usually not until a later period that the credit is resolved and a NCO is
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recognized. If the previously established reserves exceed that needed to satisfactorily resolve the problem credit, a recovery would be recognized; if not, a final NCO is recorded. Increases in reserves precede increases in NALs. Once a credit is classified as NAL, it is evaluated for specific reserves. As a result, an increase in NALs does not necessarily result in an increase in reserves. In sum, the typical sequence are periods of building reserve levels, followed by periods of higher NCOs that are applied against these previously established reserves.
Total consumer NCOs during 2008 were $163.2 million, or an annualized 0.92%, compared with $92.7 million, or an annualized 0.59%, in 2007. The increases were spread across all consumer loan portfolios, and across all our regions.
The increases in automobile loan and lease NCOs from the prior year-end reflected the negative impact resulting from declines in used-car prices, as well as the impact of the Sky Financial acquisition. The automobile lease NCO rate is also negatively impacted, as the portfolio is running off as no new leases are being originated. Although we anticipate that automobile loan and lease NCOs will remain under pressure due to continued economic weakness in our regions, we believe that our focus on higher quality borrowers, as evidenced by the average FICO scores at origination exceeding 750 in 2008, over the last several years will continue to result in better performance relative to other peer bank automobile portfolios.
The increase in our home equity NCOs reflected the continued negative impacts resulting from the general economic and housing market slowdown, as well as the impact of the Sky Financial acquisition. The impact was evident across all our regions, but performance was most impacted in our Michigan regions. Given that we have: (a) no exposure to the very volatile west coast market, (b) insignificant exposure to the Florida markets, resulting from loans made to our Private Banking customers in that area, (c) less than 10% of the portfolio originated via the broker channel, and (d) conservatively assessed the borrowers’ ability to repay at the time of underwriting the loan, we continue to believe our home equity NCO experience will compare favorably relative to the industry.
The increase in our residential mortgage NCOs reflected the negative impacts resulting from the general economic conditions and housing-related pressures. We expect to see additional stress across our regions in future periods. We anticipate that our portfolio performance will continue to be positively impacted by our origination strategy that specifically excluded the more exotic mortgage structures. In addition, improved loss-mitigation strategies have been in place for over a year, and are helping to successfully address risks in our ARM portfolio.
Total NCOs during 2008 were $758.1 million, or an annualized 1.85% of average related balances compared with $477.6 million, or annualized 1.44% of average related balances in 2007. After adjusting for NCOs of $423.3 million in 2008 and $308.5 million in 2007 related to the Franklin relationship, total NCOs during 2008 were $334.8 million, compared with $169.1 million during 2007. We anticipate a challenging full-year in 2009 with regards to credit quality, resulting in continued levels of elevated NCOs across all of our loan and lease portfolios.
Investment Securities Portfolio
(This section should be read in conjunction with Significant Item 5.)
We routinely review our investment securities portfolio, and recognize impairment write-downs based primarily on fair value, issuer-specific factors and results, and our intent to hold such investments. Our investment securities portfolio is evaluated in light of established asset/liability management objectives, and changing market conditions that could affect the profitability of the portfolio, as well as the level of interest rate risk to which we are exposed.
Our investment securities portfolio is comprised of various financial instruments. At December 31, 2008, our investment securities portfolio totaled $4.4 billion. The composition and maturity of the portfolio is presented on the following table. Please refer to the“Critical Accounting Policies and Use of Significant Estimates”section for additional information regarding fair value measurements and the three-level hierarchy for determining fair value.
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Table 31 — Investment Securities
At December 31, | ||||||||||||
(in thousands) | 2008 | 2007 | 2006 | |||||||||
U.S. Treasury | $ | 11,157 | $ | 556 | $ | 1,856 | ||||||
Federal agencies | 2,231,821 | 1,744,216 | 1,431,410 | |||||||||
Other | 2,141,479 | 2,755,399 | 2,929,658 | |||||||||
Total investment securities | $ | 4,384,457 | $ | 4,500,171 | $ | 4,362,924 | ||||||
Duration in years(1) | 5.2 | 3.2 | 3.2 | |||||||||
Amortized | ||||||||||||
Cost | Fair Value | Yield(2) | ||||||||||
U.S. Treasury | ||||||||||||
Under 1 year | $ | 11,141 | $ | 11,157 | 1.44 | % | ||||||
1-5 years | — | — | — | |||||||||
6-10 years | — | — | — | |||||||||
Over 10 years | — | — | — | |||||||||
Total U.S. Treasury | 11,141 | 11,157 | 1.44 | |||||||||
Federal agencies | ||||||||||||
Mortgage backed securities | ||||||||||||
Under 1 year | — | — | — | |||||||||
1-5 years | — | — | — | |||||||||
6-10 years | 1 | — | 5.87 | |||||||||
Over 10 years | 1,625,655 | 1,627,581 | 5.85 | |||||||||
Total mortgage-backed Federal agencies | 1,625,656 | 1,627,581 | 5.85 | |||||||||
Other agencies | ||||||||||||
Under 1 year | — | — | — | |||||||||
1-5 years | 579,546 | 595,912 | 2.93 | |||||||||
6-10 years | 7,954 | 8,328 | 4.30 | |||||||||
Over 10 years | — | — | — | |||||||||
Total other Federal agencies | 587,500 | 604,240 | 2.95 | |||||||||
Total Federal agencies | 2,213,156 | 2,231,821 | 5.07 | |||||||||
Municipal securities | ||||||||||||
Under 1 year | — | — | — | |||||||||
1-5 years | 51,890 | 54,184 | 5.92 | |||||||||
6-10 years | 216,433 | 222,086 | 6.05 | |||||||||
Over 10 years | 441,825 | 434,076 | 6.74 | |||||||||
Total municipal securities | 710,148 | 710,346 | 6.46 | |||||||||
Private label CMO | ||||||||||||
Under 1 year | — | — | — | |||||||||
1-5 years | — | — | — | |||||||||
6-10 years | — | — | — | |||||||||
Over 10 years | 674,506 | 523,515 | 5.63 | |||||||||
Total private label CMO | 674,506 | 523,515 | 5.63 | |||||||||
Asset backed securities | ||||||||||||
Under 1 year | — | — | — | |||||||||
1-5 years | — | — | — | |||||||||
6-10 years | — | — | — | |||||||||
Over 10 years | 652,881 | 464,027 | 9.28 | |||||||||
Total asset-backed securities | 652,881 | 464,027 | 9.28 | |||||||||
Other | ||||||||||||
Under 1 year | 549 | 552 | 3.33 | |||||||||
1-5 years | 6,546 | 6,563 | 3.65 | |||||||||
6-10 years | 798 | 811 | 3.45 | |||||||||
Over 10 years | 64 | 136 | 5.41 | |||||||||
Non-marketable equity securities | 427,973 | 427,973 | 5.47 | |||||||||
Marketable equity securities | 8,061 | 7,556 | 4.17 | |||||||||
Total other | 443,991 | 443,591 | 5.34 | |||||||||
Total investment securities | $ | 4,705,823 | $ | 4,384,457 | 5.82 | % | ||||||
(1) | The average duration assumes a market driven pre-payment rate on securities subject to pre-payment. |
(2) | Weighted average yields were calculated using amortized cost on a fully taxable equivalent basis, assuming a 35% tax rate. |
Declines in the fair value of available for sale investment securities are recorded as either temporary impairment or other-than-temporary impairment (OTTI). Temporary adjustments are recorded when the fair value of a security fluctuates from its historical cost. Temporary adjustments are recorded in accumulated other comprehensive income, and impact our equity position. Temporary adjustments do not impact net income. A recovery of available for sale security prices also is recorded as an adjustment to other comprehensive income for securities that are temporarily impaired, and results in a positive impact to our equity position.
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OTTI is recorded when the fair value of an available for sale security is less than historical cost, and it is probable that all contractual cash flows will not be collected. OTTI is recorded to noninterest income, and therefore, results in a negative impact to net income. Because the available for sale securities portfolio is recorded at fair value, the conclusion as to whether an investment decline is other-than-temporarily impaired, does not significantly impact our equity position, as the amount of the temporary adjustment has already been reflected in accumulated other comprehensive income/loss. A recovery in the value of an other-than-temporarily impaired security is recorded as additional interest income over the remaining life of the security.
Given the continued disruption in the financial markets, we may be required to recognize additional OTTI losses in future periods with respect to our available for sale investment securities portfolio. The amount and timing of any additional OTTI will depend on the decline in the underlying cash flows of the securities.
The table below presents the credit ratings as of December 31, 2008, for certain investment securities:
Table 32 — Credit Ratings of Selected Investment Securities(1)
Average Credit Rating of Fair Value Amount at December 31, 2008 | ||||||||||||||||||||||||||||||||
Amortized | ||||||||||||||||||||||||||||||||
(in thousands) | Cost | Fair Value | AAA | AA +/- | A +/- | BBB +/- | <BBB- | Not Rated | ||||||||||||||||||||||||
Municipal securities | $ | 710,148 | $ | 710,346 | $ | 96,268 | $ | 472,094 | $ | 117,574 | $ | 11,394 | $ | — | $ | 13,016 | ||||||||||||||||
Private label CMO securities | 674,506 | 523,515 | 329,165 | 53,057 | 85,159 | 14,296 | 41,838 | — | ||||||||||||||||||||||||
Alt-A mortgage-backed securities | 368,927 | 322,421 | 51,341 | 19,320 | 88,947 | 9,380 | 153,433 | — | ||||||||||||||||||||||||
Pooled-trust-preferred securities | 283,954 | 141,606 | 10,142 | 12,000 | — | 26,024 | 93,440 | — |
(1) | Credit ratings reflect the lowest current rating assigned by a nationally recognized credit rating agency. |
Given the current economic conditions, the asset-backed securities and private-label CMO portfolios are noteworthy, and are discussed below. Asset-backed securities comprise both Alt-A mortgage backed securities and pooled-trust-preferred securities.
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Asset-backed and Private-label CMO securities
Table 33 details our asset-backed and private-label CMO securities exposure:
Table 33 — Mortgage Loan Backed and Pooled Trust Preferred Securities Selected Data At December 31, 2008
(in thousands)
Alt-A mortgage-backed securities
Impaired | Unimpaired | Total | ||||||||||
Par value | $ | 406,074 | $ | 143,615 | $ | 549,689 | ||||||
Book value | 227,933 | 140,994 | 368,927 | |||||||||
Unrealized losses | — | (46,506 | ) | (46,506 | ) | |||||||
Fair value | $ | 227,933 | $ | 94,488 | $ | 322,421 | ||||||
Cumulative OTTI | $ | 176,928 | $ | — | $ | 176,928 | ||||||
Average Credit Rating | BBB- | |||||||||||
Weighted average:(1) | ||||||||||||
Fair value | 56 | % | 66 | % | 59 | % | ||||||
Expected loss | 9.6 | — | 7.1 | |||||||||
Pooled-trust-preferred securities | ||||||||||||
Par value | $ | 25,500 | $ | 273,351 | $ | 298,851 | ||||||
Book value | 10,715 | 273,239 | 283,954 | |||||||||
Unrealized losses | — | (142,348 | ) | (142,348 | ) | |||||||
Fair value | $ | 10,715 | $ | 130,891 | $ | 141,606 | ||||||
Cumulative OTTI | $ | 14,508 | $ | — | $ | 14,508 | ||||||
Average Credit Rating | BBB- | |||||||||||
Weighted average:(1) | ||||||||||||
Fair value | 42 | % | 48 | % | 47 | % | ||||||
Expected loss | 8.0 | — | 0.7 | |||||||||
Private-label CMO securities | ||||||||||||
Par value | $ | 23,212 | $ | 664,930 | $ | 688,142 | ||||||
Book value | 16,996 | 657,510 | 674,506 | |||||||||
Unrealized losses | — | (150,991 | ) | (150,991 | ) | |||||||
Fair value | $ | 16,996 | $ | 506,519 | $ | 523,515 | ||||||
Cumulative OTTI | $ | 5,728 | $ | — | $ | 5,728 | ||||||
Average Credit Rating | A | |||||||||||
Weighted average:(1) | ||||||||||||
Fair value | 73 | % | 76 | % | 76 | % | ||||||
Expected loss | 0.5 | — | — |
(1) | Based on par values. |
As shown in the above table, the securities in the asset-backed securities and private-label CMO securities portfolios had a fair value that was $339.8 million less than their book value (net of impairment) at December 31, 2008, resulting from increased liquidity spreads and extended duration. We consider the $339.8 million of impairment to be temporary, as we believe that it is not probable that not all contractual cash flows will be collected on the related securities. However, in 2008, we recognized OTTI of $176.9 million within the Alt-A mortgage-backed securities portfolio, $14.5 million within the pooled-trust-preferred securities portfolio, and $5.7 million within the private-label CMO securities portfolio. We anticipate that the OTTI exceeds the expected actual future loss (that is, credit losses) that we will experience. Any subsequent recovery of OTTI will be recorded to interest income over the remaining life of the security. Please refer to the“Critical Account Policies and Use of Significant Estimates”for additional information.
Market Risk
Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, foreign exchange rates, equity prices, credit spreads, and expected lease residual values. We have identified two primary sources of market risk: interest rate risk and price risk. Interest rate risk is our primary market risk.
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Interest Rate Risk
Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest bearing assets and liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to terminate certificates of deposit before maturity (option risk), changes in the shape of the yield curve whereby interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk.)
Our board of directors establishes broad policy limits with respect to interest rate risk. Our Market Risk Committee (MRC) establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our MRC regularly monitors the level of interest rate risk sensitivity to ensure compliance with board of directors approved risk limits.
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk position given Line of Business forecasts, management objectives, market expectations, and policy constraints.
“Asset sensitive position” refers to a decrease in short-term interest rates that is expected to generatelower net interest income as rates earned on our interest earning assets would reprice downward more quickly than rates paid on our interest bearing liabilities. Conversely, “liability sensitive position” refers to a decrease in short-term interest rates that is expected to generatehigher net interest income as rates paid on our interest bearing liabilities would reprice downward more quickly than rates earned on our interest earning assets.
Income Simulation and Economic Value Analysis
Interest rate risk measurement is performed monthly. Two broad approaches to modeling interest rate risk are employed: income simulation and economic value analysis. An income simulation analysis is used to measure the sensitivity of forecasted net interest income to changes in market rates over a one-year time horizon. Although bank owned life insurance and automobile operating lease assets are classified as noninterest earning assets, and the income from these assets is in noninterest income, these portfolios are included in the interest sensitivity analysis because both have attributes similar to fixed-rate interest earning assets. Economic value of equity (EVE) analysis is used to measure the sensitivity of the values of period-end assets and liabilities to changes in market interest rates. EVE serves as a complement to income simulation modeling as it provides risk exposure estimates for time periods beyond the one-year simulation horizon.
The models used for these measurements take into account prepayment speeds on mortgage loans, mortgage-backed securities, and consumer installment loans, as well as cash flows of other assets and liabilities. Balance sheet growth assumptions are also considered in the income simulation model. The models include the effects of derivatives, such as interest rate swaps, interest rate caps, floors, and other types of interest rate options.
The baseline scenario for income simulation analysis, with which all other scenarios are compared, is based on market interest rates implied by the prevailing yield curve as of the period end. Alternative interest rate scenarios are then compared with the baseline scenario. These alternative interest rate scenarios include parallel rate shifts on both a gradual and immediate basis, movements in interest rates that alter the shape of the yield curve (e.g., flatter or steeper yield curve), and current interest rates remaining unchanged for the entire measurement period. Scenarios are also developed to measure short-term repricing risks, such as the impact of LIBOR-based interest rates rising or falling faster than the prime rate.
The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual “+/-100” and “+/-200” basis point parallel shifts in market interest rates over the next12-month period beyond the interest rate change implied by the current yield curve. As of December 31, 2008, management instituted an assumption that market interest rates would not fall below 0% over the next12-month period for the scenarios that used the “-100” and “-200” basis point parallel shift in market interest rates. The table below shows the results of the scenarios as of December 31, 2008, and December 31, 2007. All of the positions were well within the board of directors’ policy limits.
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Table 34 — Net Interest Income at Risk
Net Interest Income at Risk (%) | ||||||||||||||||
Basis point change scenario | –200 | –100 | +100 | +200 | ||||||||||||
Board policy limits | –4.0 | % | –2.0 | % | –2.0 | % | –4.0 | % | ||||||||
December 31, 2008 | –0.3 | % | –0.9 | % | +0.6 | % | +1.1 | % | ||||||||
December 31, 2007 | –3.0 | % | –1.3 | % | +1.4 | % | +2.2 | % |
The net interest income at risk reported as of December 31, 2008 for the ‘‘+200 basis point scenario” shows a change from the prior year to a lower near-term asset sensitive position, reflecting actions taken by us to reduce net interest income at risk. The factors contributing to the change include:
– | 1.9% incremental liability sensitivity reflecting the execution of $2.5 billion of receive fixed-rate, pay variable-rate interest rate swaps, and the termination of $0.2 billion of pay fixed-rate, receive variable-rate interest rate swaps during the 2008 first quarter. | |
– | 1.6% incremental asset sensitivity reflecting improved rate-deposit-pricing and balance-sensitivity models in the 2008 fourth quarter. The impact of these improved models, discussed above, resulted in significantly less sensitivity to changes in market interest rates. | |
– | 1.6% incremental liability sensitivity reflecting the execution of a net increase of $2.3 billion of receive fixed-rate, pay variable-rate interest rate swaps during the 2008 fourth quarter. | |
– | 0.9% incremental asset sensitivity reflecting the receipt of $1.4 billion of equity capital resulting from the TARP voluntary CPP funds during the 2008 fourth quarter(see “Capital” section). |
The remainder of the change in net interest income at risk “+200” basis points was primarily related to slower growth in fixed-rate loans and a shift in deposits towards fixed-rate time deposits from money market accounts, offset by the impact of slower prepayments on mortgage assets.
The primary simulations for EVE at risk assume immediate “+/-100” and ‘‘+/-200” basis point parallel shifts in market interest rates beyond the interest rate change implied by the current yield curve. The table below outlines the December 31, 2008, results compared with December 31, 2007. All of the positions were well within the board of directors’ policy limits.
Table 35 — Economic Value of Equity at Risk
Economic Value of Equity at Risk (%) | ||||||||||||||||
Basis point change scenario | –200 | –100 | +100 | +200 | ||||||||||||
Board policy limits | –12.0 | % | –5.0 | % | –5.0 | % | –12.0 | % | ||||||||
December 31, 2008 | –3.4 | % | –1.0 | % | –2.6 | % | –7.2 | % | ||||||||
December 31, 2007 | –0.3 | % | +1.1 | % | –4.4 | % | –10.8 | % |
The EVE at risk reported as of December 31, 2008 for the “+200 basis point scenario” shows a change from the prior year to a lower long-term liability sensitive position. The factors contributing to the change include:
– | 3.0% incremental asset sensitivity reflecting improved rate-deposit-pricing and balance-sensitivity models in the 2008 fourth quarter. The impact of these improved models, discussed above, resulted in significantly less sensitivity to changes in market interest rates. | |
– | 1.9% incremental asset sensitivity reflecting the receipt of $1.4 billion of equity capital resulting from the TARP voluntary CPP funds during the 2008 fourth quarter(see “Capital” section). |
The remainder of the change in EVE at risk “+200” basis points was primarily related to slower growth in fixed-rate loans, a shift in deposits towards fixed-rate time deposits from money market accounts, and the impact of expected faster prepayments on mortgage assets going forward, offset by the net increase in receive fixed-rate, pay variable-rate interest rate swaps executed during 2008.
Mortgage Servicing Rights (MSRs)
(This section should be read in conjunction with Significant Item 4.)
MSR fair values are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise. We have employed strategies to reduce the
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risk of MSR fair value changes. In addition, a third party has been engaged to provide improved valuation tools and assistance with our strategies with the objective to decrease the volatility from MSR fair value changes. However, volatile changes in interest rates can diminish the effectiveness of these hedges. We typically report MSR fair value adjustments net of hedge-related trading activity in the mortgage banking income category of noninterest income.
Beginning in 2006, we adopted Statement of Financial Accounting Standards (Statement) No. 156,Accounting for Servicing of Financial Assets (an amendment of FASB Statement No. 140),which allowed us to carry MSRs at fair value. This resulted in a $5.1 million pretax ($0.01 per common share) positive impact in 2006. Under the fair value approach, servicing assets and liabilities are recorded at fair value at each reporting date. Changes in fair value between reporting dates are recorded as an increase or decrease in mortgage banking income. MSR assets are included in other assets, and are presented in Table 10.
Through late 2008, we used trading account securities and trading derivatives to offset MSR valuation changes. The valuations of trading securities and trading derivatives that we use generally react to interest rate changes in an opposite direction compared with changes in MSR valuations. As a result, changes in interest rate levels that impact MSR valuations should result in corresponding offsetting, or partially offsetting, trading gains or losses. As such, in periods where MSR fair values decline, the fair values of trading account securities and derivatives typically increase, resulting in a recognition of trading gains that offset, or partially offset, the decline in fair value recognized for the MSR, and vice versa. The MSR valuation changes and the gains or losses from the trading account securities and trading derivatives are recorded as a components of mortgage banking income, although any interest income from the securities is included in interest income.
At December 31, 2008, we had a total of $167.4 million of MSRs representing the right to service $15.8 billion in mortgage loans.(See Note 7 of the Notes to the Consolidated Financial Statements.)
Price Risk
(This section should be read in conjunction with Significant Item 5.)
Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and are subject to fair value accounting. We have price risk from trading securities, which included instruments to hedge MSRs, however the strategy of using trading securities to hedge MSRs ceased in late 2008. We also have price risk from securities owned by our broker-dealer subsidiaries, foreign exchange positions, equity investments, investments in securities backed by mortgage loans, and marketable equity securities held by our insurance subsidiaries. We have established loss limits on the trading portfolio, on the amount of foreign exchange exposure that can be maintained, and on the amount of marketable equity securities that can be held by the insurance subsidiaries.
Equity Investment Portfolios
In reviewing our equity investment portfolio, we consider general economic and market conditions, including industries in which private equity merchant banking and community development investments are made, and adverse changes affecting the availability of capital. We determine any impairment based on all of the information available at the time of the assessment. New information or economic developments in the future could result in recognition of additional impairment.
From time to time, we invest in various investments with equity risk. Such investments include investment funds that buy and sell publicly traded securities, investment funds that hold securities of private companies, direct equity or venture capital investments in companies (public and private), and direct equity or venture capital interests in private companies in connection with our mezzanine lending activities. These investments are reported as a component of “accrued income and other assets” on our consolidated balance sheet. At December 31, 2008, we had a total of $44.7 million of such investments, down from $48.7 million at December 31, 2007. The following table details the components of this change during 2008:
Table 36 — Equity Investment Activity
Balance at | New | Returns of | Balance at | |||||||||||||
(in thousands) | December 31, 2007 | Investments | Capital | Gain/(Loss) | December 31, 2008 | |||||||||||
Type: | ||||||||||||||||
Public equity | $ | 16,583 | $ | — | $ | — | $ | (4,454 | ) | $ | 12,129 | |||||
Private equity | 20,202 | 7,579 | (391) | (1,439 | ) | 25,951 | ||||||||||
Direct investment | 11,962 | 2,161 | (4,443) | (3,104 | ) | 6,576 | ||||||||||
Total | $ | 48,747 | $ | 9,740 | $ | (4,834) | $ | (8,997 | ) | $ | 44,656 | |||||
The equity investment losses in 2008 reflected a $5.9 million venture capital loss during the 2008 first quarter, and $4.5 million of losses on public equity investment funds that buy and sell publicly traded securities, and private equity investments. These
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investments were in funds that focus on the financial services sector that, during 2008, performed worse than the broad equity market.
Investment decisions that incorporate credit risk require the approval of the independent credit administration function. The degree of initial due diligence and subsequent review is a function of the type, size, and collateral of the investment. Performance is monitored on a regular basis, and reported to the MRC and the Risk Committee of the board of directors.
Liquidity Risk
Liquidity risk is the risk of loss due to the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, investor and customer perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues. We manage liquidity risk at both the Bank and at the parent company, Huntington Bancshares Incorporated.
Liquidity policies and limits are established by our board of directors, with operating limits set by the MRC, based upon analyses of the ratio of loans to deposits, the percentage of assets funded with noncore or wholesale funding, and the amount of liquid assets available to cover noncore funds maturities. In addition, guidelines are established to ensure diversification of wholesale funding by type, source, and maturity and provide sufficient balance sheet liquidity to cover 100% of wholesale funds maturing within a six-month period. A contingency funding plan is in place, which includes forecasted sources and uses of funds under various scenarios in order to prepare for unexpected liquidity shortages, including the implications of any rating changes. The MRC meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and the maintenance of, the contingency funding plan.
Conditions in the capital markets remained volatile throughout 2008 resulting from the disruptions caused by the crises of investment banking firms and subsequent forced portfolio liquidations from a variety of investment funds. As a result, liquidity premiums and credit spreads widened significantly and many investors remained invested in lower risk investments such as U.S. Treasuries. Many banks relying on short-term funding structures, such as commercial paper, alternative collateral repurchase agreements, or other short-term funding vehicles, have had limited access to these funding markets. We, however, have maintained a diversified wholesale funding structure with an emphasis on reducing the risk from maturing borrowings resulting in minimizing our reliance on the short-term funding markets. We do not have an active commercial paper funding program and, while historically we have used the securitization markets (primarily indirect auto loans and leases) to provide funding, we do not rely heavily on these sources of funding. In addition, we do not provide liquidity facilities for conduits, structured investment vehicles, or other off-balance sheet financing structures. As expected, indicative credit spreads have widened in the secondary market for our debt. We expect these spreads to remain wider than in prior periods for the foreseeable future.
Bank Liquidity and Sources of Liquidity
Our primary sources of funding for the Bank are retail and commercial core deposits. As of December 31, 2008, these core deposits, of which our Regional Banking line of business provided 95%, funded 60% of total assets. The types and sources of deposits by business segment at December 31, 2008, are detailed in Table 37. At December 31, 2008, total core deposits represented 85% of total deposits, an increase from 84% at the prior year-end.
Core deposits are comprised of interest bearing and noninterest bearing demand deposits, money market deposits, savings and other domestic time deposits, consumer certificates of deposit both over and under $100,000, and nonconsumer certificates of deposit less than $100,000. Noncore deposits are comprised of brokered money market deposits and certificates of deposit, foreign time deposits, and other domestic time deposits of $100,000 or more comprised primarily of public fund certificates of deposit greater than $100,000.
Core deposits may increase our need for liquidity as certificates of deposit mature or are withdrawn before maturity and as nonmaturity deposits, such as checking and savings account balances, are withdrawn. Additionally, we are exposed to the risk that customers with large deposit balances will withdraw all or a portion of such deposits as the FDIC establishes certain limits on the amount of insurance coverage provided to depositors(see “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008). To mitigate our uninsured deposit risk, we have joined the Certificate of Deposit Account Registry Service (CDARS), a program that allows customers to invest up to $50 million in certificates of deposit through one participating financial institution, with the entire amount being covered by FDIC insurance.
Demand deposit overdrafts that have been reclassified as loan balances were $17.1 million and $23.4 million at December 31, 2008 and 2007, respectively.
In 2008, we reduced our dependence on noncore funds (total liabilities less core deposits and accrued expenses and other liabilities) to 29% of total assets, down from 30% in 2007. However, to the extent that we are unable to obtain sufficient liquidity through core deposits, we may meet our liquidity needs through sources of wholesale funding. These sources include other domestic time deposits of $100,000 or more, brokered deposits and negotiable CDs, deposits in foreign offices, short-term
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borrowings, FHLB advances, other long-term debt, and subordinated notes. At December 31, 2008, total wholesale funding was $13.8 billion, a decrease from $16.0 billion at December 31, 2007. The $13.8 billion portfolio at December 31, 2008, had a weighted average maturity of 4.2 years.
Domestic time deposits of $100,000 or more, brokered deposits and negotiable CDs totaled $4.9 billion at the end of 2008 and $5.2 billion at the end of 2007. The contractual maturities of these deposits at December 31, 2008 were as follows: $1.9 billion in three months or less, $0.8 billion in three months through six months, $1.2 billion in six months through twelve months, and $1.0 billion after twelve months.
We are a member of the FHLB of Cincinnati, which provides funding to members through advances. These advances carry maturities from one month to 20 years. At December 31, 2008, our wholesale funding included a maximum borrowing capacity of $4.6 billion, of which $2.0 billion remained unused at December 31, 2008. All FHLB borrowings are collateralized with mortgage-related assets such as residential mortgage loans and home equity loans.
The Bank also has access to the Federal Reserve’s discount window and Term Auction Facility (TAF). As of December 31, 2008, a total of $8.4 billion of commercial loans and home equity lines of credit were pledged to these facilities. As of December 31, 2008, we had no outstanding TAF borrowings, with a combined total of $6.7 billion of borrowing capacity available from both facilities. Also, we have a $6.0 billion domestic bank note program with $2.8 billion available for future issuance under this program as of December 31, 2008, that enables us to issue notes with maturities from one month to 30 years.
Table 37 — Deposit Composition
At December 31, | |||||||||||||||||||||||||||||||||||||||||
(in millions) | 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||||||||||||||||||||||
By Type | |||||||||||||||||||||||||||||||||||||||||
Demand deposits — noninterest bearing | $ | 5,477 | 14.4 | % | $ | 5,372 | 14.2 | % | $ | 3,616 | 14.4 | % | $ | 3,390 | 15.1 | % | $ | 3,392 | 16.3 | % | |||||||||||||||||||||
Demand deposits — interest bearing | 4,083 | 10.8 | 4,049 | 10.7 | 2,389 | 9.5 | 2,016 | 9.0 | 2,087 | 10.0 | |||||||||||||||||||||||||||||||
Money market deposits | 5,182 | 13.7 | 6,643 | 17.6 | 5,362 | 21.4 | 5,364 | 23.9 | 5,699 | 27.4 | |||||||||||||||||||||||||||||||
Savings and other domestic time deposits | 4,846 | 12.8 | 4,968 | 13.2 | 3,061 | 12.2 | 3,143 | 14.0 | 3,556 | 17.1 | |||||||||||||||||||||||||||||||
Core certificates of deposit | 12,727 | 33.5 | 10,736 | 28.4 | 5,365 | 21.4 | 3,988 | 17.8 | 2,755 | 13.3 | |||||||||||||||||||||||||||||||
Total core deposits | 32,315 | 85.2 | 31,768 | 84.1 | 19,793 | 78.9 | 17,901 | 79.8 | 17,489 | 84.1 | |||||||||||||||||||||||||||||||
Other domestic time deposits of $100,000 or more | 1,541 | 4.1 | 1,871 | 5.0 | 1,117 | 4.5 | 838 | 3.7 | 741 | 3.6 | |||||||||||||||||||||||||||||||
Brokered deposits and negotiable CDs | 3,354 | 8.8 | 3,377 | 8.9 | 3,346 | 13.4 | 3,200 | 14.3 | 2,097 | 10.1 | |||||||||||||||||||||||||||||||
Deposits in foreign offices | 733 | 1.9 | 727 | 2.0 | 792 | 3.2 | 471 | 2.2 | 441 | 2.2 | |||||||||||||||||||||||||||||||
Total deposits | $ | 37,943 | 100.0 | % | $ | 37,743 | 100.0 | % | $ | 25,048 | 100.0 | % | $ | 22,410 | 100.0 | % | $ | 20,768 | 100.0 | % | |||||||||||||||||||||
Total core deposits: | |||||||||||||||||||||||||||||||||||||||||
Commercial | $ | 7,758 | 24.0 | % | $ | 9,018 | 28.4 | % | $ | 6,063 | 30.6 | % | $ | 5,352 | 29.9 | % | $ | 5,294 | 30.3 | % | |||||||||||||||||||||
Personal | 24,557 | 76.0 | 22,750 | 71.6 | 13,730 | 69.4 | 12,549 | 70.1 | 12,195 | 69.7 | |||||||||||||||||||||||||||||||
Total core deposits | $ | 32,315 | 100.0 | % | $ | 31,768 | 100.0 | % | $ | 19,793 | 100.0 | % | $ | 17,901 | 100.0 | % | $ | 17,489 | 100.0 | % | |||||||||||||||||||||
By Business Segment(1) | |||||||||||||||||||||||||||||||||||||||||
Regional and Business Banking | $ | 27,314 | 71.9 | % | $ | 25,567 | 67.7 | % | |||||||||||||||||||||||||||||||||
Commercial Banking | 5,180 | 13.7 | 6,296 | 16.7 | |||||||||||||||||||||||||||||||||||||
Commercial Real Estate | 433 | 1.1 | 672 | 1.8 | |||||||||||||||||||||||||||||||||||||
Dealer Sales | 68 | 0.2 | 62 | 0.2 | |||||||||||||||||||||||||||||||||||||
Private Financial and Capital Markets Group | 1,777 | 4.7 | 1,664 | 4.4 | |||||||||||||||||||||||||||||||||||||
Treasury/Other (2) | 3,171 | 8.4 | 3,482 | 9.2 | |||||||||||||||||||||||||||||||||||||
Total deposits | $ | 37,943 | 100.0 | % | $ | 37,743 | 100.0 | % | |||||||||||||||||||||||||||||||||
(1) | Prior period amounts have been reclassified to conform to the current period business segment structure. | |
(2) | Comprised largely of national market deposits. |
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Table 38 — Federal Funds Purchased and Repurchase Agreements
At December 31, | ||||||||||||||||||||
(in millions) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Balance at year-end | $ | 1,389 | $ | 2,706 | $ | 1,632 | $ | 1,820 | $ | 1,124 | ||||||||||
Weighted average interest rate at year-end | 0.44 | % | 3.54 | % | 4.25 | % | 3.46 | % | 1.31 | % | ||||||||||
Maximum amount outstanding at month-end during the year | $ | 3,607 | $ | 2,961 | $ | 2,366 | $ | 1,820 | $ | 1,671 | ||||||||||
Average amount outstanding during the year | 2,485 | 2,295 | 1,822 | 1,319 | 1,356 | |||||||||||||||
Weighted average interest rate during the year | 1.75 | % | 4.14 | % | 4.02 | % | 2.41 | % | 0.88 | % |
Other potential sources of liquidity include the sale or maturity of investment securities, the sale or securitization of loans, and the issuance of common and preferred securities. During 2008, we reduced our dependency on overnight funding through: (a) an on-balance sheet securitization transaction, which raised $887 million of longer-term funding, (b) the net proceeds of our perpetual convertible preferred stock issuance, (c) the sale of $473 million of residential real estate loans, and (d) managing down of certain nonrelationship collateralized public funds deposits and related collateral securities. These actions reduced the outstanding national market maturities to $0.8 billion over the next 12 months. We anticipate that these maturities can be met through core deposit growth, FHLB advances, and normal national market funding sources, including brokered deposits and additional securitizations.
The relatively short-term nature of our loans and leases also provides significant liquidity. As shown in the table below, of the $23.6 billion total commercial loans at December 31, 2008, approximately 42% matures within one year.
Table 39 — Maturity Schedule of Commercial Loans
At December 31, 2008 | ||||||||||||||||||||
One Year | One to | After | Percent | |||||||||||||||||
(in millions) | or Less | Five Years | Five Years | Total | of total | |||||||||||||||
Commercial and industrial | $ | 6,185 | $ | 5,245 | $ | 2,111 | $ | 13,541 | 57.3 | % | ||||||||||
Commercial real estate - construction | 1,007 | 979 | 94 | 2,080 | 8.8 | |||||||||||||||
Commercial real estate - commercial | 2,646 | 3,547 | 1,825 | 8,018 | 33.9 | |||||||||||||||
Total | $ | 9,838 | $ | 9,771 | $ | 4,030 | $ | 23,639 | 100.0 | % | ||||||||||
Variable interest rates | $ | 9,409 | $ | 7,617 | $ | 3,407 | $ | 20,433 | 86.4 | % | ||||||||||
Fixed interest rates | 429 | 2,154 | 623 | 3,206 | 13.6 | |||||||||||||||
Total | $ | 9,838 | $ | 9,771 | $ | 4,030 | $ | 23,639 | 100.0 | % | ||||||||||
Percent of total | 41.6 | % | 41.3 | % | 17.1 | % | 100.0 | % |
At December 31, 2008, the fair value of our portfolio of investment securities totaled $4.4 billion, of which $2.7 billion was pledged to secure public and trust deposits, interest rate swap agreements, U.S. Treasury demand notes, and securities sold under repurchase agreements. The composition and maturity of these securities were presented in Table 31. Another source of liquidity is nonpledged securities, which decreased to $1.2 billion at December 31, 2008, from $1.7 billion at December 31, 2007.
In the 2008 fourth quarter, the FDIC introduced the TLGP. One component of this program guarantees certain newly issued senior unsecured debt. In the 2009 first quarter, we issued $600 million of such debt, and anticipate using the resultant proceeds to satisfy all of our maturing unsecured debt obligations in 2009.
Parent Company Liquidity
The parent company’s funding requirements consist primarily of dividends to shareholders, income taxes, funding of non-bank subsidiaries, repurchases of our stock, debt service, acquisitions, and operating expenses. The parent company obtains funding to meet obligations from dividends received from direct subsidiaries, net taxes collected from subsidiaries included in the federal consolidated tax return, fees for services provided to subsidiaries, and the issuance of debt securities.
At December 31, 2008, the parent company had $1.1 billion in cash or cash equivalents, compared with $0.2 billion at December 31, 2007. The $0.9 billion change primarily reflected the receipt of the $1.4 billion proceeds resulting from our participation in the TARP voluntary CPP, partially offset by a $0.5 billion subordinated note issued by the Bank to the parent company. Quarterly cash dividends paid on our common stock totaled $279.6 million during 2008. Table 51 provides additional detail regarding quarterly dividends declared per common share. Based on our most current quarterly common stock dividend declared of $0.01 per common share, cash demands of $59.5 million will be required in 2009 to pay declared dividends.
During 2008, we issued an aggregate $569 million of Series A Preferred Stock. The Series A Preferred Stock will pay, as declared by our board of directors, dividends in cash at a rate of 8.50% per annum, payable quarterly.(See Note 15 of the Notes to Consolidated Financial Statements.)Cash dividends paid on the Series A Preferred Stock totaled $23.2 million during 2008. An additional cash demand of $12.1 million is required in the 2009 first quarter, representing a quarterly cash dividend declared on our Series A Preferred Stock that was not payable until after January 1, 2009.
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Also during 2008, we received $1.4 billion of equity capital by issuing to the U.S. Department of Treasury 1.4 million shares of Series B Preferred Stock as a result of our participation in the TARP voluntary CPP. The Series B Preferred Stock will pay cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter, resulting in quarterly cash demands of $17.5 million through 2012, and $31.5 million thereafter. (See Note 15 of the Notes to the Consolidated Financial Statements for additional information regarding the Series B Preferred Stock issuance.)
Based on a regulatory dividend limitation, the Bank could not have declared and paid a dividend to the parent company at December 31, 2008, without regulatory approval. We do not anticipate the resumption of cash bank dividends to the parent company for the foreseeable future as we continue to build Bank regulatory capital above our already “well-capitalized” level. To help meet any additional liquidity needs, we have an open-ended, automatic shelf registration statement filed and effective with the SEC, which permits us to issue an unspecified amount of debt or equity securities.
With the exception of the common and preferred dividends previously discussed, the parent company does not have any significant cash demands. There are no debt maturities until 2013, when a debt maturity of $50 million is payable.
Considering our participation in the TARP voluntary CPP(see “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008),anticipated earnings, capital raised from the 2008 second quarter preferred-stock issuance, other factors discussed above, and other analyses that we have performed, we believe the parent company has sufficient liquidity to meet its cash flow obligations for the foreseeable future.
Credit Ratings
Credit ratings by the three major credit rating agencies are an important component of our liquidity profile. Among other factors, the credit ratings are based on financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and our ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating triggers that could increase funding needs if a negative rating change occurs. Letter of credit commitments for marketable securities, interest rate swap collateral agreements, and certain asset securitization transactions contain credit rating provisions.(See “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008)
The most recent credit ratings for the parent company and the Bank are as follows:
Table 40 — Credit Ratings
February 13, 2009 | ||||||||||||||||
Senior Unsecured | Subordinated | |||||||||||||||
Notes | Notes | Short-term | Outlook | |||||||||||||
Huntington Bancshares Incorporated | ||||||||||||||||
Moody’s Investor Service | A3 | Baal | P-2 | Negative | ||||||||||||
Standard and Poor’s | BBB | BBB- | A-2 | Negative | ||||||||||||
Fitch Ratings | A- | BBB+ | F1 | Stable | ||||||||||||
The Huntington National Bank | ||||||||||||||||
Moody’s Investor Service | �� | A2 | A3 | P-1 | Negative | |||||||||||
Standard and Poor’s | BBB+ | BBB | A-2 | Negative | ||||||||||||
Fitch Ratings | A- | BBB+ | F1 | Stable |
A security rating is not a recommendation to buy, sell, or hold securities, is subject to revision or withdrawal at any time by the assigning rating organization, and should be evaluated independently of any other rating.
Off-Balance Sheet Arrangements
In the normal course of business, we enter into various off-balance sheet arrangements. These arrangements include financial guarantees contained in standby letters of credit issued by the Bank and commitments by the Bank to sell mortgage loans.
Standby letters of credit are conditional commitments issued 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, bond financing, and similar transactions. Most of these arrangements mature within two years, and are expected to expire without being drawn upon. Standby letters of credit are included in the determination of the amount of risk-based capital that the parent company, and the Bank, are required to hold.
Through our credit process, we monitor the credit risks of outstanding standby letters of credit. When it is probable that a standby letter of credit will be drawn and not repaid in full, losses are recognized in the provision for credit losses. At December 31, 2008, we had $1.3 billion of standby letters of credit outstanding, of which 49% were collateralized. Included in this $1.3 billion total are
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letters of credit issued by the Bank that support $0.5 billion of securities that were issued by our customers and sold by The Huntington Investment Company (HIC), our broker-dealer subsidiary. If the Bank’s short-term credit ratings were downgraded, the Bank could be required to obtain funding in order to purchase the entire amount of these securities pursuant to its letters of credit. Due to lower demand, investors began returning these securities to the Bank. Subsequently, the Bank tendered these securities to its trustee, where the securities were held for re-marketing, maturity, or payoff. Pursuant to the letters of credit issued by the Bank, the Bank repurchased $197.4 million of these securities, net of payments and maturities, during 2008.See “Risk Factors” included in Item 1A of ourForm 10-K for the year ended December 31, 2008 for additional information.
We enter into forward contracts relating to the mortgage banking business to hedge the exposures we have from commitments to extend new residential mortgage loans to our customers and from our held-for-sale mortgage loans. At December 31, 2008 and December 31, 2007, we had commitments to sell residential real estate loans of $759.4 million and $555.9 million, respectively. These contracts mature in less than one year.
We do not believe that off-balance sheet arrangements will have a material impact on our liquidity or capital resources.
Table 41 — Contractual Obligations(1)
At December 31, 2008 | ||||||||||||||||||||
One Year | 1 to 3 | 3 to 5 | More than | |||||||||||||||||
(in millions) | or Less | Years | Years | 5 years | Total | |||||||||||||||
Certificates of deposit and other time deposits | $ | 13,093 | $ | 5,325 | $ | 702 | $ | 132 | $ | 19,252 | ||||||||||
Deposits without a stated maturity | 18,691 | — | — | — | 18,691 | |||||||||||||||
Federal Home Loan Bank advances | 221 | 1,292 | 1,068 | 8 | 2,589 | |||||||||||||||
Other long-term debt | 266 | 462 | 453 | 1,150 | 2,331 | |||||||||||||||
Subordinated notes | — | 143 | 113 | 1,694 | 1,950 | |||||||||||||||
Short-term borrowings | 1,309 | — | — | — | 1,309 | |||||||||||||||
Operating lease obligations | 47 | 86 | 77 | 188 | 398 | |||||||||||||||
Purchase commitments | 112 | 116 | 21 | 4 | 253 |
(1) Amounts do not include associated interest payments.
Operational Risk
As with all companies, we are subject to operational risk. Operational risk is the risk of loss due to human error, inadequate or failed internal systems and controls, violations of, or noncompliance with, laws, rules, regulations, prescribed practices, or ethical standards, and external influences such as market conditions, fraudulent activities, disasters, and security risks. We continuously strive to strengthen our system of internal controls to ensure compliance with laws, rules and regulations, and to improve the oversight of our operational risk.
Risk Management, through a combination of business units and centralized processes, manages the risk for the company through processes that assess the overall level of risk on a regular basis and identifies specific risks and the steps being taken to control them. To mitigate operational and compliance risks, we have established a senior management level Operational Risk Committee, headed by the chief operational risk officer, and a senior management level Legal, Regulatory, and Compliance Committee, headed by the director of corporate compliance. The responsibilities of these committees, among other things, include establishing and maintaining management information systems to monitor material risks and to identify potential concerns, risks, or trends that may have a significant impact and develop recommendations to address the identified issues. Both of these committees report any significant findings and recommendations to the executive level Risk Management Committee, headed by the chief risk officer. Additionally, potential concerns may be escalated to the Risk Committee of the board of directors, as appropriate.
The goal of this framework is to implement effective operational risk techniques and strategies, minimize operational losses, and strengthen our overall performance.
Capital
Capital is managed both at the Bank and on a consolidated basis. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, liquidity, and operational risks inherent in our business, and to provide the flexibility needed for future growth and new business opportunities.
During 2008, we received $1.4 billion of equity capital by issuing to the U.S. Department of Treasury 1.4 million shares of Series B Preferred Stock, and a ten-year warrant to purchase up to 23.6 million shares of Huntington’s common stock, par value $0.01 per share, at an exercise price of $8.90 per share. The proceeds received were allocated to the preferred stock and additionalpaid-in-capital. The resulting discount on the preferred stock will be amortized, resulting in additional dilution to Huntington’s earnings per share. (See Note 15 of the Notes to the Consolidated Financial Statements for additional information regarding the Series B Preferred Stock issuance).Also, during 2008, we issued an aggregate $0.6 billion of Series A Preferred Stock. The Series A Preferred
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Stock is nonvoting and may be convertible at any time, at the option of the holder, into 83.668 shares of Huntington common stock.
As shown in Table 42, our consolidated tangible equity to assets ratio was 7.72% at December 31, 2008, an increase from 5.08% at December 31, 2007. The 264 basis point increase from December 31, 2007, primarily reflected an increase in shareholder’ equity largely due to the issuance of Series A Preferred Stock during the 2008 second quarter, and the issuance of Series B Preferred Stock during the 2008 fourth quarter as a result of our participation in the TARP voluntary CPP.(See “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008).
Table 42 — Capital Adequacy
“Well- | At December 31, | |||||||||||||||||||||||||||
Capitalized” | ||||||||||||||||||||||||||||
Minimums | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||||||||||
Total risk-weighted assets(in millions) | Consolidated | $ | 46,994 | $ | 46,044 | $ | 31,155 | $ | 29,599 | $ | 29,542 | |||||||||||||||||
Bank | 46,477 | 45,731 | 30,779 | 29,243 | 29,093 | |||||||||||||||||||||||
Ratios: | ||||||||||||||||||||||||||||
Tier 1 leverage ratio(1) | Consolidated | 5.00 | % | 9.82 | % | 6.77 | % | 8.00 | % | 8.34 | % | 8.42 | % | |||||||||||||||
Bank | 5.00 | 5.99 | 5.99 | 5.81 | 6.21 | 5.66 | ||||||||||||||||||||||
Tier 1 risk-based capital ratio(1) | Consolidated | 6.00 | 10.72 | 7.51 | 8.93 | 9.13 | 9.08 | |||||||||||||||||||||
Bank | 6.00 | 6.44 | 6.64 | 6.47 | 6.82 | 6.08 | ||||||||||||||||||||||
Total risk-based capital ratio(1) | Consolidated | 10.00 | 13.91 | 10.85 | 12.79 | 12.42 | 12.48 | |||||||||||||||||||||
Bank | 10.00 | 10.71 | 10.17 | 10.44 | 10.56 | 10.16 | ||||||||||||||||||||||
Tangible equity / asset ratio(2) | Consolidated | 7.72 | 5.08 | 6.93 | 7.19 | 7.18 | ||||||||||||||||||||||
Tangible common equity / asset ratio(3) | Consolidated | 4.04 | 5.08 | 6.93 | 7.19 | 7.18 | ||||||||||||||||||||||
Tangible equity / risk-weighted assets ratio | Consolidated | 8.38 | 5.67 | 7.72 | 7.91 | 7.87 | ||||||||||||||||||||||
Average equity / average asset ratio | Consolidated | 11.64 | 10.36 | 8.39 | 7.91 | 7.55 |
(1) | Based on an interim decision by the banking agencies on December 14, 2006, we have excluded the impact of adopting Statement 158 from the regulatory capital calculations. |
(2) | Tangible equity (total equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
(3) | Tangible common equity (total common equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
The Bank is primarily supervised and regulated by the Office of the Comptroller of the Currency (OCC), which establishes regulatory capital guidelines for banks similar to those established for bank holding companies by the Federal Reserve Board. We intend to maintain both the parent company’s and the Bank’s risk-based capital ratios at levels at which each would be considered “well-capitalized” by regulators. Regulatory capital ratios are the primary metrics used by regulators in assessing the “safety and soundness” of banks. At December 31, 2008, the Bank had Tier 1 and Total risk-based capital in excess of the minimum level required to be considered “well-capitalized” of $0.2 billion and $0.3 billion, respectively; and the parent company had Tier 1 and Total risk-based capital in excess of the minimum level required to be considered “well-capitalized” of $2.2 billion and $1.8 billion, respectively. The parent company has the ability to provide additional capital to the Bank.
Our tangible common equity (TCE) ratio at 2008 year-end was 4.04%, down from 5.08% at 2007 year-end. In recent months, equity markets have increased their focus on the absolute level of TCE ratios. This focus is not done within a “safety and soundness” context, as that is reflected through our regulatory capital ratios, but rather is more centered in stock price valuation analysis. Being mindful of this, certain actions, including selective asset sales and other reduction strategies, are under various stages of consideration and implementation to reduce the size of our balance sheet with the intent of providing additional support to our TCE ratio.
Our participation in the TARP voluntary CPP(see “Risk Factors” included in Item 1A of our 2008Form 10-K for the year ended December 31, 2008) increased our Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and total risk-based capital ratio by approximately three percentage points.
Shareholders’ equity totaled $7.2 billion at December 31, 2008. This represented an increase compared with $5.9 billion at December 31, 2007, primarily reflecting the previously discussed issuances of Series A Preferred Stock and Series B Preferred Stock in 2008.
Additionally, to accelerate the building of capital and to lower the cost of issuing the aforementioned securities, we reduced our quarterly common stock dividend to $0.1325 per common share, effective with the dividend paid July 1, 2008. The quarterly common stock dividend was further reduced to $0.01 per common share, effective with the dividend to be paid April 1, 2009.
No shares were repurchased during 2008. At the end of the period, 3.9 million shares were available for repurchase under the 2006 Repurchase Program for the year-ended December 31, 2008; however, on February 18, 2009, the 2006 Repurchase Program was terminated. Additionally, as a condition to participate in the TARP, we may not repurchase any additional shares without prior approval from the Department of Treasury.
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BUSINESS SEGMENT DISCUSSION
This section reviews financial performance from a business segment perspective and should be read in conjunction with the Discussion of Results of Operations, Note 24 of the Notes to Consolidated Financial Statements, and other sections for a full understanding of our consolidated financial performance.
We have five major business segments: Retail and Business Banking, Commercial Banking, Commercial Real Estate, Auto Finance and Dealer Services (AFDS), and the Private Financial Group (PFG). A Treasury/Other function includes other unallocated assets, liabilities, revenue, and expense. The Treasury/Other function reconciles the combined results of the five business segments with the consolidated information. For each of our business segments, we expect the combination of our business model and exceptional service to provide a competitive advantage that supports revenue and earnings growth. Our business model emphasizes the delivery of a complete set of banking products and services offered by larger banks, but distinguished by local decision-making about the pricing and offering of these products.
Acquisition of Sky Financial
The businesses acquired in the Sky Financial merger were fully integrated into each of the corresponding Huntington business segments as of July 1, 2007. The Sky Financial merger had the largest impact to the Retail and Business Banking, Commercial Banking, and Commercial Real Estate business segments, but also impacted PFG and Treasury/Other. The merger did not significantly impact AFDS.
Methodologies were implemented to estimate the approximate effect of the acquisition for the entire company; however, these methodologies were not designed to estimate the approximate effect of the acquisition to individual business segments. As a result, the effect of the acquisition to the individual business segments is not quantifiable. In the following business segment discussions, with the exception of AFDS, the discussion is primarily focused on the 2008 fourth quarter results compared with the 2008 third quarter results. We believe that this comparison provides the most meaningful analysis because: (a) the impacts of the Sky Financial acquisition are included in both periods, (b) the comparisons of the 2008 reported results to the 2007 reported results are distorted as a result of the nonquantifiable impact of the Sky Financial acquisition to the Retail and Business Banking, Commercial Banking, Commercial Real Estate, and PFG lines of business, and (c) the comparisons of the 2008 fourth quarter to the 2007 fourth quarter are distorted as a result of numerous significant adjustments(see “Significant Items” located within the “Discussion of Results of Operations” section), including adjustments related to Franklin, during both the 2008 and 2007 fourth quarters. As a result, we believe that a more meaningful analysis of our core activities is obtained by comparisons to the prior quarter. As mentioned previously, AFDS was not significantly impacted by the acquisition. As a result, the AFDS business segment discussion compares full-year 2008 reported results with full-year 2007 reported results.
Funds Transfer Pricing
We use a centralized funds transfer pricing (FTP) methodology to attribute appropriate net interest income to the business segments. The Treasury/Other function charges (credits) an internal cost of funds for assets held in (or pays for funding provided by) each line of business. The FTP rate is based on prevailing market interest rates for comparable duration assets (or liabilities). Deposits of an indeterminate maturity receive an FTP credit based on vintage-based pool rates. Other assets, liabilities, and capital are charged (credited) with a four-year moving average FTP rate. The intent of the FTP methodology is to eliminate all interest rate risk from the business segments by providing matched duration funding of assets and liabilities. The result is to centralize the financial impact, management, and reporting of interest rate and liquidity risk in Treasury/Other where it can be monitored and managed. The denominator in net interest margin calculation has been modified to add the amount of net funds provided by each business segment for all periods presented.
Fee Sharing
Our business segments operate in cooperation to provide products and services to our customers. Revenue is recorded in the business segment responsible for the related product or service. Fee sharing is recorded to allocate portions of such revenue to other business segments involved in selling to or providing service to customers. The most significant revenues for which fee sharing is recorded relate to customer derivatives and brokerage services, which are recorded by PFG and shared with Retail and Business Banking.
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Expense Allocation
Business segment results are determined based upon our management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around our organizational and management structure and, accordingly, the results derived are not necessarily comparable with similar information published by other financial institutions. For comparability purposes, the amounts in all periods were based on business segments and methodologies in effect at December 31, 2008.
The management accounting process used to develop the business segment reporting utilized various estimates and allocation methodologies to measure the performance of the business segments. To determine the financial performance for each business segment, we allocated a portion of the provision for credit losses and certain noninterest expenses related to shared services and corporate overhead. The provision for credit losses was allocated based on the level of each business segment’s respective ACL. Noninterest expenses were allocated based on various methodologies, including volume of activity and the number of full-time equivalent employees.
Treasury/Other
The Treasury/Other function includes revenue and expense related to assets, liabilities, and equity not directly assigned or allocated to one of the other five business segments. Assets in this segment include investment securities, bank owned life insurance, and our loan to Franklin. The financial impact associated with our FTP methodology, as described above, is also included.
Net interest income includes the impact of administering our investment securities portfolios and the net impact of derivatives used to hedge interest rate sensitivity. Noninterest income includes miscellaneous fee income not allocated to other business segments, such as bank owned life insurance income, any investment securities, and trading assets gains or losses. Noninterest expense includes certain corporate administrative, merger, and other miscellaneous expenses not allocated to other business segments. The provision for income taxes for the other business segments is calculated at a statutory 35% tax rate, though our overall effective tax rate is lower. As a result, Treasury/Other reflects a credit for income taxes representing the difference between the lower actual effective tax rate and the statutory tax rate used to allocate income taxes to the other segments.
Net Income by Business Segment
The company reported net loss of $417.3 million in the 2008 fourth quarter. This compared with a net income of $75.1 million in the 2008 third quarter. The breakdown of net income for the 2008 fourth quarter by business segment is as follows:
• | Retail and Business Banking: $37.4 million income ($34.5 million decline compared with 2008 third quarter) | ||
• | Commercial Banking: $9.9 million loss ($43.3 million decline compared with 2008 third quarter) | ||
• | Commercial Real Estate: $33.2 million loss ($36.8 million decline compared with 2008 third quarter) | ||
• | AFDS: $6.3 million loss ($7.9 million decline compared with 2008 third quarter) | ||
• | PFG: $7.4 million income ($9.4 million decline compared with 2008 third quarter) | ||
• | Treasury/Other: $412.8 million loss ($360.5 million decline compared with 2008 third quarter) |
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Retail and Business Banking
(This section should be read in conjunction with Significant Items 1, 4, and 6.)
(This section should be read in conjunction with Significant Items 1, 4, and 6.)
Objectives, Strategies, and Priorities
Our Retail and Business Banking segment provides traditional banking products and services to consumer and small business customers located in our 11 operating regions within the six states of Ohio, Michigan, Pennsylvania, Indiana, West Virginia, and Kentucky. It provides these services through a banking network of over 600 branches, and almost 1,400 ATMs, along with internet and telephone banking channels. It also provides certain services on a limited basis outside of these six states, including mortgage banking and small business administration (SBA) lending. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, small business loans, personal and business deposit products, as well as sales of investment and insurance services. At December 31, 2008, Retail and Business Banking accounted for 40% and 72% of consolidated loans and leases and deposits, respectively.
The Retail and Business Banking strategy is to focus on building a deeper relationship with our customers by providing an exceptional service experience. This focus on service involves continued investments in state-of-the-art platform technology in our branches, award-winning retail and business websites for our customers, extensive development of associates, and internal processes that empower our local bankers to serve our customers better.
Table 43a — Key Performance Indicators for Retail and Business Banking
Twelve Months Ended | |||||||||||||||||||||||||||||||||
December 31, | Change from 2007 | 2008 | Change from 3Q08 | ||||||||||||||||||||||||||||||
(in thousands unless otherwise noted) | 2008 | 2007 | Amount | Percent | Fourth | Third | Amount | Percent | |||||||||||||||||||||||||
Net interest income | $ | 973,869 | $ | 737,972 | $ | 235,897 | 32.0 | % | $ | 254,377 | $ | 241,783 | $ | 12,594 | 5.2 | % | |||||||||||||||||
Provision for credit losses | 237,723 | 68,112 | 169,611 | N.M. | 90,496 | 53,536 | 36,960 | 69.0 | |||||||||||||||||||||||||
Noninterest income | 405,671 | 364,145 | 41,526 | 11.4 | 88,569 | 113,040 | (24,471 | ) | (21.6 | ) | |||||||||||||||||||||||
Noninterest expense | 785,425 | 699,745 | 85,680 | 12.2 | 194,886 | 190,593 | 4,293 | 2.3 | |||||||||||||||||||||||||
Provision for income taxes | 124,737 | 116,991 | 7,746 | 6.6 | 20,147 | 38,743 | (18,596 | ) | (48.0 | ) | |||||||||||||||||||||||
Net income | $ | 231,655 | $ | 217,269 | $ | 14,386 | 6.6 | % | $ | 37,417 | $ | 71,951 | $ | (34,534 | ) | (48.0) | % | ||||||||||||||||
Total average assets(in millions) | $ | 18,688 | 15,475 | 3,213 | 20.8 | % | $ | 18,269 | 18,386 | (117 | ) | (0.6) | % | ||||||||||||||||||||
Total average loans/leases(in millions) | 16,764 | 13,931 | 2,833 | 20.3 | 16,500 | 16,557 | (57 | ) | (0.3 | ) | |||||||||||||||||||||||
Total average deposits(in millions) | 26,276 | 20,350 | 5,926 | 29.1 | 26,988 | 26,476 | 512 | 1.9 | |||||||||||||||||||||||||
Net interest margin | 3.69 | % | 3.49 | % | 0.20 | % | 5.7 | 3.71 | % | 3.61 | % | 0.10 | % | 2.8 | |||||||||||||||||||
Net charge-offs (NCOs) | $ | 146,346 | $ | 77,334 | $ | 69,012 | 89.2 | $ | 49,011 | $ | 38,163 | $ | 10,848 | 28.4 | |||||||||||||||||||
NCOs as a % of average loans and leases | 0.87 | % | 0.56 | % | 0.3 | % | 55.4 | 1.19 | % | 0.92 | % | 0.27 | % | 29.3 | |||||||||||||||||||
Return on average equity | 22.4 | 28.1 | (5.7 | ) | (20.3 | ) | 13.0 | 27.0 | (14.0 | ) | (51.9 | ) | |||||||||||||||||||||
Retail banking # DDA households(eop) | 896,412 | 896,567 | (155 | ) | (0.0 | ) | 896,412 | 898,966 | (2,554 | ) | (0.3 | ) | |||||||||||||||||||||
Retail banking # new relationships 90-day cross-sell(average) | 2.38 | 2.79 | (0.41 | ) | (14.7 | ) | 2.12 | 2.23 | (0.11 | ) | (4.9 | ) | |||||||||||||||||||||
Small business # business DDA relationships(eop) | 107,241 | 103,765 | 3,476 | 3.3 | 107,241 | 106,538 | 703 | 0.7 | |||||||||||||||||||||||||
Small business # new relationships 90-day cross-sell(average) | 2.05 | 2.31 | (0.26 | ) | (11.3 | ) | 2.03 | 2.06 | (0.03 | ) | (1.5 | ) | |||||||||||||||||||||
Mortgage banking closed loan volume(in millions) | $ | 3,773 | $ | 3,493 | $ | 280 | 8.0 | % | $ | 724 | $ | 680 | $ | 44 | 6.5 | % | |||||||||||||||||
eop — End of Period.
2008 Fourth Quarter versus 2008 Third Quarter
Retail and Business Banking reported net income of $37.4 million in the 2008 fourth quarter, compared with net income of $72.0 million in the 2008 third quarter.
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The most notable factor contributing to the $34.5 million decline in net income was a $37.0 million increase to the provision for credit losses reflecting a $26.1 million increase in the credit quality and growth provision, and a $10.8 million increase in NCOs. NALs also increased to $302 million from $248 million, and represented 1.83% of total average loans and leases. The increase in both NCOs and NALs reflected the overall economic weakness across our regions.
Fully taxable equivalent net interest income increased $12.6 million, or 5%, reflecting a 10 basis point improvement in the net interest margin to 3.71% from 3.61%. The improvement in net interest margin is largely a result of decreases in our funding costs and widening spreads on our loan portfolios due to continued disciplined pricing on new loan originations.
Average deposits increased $512 million, or 2%, compared with the prior quarter. Consumer deposits increased $621.7 million, or 3%, reflecting increased marketing efforts for consumer time deposit accounts in the fourth quarter. This increase was partially offset by a $122.5 million, or 4%, decline in commercial deposits, a result of the weakening economic conditions and interest rate declines. The decline in number of DDA households was centered primarily in our Central Indiana region, which has had significant consumer account attrition resulting from the Sky Financial acquisition. We are optimistic that this account attrition trend will curtail in 2009. Although the number of DDA households declined, total consumer deposits for our Central Indiana region increased $23 million, or 2%.
Noninterest income decreased $24.5 million, or 22%, primarily reflecting: (a) $17.1 million decrease in mortgage banking income including a $15.6 million decline in the net hedging impact of MSRs, and (b) $4.9 million decrease in service charges on deposit accounts primarily reflecting lower nonsufficient fund and overdraft fees, a continuing trend as a result of current economic conditions.
Noninterest expense increased $4.3 million, or 2%, primarily reflecting: (a) $2.7 million increase in marketing expense as a result of considerable marketing efforts in the fourth quarter 2008, and (b) $0.8 million higher operational losses primarily resulting from the repurchasing of loans previously sold to investors.
2008 versus 2007
Retail and Business Banking reported net income of $231.7 million in 2008, compared with net income of $217.3 million in 2007. The $14.4 million increase was driven by the net positive impact of the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans and average total deposits from the prior year. The positive impact of the Sky Financial acquisition was partially offset by a $169.6 million increase in provision for credit losses. This increase was largely due to a $69.0 million increase in NCOs, and a $161 million increase in NALs compared with the prior year-end. The increase in both NCOs and NALs reflected the impact of the overall weakened economy across all of our regions.
2007 versus 2006
Retail and Business Banking reported net income of $217.3 million in 2007, compared with $190.0 million in 2006. This increase primarily reflected the net positive impact of the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans, and average total deposits all increased from the prior year. This increase was partially offset by a $23.5 million increase in the provision for credit losses. This increase was largely due to the negative impact of the economic weakness in our Midwest markets, most notably among our borrowers in eastern Michigan and northern Ohio.
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Commercial Banking
(This section should be read in conjunction with Significant Items 1 and 6.)
(This section should be read in conjunction with Significant Items 1 and 6.)
Objectives, Strategies, and Priorities
The Commercial Banking segment provides a variety of banking products and services to customers within our primary banking markets who generally have larger credit exposures and sales revenues compared with our Retail and Business Banking customers. Commercial Banking products include commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities. Our Commercial Banking team also serves customers that specialize in equipment leasing, as well as serving the commercial banking needs of government entities, not-for-profit organizations, and large corporations. Commercial bankers personally deliver these products and services by developing leads through community involvement, referrals from other professionals, and targeted prospect calling.
The Commercial Banking strategy is to focus on building a deeper relationship with our customers by providing an exceptional service experience. This focus on service requires continued investments in technology for our product offerings, websites for our customers, extensive development of associates, and internal processes that empower our local bankers to serve our customers better.
Table 43b — Key Performance Indicators for Commercial Banking
Twelve Months Ended | ||||||||||||||||||||||||||||||||||||
December 31, | Change from 2007 | 2008 | Change from 3Q08 | |||||||||||||||||||||||||||||||||
(in thousands unless otherwise noted) | 2008 | 2007 | Amount | Percent | Fourth | Third | Amount | Percent | ||||||||||||||||||||||||||||
Net interest income | $ | 317,908 | $ | 249,637 | $ | 68,271 | 27.3 | % | $ | 80,481 | $ | 77,711 | $ | 2,770 | 3.6 | % | ||||||||||||||||||||
Provision for credit losses | 114,067 | 4,996 | 109,071 | N.M. | 77,725 | 10,941 | 66,784 | N.M. | ||||||||||||||||||||||||||||
Noninterest income | 94,915 | 80,810 | 14,105 | 17.5 | 22,611 | 23,368 | (757 | ) | (3.2 | ) | ||||||||||||||||||||||||||
Noninterest expense | 158,888 | 139,305 | 19,583 | 14.1 | 40,532 | 38,739 | 1,793 | 4.6 | ||||||||||||||||||||||||||||
Provision (Benefit) for income taxes | 48,954 | 65,151 | (16,197 | ) | (24.9 | ) | (5,308 | ) | 17,990 | (23,298 | ) | N.M. | ||||||||||||||||||||||||
Net income | $ | 90,914 | $ | 120,995 | $ | (30,081 | ) | (24.9) | % | $ | (9,857 | ) | $ | 33,409 | $ | (43,266 | ) | N.M. | % | |||||||||||||||||
Total average assets(in millions) | $ | 8,750 | $ | 7,461 | $ | 1,289 | 17.3 | % | $ | 8,925 | $ | 8,708 | $ | 217 | 2.5 | % | ||||||||||||||||||||
Total average loans/leases(in millions) | 8,274 | 6,985 | 1,289 | 18.5 | 8,531 | 8,280 | 251 | 3.0 | ||||||||||||||||||||||||||||
Total average deposits(in millions) | 6,048 | 5,302 | 746 | 14.1 | 5,349 | 6,031 | (682 | ) | (11.3 | ) | ||||||||||||||||||||||||||
Net interest margin | 3.80 | % | 3.56 | % | 0.24 | % | 6.7 | 3.68 | % | 3.75 | % | (0.07 | )% | (1.9 | ) | |||||||||||||||||||||
Net charge-offs (NCOs) | $ | 76,339 | $ | 20,615 | $ | 55,724 | N.M. | $ | 35,339 | $ | 25,444 | $ | 9,895 | 38.9 | ||||||||||||||||||||||
NCOs as a % of average loans and leases | 0.92 | % | 0.30 | % | 0.6 | % | N.M. | 1.66 | % | 1.23 | % | 0.43 | % | 35.0 | ||||||||||||||||||||||
Return on average equity | 11.8 | 21.9 | (10.1 | ) | (46.1 | ) | (5.1 | ) | 17.7 | (22.8 | ) | N.M. | ||||||||||||||||||||||||
N.M., not a meaningful value.
eop — End of Period.
eop — End of Period.
2008 Fourth Quarter versus 2008 Third Quarter
Commercial Banking reported a net loss of $9.9 million in the 2008 fourth quarter, compared with net income of $33.4 million in the 2008 third quarter.
The most notable factors contributing to the $43.3 million decline in net income were a $66.8 million increase to the provision for credit losses reflecting a $56.9 million increase in the credit quality and growth provision, and a $9.9 million increase in NCOs. NALs were $204 million at December 31, 2008, an increase of $79 million from prior quarter levels. The increase in both NCOs and NALs reflected the overall economic weakness across our regions.
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Fully taxable equivalent net interest income increased $0.9 million, or 1%, from the prior quarter reflecting a $252 million, or 3%, increase in total average earning assets and widening spreads on our loan portfolios as interest rates declined during the 2008 fourth quarter combined with continued disciplined pricing on new loan originations. This increase in net interest income was slightly offset by a decline in average deposits balances.
Total average loans and leases increased $251 million, or 3%, from the prior quarter, and was essentially entirely centered within the commercial loan portfolio. This increase primarily reflected the funding of letters of credit that had supported floating rate bonds issued by our customers.
Average deposits declined $682 million, or 11%, compared with the prior quarter. The decline reflected (a) a decrease in foreign deposits and money market accounts, (b) balance decreases related to overall market interest rates, which declined quickly and significantly during the 2008 fourth quarter and (c) the weakening economic conditions, which decreased excess deposits for commercial customers.
Noninterest income decreased $0.8 million, or 3%, primarily reflecting a decrease in income on terminated leases.
Noninterest expense increased $1.8 million, or 5%, including an increase in commercial loan collections expense.
2008 versus 2007
Commercial Banking reported net income of $90.9 million in 2008, compared with net income of $121.0 million in 2007. The $30.1 million decline included a $109.1 million increase in provision for credit losses. This increase was largely due to a $55.7 million increase in NCOs, and a $143 million increase in NALs compared with the prior year-end. The increase in both NCOs and NALs reflected the overall economic weakness across our regions. The increase to provision for credit losses was partially offset by the net positive impact of the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans and average total deposits from the prior year.
2007 versus 2006
Commercial Banking reported net income of $121.0 million in 2007, compared with $90.3 million in 2006. This increase primarily reflected the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans, and average total deposits when compared to the prior year.
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Commercial Real Estate
(This section should be read in conjunction with Significant Items 1 and 6.)
Objectives, Strategies, and Priorities
Our Commercial Real Estate segment serves professional real estate developers or other customers with real estate project financing needs within our primary banking markets. Commercial Real Estate products and services include CRE loans, cash management, interest rate protection products, and capital market alternatives. Commercial real estate bankers personally deliver these products and services through: (a) relationships with developers in our footprint who are recognized as the most experienced, well-managed and well-capitalized, and are capable of operating in all phases of the real estate cycle (top-tier developers), (b) leads through community involvement, and (c) referrals from other professionals.
The Commercial Real Estate strategy is to focus on building a deeper relationship with top-tier developers within our geographic footprint. Our local expertise of the customers, market, and products, gives us a competitive advantage and supports revenue growth in our footprint. Our strategy is to continue to expand the relationships of our current customer base and to attract new, profitable business with top-tier developers in our footprint.
Table 43c — Key Performance Indicators for Commercial Real Estate
Twelve Months Ended | |||||||||||||||||||||||||||||||||
December 31, | Change from 2007 | 2008 | Change from 3Q08 | ||||||||||||||||||||||||||||||
(in thousands unless otherwise noted) | 2008 | 2007 | Amount | Percent | Fourth | Third | Amount | Percent | |||||||||||||||||||||||||
Net interest income | $ | 177,977 | $ | 132,277 | $ | 45,700 | 34.5 | % | $ | 47,498 | $ | 44,111 | $ | 3,387 | 7.7 | % | |||||||||||||||||
Provision for credit losses | 185,487 | 114,615 | 70,872 | 61.8 | 87,658 | 36,918 | 50,740 | N.M. | |||||||||||||||||||||||||
Noninterest income | 12,845 | 11,450 | 1,395 | 12.2 | (633 | ) | 5,213 | (5,846 | ) | N.M. | |||||||||||||||||||||||
Noninterest expense | 31,351 | 24,021 | 7,330 | 30.5 | 10,268 | 6,905 | 3,363 | 48.7 | |||||||||||||||||||||||||
(Benefit) Provision for income taxes | (9,106 | ) | 1,782 | (10,888 | ) | N.M. | (17,871 | ) | 1,925 | (19,796 | ) | N.M. | |||||||||||||||||||||
Net income (loss) | $ | (16,910 | ) | $ | 3,309 | $ | (20,219 | ) | N.M. | % | $ | (33,190 | ) | $ | 3,576 | $ | (36,766 | ) | N.M. | % | |||||||||||||
Total average assets(in millions) | $ | 6,655 | $ | 4,463 | $ | 2,192 | 49.1 | % | $ | 7,078 | $ | 6,836 | $ | 242 | 3.5 | % | |||||||||||||||||
Total average loans/leases(in millions) | 6,647 | 4,399 | 2,248 | 51.1 | 7,104 | 6,839 | 265 | 3.9 | |||||||||||||||||||||||||
Total average deposits(in millions) | 510 | 520 | (10 | ) | (1.9 | ) | 450 | 486 | (36 | ) | (7.4 | ) | |||||||||||||||||||||
Net interest margin | 2.68 | % | 3.01 | % | (0.33 | )% | (11.0 | ) | 2.67 | % | 2.57 | % | 0.10 | % | 3.9 | ||||||||||||||||||
Net charge-offs (NCOs) | $ | 46,516 | $ | 40,407 | $ | 6,109 | 15.1 | $ | 30,107 | $ | 5,345 | $ | 24,762 | N.M. | |||||||||||||||||||
NCOs as a% of average loans and leases | 0.70 | % | 0.92 | % | (0.2 | )% | (23.9 | ) | 1.70 | % | 0.31 | % | 1.39 | % | N.M. | ||||||||||||||||||
Return on average equity | (3.8 | ) | 1.1 | (4.9 | ) | N.M. | (28.6 | ) | 3.2 | (31.8 | ) | N.M. | |||||||||||||||||||||
N.M., | not a meaningful value. | |
eop — | End of Period. |
2008 Fourth Quarter versus 2008 Third Quarter
Commercial Real Estate reported a net loss of $33.2 million in the 2008 fourth quarter, compared with a net gain of $3.6 million in the 2008 third quarter.
The most notable factors contributing to the $36.8 million decline in net income was a $50.7 million increase to the provision for credit losses reflecting a $26.0 million increase in the credit quality and growth provision, and a $24.8 million increase in NCOs. NALs were $334 million at December 31, 2008, an increase of $133 million from prior quarter levels, and represented 5% of total average loans and leases. The increase in both NCOs and NALs reflected the overall economic weakness across our regions and was primarily centered in the single family home builder segment.
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Fully taxable equivalent net interest income increased $3.4 million, or 8%, from the prior quarter reflecting a $265 million, or 4%, increase in total average earning assets and a 10 basis point improvement in the net interest margin to 2.67% from 2.57%. The improvement in the net interest margin is largely a result of widening spreads on our loan portfolios as interest rates declined during the 2008 fourth quarter combined with continued disciplined pricing on new loan originations.
Average CRE loans increased $265 million, or 4%, primarily due to funding letters of credit that had supported floating rate bonds issued by our customers.
Noninterest income decreased $5.8 million primarily reflecting $6.0 million decline in other noninterest income primarily resulting from interest rate swap losses recognized in the fourth quarter, associated with one loan relationship in the Cleveland Region.
Noninterest expense increased $3.4 million, or 49%, reflecting (a) $2.0 million primarily resulting from the increased expense associated with success fees earned by an asset manager in a mezzanine lending joint venture partner, (b) $1.0 million increase in other taxes expense, and (c) $0.3 million increase in OREO expenses, primarily attributable to real estate taxes.
2008 versus 2007
Commercial Real Estate Banking reported a net loss of $16.9 million in 2008, compared with net income of $3.3 million in 2007. The $20.2 million decline included a $70.9 million increase in provision for credit losses reflecting a $6.1 million increase in NCOs, and a $220 million increase in NALs compared with the prior year-end. The increase in NCOs and NALs reflected the overall economic weakness across our regions, and was centered in the single family home builder industry. The increase to provision for credit losses was partially offset by the net positive impact of the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans and average total deposits from the prior year.
2007 versus 2006
Commercial Real Estate reported net income of $3.3 million in 2007, compared with $64.3 million in 2006. This decrease primarily reflected a $110.3 million increase in the provision for credit losses. This increase was largely due to the negative impact of the economic weakness in our Midwest markets, most notably among our borrowers in eastern Michigan and northern Ohio. The increase to the provision for credit losses was partially offset by the net positive impact of the Sky Financial acquisition on July 1, 2007. The acquisition increased net interest income, noninterest income, noninterest expense, average total loans, and average total deposits all increased from the prior year.
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Auto Finance and Dealer Services (AFDS)
(This section should be read in conjunction with Significant Item 6.)
Objectives, Strategies, and Priorities
Our AFDS business segment provides a variety of banking products and services to more than 2,000 automotive dealerships within our primary banking markets. All lease origination activities were discontinued during the 2008 fourth quarter. AFDS finances the purchase of automobiles by customers at the automotive dealerships; finances dealerships’ new and used vehicle inventories, land, buildings, and other real estate owned by the dealership; finances dealership working capital needs; and provides other banking services to the automotive dealerships and their owners. Competition from the financing divisions of automobile manufacturers and from other financial institutions is intense. AFDS’ production opportunities are directly impacted by the general automotive sales business, including programs initiated by manufacturers to enhance and increase sales directly. We have been in this business segment for over 50 years.
The AFDS strategy focuses on developing relationships with the dealership through its finance department, general manager, and owner. An underwriter who understands each local region makes loan decisions, though we prioritize maintaining pricing discipline over market share.
Table 44 — Key Performance Indicators for Auto Finance and Dealer Services
Twelve Months Ended | ||||||||||||||||
December 31, | Change from 2007 | |||||||||||||||
(in thousands unless otherwise noted) | 2008 | 2007 | Amount | Percent | ||||||||||||
Net interest income | $ | 149,024 | $ | 138,348 | $ | 10,676 | 7.7 | % | ||||||||
Provision for credit losses | 69,037 | 30,628 | 38,409 | N.M. | ||||||||||||
Noninterest income | 59,224 | 41,617 | 17,607 | 42.3 | ||||||||||||
Noninterest expense | 124,342 | 78,635 | 45,707 | 58.1 | ||||||||||||
Provision (Benefit) for income taxes | 5,204 | 24,746 | (19,542 | ) | (79.0 | ) | ||||||||||
Net income | $ | 9,665 | $ | 45,956 | $ | (36,291 | ) | (79.0) | % | |||||||
Total average assets(in millions) | $ | 5,731 | $ | 5,130 | $ | 601 | 11.7 | % | ||||||||
Total average loans/leases(in millions) | 5,860 | 5,200 | 660 | 12.7 | ||||||||||||
Total automobile loans(in millions) | 3,677 | 2,630 | 1,047 | 39.8 | ||||||||||||
Total automobile direct leases(in millions) | 852 | 1,486 | (634 | ) | (42.7 | ) | ||||||||||
Total automobile operating lease assets(in millions) | 180 | 17 | 163 | N.M. | ||||||||||||
Total automobile operating lease income | 39,851 | 7,810 | 32,041 | N.M. | ||||||||||||
Total automobile operating lease expense | $ | 31,282 | $ | 5,161 | $ | 26,121 | N.M. | |||||||||
Net interest margin | 2.49 | % | 2.60 | % | (0.11 | )% | (4.2 | ) | ||||||||
Net charge-offs (NCOs) | $ | 57,398 | $ | 29,288 | $ | 28,110 | 96.0 | |||||||||
NCOs as a % of average loans and leases | 0.98 | % | 0.56 | % | 0.42 | % | 75.0 | |||||||||
Return on average equity | 4.6 | 25.3 | (20.7 | ) | (81.8 | ) | ||||||||||
Automobile loans production(in millions) | $ | 2,212.5 | $ | 1,910.7 | $ | 302 | 15.8 | |||||||||
Automobile leases production(in millions) | 209.7 | 316.3 | (106.6 | ) | (33.7) | % | ||||||||||
N.M., | not a meaningful value. |
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2008 versus 2007
AFDS reported a net income of $9.7 million during 2008, compared with net income of $46.0 million in 2007. This decline primarily reflected a $38.4 million increase to the provision for credit losses resulting from the continuing economic and automobile industry related weaknesses in our regions, as well as declines in values of used vehicles, which have resulted in lower recovery rates on sales of repossessed vehicles.
Fully taxable equivalent net interest income increased $10.7 million, or 8%, reflecting strong automobile loan origination volumes which totaled $2.2 billion during 2008, compared with $1.9 billion in 2007. Although declining in recent months, automobile loan origination volumes increased 16% during 2008 compared with 2007. This increase reflected the consistent execution of our commitment of service quality to our dealers, as well as market dynamics that have resulted in some competitors reducing their automobile lending activities. Average lease balances (operating and direct leases, combined) declined $0.5 billion reflecting consistent declines in automobile lease production volumes since the 2007 second quarter, as well as the decision during the 2008 fourth quarter to discontinue lease origination activities. The increase in total net average loans and leases was partially offset by a decline in the net interest margin to 2.49% in 2008 from 2.60% in 2007 due to higher balances of noninterest earning assets, primarily operating leases.
Noninterest income (excluding operating lease income) declined $14.4 million primarily reflecting declines in servicing income as our serviced-loan portfolio continued to run-off, lower fee income from the sale of Huntington Plus loans as this program was reduced and ultimately discontinued in 2008, and declines in fee income associated with customers exercising their purchase options on leased vehicles.
Noninterest expense (excluding operating lease expense) increased $19.5 million primarily reflecting a $17.7 million increase in losses on sales of vehicles returned at the end of their lease terms. At 2008 year-end, market values for used vehicles, as measured by the Manheim Used Vehicle Value Index, declined to the lowest levels since April 1995.
Net automobile operating lease income increased $5.9 million and consisted of a $32.0 million increase in noninterest income, offset by a $26.1 million increase in noninterest expense. These increases primarily reflected a significant increase in operating lease assets resulting from all automobile lease originations since the 2007 fourth quarter being recorded as operating leases. However, as previously noted, lease origination activities were discontinued during the 2008 fourth quarter.
2007 versus 2006
AFDS reported net income of $46.0 million in 2007, compared with $61.4 million in 2006. This decrease primarily reflected: (1) $16.4 million increase to the provision for credit losses due to economic weaknesses in our markets, (2) $9.2 million decrease in net automobile operating lease income due to lower average operating lease assets, and (3) $8.0 million decline in nonrelated automobile operating lease noninterest income, reflecting declines in lease termination income and servicing income due to lower underlying balances.
These above factors were partially offset by the benefit of a decreased provision for income taxes, and a $8.0 million decline in nonrelated automobile operating lease noninterest expense, primarily reflecting a decline in lease residual value insurance and other residual value related losses due to an overall decline in the lease portfolio.
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Private Financial Group (PFG)
(This section should be read in conjunction with Significant Items 1, 5, and 6.)
Objectives, Strategies, and Priorities
PFG provides products and services designed to meet the needs of higher net worth customers. Revenue results from the sale of trust, asset management, investment advisory, brokerage, insurance, and private banking products and services, including credit and lending activities. PFG also focuses on financial solutions for corporate and institutional customers that include investment banking, sales and trading of securities, and interest rate risk management products. To serve high net worth customers, we use a unique distribution model that employs a single, unified sales force to deliver products and services mainly through Retail and Business Banking distribution channels. PFG provides investment management and custodial services to the Huntington Funds, which consists of 32 proprietary mutual funds, including 11 variable annuity funds. Huntington Funds assets represented 29% of the approximately $13.3 billion total assets under management at December 31, 2008. The Huntington Investment Company (HIC) offers brokerage and investment advisory services to both Regional Banking and PFG customers through a combination of licensed investment sales representatives and licensed personal bankers. PFG’s Insurance group provides a complete array of insurance products including individual life insurance products ranging from basic term-life insurance to estate planning, group life and health insurance, property and casualty insurance, mortgage title insurance, and reinsurance for payment protection products.
PFG’s primary goals are to consistently increase assets under management by offering innovative products and services that are responsive to our clients’ changing financial needs, and to grow deposits through increased focus and improved cross-selling efforts. To grow managed assets, the HIC sales team has been utilized as the primary distribution source for trust and investment management.
Table 45 — Key Performance Indicators for Private Financial Group
Twelve Months Ended | |||||||||||||||||||||||||||||||||
December 31, | Change from 2007 | 2008 | Change from 3Q08 | ||||||||||||||||||||||||||||||
(in thousands unless otherwise noted) | 2008 | 2007 | Amount | Percent | Fourth | Third | Amount | Percent | |||||||||||||||||||||||||
Net interest income | $ | 80,812 | $ | 61,992 | $ | 18,820 | 30.4 | % | $ | 21,127 | $ | 20,280 | $ | 847 | 4.2 | % | |||||||||||||||||
Provision for credit losses | 13,149 | 1,510 | 11,639 | N.M. | 5,975 | 2,131 | 3,844 | N.M. | |||||||||||||||||||||||||
Noninterest income | 259,586 | 198,140 | 61,446 | 31.0 | 59,597 | 68,241 | (8,644 | ) | (12.7 | ) | |||||||||||||||||||||||
Noninterest expense | 250,541 | 203,245 | 47,296 | 23.3 | 63,360 | 60,556 | 2,804 | 4.6 | |||||||||||||||||||||||||
Provision for income taxes | 26,848 | 19,382 | 7,466 | 38.5 | 3,986 | 9,042 | (5,056 | ) | (55.9 | ) | |||||||||||||||||||||||
Net income | $ | 49,860 | $ | 35,995 | $ | 13,865 | 38.5 | % | $ | 7,403 | $ | 16,792 | $ | (9,389 | ) | (55.9) | % | ||||||||||||||||
Total average assets(in millions) | $ | 2,996 | $ | 2,375 | $ | 621 | 26.1 | % | $ | 3,090 | $ | 2,943 | $ | 147 | 5.0 | % | |||||||||||||||||
Total average loans/leases(in millions) | 2,287 | 1,920 | 367 | 19.1 | 2,306 | 2,283 | 23 | 1.0 | |||||||||||||||||||||||||
Net interest margin | 3.42 | % | 3.13 | % | 0.29 | % | 9.3 | 3.50 | % | 3.42 | % | 0.08 | % | 2.3 | |||||||||||||||||||
Net charge-offs (NCOs) | $ | 8,199 | $ | 1,491 | $ | 6,708 | N.M. | $ | 3,568 | $ | 810 | $ | 2,758 | N.M. | |||||||||||||||||||
NCOs as a % of average loans and leases | 0.36 | % | 0.08 | % | 0.28 | % | N.M. | 0.62 | % | 0.14 | % | 0.48 | % | N.M. | |||||||||||||||||||
Return on average equity | 22.3 | 22.4 | (0.1 | ) | (0.4 | ) | 12.2 | 28.7 | (16.5 | ) | (57.5 | ) | |||||||||||||||||||||
Noninterest income shared with other lines-of-business(1) | $ | 49,312 | $ | 36,719 | $ | 12,593 | 34.3 | $ | 10,567 | $ | 9,953 | $ | 614 | 6.2 | |||||||||||||||||||
Total assets under management(in billions) | 13.3 | 16.3 | (3.0 | ) | (18.4 | ) | 13.3 | 14.3 | (1.0 | ) | (7.0 | ) | |||||||||||||||||||||
Total trust assets(in billions) | $ | 44.0 | $ | 60.1 | $ | (16.1 | ) | (26.8) | % | $ | 44.0 | $ | 49.7 | $ | (5.7 | ) | (11.5 | )% | |||||||||||||||
N.M., | not a meaningful value. | |
(1) | Amount is not included in noninterest income reported above. |
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2008 Fourth Quarter versus 2008 Third Quarter
PFG reported net income of $7.4 million in the 2008 fourth quarter, compared with $16.8 million in the 2008 third quarter.
The primary factors contributing to the decrease of $9.4 million were a $3.8 million increase in provision for credit losses primarily as a result of increased NCOs, and a $5.0 million decline in the equity funds portfolio ($1.8 million loss in the current quarter, compared with $3.2 million gain in the prior quarter).
Net interest income increased $0.8 million, or 4%, reflecting a 8 basis point improvement in the net interest margin to 3.50% from 3.42%. The increase in the net interest margin reflected increased spreads on the home equity portfolio due to the timing differences between customer-rate resets and interest rate declines.
In addition to the decline in the equity funds portfolio discussed above, noninterest income decreased as a result of: (a) $3.2 million decline in trust services income mainly reflecting a $5.7 billion decline in total trust assets due to the impact of lower market values, and (b) $1.8 million decline in brokerage and insurance income primarily reflecting the general decline in market and economic conditions.
Noninterest expense increased $2.8 million, or 5%. This increase resulted primarily from a $1.9 million increase in personnel expense largely due to increased commission expense.
2008 versus 2007
PFG reported net income of $49.9 million in 2008, compared with $36.0 million in 2007. This increase primarily reflected the impact of the Sky Financial acquisition on July 1, 2007, and a $14.1 million improvement in the market value adjustments to the equity funds portfolio. These benefits were partially offset by: (a) $11.6 million increase in provision for credit losses resulting from a $6.7 million increase in NCOs primarily reflecting increased charge-offs in the home equity portfolio, and (b) a decrease in total assets under management to $13.3 billion from $16.3 billion reflecting the impact of lower market values associated with the decline in the general economic and market conditions.
2007 versus 2006
PFG reported net income of $36.0 million in 2007, compared with $46.2 million in 2006. This decrease primarily reflected the negative market value adjustments to the equity funds portfolio, partially offset by the positive impact of the Sky Financial acquisition to net interest income and noninterest income. Noninterest income was also positively impacted by the acquisition of Unified Fund Services on December 31, 2006, and the growth of assets under management to $16.3 billion from $12.2 billion.
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RESULTS FOR THE FOURTH QUARTER
Earnings Discussion
2008 fourth quarter results were a net loss of $417.3 million, or $1.20 per common share, compared with a net loss of $239.3 million, or $0.65 per common share, in the year-ago quarter. Significant items impacting 2008 fourth quarter performance included(see table below):
– | $454.3 million pre-tax ($0.81 per common share) negative impact related to our relationship with Franklin consisting of: |
– | $438.0 million of provision for credit losses, | |
– | $9.0 million of interest income reversals as the loans were placed on nonaccrual loan status, and | |
– | $7.3 million of interest rate swap losses. |
– | $141.7 million pre-tax ($0.25 per common share) negative impact of net market-related losses consisting of: |
– | $127.1 million of securities losses, related to OTTI on certain investment securities, | |
– | $12.6 million net negative impact of MSR hedging consisting of a $22.1 million net impairment loss reflected in noninterest income, partially offset by a $9.5 million net interest income benefit, and | |
– | $2.0 million of equity investment losses. |
– | $2.9 million ($0.01 per common share) increase to provision for income taxes, representing an increase to the previously established capital loss carryforward valuation allowance related to the decline in value of Visa® shares held and the reduction of shares resulting from the revised conversion ratio. | |
– | $4.6 million pre-tax ($0.01 per common share) decline in other noninterest expense, representing a partial reversal of the 2007 fourth quarter accrual of $24.9 million for our portion of the bank guaranty covering indemnification charges against Visa® following its funding of an escrow account for a portion of such indemnification. |
Table 46 — Significant Items Impacting Earnings Performance Comparisons
Three Months Ended | ||||||||
Impact(1) | ||||||||
(in millions, except per share amounts) | Pre-tax | EPS(2) | ||||||
December 31, 2008 — GAAP loss | $ | (417.3 | )(2) | ($ | 1.20 | ) | ||
– Franklin relationship | (454.3 | ) | (0.81 | ) | ||||
– Net market-related losses | (141.7 | ) | (0.25 | ) | ||||
– Visa®-related deferred tax valuation allowance provision | (2.9 | )(2) | (0.01 | ) | ||||
– Visa® indemnification | 4.6 | 0.02 | ||||||
September 30, 2008 — GAAP earnings | $ | 75.1 | (2) | $ | 0.17 | |||
– Net market-related losses | (47.1 | ) | (0.08 | ) | ||||
– Visa®-related deferred tax valuation allowance provision | (3.7 | )(2) | (0.01 | ) | ||||
December 31, 2007 — GAAP earnings | ($ | 239.3 | ) | ($ | 0.65 | ) | ||
– Franklin relationship restructuring | (423.6 | ) | (0.75 | ) | ||||
– Net market-related losses | (63.5 | ) | (0.11 | ) | ||||
– Merger costs | (44.4 | ) | (0.08 | ) | ||||
– Visa® indemnification charge | (24.9 | ) | (0.04 | ) | ||||
– Increases to litigation reserves | (8.9 | ) | (0.02 | ) |
(1) | Favorable (unfavorable) impact on GAAP earnings; pre-tax unless otherwise noted | |
(2) | After-tax |
Net Interest Income, Net Interest Margin, Loans and Average Balance Sheet
(This section should be read in conjunction with Significant Item 2.)
Fully taxable equivalent net interest income decreased $8.3 million, or 2%, from the year-ago quarter. This reflected the unfavorable impact of an 8 basis point decline in the net interest margin to 3.18%. Average earning assets increased $0.3 billion, or 1%, reflecting a $1.3 billion, or 3%, increase in average total loans and leases, partially offset by declines in other earning assets, most notably federal funds sold.
Table 47 details the $1.3 billion increase in average loans and leases.
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Table 47 — Loans and Leases — 4Q08 vs. 4Q07
Fourth Quarter | Change | |||||||||||||||
(in billions) | 2008 | 2007 | Amount | Percent | ||||||||||||
Average Loans and Leases | ||||||||||||||||
Commercial and industrial | $ | 13.7 | $ | 13.3 | $ | 0.5 | 4 | % | ||||||||
Commercial real estate | 10.2 | 9.1 | 1.2 | 13 | ||||||||||||
Total commercial | 24.0 | 22.3 | 1.6 | 7 | ||||||||||||
Automobile loans and leases | 4.5 | 4.3 | 0.2 | 5 | ||||||||||||
Home equity | 7.5 | 7.3 | 0.2 | 3 | ||||||||||||
Residential mortgage | 4.7 | 5.4 | (0.7 | ) | (13 | ) | ||||||||||
Other consumer | 0.7 | 0.7 | (0.1 | ) | (7 | ) | ||||||||||
Total consumer | 17.5 | 17.8 | (0.3 | ) | (2 | ) | ||||||||||
Total loans and leases | $ | 41.4 | $ | 40.1 | $ | 1.3 | 3 | % | ||||||||
The $1.3 billion, or 3%, increase in average total loans and leases primarily reflected:
– | $1.6 billion, or 7%, increase in average total commercial loans, with growth reflected in both C&I loans and CRE loans. The $1.2 billion, or 13%, increase in average CRE loans reflected a combination of factors, including the previously mentioned funding of letters of credit that had supported floating rate bonds, loans to existing borrowers, and draws on existing commitments, and loans to new business customers. The new loan activity, both to existing and new customers, was focused on traditional income producing property types and was not related to the single family residential developer segment. The $0.5 billion, or 4%, growth in average C&I loans reflected a combination of draws associated with existing commitments, new loans to existing borrowers, and some originations to new high credit quality customers. Given our consistent positioning in the market, we have been able to attract new relationships that historically dealt exclusively with competitors. These “house account” types of relationships are typically the highest quality borrowers and bring with them the added benefit of significant new deposit and other noncredit relationships. |
Partially offset by:
– | $0.3 billion, or 2%, decrease in average total consumer loans. This reflected a $0.7 billion, or 13%, decline in average residential mortgages, reflecting the impact of a loan sale in the 2008 second quarter, as well as the continued slump in the housing markets. Average home equity loans increased 3%, due to significant activity in home equity lines, particularly in the second half of the year due to the significantly lower rate environment. There was a decrease in the level of home equity loans, as borrowers moved back to the variable-rate product. Huntington has underwritten home equity lines with credit policies designed to continue to improve the risk profile of the portfolio. Notably, our interest rate stress policies associated with this variable-rate product continue to be in place. While clearly some borrowers have increased their funding percentage, the overall funding percentage on the home equity lines increased only slightly to 48%. Average automobile loans and leases increased 5% from the year-ago quarter, despite the dramatic decline in automobile sales that negatively affected growth in the 2008 fourth quarter due to the growth experienced earlier in 2008. Even though automobile loan origination volumes have declined, the impact of prepayments on this portfolio is lower because of loan sales in prior years. |
Table 48 details the $0.1 billion reported decrease in average total deposits.
Table 48 — Deposits — 4Q08 vs. 4Q07
Fourth Quarter | Change | |||||||||||||||
(in billions) | 2008 | 2007 | Amount | Percent | ||||||||||||
Average Deposits | ||||||||||||||||
Demand deposits — noninterest bearing | $ | 5.2 | $ | 5.2 | $ | (0.0 | ) | (0 | )% | |||||||
Demand deposits — interest bearing | 4.0 | 3.9 | 0.1 | 2 | ||||||||||||
Money market deposits | 5.5 | 6.8 | (1.3 | ) | (20 | ) | ||||||||||
Savings and other domestic deposits | 4.8 | 5.0 | (0.2 | ) | (3 | ) | ||||||||||
Core certificates of deposit | 12.5 | 10.7 | 1.8 | 17 | ||||||||||||
Total core deposits | 32.0 | 31.7 | 0.3 | 1 | ||||||||||||
Other deposits | 5.6 | 6.0 | (0.4 | ) | (7 | ) | ||||||||||
Total deposits | $ | 37.6 | $ | 37.7 | $ | (0.1 | ) | (0 | )% | |||||||
The $0.1 billion decrease in average total deposits reflected growth in average total core deposits, as average other deposits declined. Changes from the year-ago period reflected the continuation of customers transferring funds from lower rate to higher rate accounts like certificates of deposits as short-term rates have fallen. Specifically, average core certificates of deposit increased $1.8 billion, or 17%, whereas average money market deposits and savings and other domestic deposits decreased 20% and 3%, respectively.
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Provision for Credit Losses
(This section should be read in conjunction with Significant Item 2.)
The provision for credit losses in the 2008 fourth quarter was $722.6 million, up $597.2 million from the third quarter, of which $438.0 million reflected the Franklin relationship actions during the current quarter. The provision for credit losses in the current quarter was $210.5 million higher than in the year-ago quarter.(See “Franklin Relationship” located within the “Credit Risk” section and “Significant Items” located within the “Discussion of Results of Operations” section for additional details).
Noninterest Income
(This section should be read in conjunction with Significant Items 2, 4, 5 and 6.)
Noninterest income decreased $103.5 million, or 61%, from the year-ago quarter.
Table 49 — Noninterest Income — 4Q08 vs. 4Q07
Change attributable to: | ||||||||||||||||||||||||||||
Fourth Quarter | Change | Other | ||||||||||||||||||||||||||
Significant | ||||||||||||||||||||||||||||
(in thousands) | 2008 | 2007 | Amount | Percent | Items | Amount | Percent | |||||||||||||||||||||
Service charges on deposit accounts | $ | 75,247 | $ | 81,276 | $ | (6,029 | ) | (7.4 | )% | $ | — | $ | (6,029 | ) | (7.4 | )% | ||||||||||||
Brokerage and insurance income | 31,233 | 30,288 | 945 | 3.1 | — | 945 | 3.1 | |||||||||||||||||||||
Trust services | 27,811 | 35,198 | (7,387 | ) | (21.0 | ) | — | (7,387 | ) | (21.0 | ) | |||||||||||||||||
Electronic banking | 22,838 | 21,891 | 947 | 4.3 | — | 947 | 4.3 | |||||||||||||||||||||
Bank owned life insurance income | 13,577 | 13,253 | 324 | 2.4 | — | 324 | 2.4 | |||||||||||||||||||||
Automobile operating lease income | 13,170 | 2,658 | 10,512 | N.M. | — | 10,512 | N.M. | |||||||||||||||||||||
Mortgage banking income | (6,747 | ) | 3,702 | (10,449 | ) | N.M. | (10,318 | )(1) | (131 | ) | (3.5 | ) | ||||||||||||||||
Securities (losses) gains | (127,082 | ) | (11,551 | ) | (115,531 | ) | N.M. | (115,531 | )(2) | — | 0.0 | |||||||||||||||||
Other income | 17,052 | (6,158 | ) | 23,210 | N.M. | 34,088 | (3) | (10,878 | ) | N.M. | ||||||||||||||||||
Total noninterest income | $ | 67,099 | $ | 170,557 | $ | (103,458 | ) | (60.7 | )% | $ | (91,761 | ) | $ | (11,697 | ) | (6.9 | )% | |||||||||||
N.M., not a meaningful value.
(1) | Refer to Significant Item 4 of the “Significant Items” discussion. | |
(2) | Refer to Significant Item 5 of the “Significant Items” discussion. | |
(3) | Refer to Significant Items 2, 5, and 7 of the “Significant Items” discussion. |
The $103.5 million decrease in total noninterest income reflected the $91.8 million negative impact in the current quarter from significant items(see “Significant Items” located within the “Discussion of Results of Operations” section), as well as a 7% decline in the remaining components of noninterest income. The $10.9 million decline in other income reflected lower capital markets income.
Noninterest Expense
(This section should be read in conjunction with Significant Items 1 and 3.)
Noninterest expense decreased $49.5 million, or 11%, from the year-ago quarter.
Table 50 — Noninterest Expense — 4Q08 vs. 4Q07
Change attributable to: | ||||||||||||||||||||||||||||||||
Fourth Quarter | Change | Other | ||||||||||||||||||||||||||||||
Restructuring/ | Significant | |||||||||||||||||||||||||||||||
(in thousands) | 2008 | 2007 | Amount | Percent | Merger Costs | Items | Amount | Percent(1) | ||||||||||||||||||||||||
Personnel costs | $ | 196,785 | $ | 214,850 | $ | (18,065 | ) | (8.4 | )% | $ | (22,780 | ) | $ | — | $ | 4,715 | 2.5 | % | ||||||||||||||
Outside data processing and other services | 31,230 | 39,130 | (7,900 | ) | (20.2 | ) | (7,005 | ) | — | (895 | ) | (2.8 | ) | |||||||||||||||||||
Net occupancy | 22,999 | 26,714 | (3,715 | ) | (13.9 | ) | (1,204 | ) | — | (2,511 | ) | (9.8 | ) | |||||||||||||||||||
Equipment | 22,329 | 22,816 | (487 | ) | (2.1 | ) | (175 | ) | — | (312 | ) | (1.4 | ) | |||||||||||||||||||
Amortization of intangibles | 19,187 | 20,163 | (976 | ) | (4.8 | ) | — | — | (976 | ) | (4.8 | ) | ||||||||||||||||||||
Professional services | 17,420 | 14,464 | 2,956 | 20.4 | (3,447 | ) | — | 6,403 | 58.1 | |||||||||||||||||||||||
Marketing | 9,357 | 16,175 | (6,818 | ) | (42.2 | ) | (6,915 | ) | — | 97 | 1.0 | |||||||||||||||||||||
Automobile operating lease expense | 10,483 | 1,918 | 8,565 | N.M. | — | — | 8,565 | N.M. | ||||||||||||||||||||||||
Telecommunications | 5,892 | 8,513 | (2,621 | ) | (30.8 | ) | (954 | ) | — | (1,667 | ) | (22.1 | ) | |||||||||||||||||||
Printing and supplies | 4,175 | 6,594 | (2,419 | ) | (36.7 | ) | (1,043 | ) | — | (1,376 | ) | (24.8 | ) | |||||||||||||||||||
Other expense | 50,237 | 68,215 | (17,978 | ) | (26.4 | ) | (893 | ) | (29,430 | )(2) | 12,345 | 18.3 | ||||||||||||||||||||
Total noninterest expense | $ | 390,094 | $ | 439,552 | $ | (49,458 | ) | (11.3 | )% | $ | (44,416 | ) | $ | (29,430 | ) | $ | 24,388 | 6.2 | % | |||||||||||||
N.M., not a meaningful value.
(1) | Calculated as other / (prior period + restructuring/merger costs) |
(2) | Refer to Significant Item 3 of the “Significant Items” discussion. |
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Of the $49.5 million decline, $44.4 million represented Sky Financial merger/restructuring costs in the year-ago quarter with $29.4 million from significant items(see “Significant Items” discussion located within the “Discussion of Results of Operations” section). The remaining $24.4 million, or 6%, increase primarily reflected a $12.3 million, or 18%, increase in other expense due to higher automobile lease residual losses, corporate insurance expense, and FDIC insurance premiums.
Income Taxes
The provision for income taxes in the 2008 fourth quarter was a benefit of $251.9 million, resulting in an effective tax rate benefit of 37.6%. The effective tax rates in prior quarter and year-ago quarters were 18.5% and a benefit of 39.9% respectively.
Credit Quality
Credit quality performance in the 2008 fourth quarter was negatively impacted by the Franklin relationship actions(see “Franklin Relationship” located within the “Credit Risk” section and “Significant Items” located within the “Discussion of Results of Operations” section), as well as accelerated economic weakness in our Midwest markets. These economic factors influenced the performance of NCOs and NALs, as well as an expected commensurate significant increase in the provision for credit losses(see “Provision for Credit Losses” located within the “Discussion of Results of Operations” section)that significantly increased the absolute and relative levels of our ACL.
Net Charge-offs
(This section should be read in conjunction with Significant Item 2.)
Total NCOs for the 2008 fourth quarter were $560.6 million, or an annualized 5.41% of average total loans and leases. This was up significantly from total NCOs in the year-ago quarter of $377.9 million, or an annualized 3.77%. The 2008 fourth quarter, as well as the year-ago quarter, included Franklin relationship-related NCOs of $423.3 million and $308.5 million, respectively.
Total commercial NCOs for the 2008 fourth quarter were $511.8 million, or an annualized 8.54% of related loans, up from the year-ago quarter of $344.6 million, or an annualized 6.18%. Franklin relationship-related NCOs in the current and year-ago quarter were $423.3 million and $308.5 million, respectively. Non-Franklin C&I NCOs in the 2008 fourth quarter were $50.2 million, or an annualized 1.58%, of related loans. The current quarter’s non-Franklin C&I NCOs reflected the impact of two relationships totaling $11.5 million, with the rest of the increase spread among smaller loans across the portfolio.
Current quarter CRE NCOs were $38.4 million, or an annualized 1.50%, up from $20.7 million, or an annualized 0.92% in the prior quarter. The fourth quarter losses were centered in the single family home builder portfolio, spread across our regions.
Total consumer NCOs in the current quarter were $48.8 million, or an annualized 1.12% of related loans, up from $33.3 million, or an annualized 0.75%, in the year-ago quarter.
Automobile loan and lease NCOs were $18.6 million, or an annualized 1.64% in the current quarter, up from 0.96% in the year-ago period. NCOs for automobile loans were an annualized 1.53% in the current quarter, up from 0.96% in the year-ago quarter, with NCOs for automobile leases also increasing to an annualized 2.31% from 0.96%. Both automobile loan and automobile lease NCOs continued to be negatively impacted by declines in used car prices, with automobile lease NCO rates also being negatively impacted by a portfolio that is in a run-off mode. Although we anticipate that automobile loan and lease NCOs will remain under pressure due to continued economic weakness in our markets, we believe that our focus on prime borrowers over the last several years will continue to result in better performance relative to other peer bank automobile portfolios.
Home equity NCOs in the 2008 fourth quarter were $19.2 million, or an annualized 1.02%, up from an annualized 0.67%, in the year-ago quarter. This portfolio continued to be negatively impacted by the general economic and housing market slowdown. The impact was evident across our footprint, particularly so in our Michigan markets. Given that we have no exposure to the very volatile West Coast and minimal exposure to Florida markets, less than 10% of the portfolio was originated via the broker channel, and our conservative assessment of the borrower’s ability to repay at the time of underwriting, we continue to believe our home equity NCO experience will compare very favorably relative to the industry.
Residential mortgage NCOs were $7.3 million, or an annualized 0.62% of related average balances. This was up from an annualized 0.25% in the year-ago quarter. The residential portfolio is subject to the regional economic and housing related pressures, and we expect to see additional stress in our markets in future periods. Our portfolio performance will continue to be positively impacted by our origination strategy that specifically excluded the more exotic mortgage structures. In addition, loss mitigation strategies have been in place for over a year and are helping to successfully address risks in our ARM portfolio.
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Nonaccrual Loans (NALs) and Nonperforming Assets (NPAs)
(This section should be read in conjunction with Significant Item 2.)
NALs were $1,502.1 million at December 31, 2008, and represented 3.66% of total loans and leases. This was significantly higher than $319.8 million, or 0.80%, at the end of the year-ago period. Of the $1,182.4 million increase in NALs from the end of the year-ago quarter, $650.2 million were related to the placing of the Franklin portfolio on nonaccrual status, $297.3 million increase in CRE NALs and a $194.8 million increase in non-Franklin-related C&I NALs.
NPAs, which include NALs, were $1,636.6 million at December 31, 2008. This was significantly higher than the $472.9 million at the end of the year-ago period. The $1,163.7 million increase in NPAs from the end of the year-ago period reflected the $1,182.4 million increase in NALs.
The over90-day delinquent, but still accruing, ratio was 0.50% at December 31, 2008, up from 0.35% at the end of the year-ago quarter. The 15 basis point increase in the90-day delinquent ratio from December 31, 2007, primarily reflected increases in loan balances over90-days delinquent in our commercial real estate and residential mortgage portfolios.
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Table 51 — Selected Quarterly Income Statement Data(1)
2008 | 2007 | |||||||||||||||||||||||||||||||
(in thousands, except per share amounts) | Fourth | Third | Second | First | Fourth | Third | Second | First | ||||||||||||||||||||||||
Interest income | $ | 662,508 | $ | 685,728 | $ | 696,675 | $ | 753,411 | $ | 814,398 | $ | 851,155 | $ | 542,461 | $ | 534,949 | ||||||||||||||||
Interest expense | 286,143 | 297,092 | 306,809 | 376,587 | 431,465 | 441,522 | 289,070 | 279,394 | ||||||||||||||||||||||||
Net interest income | 376,365 | 388,636 | 389,866 | 376,824 | 382,933 | 409,633 | 253,391 | 255,555 | ||||||||||||||||||||||||
Provision for credit losses | 722,608 | 125,392 | 120,813 | 88,650 | 512,082 | 42,007 | 60,133 | 29,406 | ||||||||||||||||||||||||
Net interest income (loss) after provision for credit losses | (346,243 | ) | 263,244 | 269,053 | 288,174 | (129,149 | ) | 367,626 | 193,258 | 226,149 | ||||||||||||||||||||||
Service charges on deposit accounts | 75,247 | 80,508 | 79,630 | 72,668 | 81,276 | 78,107 | 50,017 | 44,793 | ||||||||||||||||||||||||
Brokerage and insurance income | 31,233 | 34,309 | 35,694 | 36,560 | 30,288 | 28,806 | 17,199 | 16,082 | ||||||||||||||||||||||||
Trust services | 27,811 | 30,952 | 33,089 | 34,128 | 35,198 | 33,562 | 26,764 | 25,894 | ||||||||||||||||||||||||
Electronic banking | 22,838 | 23,446 | 23,242 | 20,741 | 21,891 | 21,045 | 14,923 | 13,208 | ||||||||||||||||||||||||
Bank owned life insurance income | 13,577 | 13,318 | 14,131 | 13,750 | 13,253 | 14,847 | 10,904 | 10,851 | ||||||||||||||||||||||||
Automobile operating lease income | 13,170 | 11,492 | 9,357 | 5,832 | 2,658 | 653 | 1,611 | 2,888 | ||||||||||||||||||||||||
Mortgage banking (loss) income | (6,747 | ) | 10,302 | 12,502 | (7,063) | 3,702 | 9,629 | 7,122 | 9,351 | |||||||||||||||||||||||
Securities (losses) gains | (127,082 | ) | (73,790 | ) | 2,073 | 1,429 | (11,551 | ) | (13,152 | ) | (5,139 | ) | 104 | |||||||||||||||||||
Other income (loss) | 17,052 | 37,320 | 26,712 | 57,707 | (6,158 | ) | 31,177 | 32,792 | 22,006 | |||||||||||||||||||||||
Total noninterest income | 67,099 | 167,857 | 236,430 | 235,752 | 170,557 | 204,674 | 156,193 | 145,177 | ||||||||||||||||||||||||
Personnel costs | 196,785 | 184,827 | 199,991 | 201,943 | 214,850 | 202,148 | 135,191 | 134,639 | ||||||||||||||||||||||||
Outside data processing and other services | 31,230 | 32,386 | 30,186 | 34,361 | 39,130 | 40,600 | 25,701 | 21,814 | ||||||||||||||||||||||||
Net occupancy | 22,999 | 25,215 | 26,971 | 33,243 | 26,714 | 33,334 | 19,417 | 19,908 | ||||||||||||||||||||||||
Equipment | 22,329 | 22,102 | 25,740 | 23,794 | 22,816 | 23,290 | 17,157 | 18,219 | ||||||||||||||||||||||||
Amortization of intangibles | 19,187 | 19,463 | 19,327 | 18,917 | 20,163 | 19,949 | 2,519 | 2,520 | ||||||||||||||||||||||||
Professional services | 17,420 | 13,405 | 13,752 | 9,090 | 14,464 | 11,273 | 8,101 | 6,482 | ||||||||||||||||||||||||
Marketing | 9,357 | 7,049 | 7,339 | 8,919 | 16,175 | 13,186 | 8,986 | 7,696 | ||||||||||||||||||||||||
Automobile operating lease expense | 10,483 | 9,093 | 7,200 | 4,506 | 1,918 | 337 | 875 | 2,031 | ||||||||||||||||||||||||
Telecommunications | 5,892 | 6,007 | 6,864 | 6,245 | 8,513 | 7,286 | 4,577 | 4,126 | ||||||||||||||||||||||||
Printing and supplies | 4,175 | 4,316 | 4,757 | 5,622 | 6,594 | 4,743 | 3,672 | 3,242 | ||||||||||||||||||||||||
Other expense | 50,237 | 15,133 | 35,676 | 23,841 | 68,215 | 29,417 | 18,459 | 21,395 | ||||||||||||||||||||||||
Total noninterest expense | 390,094 | 338,996 | 377,803 | 370,481 | 439,552 | 385,563 | 244,655 | 242,072 | ||||||||||||||||||||||||
(Loss) Income before income taxes | (669,238 | ) | 92,105 | 127,680 | 153,445 | (398,144 | ) | 186,737 | 104,796 | 129,254 | ||||||||||||||||||||||
(Benefit) Provision for income taxes | (251,949 | ) | 17,042 | 26,328 | 26,377 | (158,864 | ) | 48,535 | 24,275 | 33,528 | ||||||||||||||||||||||
Net (loss) income | $ | (417,289 | ) | $ | 75,063 | $ | 101,352 | $ | 127,068 | $ | (239,280 | ) | $ | 138,202 | $ | 80,521 | $ | 95,726 | ||||||||||||||
Dividends on preferred shares | 23,158 | 12,091 | 11,151 | — | — | — | — | — | ||||||||||||||||||||||||
Net income (loss) applicable to common shares | $ | (440,447 | ) | $ | 62,972 | $ | 90,201 | $ | 127,068 | $ | (239,280 | ) | $ | 138,202 | $ | 80,521 | $ | 95,726 | ||||||||||||||
Average common shares — basic | 366,054 | 366,124 | 366,206 | 366,235 | 366,119 | 365,895 | 236,032 | 235,586 | ||||||||||||||||||||||||
Average common shares — diluted (2) | 366,054 | 367,361 | 367,234 | 367,208 | 366,119 | 368,280 | 239,008 | 238,754 | ||||||||||||||||||||||||
Per common share | ||||||||||||||||||||||||||||||||
Net (loss) income — basic | $ | (1.20 | ) | $ | 0.17 | $ | 0.25 | $ | 0.35 | $ | (0.65 | ) | $ | 0.38 | $ | 0.34 | $ | 0.40 | ||||||||||||||
Net (loss) income — diluted | (1.20 | ) | 0.17 | 0.25 | 0.35 | (0.65 | ) | 0.38 | 0.34 | 0.40 | ||||||||||||||||||||||
Cash dividends declared | 0.1325 | 0.1325 | 0.1325 | 0.2650 | 0.2650 | 0.2650 | 0.2650 | 0.2650 | ||||||||||||||||||||||||
Return on average total assets | (3.04 | )% | 0.55 | % | 0.73 | % | 0.93 | % | (1.74 | )% | 1.02 | % | 0.92 | % | 1.11 | % | ||||||||||||||||
Return on average total shareholders’ equity | (23.7 | ) | 4.7 | 6.4 | 8.7 | (15.3 | ) | 8.8 | 10.6 | 12.9 | ||||||||||||||||||||||
Return on average tangible shareholders’ equity (3) | (43.2 | ) | 11.6 | 15.0 | 22.0 | (30.7 | ) | 19.7 | 13.5 | 16.4 | ||||||||||||||||||||||
Net interest margin (4) | 3.18 | 3.29 | 3.29 | 3.23 | 3.26 | 3.52 | 3.26 | 3.36 | ||||||||||||||||||||||||
Efficiency ratio (5) | 64.6 | 50.3 | 56.9 | 57.0 | 73.5 | 57.7 | 57.8 | 59.2 | ||||||||||||||||||||||||
Effective tax rate (benefit) | (37.6 | ) | 18.5 | 20.6 | 17.2 | (39.9 | ) | 26.0 | 23.2 | 25.9 | ||||||||||||||||||||||
Revenue — fully taxable equivalent (FTE) | ||||||||||||||||||||||||||||||||
Net interest income | $ | 376,365 | $ | 388,636 | $ | 389,866 | $ | 376,824 | $ | 382,933 | $ | 409,633 | $ | 253,391 | $ | 255,555 | ||||||||||||||||
FTE adjustment | 3,641 | 5,451 | 5,624 | 5,502 | 5,363 | 5,712 | 4,127 | 4,047 | ||||||||||||||||||||||||
Net interest income (4) | 380,006 | 394,087 | 395,490 | 382,326 | 388,296 | 415,345 | 257,518 | 259,602 | ||||||||||||||||||||||||
Noninterest income | 67,099 | 167,857 | 236,430 | 235,752 | 170,557 | 204,674 | 156,193 | 145,177 | ||||||||||||||||||||||||
Total revenue (4) | $ | 447,105 | $ | 561,944 | $ | 631,920 | $ | 618,078 | $ | 558,853 | $ | 620,019 | $ | 413,711 | $ | 404,779 | ||||||||||||||||
(1) | Comparisons for presented periods are impacted by a number of factors. Refer to the “Significant Items” section for additional discussion regarding these key factors. |
(2) | For the three-month periods ended December 31, 2008, September 30, 2008, and June 30, 2008, the impact of the convertible preferred stock issued in April of 2008 totaling 47.6 million shares, 47.6 million shares, and 39.8 million shares, respectively, were excluded from the diluted share calculations. They were excluded because the results would have been higher than basic earnings per common share (anti-dilutive) for the periods. |
(3) | Net income excluding expense for amortization of intangibles for the period divided by average tangible shareholders’ equity. Average tangible shareholders’ equity equals average total stockholders’ equity less average intangible assets and goodwill. Expense for amortization of intangibles and average intangible assets are net of deferred tax liability, and calculated assuming a 35% tax rate. |
(4) | On a fully taxable equivalent (FTE) basis assuming a 35% tax rate. |
(5) | Noninterest expense less amortization of intangibles divided by the sum of FTE net interest income and noninterest income excluding securities (losses) gains. |
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Table of Contents
Management’s Discussion and Analysis | Huntington Bancshares Incorporated |
Table 52 — Quarterly Stock Summary, Key Ratios and Statistics, and Capital Data
Quarterly common stock summary | 2008 | 2007 | ||||||||||||||||||||||||||||||
(in thousands, except per share amounts) | Fourth | Third | Second | First | Fourth | Third | Second | First | ||||||||||||||||||||||||
Common stock price, per share | ||||||||||||||||||||||||||||||||
High (1) | $ | 11.650 | $ | 13.500 | $ | 11.750 | $ | 14.870 | $ | 18.390 | $ | 22.930 | $ | 22.960 | $ | 24.140 | ||||||||||||||||
Low (1) | 5.260 | 4.370 | 4.940 | 9.640 | 13.500 | 16.050 | 21.300 | 21.610 | ||||||||||||||||||||||||
Close | 7.660 | 7.990 | 5.770 | 10.750 | 14.760 | 16.980 | 22.740 | 21.850 | ||||||||||||||||||||||||
Average closing price | 8.276 | 7.510 | 8.783 | 12.268 | 16.125 | 18.671 | 22.231 | 23.117 | ||||||||||||||||||||||||
Dividends, per share | ||||||||||||||||||||||||||||||||
Cash dividends declared on common stock | $ | 0.1325 | $ | 0.1325 | $ | 0.1325 | $ | 0.265 | $ | 0.265 | $ | 0.265 | $ | 0.265 | $ | 0.265 | ||||||||||||||||
Common shares outstanding | ||||||||||||||||||||||||||||||||
Average — basic | 366,054 | 366,124 | 366,206 | 366,235 | 366,119 | 365,895 | 236,032 | 235,586 | ||||||||||||||||||||||||
Average — diluted | 366,054 | 367,361 | 367,234 | 367,208 | 366,119 | 368,280 | 239,008 | 238,754 | ||||||||||||||||||||||||
Ending | 366,058 | 366,069 | 366,197 | 366,226 | 366,262 | 365,898 | 236,244 | 235,714 | ||||||||||||||||||||||||
Book value per share | $ | 14.61 | $ | 15.86 | $ | 15.87 | $ | 16.13 | $ | 16.24 | $ | 17.08 | $ | 12.97 | $ | 12.95 | ||||||||||||||||
Tangible book value per share (2) | 5.63 | 6.84 | 6.82 | 7.08 | 7.13 | 8.10 | 10.41 | 10.37 | ||||||||||||||||||||||||
Quarterly key ratios and statistics | ||||||||||||||||||||||||||||||||
Margin analysis-as a% of average earning assets (3) | ||||||||||||||||||||||||||||||||
Interest income (3) | 5.57 | % | 5.77 | % | 5.85 | % | 6.40 | % | 6.88 | % | 7.25 | % | 6.92 | % | 6.98 | % | ||||||||||||||||
Interest expense | 2.39 | 2.48 | 2.56 | 3.17 | 3.62 | 3.73 | 3.66 | 3.62 | ||||||||||||||||||||||||
Net interest margin (3) | 3.18 | % | 3.29 | % | 3.29 | % | 3.23 | % | 3.26 | % | 3.52 | % | 3.26 | % | 3.36 | % | ||||||||||||||||
Return on average total assets | (3.04 | )% | 0.55 | % | 0.73 | % | 0.93 | % | (1.74 | )% | 1.02 | % | 0.92 | % | 1.11 | % | ||||||||||||||||
Return on average total shareholders’ equity | (23.7 | ) | 4.7 | 6.4 | 8.7 | (15.3 | ) | 8.8 | 10.6 | 12.9 | ||||||||||||||||||||||
Return on average tangible shareholders’ equity (4) | (43.2 | ) | 11.6 | 15.0 | 22.0 | (30.7 | ) | 19.7 | 13.5 | 16.4 |
Capital adequacy | 2008 | 2007 | ||||||||||||||||||||||||||||||
(in millions of dollars) | December 31, | September 30, | June 30, | March 31, | December 31, | September 30, | June 30, | March 31, | ||||||||||||||||||||||||
Total risk-weighted assets | $ | 46,994 | $ | 46,608 | $ | 46,602 | $ | 46,546 | $ | 46,044 | $ | 45,931 | $ | 32,121 | $ | 31,473 | ||||||||||||||||
Tier 1 leverage ratio | 9.82 | % | 7.99 | % | 7.88 | % | 6.83 | % | 6.77 | % | 7.57 | % | 9.07 | % | 8.24 | % | ||||||||||||||||
Tier 1 risk-based capital ratio | 10.72 | 8.80 | 8.82 | 7.56 | 7.51 | 8.35 | 9.74 | 8.98 | ||||||||||||||||||||||||
Total risk-based capital ratio | 13.91 | 12.03 | 12.05 | 10.87 | 10.85 | 11.58 | 13.49 | 12.82 | ||||||||||||||||||||||||
Tangible common equity/asset ratio (5) | 4.04 | 4.88 | 4.80 | 4.92 | 5.08 | 5.70 | 6.87 | 7.11 | ||||||||||||||||||||||||
Tangible equity/asset ratio (6) | 7.72 | 5.98 | 5.90 | 4.92 | 5.08 | 5.70 | 6.87 | 7.11 | ||||||||||||||||||||||||
Tangible equity/risk-weighted assets ratio | 8.38 | 6.59 | 6.58 | 5.57 | 5.67 | 6.46 | 7.66 | 7.77 | ||||||||||||||||||||||||
Average equity/average assets | 12.85 | 11.56 | 11.44 | 10.70 | 11.40 | 11.50 | 8.66 | 8.63 |
(1) | High and low stock prices areintra-day quotes obtained from NASDAQ. |
(2) | Deferred tax liability related to other intangible assets is calculated assuming a 35% tax rate. |
(3) | Presented on a fully taxable equivalent basis assuming a 35% tax rate. |
(4) | Net income less expense for amortization of intangibles (net of tax) for the period divided by average tangible common shareholders’ equity. Average tangible common shareholders’ equity equals average total common shareholders’ equity less other intangible assets and goodwill. Other intangible assets are net of deferred tax. |
(5) | Tangible common equity (total common equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
(6) | Tangible equity (total equity less goodwill and other intangible assets) divided by tangible assets (total assets less goodwill and other intangible assets). Other intangible assets are net of deferred tax, and calculated assuming a 35% tax rate. |
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