UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
QUARTERLY PERIOD ENDED June 30, 2004
Commission File Number 0-2525
Huntington Bancshares Incorporated
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
41 South High Street, Columbus, Ohio 43287
Registrant’s telephone number (614) 480-8300
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
There were 229,685,385 shares of Registrant’s without par value common stock outstanding on July 31, 2004.
INDEX
Part I.
Item 1.
Item 2.
Item 3.
Item 4.
Part II.
Item 6.
Signatures
2
Part 1. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
(in thousands, except number of shares)
June 30,
2004
December 31,
2003
Assets
Cash and due from banks
Federal funds sold and securities purchased under resale agreements
Interest bearing deposits in banks
Trading account securities
Loans held for sale
Securities available for sale - at fair value
Investment securities held to maturity - fair value $3,224; $3,937 and $6,780, respectively
Loans and leases
Allowance for loan and lease losses
Net loans and leases
Operating lease assets
Bank owned life insurance
Premises and equipment
Goodwill and other intangible assets
Customers’ acceptance liability
Accrued income and other assets
Total Assets
Liabilities
Deposits
Short-term borrowings
Federal Home Loan Bank advances
Other long-term debt
Subordinated notes
Company obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated debentures of the parent company
Allowance for unfunded loan commitments and letters of credit
Bank acceptances outstanding
Accrued expenses and other liabilities
Total Liabilities
Shareholders’ Equity
Preferred stock - authorized 6,617,808 shares; none outstanding
Common stock - without par value; authorized 500,000,000 shares; issued 257,866,255 shares; outstanding 229,475,821; 229,008,088 and 228,660,038 shares, respectively
Less 28,390,434; 28,858,167 and 29,206,217 treasury shares, respectively
Accumulated other comprehensive income (loss)
Retained earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
See notes to unaudited condensed consolidated financial statements
3
Condensed Consolidated Statements of Income
(Unaudited)
Six Months Ended
(in thousands, except per share amounts)
Interest and fee income
Taxable
Taxable-exempt
Securities
Other
Total Interest Income
Interest expenses
Subordinated notes and other long-term debt including preferred capital securities
Total Interest Expense
Net Interest Income
Provision for credit losses
Net Interest Income After Provision for Credit Losses
Operating lease income
Service charges on deposit accounts
Trust services
Brokerage and insurance income
Mortgage banking
Bank owned life insurance income
Gain on sales of automobile loans
Other service charges and fees
Securities gains (losses)
Total Non-Interest Income
Personnel costs
Operating lease expense
Outside data processing and other services
Equipment
Net occupancy
Professional services
Marketing
Telecommunications
Printing and supplies
Amortization of intangibles
Restructuring reserve releases
Total Non-Interest Expense
Income Before Income Taxes
Provision for income taxes
Net Income
Average Common Shares:
Basic
Diluted
Per Common Share:
Net Income - Basic
Net Income - Diluted
Cash Dividends Declared
4
Consolidated Statements of Changes in Shareholders’ Equity
(in thousands)
Accumulated
Comprehensive
Income
RetainedEarnings
Total
Six Months Ended June 30, 2003 (Unaudited):
Balance, beginning of period
Comprehensive Income:
Net income
Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income
Unrealized losses on derivative instruments used in cash flow hedging relationships
Total comprehensive income
Cash dividends declared ($0.32 per share)
Stock options exercised
Treasury shares purchased
Balance, end of period (Unaudited)
Six Months Ended June 30, 2004 (Unaudited):
Unrealized gains on derivative instruments used in cash flow hedging relationships
Cash dividends declared ($0.35 per share)
See notes to unaudited condensed consolidated financial statements.
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Consolidated Statements of Cash Flows
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation on operating lease assets
Other depreciation and amortization
Deferred income tax expense
Increase in trading account securities
Increase in mortgages held for sale
Gains on sales of securities available for sale
Gains on sales/securitizations of loans
Other, net
Net Cash Provided by Operating Activities
Investing Activities
Decrease (increase) in interest bearing deposits in banks
Proceeds from:
Maturities and calls of investment securities held to maturity
Maturities and calls of securities available for sale
Sales of securities available for sale
Purchases of securities available for sale
Proceeds from sales/securitizations of loans
Net loan and lease originations, excluding sales
Net decrease in operating lease assets
Proceeds from sale of premises and equipment
Purchases of premises and equipment
Proceeds from sales of other real estate
Net Cash Used for Investing Activities
Financing Activities
Increase in deposits
Decrease in short-term borrowings
Proceeds from issuance of subordinated notes
Maturity of subordinated notes
Proceeds from Federal Home Loan Bank advances
Maturity of Federal Home Loan Bank advances
Proceeds from issuance of long-term debt
Maturity of long-term debt
Dividends paid on common stock
Repurchases of common stock
Net proceeds from issuance of common stock
Net Cash Provided by Financing Activities
Change in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Period
Cash and Cash Equivalents at End of Period
Supplemental disclosures:
Income taxes paid
Interest paid
Non-cash activities
Residential mortgage loans securitized and retained in securities available for sale
Common stock dividends accrued not paid
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Notes to Unaudited Condensed Consolidated Financial Statements
Note 1 – Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Huntington Bancshares Incorporated (Huntington) reflect all adjustments consisting of normal recurring accruals, which are, in the opinion of Management, necessary for a fair presentation of the consolidated financial position, the results of operations, and cash flows for the periods presented. These unaudited condensed consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been omitted. The Notes to the Consolidated Financial Statements appearing in Huntington’s 2003 Annual Report on Form 10-K (2003 Form 10-K), which include descriptions of significant accounting policies, as updated by the information contained in this report, should be read in conjunction with these interim financial statements.
Certain amounts in the prior year’s financial statements have been reclassified to conform to the 2004 presentation.
For statement of cash flows purposes, cash and cash equivalents are defined as the sum of “Cash and due from banks” and “Federal funds sold and securities purchased under resale agreements”.
Note 2 – New Accounting Pronouncements
Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (EITF 03-1): The Emerging Issues Task Force reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. EITF 03-1 also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. EITF 03-1 will apply to the evaluation of other-than-temporary impairment in reporting periods beginning after June 15, 2004.
At June 30, 2004, Huntington had $3.3 billion of securities whose fair value was less than book value. The unrealized loss in these securities totaled $88.9 million. Of these securities, Huntington held $3.1 billion of securities, with an unrealized loss of $80.0 million, where the security cannot be contractually prepaid or where Huntington would recover substantially all of its cost if the securities were contractually prepaid. Management continues to evaluate its options with respect to adopting this new accounting guidance and cannot currently estimate the impact of adopting EITF 03-1.
Emerging Issues Task Force Issue No. 03-16, Accounting for Investment in Limited Liability Companies (EITF 03-16): The Task Force reached a consensus that an investment in a limited liability company (LLC) that maintains a “specific ownership account” for each investor should be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in an LLC should be accounted for using the cost method or the equity method. The current rules require a noncontrolling investment in a limited partnership to be accounted for under the equity method unless the interest is so minor that the limited partner may have virtually no influence over the partnership operating and financial policies. The guidance for evaluating an investment in a LLC should be applied for reporting periods beginning after June 15, 2004. The impact of EITF 03-16 is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.
SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments (SAB 105): On March 9, 2004, the SEC issued SAB 105, which summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. Specifically, SAB 105 indicated that the fair value of loan commitments that are required to follow derivative accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of the future loan. Prior to SAB 105, Huntington did not consider the expected future cash flows related to the associated servicing in determining the fair value of loan commitments. The adoption of SAB 105 did not have a material effect on Huntington’s financial results.
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FASB Staff Position No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2): In December 2003, a law was approved that expands Medicare benefits, primarily adding a prescription drug benefit for Medicare-eligible retirees beginning in 2006. The law also provides a federal subsidy to companies that sponsor postretirement benefit plans providing prescription drug coverage. FSP 106-2 was issued in May 2004 and supersedes FSP 106-1 issued in January 2004. FSP 106-2 specifies that any Medicare subsidy must be taken into account in measuring the employer’s postretirement health care benefit obligation and will also reduce the net periodic postretirement cost in future periods. The new guidance is effective for the reporting periods beginning on or after June 15, 2004. Accordingly, the postretirement benefit obligations and net periodic costs reported in the accompanying financial statements and notes do not reflect the impact of this legislation. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.
AICPA Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3): In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 03-3 to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities acquired in purchase business combinations and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.
FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (FAS 148): FAS 148 was issued in December 2002, as an amendment of Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to FAS 123’s fair value method of accounting for stock-based employee compensation. FAS 148 also amends the disclosure provisions of FAS 123 and Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting (APB 28), to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While FAS 148 does not require companies to account for employee stock options using the fair value method, the disclosure provisions of FAS 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of FAS 123 or the intrinsic value method of APB 25, which is the method currently used by Huntington. See note 11 for the disclosures.
Note 3 – Securities and Exchange Commission Investigation
As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington. The SEC staff has notified Huntington that the staff is considering recommending to the SEC that it institute enforcement action against Huntington and certain of its senior officers for, among other possible matters, violations of various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933 in connection with certain financial accounting matters relating to fiscal years 2002 and earlier, and certain related disclosure matters.
Huntington is presently in negotiations with the staff of the SEC regarding a settlement of its investigation. Huntington’s chief executive officer has indicated he accepts responsibility in his position as the chief executive officer for matters that occur on his watch, and has indicated a willingness to negotiate a settlement with the SEC of these matters. Huntington expects that a settlement of this matter would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a fine and other possible measures. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.
Huntington also remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.
Donald R. Kimble, who joined Huntington earlier this year as executive vice president in the Finance area, has been named chief financial officer and controller. Prior to joining Huntington, Kimble was executive vice president and controller of AmSouth Bancorporation, and previously held various subsidiary chief financial officer or accounting positions at Bank One Corporation. Michael J. McMennamin and John D. Van Fleet have relinquished their positions of chief financial officer and controller, respectively. Both remain with the company.
8
Note 4 – Pending Acquisition
On January 27, 2004, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio, with $2.7 billion of assets at December 31, 2003. Under the terms of the agreement, Unizan shareholders will receive 1.1424 shares of Huntington common stock, on a tax-free basis, for each share of Unizan. Based on the $23.10 closing price of Huntington’s common stock on January 26, 2004, this represented a price of $26.39 per Unizan share, and valued the transaction at approximately $587 million. Both boards unanimously approved the merger, and on May 25, 2004, Unizan shareholders approved the merger. Approval by Huntington shareholders is not required.
As reported on June 16, 2004, the Federal Reserve Board had informed Huntington that it had extended its review period to coordinate further with the staff of the SEC regarding the SEC’s ongoing formal investigation of Huntington and to complete its review of the Community Reinvestment Act aspects of the merger. Huntington remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters (see Note 3 for additional discussion).
Huntington and Unizan are ready to close the merger, subject to the receipt of all necessary regulatory approvals. After the merger, Huntington also intends to purchase approximately 2.5 million common shares from time-to-time in the open market or through privately negotiated transactions depending on market conditions, to offset the dilutive effect of issuing shares to Unizan shareholders.
Note 5 – Stock Repurchase Plan
Effective April 27, 2004, the board of directors authorized a new share repurchase program (the 2004 Repurchase Program) which cancelled the 2003 Repurchase Program and authorized Management to repurchase not more than 7,500,000 shares of Huntington common stock. Any share repurchases will be made under this authorization. Purchases will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions. No share repurchases were made under the 2004 repurchase program.
Note 6 – Operating Lease Assets
Operating lease assets at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:
Cost of assets under operating leases
Deferred lease origination fees and costs
Accumulated depreciation
Operating Lease Assets, Net
Depreciation and residual losses at termination related to operating lease assets was $57.4 million and $91.4 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, depreciation and residual losses at termination was $121.3 million and $190.7 million.
9
Note 7 – Securities Available for Sale
Securities available for sale at June 30, 2004, December 31, 2003, and June 30, 2003 were as follows:
(in thousands of dollars)
U.S. Treasury
Under 1 year
1-5 years
6-10 years
Over 10 years
Total U.S. Treasury
Federal Agencies
Mortgage backed securities
Total Mortgage-Backed
Other Federal Agencies
Total Other Agencies
Total U.S. Treasury and Other Federal Agencies
Municipal Securities
Total Municipal Securities
Private Label CMO
Total Private Label CMO
Asset Backed Securities
Total Asset Backed Securities
Retained interest in securitizations
Marketable equity securities
Total Other
Total Securities Available for Sale
The growth from year-end and the year-ago quarter primarily consisted of over 10-year variable-rate asset backed securities.
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Note 8 – Segment Reporting
Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes Huntington’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Line of business results are determined based upon Huntington’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around Huntington’s organizational and management structure and, accordingly, the results below are not necessarily comparable with similar information published by other financial institutions.
Management relies on “operating earnings” for review of performance and for critical decision making purposes. Operating earnings exclude the impact of the significant items listed in the reconciliation table below. See Note 12 for further discussions regarding Restructuring Reserves.
The following provides a brief description of the four operating segments of Huntington:
Regional Banking: This segment provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 57% and 81% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including, commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.
Dealer Sales: This segment serves automotive dealerships within Huntington’s primary banking markets, as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. This segment finances the purchase of automobiles by customers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.
Private Financial Group: This segment provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services.
Treasury/Other: This segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the three business segments. Assets included in this segment include bank owned life insurance, investment securities, and mezzanine loans originated through Huntington Capital Markets Group.
A match-funded transfer pricing system is used to attribute appropriate interest income and interest expense to other business segments. The Treasury/Other segment includes the net impact of interest rate risk management, including derivative activities. Furthermore, this segment’s results include the investment securities portfolios and capital markets activities. Additionally, income or expense and provision for income taxes, not allocated to other business segments, are also included.
11
Listed below is certain reported financial information reconciled to Huntington’s three and six month 2004 and 2003 operating results by line of business.
Income Statements
Net interest income
Non-Interest income
Non-Interest expense
Net income, as reported
Gain on sale of automobile loans, net of tax
Operating Earnings
Restructuring releases, net of taxes
12
Period-end Balance Sheet Data
(in millions)
Regional Banking
Dealer Sales
PFG
Treasury / Other
Note 9 – Comprehensive Income
The components of Huntington’s Other Comprehensive Income in the three and six months ended June 30 were as follows:
Three Months Ended
Unrealized holding (losses) gains on securities available for sale arising during the period:
Unrealized net (losses) gains
Related tax benefit (expense)
Net
Less: Reclassification adjustment for net gains (losses) included in net income:
Realized net gains (losses)
Related tax (expense) benefit
Total unrealized holding (losses) gains on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income.
Unrealized gains (losses) on derivatives used in cash flow hedging relationships arising during the period:
Unrealized net gains (losses)
Total Other Comprehensive Loss
13
Activity in Accumulated Other Comprehensive Income for the six months ended June 30, 2004 and 2003 was as follows:
Balance, December 31, 2002
Period change
Balance, June 30, 2003
Balance, December 31, 2003
Balance, June 30, 2004
Note 10 – Earnings per Share
Basic earnings per share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares upon the exercise of stock options. The calculation of basic and diluted earnings per share for each of the three and six months ended June 30 is as follows:
(in thousands, except per share amount)
Average common shares outstanding
Dilutive effect of common stock equivalents
Diluted Average Common Shares Outstanding
Earnings Per Share
The average market price of Huntington’s common stock for the period was used in determining the dilutive effect of outstanding stock options. Common stock equivalents are computed based on the number of shares subject to stock options that have an exercise price less than the average market price of Huntington’s common stock for the period.
Approximately 6.8 million and 5.1 million stock options were vested and outstanding at June 30, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares for the period and, therefore, the effect would be antidilutive. The weighted average exercise price for these options was $22.06 per share and $23.73 per share at the end of the same respective periods.
On July 30, 2004, Huntington entered into an agreement with the former shareholders of LeaseNet, Inc. to issue in early 2005 up to 86,118 shares of Huntington common stock previously held in escrow subject to LeaseNet meeting certain contractual performance criteria. A total of 366,576 common shares, previously held in escrow, will be returned to Huntington. All shares in escrow had been accounted for as treasury stock.
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Note 11 – Stock-Based Compensation
Huntington’s stock-based compensation plans are accounted for based on the intrinsic value method promulgated by APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation expense for employee stock options is generally not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant.
The following pro forma disclosures for net income and earnings per diluted common share is presented as if Huntington had applied the fair value method of accounting of Statement No. 123 in measuring compensation costs for stock options. The fair values of the stock options granted were estimated using the Black-Scholes option-pricing model. This model assumes that the estimated fair value of the options is amortized over the options’ vesting periods and the compensation costs would be included in personnel expense on the income statement. The following table also includes the weighted-average assumptions that were used in the option-pricing model for options granted in each of the quarters presented:
Stock Options Outstanding at period end (in thousands)
Assumptions
Risk-free interest rate
Expected dividend yield
Expected volatility of Huntington’s common stock
Pro Forma Results (in millions of dollars)
Less pro forma expense, net of tax, related to options granted
Pro Forma Net Income
Net Income Per Common Share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
Note 12 – Restructuring Reserves
On a quarterly basis, Huntington assesses its remaining restructuring reserves and makes adjustments to those reserves as necessary. Huntington had remaining reserves for restructuring of $8.3 million, $9.7 million, and $9.4 million as of June 30, 2004, December 31, 2003, and June 30, 2003, respectively. Huntington expects that the reserves will be adequate to fund the estimated future cash outlays.
Note 13 – Benefit Plans
Huntington sponsors the Huntington Bancshares Retirement Plan (the Plan), a non-contributory defined benefit pension plan covering substantially all employees. The Plan provides benefits based upon length of service and compensation levels. The funding policy of Huntington is to contribute an annual amount that is at least equal to the minimum funding requirements but not more than that deductible under the Internal Revenue Code. In addition, Huntington has an unfunded defined benefit post-retirement plan that provides certain healthcare and life insurance benefits to retired employees who have attained the age of 55 and have at least 10 years of vesting service under this plan. For any employee retiring on or after January 1, 1993, post-retirement healthcare benefits are based upon the employee’s number of months of service and are limited to the actual cost of coverage. Life insurance benefits are a percentage of the employee’s base salary at the time of retirement, with a maximum of $50,000 of coverage.
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The following table shows the components of net periodic benefit expense:
Pension Benefits
Service cost
Interest cost
Expected return on plan assets
Amortization of transition asset
Amortization of prior service cost
Settlements
Recognized net actuarial loss
Benefit Expense
Huntington also sponsors other retirement plans. One of those plans is an unfunded Supplemental Executive Retirement Plan. This plan is a nonqualified plan that provides certain former officers of Huntington and its subsidiaries with defined pension benefits in excess of limits imposed by federal tax law. Other plans, including plans assumed in various past acquisitions, are unfunded, nonqualified plans that provide certain active and former officers of Huntington and its subsidiaries nominated by Huntington’s compensation committee with deferred compensation, post-employment, and/or defined pension benefits in excess of the qualified plan limits imposed by federal tax law.
Huntington has a 401(k) plan, which is a defined contribution plan that is available to eligible employees. Matching contributions by Huntington equal 100% on the first 3%, then 50% on the next 2%, of participant elective deferrals. The cost of providing this plan was $2.3 million and $2.1 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, the cost was $4.7 million and $4.3 million.
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Note 14 – Commitments and Contingent Liabilities
In the ordinary course of business, Huntington makes various commitments to extend credit that are not reflected in the financial statements. The contract amount of these financial agreements at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:
Contract amount represents credit risk
Commitments to extend credit
Commercial
Consumer
Commercial real estate
Standby letters of credit
Commercial letters of credit
Commitments to extend credit:
Commitments to extend credit generally have fixed expiration dates, are variable-rate, and contain clauses that permit Huntington to terminate or otherwise renegotiate the contracts in the event of a significant deterioration in the customer’s credit quality. These arrangements normally require the payment of a fee by the customer, the pricing of which is based on prevailing market conditions, credit quality, probability of funding, and other relevant factors. Since many of these commitments are expected to expire without being drawn upon, the contract amounts are not necessarily indicative of future cash requirements. The interest rate risk arising from these financial instruments is insignificant as a result of their predominantly short-term, variable-rate nature.
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. The carrying amount of deferred revenue associated with these guarantees was $3.2 million, $3.8 million, and $3.3 million at June 30, 2004, December 31, 2003, and June 30, 2003, respectively.
Commercial letters of credit represent short-term, self-liquidating instruments that facilitate customer trade transactions and generally have maturities of no longer than 90 days. The merchandise or cargo being traded normally secures these instruments.
Litigation:
In the ordinary course of business, there are various legal proceedings pending against Huntington and its subsidiaries. In the opinion of management, the aggregate liabilities, if any, arising from such proceedings are not expected to have a material adverse effect on Huntington’s consolidated financial position. (See also Note 3.)
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
INTRODUCTION
Huntington Bancshares Incorporated (Huntington or the company) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through its subsidiaries, Huntington is engaged in providing full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, and discount brokerage services, as well as reinsuring credit life and disability insurance, and selling other insurance and financial products and services. Huntington’s banking offices are located in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Selected financial services are also conducted in other states including Arizona, Florida, Georgia, Maryland, New Jersey, Pennsylvania, and Tennessee. Huntington has a foreign office in the Cayman Islands and a foreign office in Hong Kong. The Huntington National Bank (the Bank), organized in 1866, is Huntington’s only bank subsidiary.
The following discussion and analysis provides investors and others with information that Management believes to be necessary for an understanding of Huntington’s 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.
Forward-Looking Statements
This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements about Huntington. These include descriptions of products or services, plans or objectives of Management for future operations, including pending acquisitions, and forecasts of revenues, earnings, cash flows, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.
By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, those set forth below and under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2003 (2003 Form 10-K), and other factors described in this report and from time to time in other filings with the Securities and Exchange Commission.
Management encourages readers of this report to understand forward-looking statements to be strategic objectives rather than absolute forecasts of future performance. Forward-looking statements speak only as of the date they are made. Huntington assumes 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.
Risk Factors
Huntington, like other financial companies, is subject to a number of risks, many of which are outside of Management’s control, though Management strives to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk, which is the risk that loan and lease customers or other counter parties will be unable to perform their contractual obligations, (2) market risk, which is the risk that changes in market rates and prices will adversely affect Huntington’s financial condition or results of operations, (3) liquidity risk, which is the risk that Huntington and / or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people, or systems, or external events. The description of Huntington’s business contained in Item 1 of its 2003 Form 10-K, while not all inclusive, discusses a number of business risks that, in addition to the other information in this report, readers should carefully consider.
Securities and Exchange Commission Investigation
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Critical Accounting Policies and Use of Significant Estimates
Note 1 to the company’s Notes to Consolidated Financial Statements included in Huntington’s 2003 Form 10-K lists significant accounting policies used in the development and presentation of its financial statements. These significant accounting policies, as well as the following discussion and analysis and other financial statement disclosures, identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of Huntington, its financial position, results of operations, and cash flows.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires Huntington’s management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements of Huntington if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this interim report should understand that estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. Huntington’s management has identified the most significant accounting estimates and their related application in Huntington’s 2003 Form 10-K.
SUMMARY DISCUSSION OF RESULTS
Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Understanding the nature and implications of these factors on financial results is important in understanding the company’s income statement, balance sheet, and credit quality trends and the comparison of the current quarter and year-to-date performance with comparable prior-year periods. The key factors impacting the current reporting period comparisons are more fully described in the Significant Factors Influencing Financial Performance Comparisons section, which follows the summary of results below.
2004 Second Quarter versus 2003 Second Quarter
Huntington’s 2004 second quarter earnings were $110.1 million, or $0.47 per common share, up 14% and 12%, respectively, from $96.5 million and $0.42 per common share in the year-ago quarter. This increase in earnings reflected:
Partially offset by a 21% decline in non-interest income.
The return on average assets (ROA) and return on average equity (ROE), were 1.41% and 19.1%, respectively, compared with 1.38% and 18.0% in the year-ago quarter (see Table 1).
2004 Second Quarter versus 2004 First Quarter
Compared with 2004 first quarter net income of $104.2 million, or $0.45 per common share, 2004 second quarter earnings were up 6% and 4%, respectively. This increase in earnings primarily reflected:
Partially offset by a 4% decline in non-interest income.
The ROA and ROE were 1.41% and 19.1%, respectively, in the current quarter, compared with 1.36% and 18.4% in the 2004 first quarter (see Table 1).
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Table 1 - Selected Quarterly Income Statement Data
Total interest income
Total interest expense
Net interest income after provision for credit losses
Brokerage and insurance
Gain on sale of automobile loans
Gain on sale of branch office
Total non-interest income
Loss on early extinguishment of debt
Total non-interest expense
Income before provision for income taxes
Income before cumulative effect effect of change in accounting principle
Cumulative effect of change in accounting principle, net of tax (1)
Per Common Share
Income before cumulative effect of change in accounting
principle - Diluted
Net income - Diluted
Cash dividends declared
Return on:
Average total assets (2)
Average total shareholders’ equity (2)
Net interest margin (3)
Efficiency ratio (4)
Effective tax rate
Revenue - Fully Taxable Equivalent (FTE)
Tax equivalent adjustment (3)
Non-Interest Income
Total Revenue
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Table 2 - Selected Year to Date Income Statement Data
Six Months Ending
Securities gains
Average total assets
Average total shareholders’ equity
Net interest margin (1)
Efficiency ratio (2)
Tax equivalent adjustment (1)
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2004 First Six Months versus 2003 First Six Months
Earnings for the first six months of 2004 were $214.3 million, or $0.92 per common share, both up 14% from the comparable year-ago period earnings of $188.2 million, or $0.81 per common share. This increase in earnings reflected:
Partially offset by a 19% decline in non-interest income.
The ROA and ROE were 1.36% and 18.4%, respectively, compared with 1.35% and 17.3% in the year-ago six-month period (see Table 2).
Significant Factors Influencing Financial Performance Comparisons
Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Those key factors are summarized below.
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The following table quantifies the earnings impact of changes in MSR and investment securities valuation, sales of automobile loans, restructuring reserve releases, and a single, large commercial credit recovery on the specified periods.
Table 3 - Significant Items Influencing Earnings Performance Comparisons
(in millions, except per share )
Pre-tax
Impact
After-tax (1)
EPS
Three Months Ended:
June 30, 2004 - GAAP earnings
Mortgage servicing right (MSR) temporary impairment recovery
Investment securities losses
Single commercial credit recovery
June 30, 2003 - GAAP earnings
MSR temporary impairment
Investment securities gains
Six Months Ended:
MSR temporary impairment recovery
Investment securities gain on sale
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RESULTS OF OPERATIONS
Fully taxable equivalent net interest income increased $21.0 million, or 10%, from the year-ago quarter, reflecting the favorable impact of a 16% increase in average earning assets, partially offset by an 18 basis point, or an effective 5%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.29% from 3.47%, reflecting the continued impact of historically low interest rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.
Average total loans and leases increased $2.5 billion, or 13%, from the 2003 second quarter due primarily to a $2.2 billion, or 23%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.1 billion, or 58%, increase in average residential mortgages and a $0.8 billion, or 23%, increase in average home equity loans. Average total automobile loans and leases increased $0.3 billion, or 8%. This growth from the year-ago quarter reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Offsetting these positive impacts was the sale of $2.4 billion of automobile loans over this 12-month period (see Loan and Lease Composition for additional discussion and Table 10).
Average total C&I and CRE loans increased $0.3 billion, or 3%, from the year-ago quarter, reflecting an 11% increase in small business C&I and CRE loans and a 9% increase in middle-market CRE loans. Average middle-market C&I loans were down 4% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.
Average investment securities increased $1.6 billion, or 43%, from the year-ago quarter, primarily reflecting the investment of a portion of the proceeds from the automobile loan sales. The growth from the year-ago quarter primarily consisted of 10-year variable-rate securities.
Average total core deposits in the second quarter were $16.2 billion, up $0.8 billion, or 5%, from the year-ago quarter. This growth primarily reflected a $1.1 billion, or 18%, increase in interest bearing demand deposits, partially offset by a $0.4 billion, or 14%, decline in retail CDs.
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Tables 4 and 5 reflect quarterly average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities:
Table 4 - Condensed Consolidated Quarterly Average Balance Sheets
Fully Tax Equivalent Basis
Securities:
Tax exempt
Total Securities
Loans and Leases:
Commercial and industrial
Real Estate
Construction
Automobile loans
Automobile leases
Automobile loans and leases
Home equity
Residential mortgage
Other loans
Total Consumer
Total Loans and Leases
Total earning assets
Intangible assets
All other assets
Liabilities and Shareholders’ Equity
Core deposits
Non-interest bearing deposits
Interest bearing demand deposits
Savings deposits
Retail certificates of deposit
Other domestic time deposits
Total core deposits
Domestic time deposits of $100,000 or more
Brokered time deposits and negotiable CDs
Foreign time deposits
Total deposits
Subordinated notes and other long-term debt,
including preferred capital securities
Total interest bearing liabilities
All other liabilities
Shareholders’ equity
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Table 5 - Condensed Consolidated Quarterly Net Interest Margin Analysis
Fully Tax Equivalent Basis (1)
Loans and Leases: (2)
Subordinated notes and other long-term debt, including preferred capital securities
Net interest rate spread
Impact of non-interest bearing funds on margin
Net Interest Margin
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Compared with the 2004 first quarter, fully taxable equivalent net interest income decreased only $0.2 million, reflecting the adverse impact of automobile loan sales. The fully taxable equivalent net interest margin declined 7 basis points, or an effective 2%, to 3.29% from 3.36%. Average earnings assets, despite the negative impact from the sale of automobile loans, increased $0.6 billion, or 2%. The decline in the net interest margin from the first quarter reflected the same factors as those impacting the decrease from the year-ago quarter.
Average total loans and leases in the second quarter increased $0.3 billion, or 1%, from the first quarter, as the growth rate was mitigated by a $0.7 billion, or 23%, decline in average automobile loans due to the first quarter sale of $868 million of automobile loans. Growth in mortgage-related consumer loans remained strong with average residential mortgages up $0.3 billion, or 12%, and average home equity loans up $0.3 billion, or 7%. Total average C&I and CRE loans increased $0.2 billion, or 2%, reflecting a 2% increase in small business C&I and CRE loans, a 3% increase in middle-market C&I loans, and a 1% increase in middle-market CRE loans.
Average investment securities increased $0.2 billion, or 4%, from the first quarter, primarily reflecting the investment of a portion of the proceeds from the first quarter automobile loan sale. However, investment securities at June 30, 2004, were down $0.5 billion, or 9%, from the end of the first quarter. Average loans held for sale decreased $0.3 billion, or 58%, from the year-ago quarter.
Average total core deposits in the second quarter increased $0.7 billion, or 5%, reflecting strong growth in interest bearing demand deposits, up $0.6 billion, or 8%, as well as non-interest bearing deposits, up $0.2 billion, or 7%.
Fully taxable equivalent net interest income for the first six months of 2004 increased $42.8 million, or 10%, from the comparable year-ago period, reflecting the favorable impact of a 17% increase in average earning assets, partially offset by an 20 basis point, or an effective 6%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.32% from 3.52%, reflecting the impact of lower rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.
Average total loans and leases increased $2.6 billion, or 13%, from the first six months of 2003 due primarily to a $2.3 billion, or 24%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.0 billion, or 52%, increase in average residential mortgages and a $0.7 billion, or 22%, increase in average home equity loans. Average total automobile loans and leases increased $0.6 billion, or 16%. This growth from the year-ago six-month period reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Partially offsetting these positive impacts was the sale of automobile loans over this period.
Average total C&I and CRE loans in the first six months of 2004 increased $0.2 billion, or 2%, from the comparable year-ago period, reflecting an 11% increase in small business C&I and CRE loans and a 10% increase in middle-market CRE loans. Average middle-market C&I loans were down 5% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.
Average investment securities increased $1.7 billion, or 48%, from the year-ago six-month period, primarily reflecting the investment of a portion of the proceeds from the automobile loan sales.
Average total core deposits in the first six months of 2004 were $15.9 billion, up $0.7 billion, or 4%, from the year-ago period. This growth primarily reflected a $1.0 billion, or 17%, increase in interest bearing demand deposits, partially offset by a $0.5 billion, or 17%, decline in retail CDs.
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Table 6 reflects average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities, respectively for the first six-month periods of 2004 and 2003:
Table 6 - Condensed Consolidated YTD Average Balance Sheets and Net Interest Margin Analysis
Mortgages held for sale
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Provision for Credit Losses
The provision for credit losses is the expense necessary to maintain the ALLL and the allowance for unfunded loan commitments (AULC) at levels adequate to absorb Management’s estimate of inherent losses in the total loan and lease portfolio, unfunded loan commitments, and letters of credit. Taken into consideration are such factors as current period net charge-offs that are charged against these allowances, current period loan and lease growth and any related estimate of likely losses associated with that growth based on historical experience, the current economic outlook, and the anticipated impact on credit quality of existing loans and leases and unfunded commitments and letters of credit (see Allowances for Credit Losses for additional discussion and Table 14).
The provision for credit losses in the 2004 second quarter was $5.0 million, a $44.2 million reduction from the year-ago quarter and a $20.6 million decline from the 2004 first quarter. This reduction in provision expense reflected the $9.7 million commercial loan recovery and overall improved portfolio quality performance, as well as an improved economic outlook, only partially offset by provision expense related to loan growth. As previously disclosed, effective January 1, 2004, the company adopted a more quantitative approach to calculating the economic reserve component of the ALLL, making this component more responsive to changes in economic conditions. This change, combined with the existing quantitative approach for determining the transaction reserve component, as well as changes to the specific reserve component, will result in more volatility in the total ALLL and corresponding provision for credit losses (see Credit Risk for additional discussion).
The provision for credit losses in the first six months of 2004 was $30.6 million, a $55.4 million, or 64%, decline from the comparable year-ago period. This reduction reflected the same factors impacting second quarter year-over-year performance.
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Table 7 reflects non-interest income detail for each of the past five quarters, and the first six-months of 2004 and 2003:
Table 7 - Non-Interest Income
Gain on sale of branch offices
Sub-total before operating lease income
N.M. - Not Meaningful.
Non-interest income decreased $58.8 million, or 21%, from the year-ago quarter. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income. These trends are expected to continue as all automobile leases originated since April 2002 are direct financing leases with income reflected in net interest income, not non-interest income. Reflecting the run-off of the operating lease portfolio, operating lease income declined $49.9 million, or 39%, from the 2003 second quarter. Excluding operating lease income, non-interest income decreased $9.0 million, or 6%, from the year-ago quarter with the primary drivers being:
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Partially offset by:
Compared with the 2004 first quarter, non-interest income declined $9.5 million, or 4%. This comparison is also heavily influenced by the decline in operating lease income for the reasons noted above. Reflecting the run-off of the operating lease portfolio, operating lease income declined $10.2 million, or 11%, from the 2004 first quarter. Excluding operating lease income, non-interest income increased $0.7 million from the 2004 first quarter with the primary drivers being:
Non-interest income for the first six months of 2004 declined $104.1 million, or 19%, from the comparable year-ago period. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income (see above discussion). Reflecting the run-off of the operating lease portfolio, operating lease income for the first six months of 2004 declined $99.2 million, or 37%, from the comparable year-ago period. Excluding operating lease income, non-interest income for the first six months of 2004 decreased $4.9 million, or 2%, from the year-ago period with the primary drivers being:
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Non-Interest Expense
Table 8 reflects non-interest expense detail for each of the last five quarters and the first six-month period for 2004 and 2003:
Table 8 - Non-Interest Expense
Amortization of intangible assets
Sub-total before operating lease expense
Non-interest expense decreased $14.9 million, or 5%, from the year-ago quarter. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Operating lease expense declined $40.4 million, or 39%, from the 2003 second quarter. Excluding operating lease expense, non-interest expense increased $25.5 million, or 13%, from the year-ago quarter with the primary drivers being:
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Compared with the 2004 first quarter, non-interest expense declined $3.5 million, or 1%. Comparisons with prior-period results are also heavily influenced by the decline in operating lease expense. Operating lease expense declined $8.1 million, or 12%, from the 2004 first quarter. Excluding operating lease expense, non-interest expense increased $4.6 million, or 2%, from the first quarter with the primary drivers being:
Non-interest expense for the first six months of 2004 declined $44.7 million, or 7%, from the comparable year-ago period. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Operating lease expense declined $81.3 million, or 38%, from the 2003 six-month period. Excluding operating lease expense, non-interest expense for the first six months of 2004 increased $36.5 million, or 9%, from the year-ago period with the primary drivers being:
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Operating Lease Assets
Table 9 reflects operating lease assets performance detail for each of the last five quarters, and the first six-month period for 2004 and 2003:
Table 9 - Operating Lease Assets Performance
Balance Sheet (in millions)
Average operating lease assets outstanding
Income Statement (in thousands)
Net rental income
Fees
Recoveries - early terminations
Total Operating Lease Income
Depreciation and residual losses at termination
Losses - early termination
Total Operating Lease Expense
Net Earnings Contribution
Earnings ratios (1)
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Operating lease assets represent automobile leases originated before May 2002. This operating lease portfolio will run-off over time since all automobile lease originations after April 2002 have been recorded as direct financing leases and are reported in the automobile loan and lease category in earning assets. As a result, the non-interest income and non-interest expenses associated with the operating lease portfolio will also decline over time.
2004 Second Quarter versus 2003 Second Quarter and 2004 First Quarter
Average operating lease assets in the 2004 second quarter were $1.0 billion, down 46% from the year-ago quarter and 12% from the 2004 first quarter.
Operating lease income, which totaled $78.7 million in the 2004 second quarter, represented 36% of non-interest income in the quarter. Operating lease income was down $49.9 million, or 39%, from the year-ago quarter and $10.2 million, or 11%, from the 2004 first quarter, reflecting the declines in average operating leases. As no new operating leases have been originated after April 2002, the operating lease asset balances will continue to decline through both depreciation and lease terminations. Net earnings contribution was down 37% and 11%, respectively, from the year-ago and 2004 first quarter. Fees declined 11% from the year-ago quarter, but increased $1.3 million, or 37%, from the first quarter, reflecting the recognition of deferred fees resulting from higher than expected prepayments of operating lease assets. Recoveries from early terminations declined 45% from the year-ago quarter and 19% from the first quarter.
Operating lease expense totaled $62.6 million, down $40.4 million, or 39%, from the year-ago quarter and down $8.1 million, or 12%, from the 2004 first quarter. These declines also reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated. Losses on early terminations, included in operating lease expense, declined $6.4 million, or 55%, from the year-ago quarter, and $1.6 million, or 24%, from the prior quarter.
Losses on operating lease assets consist of residual losses at termination and losses on early terminations. Residual losses arise if the ultimate value or sales proceeds from the automobile are less then Black Book value, which represents the insured amount under the company’s residual value insurance policies. This situation may occur due to excess wear-and-tear or excess mileage not collected from the lessee. Losses on early terminations occur when a lessee, due to credit or other reasons, turns in the automobile before the end of the lease term. A loss is realized if the automobile is sold for a value less than the net book value at the date of turn-in. Such losses are not covered by the residual value insurance policies. To the extent the company is successful in collecting any deficiency from the lessee, amounts received are recorded as recoveries from early terminations.
The ratio of operating lease asset credit losses, net of recoveries, to average operating lease assets outstanding was an annualized 1.51% in the current quarter, 1.97% in the year-ago quarter, and 1.78% in the 2004 first quarter.
On a quarterly basis, Management evaluates the amount of residual value losses that it anticipates will result from the estimated fair value of a leased vehicle being less than the residual value inherent in the lease. Fair value includes estimated net proceeds from the sale of the leased vehicle plus expected residual value insurance proceeds and amounts expected to be collected from the lessee for excess mileage and other items that are billable under terms of the lease contract. When estimating the amount of expected insurance proceeds, Management takes into consideration policy caps that exist in two of the residual value insurance policies and whether it expects aggregate claims under such policies to exceed these caps. Management currently anticipates that aggregate claims for losses under the policy that insures residual values on automobile leases originated prior to October 2000 will exceed the policy cap of $120 million. Residual value losses exceeding the insurance policy cap are reflected in higher depreciation expense over the remaining life of the affected automobile lease. Also as part of its quarterly analysis, Management evaluates automobile leases individually for impairment.
All automobile leases covered under the two policies containing caps are accounted for using the operating lease method of accounting. Accordingly, residual value losses are provided for as additional depreciation expense over the remaining term to maturity of the underlying lease so that the carrying amount of the operating lease asset at the end of the lease term does not exceed its estimated fair value. At June 30, 2004, estimated future residual value losses on operating leases outstanding were expected to be between $15 million to $19 million. As of June 30, 2004, $11.7 million of this amount had been provided for through additional depreciation expense. Any remaining losses above $11.7 million will be provided for through additional depreciation expense over future periods.
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Average operating lease assets in the first six months of 2004 were $1.1 billion, down 45% from the comparable year-ago period.
Operating lease income, which totaled $167.6 million in the first six months of 2004, was down $99.2 million, or 37%, from the comparable year-ago period, reflecting the decline in average operating leases. As no new operating leases have been originated after April 2002, the operating lease asset balances will continue to decline through both depreciation and lease terminations. Net rental income for the first six months of 2004 was down 38%, with fees declining 24%. Recoveries from early terminations declined 34% from the comparable year-ago six-month period.
Operating lease expense for the first six months of 2004 totaled $133.3 million, down $81.3 million, or 38%, from the year-ago period. This decline also reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated. Losses on early terminations for the first six months of 2004, included in operating lease expense, declined $11.9 million, or 50%, from the comparable year-ago period.
The ratio of operating lease asset credit losses, net of recoveries, to average operating lease assets outstanding for the first six months was an annualized 1.62% in the current six-month period, down from 1.95% in the comparable year-ago period.
Provision for Income Taxes
The provision for income taxes in the second quarter of 2004 was $43.4 million and represented an effective tax rate on income before taxes of 28.3%. The provision for income taxes increased $6.7 million from the year-ago quarter, primarily due to higher pre-tax income. The effective tax rates in the second quarter of 2003 and first quarter of 2004 were 27.5% and 25.1%, respectively. For the first six months of 2004, provision for income taxes was $78.3 million and represented an effective tax rate on income before taxes of 26.8%. This increased $11.0 million from the same period in 2003, in which the effective tax rate was 26.3%, reflecting higher pre-tax income.
Each quarter, taxes for the full year are estimated and year-to-date tax accrual adjustments are made. Revisions to the full year estimate of accrued taxes occur periodically due to changes in the tax rates, audit resolution with taxing authorities, and newly enacted statutory, judicial, and regulatory guidance. These changes, when they occur, affect accrued taxes and can result in fluctuations in the quarterly effective tax rate.
The cost of investments in partnerships, along with the related tax credit is recognized in the financial statements as a component of income taxes under the effective yield method. The cost of the investment in partnerships is reported in non-interest expense. During the second quarter 2004, $5.8 million of costs related to such investments in partnerships were recorded in non-interest expense.
In accordance with FAS 109, Accounting for Income Taxes, no deferred income taxes are to be recorded when a company intends to permanently reinvest their earnings from a foreign activity. As of June 30, 2004, the company intended to permanently reinvest the earnings from its foreign asset securitization activities of approximately $79.4 million.
Management expects the 2004 effective tax rate to remain below 30% as the level of tax-exempt income, general business credits, and asset securitization activities remain consistent with prior years.
CREDIT RISK
Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. The company is subject to credit risk in 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 the company’s credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. Credit risk represents a limited portion of the total risks associated with the investment portfolio and is incidental to trading activities. Credit risk is mitigated through a combination of credit policies and processes and portfolio diversification. These include origination/underwriting criteria, portfolio monitoring processes, and effective problem asset management. There are very specific and differing methodologies for managing credit risk for commercial credits compared with consumer credits (see Credit Risk Management section of the company’s 2003 Form 10-K for a complete discussion).
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Loan and Lease Composition
Table 10 reflects period-end loan and lease portfolio mix by type of loan or lease, as well as by business segment:
Table 10 - Loans and Lease Portfolio Composition
2004 (1)
March 31,
September 30,
By Type
Total Commercial
Total automobile loans and leases
Securitized loans
Total Automobile Exposure (2)
Total Credit Exposure
By Business Segment (3)
Central Ohio
Northern Ohio
Southern Ohio/Kentucky
West Michigan
East Michigan
West Virginia
Indiana
Total Regional Banking
Private Financial Group
During 2004, the composition of the loan and lease portfolio changed such that lower credit risk home equity loans and residential mortgages represented 19% and 14%, respectively, of total credit exposure at June 30, 2004, up from 18% and 10%, respectively, a year earlier. Conversely, C&I loans have declined from 29% a year ago to 23% at June 30, 2004, reflecting, in part, strategies to exit large, individual commercial credits, including out-of-footprint shared national credits.
At the beginning of the 2004 second quarter, the criteria for categorizing commercial loans as either C&I loans or CRE loans was clarified. The new criteria are based on the purpose of the loan. Previously, the categorization was based on the nature of the collateral securing, or partially securing, the loan. As a result of this change, $282 million in C&I loans were reclassified to CRE loans effective June 30, 2004. This change had no impact on total commercial loans, underlying credit quality, or 2004 second quarter reported income. Under this new methodology, as new loans are originated or existing loans renewed, loans secured by owner-occupied real estate will be categorized as C&I loans (previously CRE loans) and unsecured loans for the purpose of developing real estate will be categorized as CRE loans (previously C&I loans).
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The company also has a portfolio of automobile operating lease assets. Although these assets are reflected on the balance sheet, they are not part of total loans and leases or earning assets. In addition, prior to June 30, 2004, there was a small pool of securitized automobile loans, which represented off-balance sheet securitized automobile loan assets. Both of these asset classes represent automobile financing credit exposure, despite not being components of total loans and leases. As such, operating lease assets and securitized loans are added to the on-balance sheet automobile loans and leases to determine a total automobile financing exposure, which Management finds helpful in evaluating the overall credit risk for the company.
On June 30, 2004, $512 million of automobile loans were sold and $102 million of automobile loans were transferred to loans held for sale. Combined, these transactions resulted in second quarter net pre-tax gains on the sale of automobile loans of $4.9 million: $5.1 million associated with the $512 million sale, partially offset by a $0.2 million lower of cost or market write-down on the loans held for sale. On a combined basis, these transactions increased the total automobile loans sold since the beginning of 2003 to $3.6 billion. These sales represented a continuation of a strategy to reduce exposure to automobile financing to approximately 20% of total credit exposure (see Table 10). At June 30, 2004, this exposure was $4.9 billion, down from $6.2 billion at year-end, and represented 22% of total credit exposure, down from 24% at the end of the last quarter and from 33% at the end of 2002.
Net Loan and Lease Charge-offs
Table 11 reflects net loan and lease charge-off detail for each of the last five quarters, and the first six-month period for 2003 and 2004:
Table 11 - Net Loan and Lease Charge-offs
Net Charge-offs by Loan and Lease Type
Automobile direct financing leases
Total Net Charge-offs
Net Charge-offs - Annualized Percentages
Net Charge-offs as a % of Average Loans
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Table 11 - Net Loan and Lease Charge-offs, Continued
Total net charge-offs for the 2004 second quarter were $12.5 million, or an annualized 0.23% of average total loans and leases. This was a reduction from $41.1 million, or 0.85%, in the year-ago quarter and from $28.6 million, or 0.53% of average total loans and leases, in the prior quarter. Total net charge-offs in the current and 2004 first quarter were influenced by one-time events.
Current quarter total net charge-offs were reduced by a $9.7 million one-time recovery on a C&I loan charged-off in the fourth quarter of 2002. This recovery lowered total commercial (C&I and CRE) net charge-offs by an annualized 39 basis points and total loan and lease net charge-offs by 18 basis points. Excluding the impact of this recovery, current quarter total net charge-offs would have been $22.2 million, or an annualized 0.41% of average total loans and leases. As previously reported, total net charge-offs in the 2004 first quarter included a one-time $4.7 million cumulative increase in automobile loan and lease charge-offs related to the accounting treatment of certain auto-related insurance policies. Excluding the 8 basis point impact of this adjustment, 2004 first quarter net charge-offs would have represented 0.45% of average total loans and leases.
Total commercial (C&I and CRE) net charge-offs in the second quarter were only $0.1 million. Adjusting for the $9.7 million recovery noted above (39 basis point impact), total commercial net charge-offs would have been $9.8 million, or an annualized 0.40% of related loans, down from $27.2 million, or 1.14% of related loans, in the year-ago quarter, and up from $7.6 million, or 0.32%, in the 2004 first quarter.
Total consumer net charge-offs in the current quarter were $12.4 million, or an annualized 0.41% of related loans. This compared with $13.9 million, or 0.57%, in the year-ago quarter, and $21.0 million, or 0.70% of related loans, in the 2004 first quarter. First quarter net consumer charge-offs included 15 basis points related to the one-time $4.7 million cumulative adjustment noted above.
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Total automobile loan and lease net charge-offs in the 2004 second quarter were $7.8 million, or 0.69% of average automobile loans and leases. This compared with $8.9 million of net charge-offs, or 0.87%, in the year-ago quarter and $16.6 million, or 1.32%, in the first quarter. The first quarter net charge-offs included 37 basis points from the one-time $4.7 million cumulative adjustment.
Total net charge-offs for the first six months of 2004 were $41.1 million, or an annualized 0.38% of average total loans and leases. This was a reduction from $73.8 million, or 0.77%, in the comparable year-ago period.
Total commercial (C&I and CRE) net charge-offs in the first six months of 2004 were only $7.7 million, or 0.16%, down from $42.6 million, or 0.90%, in the comparable year-ago period. The decline from the year-ago period reflected a $9.7 million C&I recovery in the 2004 first six-month period.
Total consumer net charge-offs in the first six months of 2004 were $33.4 million, or 0.56% of related loans. This compared with $31.2 million, or 0.65%, in the comparable year-ago period.
Total automobile loan and lease net charge-offs in the first six months of 2004 were $24.3 million, or 1.02% of average automobile loans and leases. This compared with $20.5 million, or 1.00% of average automobile loans and leases, in the year-ago six-month period.
For the second half of 2004, total loan and lease net charge-offs are expected to be in the 0.40%-0.45% range, including third and fourth quarter seasonality associated with automobile loan and lease net charge-offs.
Non-performing Assets and Past Due Loans and Leases
Table 12 reflects period-end NPAs and past due loans and leases detail for each of the last five quarters:
Table 12 - Non-Performing Assets and Past Due Loans and Leases
Non-accrual loans and leases
Total non-performing loans and leases (NPLs)
Other real estate, net
Total Non-performing Assets (NPAs)
Accruing loans and leases past due 90 days or more
NPLs as a % of total loans and leases
NPLs as a % of total loans and leases and other real estate
Allowance for loan and lease losses as a % of:
NPLs
NPAs
Allowance for loan and lease losses plus allowance for unfunded commitments and letters of credit:
Accruing loans and leases past due 90 days or more to total loans and leases
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NPAs were $74.7 million at June 30, 2004, down $59.0 million, or 44%, from the prior year, and down $17.0 million, or 19%, from March 31, 2004. NPAs as a percent of total loans and leases and other real estate were 0.34% at June 30, 2004, down from 0.70% a year-ago and from 0.43% at March 31, 2004. NPAs at June 30, 2004, included $23.3 million of lower-risk residential real estate related assets, which represented 31% of total NPAs. This compared with $20.7 million, or 15%, at the end of the year-ago quarter.
The over 90-day delinquent, but still accruing, ratio was 0.24% at June 30, 2004, down from 0.29% a year ago and 0.28% at March 31, 2004.
Table 13 - Non-Performing Asset Activity
Beginning of Period
New non-performing assets
Returns to accruing status
Loans and lease losses
Payments
Sales
End of Period
Table 13 reflects NPA activity and shows that during the 2004 second quarter the level of new NPAs continued to decline and totaled $25.7 million, down 69% from the year-ago quarter, and 5% less than in the first quarter. Also, impacting the decline in period-end NPAs was the sale of $14.8 million of NPAs during the 2004 second quarter.
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Allowances for Credit Losses (ACL)
The allowances for credit losses (ACL) include the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). Table 14 reflects activity in the ALLL and AULC for the past five quarters:
Table 14 - Allowances for Credit Losses
Allowance for Loan and Lease Losses, Beginning of Period
Loan and lease losses
Recoveries of loans previously charged off
Net loan and lease losses
Net change in allowance for unfunded loan commitments and lettes of credit
Allowance of assets sold and securitized (1)
Allowance for Loan and Lease Losses, End of Period
Allowance for Unfunded Loan Commitments and Letters of Credit, Beginning of Period
Net change
Allowance for Unfunded Loan Commitments and Letters of Credit, End of Period
Total Allowances for Credit Losses
Allowances for Credit Losses as a % of total loans and leases
The ALL as a % of total loans and leases
Components:
Transaction reserve
Economic reserve
Specific reserve
The June 30, 2004, ALLL was $286.9 million, down from $307.7 million a year ago and from $295.4 million at March 31, 2004. These declines primarily reflected improving credit quality and the change in the mix of the loan portfolio to lower-risk residential mortgages and home equity loans. Expressed as a percent of period-end loans and leases, the ALLL at June 30, 2004, was 1.32%, down from 1.61% a year-ago and from 1.39% at March 31, 2004. The ALLL as a percent of NPAs was 384% at June 30, 2004, up from 230% a year ago and from 322% at March 31, 2004.
The June 30, 2004, AULC was $31.2 million, down slightly from $33.3 million at the end of the year-ago quarter, and from $32.1 million at March 31, 2004.
On a combined basis, the ACL as a percent of total loans and leases was 1.46% at June 30, 2004, compared with 1.79% a year ago and 1.55% at the end of last quarter. Similarly, the ACL as a percent of NPAs was 426% at June 30, 2004, compared with 255% a year earlier and 357% at March 31, 2004.
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The ALLL consists of three components, the transaction reserve, the economic reserve, and specific reserves (see the Credit Risk discussion in company’s 2003 Form 10-K for additional discussion).
Transaction reserve – This ALLL component is based on historical portfolio performance information. Specifically, the probability-of-default and the loss-in-event-of-default are assigned an expected risk factor based on the type and structure of each credit. Reserve factors are then calculated and applied at an individual loan level for all products.
Specific reserve – This ALLL component represents the sum of credit-by-credit reserve decisions for individual C&I and CRE loans when it is determined that the related expected risk factor is insufficient to cover the estimated losses embedded in the specified credit facility.
Economic reserve – This ALLL component reflects anticipated losses impacted by changes in the economic environment. As previously reported, effective January 1, 2004, the company adopted a significantly more quantitative approach to the calculation of the economic reserve component. In order to quantify the economic reserve, the company identified four statistically significant indicators of loss volatility over the seven-year period from 1996 through 2003. The four variables as identified by the regression model are: (1) the US Index of Leading Economic Indicators, (2) the US Corporate Profits Index, (3) the US Unemployment Index, and (4) the University of Michigan Current Consumer Confidence Index.
This methodology permits the decomposition of the total ALLL ratio into these three components and provides increased insight into the rationale for increases or decreases in the overall ALLL ratio. As shown in Table 14, the ALLL ratio at June 30, 2004 was 1.32%, of which 0.86% represented the transaction reserve, 0.36% the economic reserve, and 0.10% specific reserves. This analysis shows that of the 7 basis point decline in the ALLL ratio from 1.39% at March 31, 2004, the transaction reserve accounted for 5 basis points. The sale of lower-performing commercial credits during the 2004 second quarter, along with the release of their inherent higher than average transaction reserve component, as well as the change in the overall loan and lease portfolio toward higher credit quality loans, contributed to this decline. The remaining 2 basis points of decline in the ALLL ratio represented lower relative economic reserves, reflecting an improved economic outlook. Specific reserves were unchanged at 10 basis points. This more quantitative methodology for determining the ALLL will be more responsive to changes in the portfolio mix, the economic environment, and to individual credit situations, with the result being an ALLL ratio that exhibits greater quarterly fluctuations.
MARKET RISK
Market risk is the potential for losses in the fair value of the company’s assets and liabilities due to changes in interest rates, exchange rates, and equity prices. The company incurs market risk in the normal course of business. Market risk arises when the company extends fixed-rate loans, purchases fixed-rate securities, originates fixed-rate certificates of deposit (CDs), obtains funding through fixed-rate borrowings, and leases automobiles and equipment based on expected lease residual values. Market risk arising from changes in interest rates, which affects the market values of fixed-rate assets and liabilities, is interest rate risk. Market risk arising from the possibility that the uninsured residual value of leased assets will be different at the end of the lease term than was estimated at the lease’s inception is residual value risk. From time to time, the company also has small exposures to trading risk and foreign exchange risk. At June 30, 2004, the company had $20.6 million of trading assets, primarily in its broker/dealer businesses.
Interest Rate Risk
Interest rate risk is the primary market risk incurred by the company. It results from timing differences in the repricing and maturity of assets and liabilities and changes in relationships between market interest rates and the yields on assets and rates on liabilities, including the impact of embedded options.
Management seeks to minimize the impact of changing interest rates on the company’s net interest income and the fair value of assets and liabilities. The board of directors establishes broad policies regarding interest rate and market risk and liquidity risk. The asset and liability committee (ALCO) establishes specific operating limits within the parameters of the board of directors’ policies. ALCO regularly monitors position concentrations and the level of interest rate sensitivity to ensure compliance with board of directors approved risk tolerances (see Interest Rate Risk discussion in the company’s 2003 Form 10-K for a complete discussion.)
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Interest rate risk modeling 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 horizon. The economic value analysis (Economic Value of Equity or EVE) is calculated by subjecting the period-end balance sheet to changes in interest rates and measuring the impact of the changes in the value of the assets and liabilities.
The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual 100 and 200 basis point increasing and decreasing parallel shifts in interest rates over the next twelve-month period beyond the interest rate change implied by the current yield curve. The table below shows the results of the scenarios as of June 30, 2004, and March 31, 2004. All of the positions were well within the board of directors’ policy limits.
Net Interest Income at Risk (%)
Basis point change scenario
Board Policy Limits
June 30, 2004
March 31, 2004
December 31, 2003
N.M., not meaningful.
The primary simulations for EVE risk assume an immediate and parallel increase in rates of +/- 100 and +/- 200 basis points beyond any interest rate change implied by the current yield curve. The table below outlines the results compared to the previous quarter and policy limits.
Economic Value of Equity at Risk (%)
LIQUIDITY RISK
The objective of effective liquidity management is to ensure that cash flow needs can be met on a timely basis at a reasonable cost under both normal operating conditions and unforeseen or unpredictable circumstances. The liquidity of the Bank is available to originate loans and leases and to repay deposit and other liabilities as they become due or are demanded by customers. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments 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 (see Liquidity discussion in the company’s 2003 Form 10-K for a complete discussion.)
The primary source of funding is core deposits from retail and commercial customers (see Table 15). As of June 30, 2004, core deposits totaled $16.5 billion, and represented 85% of total deposits. This compared with $15.9 billion, or 87% of total deposits, a year earlier. Most of the growth in core deposits was attributable to growth in interest bearing and non-interest bearing demand deposits as retail CDs declined.
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Table 15 - Deposit Liabilities
Demand deposits
Non-interest bearing
Interest bearing
Total Core Deposits
Total Deposits
By Business Segment (2)
Treasury/Other (1)
Liquidity policies and limits are established by the board of directors, with operating limits set by ALCO. Two primary liquidity measures are the ratio of loans and operating lease assets to deposits and the percentage of assets funded with non-core, or wholesale, liabilities. The limits set by the board for these two liquidity measures are 135% and 40%, respectively. At June 30, 2004, the actual ratio of loans and operating leases to deposits was 116%, while the percentage of assets funded with non-core or wholesale liabilities was 35%. In addition, guidelines are established by ALCO 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 time 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 agency changes. ALCO meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and the maintenance of, an evolving contingency funding plan.
Credit ratings by the three major credit rating agencies are an important component of the company’s liquidity profile. Among other factors, the credit ratings are based on the 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 the company’s 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.
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As a result of the formal SEC investigation announced June 26, 2003, Standard and Poor’s rating agency placed the company’s debt ratings on “CreditWatch Negative”. On April 15, 2004, Standard and Poor’s removed the company’s debt rating from “CreditWatch Negative” and revised the outlook to “Stable” from “Negative.” Credit ratings are as follows:
Senior
Unsecured
Notes
Subordinated
Short
Term
Moody’s Investor Service
Standard and Poor’s
Fitch Ratings
The Huntington National Bank
Management believes that sufficient liquidity exists to meet the funding needs of the Bank and the parent company.
OFF-BALANCE SHEET ARRANGEMENTS
Like other financial organizations, Huntington has various commitments in the ordinary course of business that, under GAAP, are not recorded in the financial statements. Specifically, Huntington makes various commitments to extend credit to customers, to sell loans, and to maintain obligations under operating-type non-cancelable leases for its facilities. Derivatives and other off-balance sheet arrangements are discussed under the “Market Risk” section of the company’s 2003 Form 10-K.
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. There were $962 million of outstanding standby letters of credit at June 30, 2004. Non-interest income was recognized from the issuance of these standby letters of credit of $2.8 million for the period ended June 30, 2004. The carrying amount of deferred revenue related to standby letters of credit at June 30, 2004, was $3.2 million. Standby letters of credit are included in the determination of the amount of risk-based capital that the company and the Bank are required to hold.
CAPITAL
Capital is managed both at the parent and the Bank levels. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, and operation risks inherent in the company’s business and to provide the flexibility needed for future growth and new business opportunities. Management places significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to the national markets under favorable terms, and enhances business growth and acquisition opportunities. The importance of managing capital is also recognized, and Management continually strives to maintain an appropriate balance between capital adequacy and providing attractive returns to shareholders.
Shareholders’ equity totaled $2.4 billion at June 30, 2004. This balance represented a $111 million increase from December 31, 2003. The growth in shareholders’ equity resulted from the retention of net income after dividends to shareholders of $134 million and stock option exercises of $7 million. The growth was offset by a decrease in accumulated other comprehensive income of $30 million. The decrease in accumulated other comprehensive income primarily resulted from a decline in the market value of securities available for sale, partially offset by an increase in the market value of cash flow hedges at June 30, 2004, compared with December 31, 2003.
At June 30, 2004, the company had unused authority to repurchase up to 7.5 million shares. On September 4, 2001, options totaling 3.2 million shares were granted to all employees, the vesting of which occurs on September 4, 2006, or earlier should Huntington’s common stock closing price for five consecutive trading days be at or
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above $25.00. Huntington’s common stock price closed at $25.07 on August 2, 2004, thus increasing the possibility that the remaining 2.2 million options outstanding at June 30, 2003, may vest in the near future. Should that occur, there is also the possibility that a portion of the current stock repurchase authorization would be used to help mitigate the dilutive earnings impact resulting from the issuance of these shares. These, and any additional purchases including the 2.5 million shares associated with the Unizan merger, will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions.
On July 16, 2004, the board of directors declared a quarterly cash dividend on its common stock of $0.20 per common share, up 14.3% from the current quarterly dividend of $0.175 per common share. The dividend is payable October 1, 2004, to shareholders of record on September 17, 2004.
Table 16 - Quarterly Common Stock Summary
Common Stock Price
High (1)
Low (1)
Close
Average closing price
Book value per share
Dividends
Common shares outstanding (000s)
Average — Basic
Average — Diluted
Ending
Common Share Repurchase Program (000s)
Number of Shares Repurchased
Average equity to average assets in the 2004 second quarter was 7.42%, down from 7.66% a year earlier, but up from 7.39% for the first quarter of 2004 (see Table 17). At June 30, 2004, the tangible equity to assets ratio was 6.95%, down from 7.06% a year ago, and from 6.97% March 31, 2004. The decline from the year-ago period primarily reflected the impact of the 2003 third quarter adoption of FIN 46, which resulted in the consolidation of $1.0 billion of securitized automobile loans, partially offset by earnings-related growth in capital. The increase from March 31, 2004, primarily reflected growth in retained earnings.
Table 17 - Capital Adequacy
Total Risk-Adjusted Assets
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
Tier 1 Leverage Ratio
Tangible Equity / Assets Ratio
Tangible Equity / Risk-Weighted Assets Ratio
Average equity / average assets
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At June 30, 2004, the tangible equity to risk-weighted assets ratio was 7.64%, up significantly from 7.23% in the year-ago quarter, and up from 7.61% at March 31, 2004. The increase in the tangible equity to risk-weighted assets ratio reflected primarily the positive impact resulting from reducing the overall risk profile of earning assets throughout this period, most notably a less risky loan portfolio mix, as well as growth in low risk investment securities.
The Federal Reserve Board, which supervises and regulates the company, sets minimum capital requirements for each of these regulatory capital ratios. In the calculation of these risk-based capital ratios, risk weightings are assigned to certain asset and off-balance sheet items such as interest rate swaps, loan commitments, and securitizations. Huntington’s Tier 1 Risk-based Capital, Total Risk-based Capital, Tier 1 Leverage ratios, and risk-adjusted assets for the recent five quarters are well in excess of minimum levels established for “well capitalized” institutions of 6.00%, 10.00%, and 5.00%, respectively. At June 30, 2004, the company had regulatory capital ratios in excess of “well capitalized” regulatory minimums.
The Bank is primarily supervised and regulated by the Office of the Comptroller of the Currency, which establishes regulatory capital guidelines for banks similar to those established for bank holding companies by the Federal Reserve Board. At June 30, 2004, the Bank had regulatory capital ratios in excess of “well capitalized” regulatory minimums.
LINES OF BUSINESS DISCUSSION
Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes the company’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Lines of business results are determined based upon the company’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. A description of each segment and discussion of financial results is provided below.
Management uses earnings on an operating basis, rather than on a GAAP basis, to measure underlying performance trends for each business segment. Operating earnings represent GAAP earnings adjusted to exclude the impact of the significant items discussed in Note 8 to the Condensed Consolidated Financial Statements. Analyzing earnings on an operating basis is very helpful in assessing underlying performance trends, a critical factor used by Management to determine the success of strategies and future earnings capabilities.
Regional Banking provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 57% and 81% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including, commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.
Regional banking contributed $60.9 million of the company’s net operating earnings in the second quarter of 2004, up $35.9 million from the second quarter of 2003. This increase primarily reflected a $44.5 million reduction in provision for credit losses. Also benefiting comparisons with the year-ago quarter was a $15.3 million, or 7%, growth in revenue, reflecting a $4.7 million, or 3%, increase in net interest income and $10.7 million, or 15%, increase in non-interest income. The benefits of lower provision for credit losses and higher revenue from the year-ago quarter were partially offset by expense growth of $4.5 million, or 3%. The ROA in the 2004 second quarter was 1.52%, up from 0.69% in the year-ago quarter. The ROE was 23.9% in the current quarter, up from 9.8% in the 2003 second quarter.
Compared with the year-ago quarter, 2004 second quarter net interest income increased $4.7 million, or 3%, reflecting a 14% increase in average total loans and 5% increase in average total deposits, partially offset by a 28 basis point decline in net interest margin to 4.15% from 4.43%.
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Average total loans increased $1.8 billion, or 14%, primarily reflecting a $1.0 billion, or 66%, increase in average residential mortgages, a $0.7 billion, or 24%, increase in home equity loans and lines of credit, as well as a $0.3 billion, or 10%, increase in average CRE loans. The growth in home equity, residential mortgages, and CRE loans reflected the favorable impact of low interest rates on demand for real estate-related financing. In addition, the launch of a new Consumer First Mortgage, targeted at high convenience, low loan-to-value ratio borrowers, accounted for $0.3 billion of the $0.7 billion increase in average home equity loans and lines of credit. Total average C&I loans declined $0.3 billion, or 7%, from the year-ago quarter. The decline in C&I loans was due in part to weak demand, as well as the impact from continued strategies to lower exposure to large individual commercial credits, including shared national credits. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.
Average total deposits increased $0.8 billion, or 5%. This reflected strong growth in average interest bearing demand deposits, up $1.0 billion, or 19%, and a $0.1 billion, or 5%, increase in non-interest bearing deposits, which was partially offset by a $0.5 billion, or 12%, decline in domestic time deposits. Of the $0.8 billion increase in average total deposits, Corporate Banking accounted for $0.6 billion and Small Business $0.4 billion, with average total deposits in Retail Banking declining $0.1 billion.
The company continued to focus on customer service and delivery channel optimization. From the year-ago quarter, eight banking offices were opened while nine were closed. Progress was made in improving the Retail Banking 90-day cross sell ratio, from 1.9 products or services to 2.2, a 19% improvement. Further, the online banking penetration of retail households with on-line banking increased to 35% from 26% a year earlier, with a 37% increase in the number of online customers.
The 28 basis points, or an effective 6%, decline in the net interest margin to 4.15% from 4.43% reflected a combination of factors. This included a shift in the loan portfolio mix to lower-margin, but higher credit quality, consumer residential real estate-related loans. In addition, interest rates offered on deposits have been near historical lows throughout this period, and as rates continued to fall from a year-ago, it was increasingly difficult to make commensurate reductions in deposit rates compared with reductions in loan yields.
Provision for credit losses for the second quarter of 2004 represented a credit of $3.9 million, or $44.5 million less than in the year-ago quarter. This decline reflected the overall improvement in credit quality, as well as the shift to lower-rate, lower-risk residential mortgages and home equity loans and lines. Net charge-offs were only $1.8 million, or an annualized 0.05% of average loans and leases, down from $31.6 million, or 0.97%, in the year-ago quarter. The 2004 second quarter net charge-offs were reduced by a $9.7 million C&I recovery on a single credit charged-off in the 2002 fourth quarter (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).
Non-interest income increased $10.7 million, or 15%, from the year-ago quarter, reflecting a combination of factors including higher mortgage banking income, an increase in deposit service charges, growth in brokerage and insurance income, and an increase in other income, partially offset by a decline in other service charges and fees.
Mortgage banking income increased $6.2 million, or 89%, from the year-ago quarter largely as a result of a change in reporting methodology. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the year-ago quarter MSR impairment of $6.4 million was reflected in Regional Banking. Deposit service charges increased $2.7 million, or 7%, reflecting higher personal NSF and overdraft fees. The $1.6 million, or 16%, increase in other income was due primarily to the full year impact of the 2003 adoption of FIN 45 for standby letters of credit, which recognizes fees over the life of the related guarantee, rather than at the time of quarterly or annual billings. Brokerage and insurance income increased $0.7 million, or 18%, due to higher credit protection insurance fees. The $0.7 million, or 7%, decline in other service charges and fees reflected lower interchange fees on debit card transactions.
Non-interest expense increased $4.5 million, or 3%, from the year-ago quarter. Higher personnel costs contributed $2.0 million to this increase due to an increase in the number of employees, as well as higher benefit costs. The $2.3 million, or 3%, increase in other expenses reflected higher occupancy, printing and supplies, depreciation, and outside servicing expenses, partially offset by lower marketing, telecommunications, legal and professional, and transportation expenses.
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Regional Banking earnings in the 2004 second quarter increased $12.8 million, or 27%, from the 2004 first quarter. This reflected a $14.4 million, or 6%, increase in revenue as non-interest income increased $10.4 million, or 14%, and net interest income increased $4.0 million, or 3%. Also contributing to the increase in earnings was a $6.1 million reduction in provision for credit losses. The benefits of higher revenue and lower provision for credit losses were partially offset by a slight increase in non-interest expense. The ROA in the 2004 second quarter was 1.52%, up from 1.27% in the 2004 first quarter, with the ROE of 23.9%, up from 19.2% in the prior quarter.
Net interest income increased $4.0 million, or 3%, from the prior quarter, reflecting growth in average total loans and deposits, partially offset by a decline in the net interest margin to 4.15% from 4.25%.
Average total loans increased $0.7 billion, or 5%. Consumer loans increased 10%, reflecting strong growth in residential mortgages and home equity loans and lines of credit. Average C&I loans increased 2% with CRE loans increasing 1%. The growth in average C&I loans is encouraging and may reflect the positive impact of a recovering economy. Total average deposits increased $0.7 billion, or 5%, reflecting strong growth in interest bearing and non-interest bearing demand deposits, up 10% and 7%, respectively.
From the end of the 2004 first quarter, the number of demand deposit account (DDA) households increased 1%, and the 90-day cross sell ratio of 2.2 products was unchanged. On-line banking penetration of retail households increased to 35% from 34%, and the number of active online users increased 5%.
The $6.1 million decline in provision for credit losses from the first quarter reflected the combination of improved credit quality performance and improved economic outlook, as well as the continued lowering of the overall credit risk profile of the loan portfolio through the growth in residential real estate-related loans. Net charge offs were $1.8 million, or an annualized 0.05% of average loans and leases in the current quarter, down from $11.6 million, or 0.33%, in the first quarter, primarily attributable to the $9.7 million C&I recovery in the current quarter.
Non-interest expense increased $0.7 million from the first quarter of 2004. This increase was largely due to a $1.9 million increase in other expenses, as personnel expense declined $1.4 million. The increase in other expenses reflected higher other real estate owned expenses, low income housing investment amortization, printing and supplies costs, and operating losses. Personnel expense declined due to higher FASB 91 deferred salary costs associated with higher loan production.
Regional banking contributed $108.9 million of the company’s net operating earnings in the first six months of 2004, up $48.8 million from the comparable year-ago period. This increase primarily reflected a $65.9 million reduction in provision for credit losses. Also benefiting comparisons with the year-ago period was a $20.3 million, or 5%, growth in revenue, reflecting a $9.3 million, or 3%, increase in net interest income and $11.1 million, or 8%, increase in non-interest income. The benefits of lower provision for credit losses and higher revenue from the year-ago period were partially offset by expense growth of $11.3 million, or 4%. The ROA in the first six months of 2004 was 1.39%, up from 0.85% in the year-ago period. The ROE was 21.5% in the first six months, up from 12.1% in the comparable 2003 period.
Net interest income in the first six months of 2004 increased $9.3 million, or 3%, reflecting a 12% increase in average total loans and 4% increase in average total deposits, partially offset by a 27 basis point decline in net interest margin to 4.19% from 4.45%.
Average total loans increased $1.5 billion, or 12%, primarily reflecting a $0.8 billion, or 57%, increase in average residential mortgages, a $0.7 billion, or 22%, increase home equity loans and lines of credit, as well as a $0.4 billion, or 11%, increase in average CRE loans. Total average C&I loans declined $0.4 million, or 8%, from the year-ago six-month period. The growth in home equity, residential mortgages, and CRE loans, as well as the decline in C&I loans reflected the same factors noted above in the year-ago quarter. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.
Average total deposits increased $0.6 billion, or 4%. This reflected strong growth in average interest bearing demand deposits, up $0.9 billion, or 18%, partially offset by a $0.5 billion, or 13%, decline in domestic time deposits. Of the $0.6 billion increase in average total deposits, Corporate Banking accounted for $0.6 billion and Small Business $0.3 billion, with average total Consumer deposits declining $0.3 billion.
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The 27 basis points, or an effective 6%, decline in the net interest margin to 4.19% from 4.45% reflected the same factors discussed above in the 2004 second quarter versus 2003 second quarter performance.
Provision for credit losses for the first six months of 2004 represented a credit of $1.8 million, or $65.9 million less than in the year-ago period. This decline reflected the overall improvement in credit quality, as well as the shift to lower risk residential mortgages and home equity loans and lines. Net charge-offs were only $13.4 million, or an annualized 0.19% of average loans and leases, down from $51.9 million, or 0.81% in the comparable year-ago period. The 2004 first-half net charge-offs were reduced by a $9.7 million C&I recovery (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).
Non-interest income for the first six months of 2004 increased $11.1 million, or 8%, from the comparable year-ago period, reflecting a combination of factors including higher other income, an increase in deposit service charges, and higher mortgage banking revenue, partially offset by a decline in other service charges and fees.
The $5.8 million, or 34%, increase in other income from the comparable year-ago six-month period was due primarily to the full year impact of the FIN 45 adjustment discussed above, and $2.3 million of other fees. Deposit service charges increased $4.7 million, or 6%, reflecting higher personal NSF and overdraft fees. Mortgage banking income increased $1.3 million, or 7%, from the year-ago period largely as a result of a change in reporting methodology. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the comparable year-ago six month period MSR impairment of $6.4 million was reflected in Regional Banking. This was partially offset by changes in origination income, marketing income and MSR amortization, as a result of changes in the interest rate environment. The $1.6 million, or 7%, decline in other service charges and fees reflected lower interchange fees on debit card transactions.
Non-interest expense for the first six months of 2004 increased $11.3 million, or 4%, from the year-ago period. Higher personnel costs contributed $5.7 million to this increase due to a 3% increase in the number of employees, as well as higher benefit costs. The $5.3 million, or 3%, increase in other expenses reflected higher marketing, depreciation, printing and supplies, and charge card processing expenses, partially offset by lower telecommunication, legal and professional, and transportation expenses.
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Table 18 - Regional Banking(1)
INCOME STATEMENT (in thousands)
Total Non-Interest Income Before Securities Gains
Income Before Provision for Income Taxes
Provision for income taxes (2)
Net Income - Operating (1)
Tax equivalent adjustment (2)
Net interest income (FTE)
Non-interest income
Total Revenue (FTE)
Total Revenue Excluding Securities Gains (FTE)
SELECTED AVERAGE BALANCES (in millions)
Loans:
C&I
CRE
Auto loans - indirect
Home equity loans & lines of credit
Total Loans
Deposits:
Domestic time deposits
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PERFORMANCE METRICS
Return on average assets
Return on average equity
Net interest margin
Efficiency ratio
CREDIT QUALITY
Net Charge-offs by Loan Type (in thousands)
Total commercial
Auto loans
Total consumer
Net Charge-offs - annualized percentages
Non-Performing Assets (NPA) (in millions)
Total Non-accrual Loans
Renegotiated loans
Total Non-performing Loans (NPL)
Other real estate, net (OREO)
Total Non-performing Assets
Accruing loans past due 90 days or more (eop)
Allowance for Loan and Lease Losses (ALLL) (eop)
ALLL as a % of total loans and leases
ALLL as a % of NPLs
ALLL + OREO as a% of NPAs
NPAs as a % of total loans and leases + OREO
54
SUPPLEMENTAL DATA
# employees - full-time equivalent (eop)
Retail Banking
Average loans (in millions)
Average deposits (in millions)
# banking offices (eop)
# ATMs (eop)
# DDA households (eop)
# New 90-day cross sell (average)(3)
# on-line customers (eop)
% on-line retail household penetration (eop)
Small Business
# customers (eop)
# New 90-day cross sell (average) (4)
Corporate Banking
Mortgage Banking
Closed loan volume (in millions)
Portfolio closed loan volume (in millions)
Agency delivery volume (in millions)
Total servicing portfolio (eop and in millions)
Portfolio serviced for others (eop and in millions)
Mortage servicing rights (eop and in millions)
Dealer Sales serves over 3,500 automotive dealerships within Huntington’s primary banking markets, as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. The segment finances the purchase of automobiles by customers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.
The accounting for automobile leases significantly impacts the presentation of Dealer Sales’ financial results. All automobile leases originated prior to May 2002 are accounted for as operating leases, with leases originated since April 2002 accounted for as direct financing leases. For automobile leases originated prior to May 2002, the related financial results are reported as operating lease income and operating lease expense, components of non-interest income and non-interest expense, respectively, whereas the cost of funding these leases is included in interest expense. Credit losses associated with these leases are also reflected in operating lease expense. With no new operating leases being originated, this portfolio, and related operating lease income and operating lease expense, will decrease over time and eventually become immaterial. In contrast, all new leases since April 2002 are originated as direct financing leases, where the income and funding are included in net interest income. The net interest margin increased during the three and six-month periods ended June 30, 2003, as compared with the same periods in 2004 as the declining operating lease portfolio resulted in less assessed interest expense. Direct financing lease credit losses are charged against an allowance for credit losses with provision for credit losses recorded to maintain an appropriate allowance level.
Residual values on leased automobiles are evaluated periodically for impairment. Residual value losses arise if the market value at the end of the lease term is less than the residual value embedded in the original lease contract. Residual value insurance covers the difference between the recorded residual value and the fair value of the automobile at the end of the lease term. Impairment of the residual values of direct financing leases is recognized by writing the leases down to fair value with a charge to non-interest income. Impairment of residual values of operating leases is evaluated under Statement No. 144. Under that Statement, when the future cash flows from the operating lease, including the expected realizable fair value of the automobile or equipment at the end of the lease, is less than the book value of the lease, an immediate impairment write-down is recognized. Otherwise, reductions in the expected residual value result in additional depreciation of the leased asset over the remaining term of the lease. Upon disposition, a gain or loss is recorded for any difference between the net book value of the lease and the proceeds from the disposition of the asset, including any insurance proceeds.
Second Quarter 2004 versus Second Quarter 2003 Performance
Dealer Sales contributed $21.0 million of the company’s net operating earnings in the second quarter of 2004, up $3.6 million, or 20%, from the 2003 second quarter. This increase was primarily due to higher net income from loan and lease assets (net interest income plus operating lease income less operating lease expense) and a lower provision for credit losses resulting from a decrease in charge-offs. The ROA and ROE for the second quarter of 2004 were 1.27% and 20.5%, respectively, up from 0.99% and 16.1%, respectively, in the 2003 second quarter.
Net interest income was $37.8 million, up $16.0 million, or 74%, from $21.7 million in the year-ago quarter. This significant increase reflected a $0.5 billion, or 10%, increase in average total loans and leases, as well as a 104 basis point increase in the net interest margin to 2.77% from 1.73% a year ago. The increase in average total loans and leases, and the net interest margin was driven by rapid growth in direct financing leases as average automobile loans declined due to loan sales.
Average automobile direct financing leases increased $833 million, reflecting the fact that this is still a relatively young portfolio with relatively fewer maturities and pay-offs than a more mature portfolio. Direct financing lease originations totaled $246 million in the second quarter of 2004, down 37% from $389 million in the 2003 second quarter. The growth in average direct financing lease balances contrasts with the $825 million decline in average operating lease assets, which consists of all leases originated prior to May 2002 with balances running off through maturities and pay-offs.
Average automobile loans declined $491 million compared with the same period a year ago, reflecting sales of automobile loans. Automobile loan originations declined $213 million, or 33%, to $431 million in the 2004 second quarter compared with $644 million in the 2003 second quarter, reflecting a softer market for new and used vehicle sales, as well as a decision to maintain high quality originations. The impact of the loan sales and lower production levels was offset in part by the consolidation in July 2003 of $1.0 billion of previously securitized automobile loans related to the adoption of FIN 46.
Also contributing to the growth in average total loans and leases was a 20% increase in C&I loans, including dealer floor plan loans.
The net interest margin continued to be favorably impacted by the run-off of operating lease assets and the fact that all of the funding cost associated with these assets is reflected in interest expense, whereas the income is reflected in non-interest income. In contrast, the net interest margin was negatively impacted by growth in lower yielding direct financing lease balances, loan sales, and a lower net interest margin associated with securitized loans that are now recorded on balance sheet as a result of the adoption of FIN 46.
56
The provision for credit losses decreased to $8.3 million from $9.2 million for the year-ago quarter, primarily reflecting a $1.3 million, or 14%, decline in charge-offs. The annualized net charge-off ratio for automobile loans was 0.96% in the second quarter of 2004, down from 1.06% in the 2003 second quarter, while the charge-off ratio for direct financing leases was 0.41%, down from 0.44% in the year-ago quarter.
Non-interest income decreased $51.2 million, or 37%, driven by a $50.2 million, or 39%, decline in operating lease income as that portfolio continued to run-off. Other non-interest income decreased $0.9 million, or 9%, primarily due to declines in securitization income that resulted from the adoption of FIN 46 in the third quarter of 2003. Non-interest expense declined $39.7 million, or 32%, primarily reflecting a $40.7 million, or 39%, decline in operating lease expense. Other non-interest expense increased slightly as lower residual value insurance costs were offset by a loss accrual for expenses associated with pending litigation. In contrast, personnel costs increased $0.8 million, or 16%, primarily due to higher benefit costs and less benefit from deferring loan origination costs, reflecting the decline in loan and lease production.
Second Quarter 2004 versus First Quarter 2004 Performance
Dealer Sales’ net operating earnings of $21.0 million in the second quarter of 2004 were up $9.1 million, or 76%,from the first quarter of 2004. The primary contributor to this increase was a lower provision for credit losses. The ROA and ROE in the 2004 second quarter were 1.27% and 20.5%, respectively, up from 0.65% and 10.7%, respectively, in the 2004 first quarter.
Net interest income was $37.8 million for second quarter of 2004, up $2.8 million, or 8%, from the previous quarter. This increase reflected a 41 basis point increase in the net interest margin to 2.77% from 2.36%, partially offset by an 8% decline in average total loans and leases.
Average automobile loans decreased $704 million, or 23%, primarily as a result of the sale loans. Also contributing to the decline from the 2004 first quarter was a 12% decrease in automobile loan originations in the second quarter of 2004 compared with the first quarter.
Average automobile direct financing leases increased $151 million, or 8%, reflecting the fact that this continues to be a relatively young portfolio. However, direct financing lease originations declined 11% compared with the first quarter of 2004. The $151 million, or 8%, growth in average direct financing lease balances contrasts with the $189 million, or 16%, decline in average operating lease assets.
During the second quarter of 2004, C&I loans, including dealer floor plan loans, increased $52 million, or 7%, from the prior quarter, consistent with seasonal patterns for usage of available credit lines.
The provision for credit losses decreased 62%, reflecting both lower charge-offs and lower provision expense for growth in loans and direct financing leases. Charge-offs in the 2004 second quarter represented an annualized 0.58%, down from 1.14% in the first quarter. The first quarter of 2004 included a $4.7 million one-time charge to correct for the classification of claims received under policies purchased to protect the company from loss in the event repossessed vehicles had physical damage.
Non-interest income decreased $8.3 million, or 9%, primarily due to a $10.4 million, or 12%, decline in operating lease income as that portfolio continues to run-off. This decrease was partially offset by increases in servicing fee income, securitization income, and fee income from lease terminations. Non-interest expense declined $5.6 million, or 6%, primarily reflecting an $8.4 million, or 12%, decline in operating lease expense, offset in part by a loss accrual in other expense associated with pending litigation.
Dealer Sales contributed $33.0 million of the company’s net operating earnings for the first six months of 2004, down slightly from $33.5 million for the same period a year ago. Earnings in 2004 compared with 2003 were primarily impacted by a higher provision for credit losses, which was driven by increased charge-offs and the provision for credit losses associated with loan and lease growth, offset by higher net income from loan and lease assets. The ROA and ROE for the first six months of 2004 were 0.95% and 15.3%, respectively, compared with 0.94% and 15.3%, respectively, for the 2003 six-month period.
57
Net interest income was $72.7 million, up $29.1 million, or 67%, from $43.6 million in the year-ago period. This significant increase reflected an $806 million, or 17%, increase in average total loans and leases, as well as a 79 basis point increase in the net interest margin to 2.55% from 1.76% a year ago. The significant increase in average total loans and leases, as well as the net interest margin, was driven by rapid growth in direct financing leases as average automobile loans declined.
Average automobile direct financing leases increased $911 million, or 79%, reflecting the fact that this is still a relatively young portfolio with fewer maturities and pay-offs than a more mature portfolio. Direct financing lease originations totaled $522 million in the first six months of 2004, down 25% from $699 million in the first six months of 2003. The growth in average direct financing lease balances contrasts with the $867 million, or 45%, decline in average operating lease assets, which consists of all leases originated prior to May 2002 with balances running off through maturities and pay-offs.
Average automobile loans declined $263 million compared with the same period a year ago, reflecting the impact of loan sales, as well as a $436 million, or 32%, decline in originations, reflecting a softer market for new and used vehicle sales, as well as a decision to maintain high quality loan originations. The impact of the loan sales and lower production levels was offset in part by the consolidation in July 2003 of $1.0 billion of previously securitized loans related to the adoption of FIN 46.
Also contributing to the growth in average total loans and leases was a $121 million, or 18%, increase in C&I loans, including dealer floor plan loans.
The net interest margin continued to be favorably impacted by the run-off of the operating lease assets and the fact that all of the funding cost associated with these assets is reflected in interest expense, whereas the income is reflected in non-interest income. In contrast, the net interest margin was negatively impacted by growth in lower yielding direct financing lease balances, loan sales, and a lower net interest margin associated with securitized loans that are now recorded on balance sheet as a result of the adoption of FIN 46.
The provision for credit losses increased from $20.6 million from the year-ago period to $29.9 million, reflecting growth in direct financing leases, an increase in provision allocation factors and a $3.6 million increase in charge-offs. Though net charge-offs increased $3.6 million from the year-ago six-month period, as an annualized percent of average total loans and leases, total net charge-offs were unchanged at 0.87%.
Non-interest income decreased $103.0 million, or 36%, driven by a $99.6 million, or 37%, decline in operating lease income as that portfolio continued to run-off. Other non-interest income decreased $2.5 million, or 14%, primarily due to declines in securitization income that resulted from the adoption of FIN 46 in the third quarter of 2003. Non-interest expense declined $82.5 million, or 32%, primarily reflecting an $81.6 million, or 38%, decline in operating lease expense. Other non-interest expense declined $2.4 million, or 7%, primarily due to lower residual value insurance costs. In contrast, personnel costs increased $1.4 million, or 14%, primarily due to higher benefit costs and less benefit from deferring loan origination costs, reflecting the decline in loan and lease production.
58
Tax Equivalent Adjustment(2)
Net Interest Income (FTE)
Auto leases – indirect
Auto loans – indirect
NM, not a meaningful value.
59
Table 19 - Dealer Sales(1)
Auto leases
Net Charge-offs—annualized percentages
Non-performing Assets (NPA) (in millions)
Accruing loans past due 90 days or more
ALLL + OREO as a % of NPAs
60
Production (in millions)
% Production new vehicles
Average term (in months)
Average residual %
eop, end of period.
61
The Private Financial Group (PFG) provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services. The trust division provides fiduciary services to more than 11,000 accounts with assets totaling $39.2 billion, including $8.7 billion managed by PFG. In addition, PFG has over $560 million in assets managed by Haberer Registered Investment Advisor, which provides investment management services to nearly 400 customers.
PFG provides investment management and custodial services to the company’s 29 proprietary mutual funds, including ten variable annuity funds, which represented nearly $3 billion in total assets under management at June 30, 2004. The Huntington Investment Company offers brokerage and investment advisory services to both Regional Banking and PFG customers through more than 100 licensed investment sales representatives and 700 licensed personal bankers. This customer base has over $4 billion in mutual fund and annuity assets. PFG’s insurance entities provide 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. Income and related expenses from the sale of brokerage and insurance products is shared with the line of business that generated the sale or provided the customer referral, most notably Regional Banking.
The Private Financial Group (PFG) contributed $6.3 million of the company’s net operating earnings in the second quarter of 2004, down $1.7 million, or 21%, from the second quarter of 2003. The decline primarily reflected higher non-interest expense and provision for credit losses, partially offset by an increase in net interest income. The ROA in the 2004 second quarter was 1.67%, down from 2.45% in the year-ago quarter. The ROE was 21.3% in the current quarter, down from 30.3% in the 2003 second quarter.
Net interest income increased $1.4 million, or 14%, from the year-ago quarter as average loan balances increased $200 million, or 17%, and average deposit balances increased $87 million, or 9%. Most of the loan growth occurred in residential real estate loans and home equity loans and lines, largely due to the favorable mortgage rate environment. Total C&I and CRE loans grew 8% from the prior-year quarter. Loan growth reflected initiatives to add relationship managers in several markets targeted for growth opportunities, most notably East and West Michigan and Central and Southern Ohio. Most of the deposit growth was attributable to growth in commercial non-interest bearing and interest bearing demand deposit accounts aided by favorable rate offerings. The net interest margin declined 9 basis points from the year-ago quarter to 3.14%, reflecting growth in lower-margin loans partially offset by deposit growth.
Provision for credit losses increased $1.1 million from the year-ago quarter. The increase was mainly due to the fact that the year-ago quarter included a provision credit resulting from a large, previously non-performing loan being brought current, thus freeing-up reserves. The annualized total net charge-off ratio increased to 0.27% in the second quarter 2004 from 0.15% in the year-ago quarter, primarily reflecting timing differences as evidenced by the fact that the annualized net charge-offs ratio for the first six months of 2004 was unchanged from the comparable year-ago period.
Non-interest income, net of fees shared with other business units, was down $0.2 million from the year-ago quarter, reflecting declines in brokerage and insurance revenue, other income, and mortgage banking income, only partially offset by growth in trust income. Brokerage and insurance revenue decreased $0.8 million, or 9%. This reflected a $0.7 million, or 20%, decline in insurance revenue mainly due to a decrease in title insurance revenue reflecting the slowdown in mortgage refinancing activity, as well as a $0.2 million, or 3%, decline in annuity revenues. The annuity revenue decrease of 3% was less than the 6% decline in annuity sales, reflecting a shift from lower-margin fixed annuity sales in the year-ago quarter to higher-margin variable and indexed annuity sales in the current quarter. While mutual fund sales volume declined 24%, mutual fund revenue increased 23%, as sales in the year-ago quarter consisted of more low-margin, individual trades greater than $1 million each. Trust income increased $1.2 million, or 8%, mainly due to revenue growth in personal trust and investment management business. Total trust assets grew 15% to $39.2 billion at June 30, 2004, from $34.2 billion at June 30, 2003. For the same periods, managed assets grew 6% to $9.3 billion from $8.8 billion. Asset growth resulted from a combination of market value growth and strong new business development, which continued to reflect the success of the new business delivery model utilizing the brokerage sales force to sell asset management services.
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Non-interest expense increased $2.7 million, or 10%, from the 2003 second quarter primarily due to a 14% increase in personnel costs. This increase reflected growth in the brokerage sales force to support the new sales distribution model, an increase in private banking relationship managers to support the expansion of the private banking presence in selected markets, higher trust and investment management sales commissions from increased new business development, and higher benefit costs.
PFG’s $6.3 million net contribution to the company’s operating earnings in the second quarter of 2004 was down $0.8 million, or 11%, from the 2004 first quarter. The decrease was primarily due to higher provision for credit losses, lower non-interest income driven by a decline in broker and insurance revenue, only partially offset by lower non-interest expense. The ROA in the second quarter was 1.67%, down slightly from 1.92% in the first quarter. The ROE was 21.3% in the current quarter, down from 24.2% in the previous quarter.
Net interest income was essentially unchanged from the previous quarter. Average loan balances increased by $34 million, or 3%, while average deposit balances decreased by $23 million, or 2%. Average loan growth in the current quarter was primarily in C&I and CRE loans. The decline in deposit balances partially reflected normal historical trends resulting from annual income tax payments, but also some balance run-off due to higher competitive rates, most notably in East Michigan. The decline in deposits, combined with the increase in lower-margin consumer loans, was reflected in a 10 basis point decline in the net interest margin to 3.14% from 3.24% in the first quarter.
Provision for credit losses increased $1.2 million from the prior quarter. The increase was largely due to a provision credit in the first quarter 2004 resulting from a large, fully-reserved loan being brought current. Although the annualized total net charge-off ratio increased to 0.27% in the current quarter from 0.06% in the first quarter, this had little impact on provision expense in the current period as several of the larger second quarter charge-offs had been fully reserved.
Non-interest income, net of fees shared with other business units, decreased $0.9 million, or 3%, from the first quarter, primarily reflecting a $2.1 million, or 20%, decline in brokerage and insurance income. Annuity revenue decreased $1.5 million as sales volume decreased 17%. The decline in annuity sales was attributable to several factors, including a slowdown in customer demand given future interest rate movement uncertainty, increased focus on growing deposits including increased rates offered on CDs, and normal post income-tax season sales decline. Mutual fund revenue declined 16% as sales in the current quarter consisted of more low-margin, individual trades greater than $1 million each. Insurance income decreased $0.2 million from the prior quarter primarily due to reduced sales in the life insurance agency business.
Trust income increased $0.5 million, or 3%, from the previous quarter. While total trust and managed assets both grew only slightly, the increase in related income was driven by growth in total personal trust assets and managed personal trust assets, both of which grew by more than 4% during the quarter. Personal trust asset growth continued despite flat market trends, which illustrated strong new business development due in part to the success of the new business delivery model, which utilizes the brokerage sales force to sell asset management services. Other income increased $0.4 million from the first quarter due to increased income from annual BOLI insurance premiums and securities gains.
Non-interest expense decreased $0.9 million, or 3%, from the prior quarter, primarily reflecting lower personnel costs due to a decline in commission expense as a result of the reduction in brokerage and insurance revenue.
PFG’s $13.3 million net contribution to the company’s operating earnings for the first six months of 2004 was essentially unchanged from the first six months of 2003 as the benefits of the growth in net interest income, lower provision for credit losses, as well as higher non-interest income, was offset by increased non-interest expense. The ROA for 2004 year-to-date was 1.79%, down from 2.10% for the same period in 2003. The ROE was 22.6% and 26.7% for the first six months of 2004 and 2003, respectively.
63
Net interest income for the first six months of 2004 increased $3.0 million, or 16%, from the comparable 2003 period as a result of strong growth in average loans and deposits. Average loans increased $212 million, or 19%, while average deposit balances increased $125 million, or 13%. Much of the loan growth was in residential real estate loans and home equity loans and lines, largely due to historically low mortgage rates. Loan growth also reflected an initiative to add relationship managers in 2004 in several markets targeted for growth opportunities, most notably East and West Michigan and Central and Southern Ohio. The deposit growth occurred mainly in consumer and commercial interest bearing accounts, which increased $88 million, or 14%, aided by promotional rate offerings resulting in both new accounts and a redirection of sweep account balances from money market mutual fund accounts. Non-interest bearing deposits also contributed to the growth in deposits, increasing $30 million, or 21%, from the comparable year-ago period. The growth in lower-margin consumer loans contributed to the 9 basis point decline in the net interest margin to 3.18% for the first half 2004 from 3.27% in the year-ago period.
Provision for credit losses decreased $1.3 million in the current six-month period from the prior-year period. This was due to a methodology change in 2003, which increased provision expense for unfunded commitments and unsecured credits. The annualized total net charge-off ratio for the first six months of 2004 was 0.17%, unchanged from the first half of 2003.
Non-interest income, net of fees shared with other business units, increased $1.2 million, or 2%, from the first six months of 2003 mainly as a result of increased trust income. Trust income increased $2.6 million, or 9%, primarily due to revenue growth in the personal trust and investment management business. Total trust assets grew 15% to $39.2 billion at June 30, 2004, from $34.2 billion at June 30, 2003. For the same period, managed assets grew 6% from $8.8 billion to $9.3 billion. Asset growth resulted from a combination of market value growth and strong new business development, which continued to reflect the success of the new business delivery model utilizing the brokerage sales force to sell asset management services.
Brokerage and insurance revenue was essentially unchanged from the prior-year six-month period as increased mutual fund revenue was offset by a decrease in insurance fees and annuity income. Mutual fund revenue increased $1.0 million, or 52%, despite a 21% decline in mutual fund sales volumes as sales in the first half of 2003 consisted of more low-margin, individual trades greater than $1 million each. Annuity revenue decreased $0.3 million due to a decline in sales volume. Annuity sales were extremely strong in early 2003 as promotional rates helped capture a significant amount of maturing CD business. Insurance income decreased $1.7 million, or 23%, primarily due to a change in accounting methodology in 2004 related to insurance coverage provided on automobile loans and leases, whereby agency commissions and excess premium refunds are no longer recognized as insurance revenue.
Mortgage banking income decreased by $0.6 million due to increased mortgage portfolio servicing costs resulting from the growth in residential real estate mortgage loans and due to a change in fee sharing methodology that resulted in reduced income shared by Huntington Mortgage Group. Other income decreased by $0.8 million as a result of a decline in fee sharing revenue received from Huntington Capital Corporation based on fewer interest rate swap referrals, and investment portfolio gains realized in the year-ago period.
Non-interest expense increased $5.5 million, or 10%, in the first half 2004 from the first half 2003, primarily due to 13% increase in personnel costs. This increase reflected the same factors which impacted 2004 second quarter versus 2003 second quarter performance. In addition, other expense increased $1.4 million, or 6%, reflecting a $1.1 million increase in allocated expense for corporate overhead and other indirect and product-related expenses.
64
Table 20 - Private Financial Group(1)
Tax Equivalent Adjustment (2)
65
Total commercial and commercial real estate
Allowance for Loan and Lease Losses (ALLL)(eop)
66
# licensed bankers (eop)
Brokerage and Insurance Income (in thousands)
Mutual fund revenue
Annuities revenue
12b-1 fees
Discount brokerage commissions and other
Total retail investment sales
Investment banking fees
Insurance fees and revenue
Total Brokerage and Insurance Income
Fee sharing
Total Brokerage and Insurance Income (net of fee sharing)
Mutual fund sales volume, excluding direct trades (in thousands)
Annuities sales volume (in thousands)
Trust Services Income (in thousands)
Personal trust revenue
Huntington funds revenue
Institutional trust revenue
Corporate trust revenue
Other trust revenue
Total Trust Services Income
Total Trust Services Income (net of fee sharing)
Assets Under Management (eop) (in billions)
Personal trust
Huntington funds
Institutional trust
Corporate trust
Haberer
Total Assets Under Management
Total Trust Assets (eop) (in billions)
Total Trust Assets
Mutual Fund Data
# Huntington mutual funds (eop)
Sales penetration (3)
Revenue penetration (whole dollars) (4)
Profit penetration (whole dollars) (5)
Average sales per licensed banker (whole dollars) annualized
Average revenue per licensed banker (whole dollars) annualized
Contribution is difference between program revenue and program expenses.
The Treasury/Other segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the other three business segments. Assets included in this segment include bank owned life insurance, investment securities, and mezzanine loans originated through Huntington Capital Markets.
Net interest income includes the net impact of administering Huntington’s investment securities portfolios as part of overall liquidity management. A match-funded transfer pricing system is used to attribute appropriate funding interest income and interest expense to other business segments. As such, net interest income includes the net impact of any over or under allocations arising from centralized management of interest rate risk. Furthermore, net interest income includes the net impact of derivatives used to hedge interest rate sensitivity as well as net interest income related to Huntington Capital Markets loan activity.
Non-interest income includes fee income related to Huntington Capital Markets activities, and miscellaneous non-interest income not allocated to other business segments, including bank owned life insurance income. Fee income also includes MSR temporary impairment valuation recoveries or impairments, as well as any securities gains or losses, which are used to mitigate MSR valuation changes. Prior to 2004, changes in MSR temporary impairment valuations were reflected in the Regional Banking business segment, whereas securities gains or loss were reflected in the Treasury/Other segment. Since securities gains or losses are used to mitigate MSR valuation changes, and since this risk is managed centrally, for 2004 reporting both MSR valuation changes, as well as securities gains or losses, are reflected in Treasury/Other results.
Non-interest expense includes expenses associated with Huntington Capital Markets activities, as well as certain corporate administrative and other miscellaneous expenses not allocated to other business segments.
The provision for income taxes for each of the other business segments is calculated at a statutory 35% tax rate though the company’s overall effective tax rate is lower. As a result, the provision for income taxes in Treasury/Other includes the difference between the actual effective tax rate and the statutory tax rate used to allocate income taxes to the other segments.
Treasury/Other net income declined $15.2 million, or 45% from the same quarter last year. This reflected a combination of higher non-interest expense, lower non-interest income, and lower net interest income, partially offset by lower provision for income taxes.
Net interest income decreased $2.0 million, or 10%, from the year-ago quarter. Driving this variance were a $5.3 million increase in wholesale funding costs and $7.5 million of lower revenue from derivatives activities, offset by $1.1 million of higher interest income in the Capital Markets margin and $10.0 million of higher interest income on securities.
The provision for credit losses was $0.1 million higher than last year, attributable to increased Huntington Capital Markets lending activity.
Non-interest income was $9.6 million, or 40%, lower than in the year-ago quarter, reflecting the impact of using securities losses to offset MSR impairment recoveries. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the year-ago quarter MSR impairment of $6.4 million was reflected in Regional Banking. Other non-interest income was also down from the year-ago quarter by $3.1 million, reflecting lower income from trading activities.
Non-interest expense for operational, administrative, and support groups, which was not specifically allocated to the other business segments was up $12.3 million from last year. Driving this variance was $5.5 million of higher incentive plan costs in the second quarter of 2004. Furthermore, $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits occurred in the second quarter of 2004.
The provision for income taxes declined $8.8 million, reflecting lower pre-tax income, partially offset by a higher overall effective tax rate in the 2004 second quarter, compared with the year-ago quarter.
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Treasury/Other’s net income was $12.5 million, or 40%, lower than the first quarter. This reflected a combination of lower non-interest income, lower net interest income, and higher non-interest expense, partially offset by lower provision for credit losses.
The net interest margin for Treasury/Other was down $7.0 million, or 27%. Driving this variance was lower net earnings from Huntington’s transfer pricing system to centrally manage interest rate risk. These earnings are allocated to the other lines of business units’.
Non-interest income was $7.1 million lower in the second quarter compared with the first quarter. Securities losses, offset by MSR impairment recovery, drive most of this reduction. Furthermore, investment banking activities from Huntington Capital Markets contributed $2.4 million less revenue in the second quarter, than in the first quarter.
Non-interest expense for Treasury/Other increased $2.2 million, or 13%, from the first quarter. Second quarter expenses include $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits. Offsetting this variance is a higher net amount of expenses allocated to the other business segments.
The provision for credit losses decline $2.3 million, reflecting lower NPAs.
The provision for income taxes decreased $1.5 million, reflecting the benefit of the company’s lower overall effective tax rate versus the 35% effective tax rate used to allocate provision for income taxes to each line of business, partially offset by an increase in the company’s higher overall effective tax rate in the current quarter compared with the first quarter.
Treasury/Other net income for the first six months of 2004 declined $11.8 million, or 19%, from the comparable year-ago period. This reflected a combination of factors primarily consisting of higher non-interest expense, lower non-interest income, and an increase in provision for credit losses, partially offset by lower provision for income taxes.
Net interest income decreased $0.3 million, or 1%, from the comparable year-ago period. Driving this variance were a $10.1 million increase in wholesale funding costs and $14.8 million of lower revenue from derivatives activities, offset by higher interest income in the Huntington Capital Markets margin and $21 million of higher interest income on securities.
The provision for credit losses was $2.5 million higher than the year-ago period, attributable to increased Huntington Capital Markets lending activity.
Non-interest income was $3.6 million, or 9%, lower than in the year-ago period, reflecting the impact of using securities losses to offset MSR impairment recoveries.
Non-interest expense for operational, administrative, and support groups, which was not specifically allocated to other business segments increased $14.7 million from last year, including $5.5 million of higher incentive plan costs, $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits, and higher sales incentives of $2.4 million in Huntington Capital Markets.
The provision for income taxes declined $9.4 million, reflecting the benefit of the company’s lower overall effective tax rate versus the 35% effective tax rate used to allocate provision for income taxes to each line of business, partially offset by the company’s higher total effective tax rate in the first six months of 2004 versus the comparable year-ago period.
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Table 21 - Treasury/Other(1)
Bank Owned Life Insurance income
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Table 22 - Total Company (1)
Auto leases - indirect
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CREDIT QUALITY (in thousands)
Net Charge-offs by Loan Type
# employees - full-time equivalent
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Quantitative and qualitative disclosures for the current period are found beginning on page 45 of this report, which includes changes in market risk exposures from disclosures presented in Huntington’s 2003 Form 10-K.
Item 4. Controls and Procedures
Huntington’s management, with the participation of its Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of Huntington’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon such evaluation, Huntington’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Huntington’s disclosure controls and procedures are effective.
There have not been any changes in Huntington’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) ad 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Huntington’s internal control over financial reporting.
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PART II. OTHER INFORMATION
In accordance with the instructions to Part II, the other specified items in this part have been omitted because they are not applicable or the information has been previously reported.
Item 2. Changes in Securities and Use of Proceeds
Period
April 1, 2004 to April 30, 2004
May 1, 2004 to May 31, 2004
June 1, 2004 to June 30, 2004
Item 4. Submission of Matters to a Vote of Security Holders
Huntington held its annual meeting of shareholders on April 27, 2004. At this meeting, the shareholders approved the following management proposals:
Abstain/
Withheld
1.
Karen A. Holbrook
David P. Lauer
Kathleen H. Ransier
2.
David L. Porteous
3.
4.
5.
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Item 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: August 9, 2004
/s/ Thomas E. Hoaglin
Thomas E. Hoaglin
Chairman, Chief Executive Officer and
President
/s/ Donald R. Kimble
Donald R. Kimble
Chief Financial Officer and Controller
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