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| HBAN > SEC Filings for HBAN > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
• Discussion of Results of Operations - Reviews financial performance from a consolidated company perspective. It also includes a "Significant Items" section that summarizes key issues helpful for understanding performance trends, including our acquisition of Sky Financial Group, Inc. (Sky Financial) and our relationship with Franklin Credit Management Corporation (Franklin). Key consolidated balance sheet and income statement trends are also discussed in this section.
• Risk Management and Capital - Discusses credit, market, liquidity, and operational risks, including how these are managed, as well as performance trends. It also includes a discussion of liquidity policies, how we obtain funding, and related performance. In addition, there is a discussion of guarantees and/or commitments made for items such as standby letters of credit and commitments to sell loans, and a discussion that reviews the adequacy of capital, including regulatory capital requirements.
• Lines of Business Discussion - Provides an overview of financial performance for each of our major lines of business and provides additional discussion of trends underlying consolidated financial performance.
A reading of each section is important to understand fully the nature of our
financial performance and prospects.
Forward-Looking Statements
This report, including MD&A, contains certain forward-looking statements,
including certain plans, expectations, goals, and projections, which are subject
to numerous assumptions, risks, and uncertainties. Statements that do not
describe historical or current facts, including statements about beliefs and
expectations, are forward-looking statements. The forward-looking statements are
intended to be subject to the safe harbor provided by Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Actual results could differ materially from those contained or implied by
such statements for a variety of factors including: (a) deterioration in the
loan portfolio could be worse than expected due to a number of factors such as
the
underlying value of the collateral could prove less valuable than otherwise
assumed and assumed cash flows may be worse than expected; (b) changes in
economic conditions; (c) movements in interest rates and spreads;
(d) competitive pressures on product pricing and services; (e) success and
timing of other business strategies; (f) the nature, extent, and timing of
governmental actions and reforms; and (g) extended disruption of vital
infrastructure. The Emergency Economic Stabilization Act of 2008 (EESA) passed
on October 3, 2008, could have an undetermined material impact on company
performance depending on rules of participation that have yet to be finalized.
Additional factors that could cause results to differ materially from those
described above can be found in Huntington's 2007 Form 10-K, and documents
subsequently filed by Huntington with the Securities and Exchange Commission
(SEC).
All forward-looking statements speak only as of the date they are made and
are based on information available at that time. We assume no obligation to
update forward-looking statements to reflect circumstances or events that occur
after the date the forward-looking statements were made or to reflect the
occurrence of unanticipated events except as required by federal securities
laws. As forward-looking statements involve significant risks and uncertainties,
readers of this document are cautioned against placing undue reliance on such
statements.
Risk Factors
We, like other financial companies, are subject to a number of risks that may
adversely affect our financial condition or results of operation, many of which
are outside of our direct control, though efforts are made to manage those risks
while optimizing returns. Among the risks assumed are: (1) credit risk, which is
the risk of loss due to loan and lease customers or other counterparties not
being able to meet their financial obligations under agreed upon terms, (2)
market risk, which is the risk of loss due to changes in the market value of
assets and liabilities due to changes in market interest rates, foreign exchange
rates, equity prices, and credit spreads, (3) liquidity risk, which is the risk
of loss due to the possibility that funds may not be available to satisfy
current or future commitments based on external macro market issues, investor
and customer perception of financial strength, and events unrelated to the
company such as war, terrorism, or financial institution market specific issues,
and (4) operational risk, which is the risk of loss due to human error,
inadequate or failed internal systems and controls, violations of, or
noncompliance with, laws, rules, regulations, prescribed practices, or ethical
standards, and external influences such as market conditions, fraudulent
activities, disasters, and security risks. (See "Risk Management and Capital"
discussion for additional information regarding risk factors.) Additionally,
more information on risk is set forth below, and under the heading "Risk
Factors" included in Item 1A of our 2007 Annual Report on Form 10-K for the year
ended December 31, 2007, and subsequent filings with the SEC.
Emergency Economic Stabilization Act of 2008
On October 3, 2008, the Emergency Economic Stabilization Act of 2008
(EESA) was enacted. EESA enables the federal government, under terms and
conditions to be developed by the Secretary of the Treasury, to insure troubled
assets, including mortgage-backed securities, and collect premiums from
participating financial institutions. EESA includes, among other provisions:
(a) the $700 billion Troubled Assets Relief Program (TARP), under which the
Secretary of the Treasury is authorized to purchase, insure, hold, and sell a
wide variety of financial instruments, particularly those that are based on or
related to residential or commercial mortgages originated or issued on or before
March 14, 2008; and (b) an increase in the amount of deposit insurance provided
by the Federal Deposit Insurance Corporation (FDIC). Both of these specific
provisions are discussed in the below sections.
We continue to evaluate the key provisions of EESA, as well as the related
accounting, tax, and business issues and their impact on Huntington's
consolidated financial statements. At this time, we are uncertain as to the
total impact EESA, other legislation, regulations, and pronouncements that may
be enacted or adopted in response to the current worldwide economic uncertainty,
may have on our financial condition, results of operations, liquidity, and stock
price.
Troubled Assets Relief Program (TARP)
Under the TARP, the Department of Treasury has authorized a voluntary capital
purchase program (CPP) to purchase up to $250 billion of senior preferred shares
of qualifying financial institutions that elect to participate by November 14,
2008. A company that participates must adopt certain standards for executive
compensation, including (a) prohibiting "golden parachute" payments as defined
in EESA to senior Executive Officers; (b) requiring recovery of any compensation
paid to senior Executive Officers based on criteria that is later proven to be
materially inaccurate; and (c) prohibiting incentive compensation that
encourages unnecessary and excessive risks that threaten the value of the
financial institution.
On October 27, 2008, we announced that the Department of Treasury had
preliminarily approved our application to participate in the TARP voluntary CPP.
Our participation is subject to the standard terms and conditions of the
program. We have been approved for approximately $1.4 billion in capital that
will take the form of non-voting cumulative preferred stock that would pay cash
dividends at the rate of 5% per annum for the first five years, and then pay
cash dividends at the rate of 9% per annum thereafter. In addition, the
Department of Treasury will receive warrants to purchase shares of our common
stock having an aggregate market price equal to 15% of the preferred stock
amount. The expected proceeds of the $1.4 billion would be allocated to the
preferred stock and additional paid-in-capital. Any resulting discount on the
preferred stock would be amortized, resulting in additional dilution to our
common stock. The exercise price for the warrant, and the market price for
determining the number of shares of common stock subject to the warrants, would
be determined on the date of the preferred investment (calculated on a
20-trading day trailing average). The warrants would be immediately exercisable,
in whole or in part, over a term of 10 years. The warrants would be included in
our diluted average common shares outstanding.
Federal Deposit Insurance Corporation (FDIC)
The FDIC is an independent agency of the United States government that
protects against the loss of insured deposits if any FDIC insured bank or
savings association fails. All participants are assessed quarterly deposit
insurance premiums.
As a participating FDIC insured bank, we were assessed quarterly deposit
insurance premiums totaling $18.1 million for the first nine-month period of
2008. However, we received a one-time assessment credit from the FDIC (see
"Business" discussion in the 2007 Form 10-K) which substantially offset our
year-to-date 2008 deposit insurance premium and, therefore, only $1.8 million of
deposit insurance premium expense was recognized for the first nine-month period
of 2008. At September 30, 2008, our remaining assessment credit available to
offset future FDIC insurance premiums was $0.2 million.
On October 7, 2008, the FDIC requested comment on a proposed rule that would
increase the rates banks pay for deposit insurance. Specifically, the assessment
rate schedule would be raised by 7 basis points (annualized) beginning
January 1, 2009. The FDIC has also proposed changing the way the system measures
risk among insured institutions in order to require riskier institutions to pay
a larger assessment. Based on these proposed changes, as well as the full
consumption of the one-time assessment credit (discussed above), we anticipate
that our full-year 2009 deposit insurance premium expense will increase
approximately $44 million compared with our expected full-year 2008 deposit
insurance premium expense.
EESA temporarily raised the limit on federal deposit insurance coverage from
$100,000 to $250,000 per depositor. Separate from EESA, in October 2008, the
FDIC also announced the Temporary Liquidity Guarantee Program. Under one
component of this program, the FDIC temporarily provides unlimited coverage for
non-interest bearing transaction deposit accounts through December 31, 2009. The
limits return to $100,000 on January 1, 2010. (See "Bank Liquidity" discussion
for additional details regarding the Temporary Liquidity Guarantee Program.)
Critical Accounting Policies and Use of Significant Estimates
Our financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The preparation of
financial statements in conformity with GAAP requires us to establish critical
accounting policies and make accounting estimates, assumptions, and judgments
that affect amounts recorded and reported in our financial statements. Note 1 of
the Notes to Consolidated Financial Statements included in our 2007 Form 10-K as
supplemented by this report lists significant accounting policies we use in the
development and presentation of our financial statements. This discussion and
analysis, the significant accounting policies, and other financial statement
disclosures identify and address key variables and other qualitative and
quantitative factors necessary for an understanding and evaluation of our
company, financial position, results of operations, and cash flows.
An accounting estimate requires assumptions about uncertain matters that
could have a material effect on the financial statements if a different amount
within a range of estimates were used or if estimates changed from period to
period. Readers of this 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. The most significant accounting estimates and their related
application are discussed in our 2007 Form 10-K. The following discussion
provides an update of our accounting estimates related to goodwill. Also, based
on recent market
developments, we now consider the results of our other-than-temporary-impairment
(OTTI) analysis of securities available-for-sale to be a significant estimate.
Goodwill
We account for goodwill in accordance with FASB Statement No. 142, Goodwill
and Other Intangible Assets. The reporting units are tested for impairment
annually as of October 1, to determine whether any goodwill impairment exists.
Goodwill is also tested for impairment on an interim basis if an event occurs or
circumstances change between annual tests that would more likely than not reduce
the fair value of the reporting unit below its carrying amount. Impairment
losses, if any, would be reflected in non-interest expense.
We apply judgment in assessing goodwill for impairment. Estimates of fair
value are based primarily on the market capitalization of Huntington, adjusted
for a control premium. Also considered are projections of cash flows considering
historical and anticipated future results, and general economic and market
conditions. Changes in market capitalization, certain judgments, and projections
could result in a significantly different estimate of the fair value of the
reporting units and could result in an impairment of goodwill.
As a result of the continued economic weakness across our Midwest markets,
our stock price declined significantly during the first six-month period of
2008. Therefore, we performed an interim impairment test of our goodwill as of
June 30, 2008. Based upon the results of the test, no impairment to goodwill was
required. No factors occurred during the 2008 third quarter that required an
additional impairment test.
Securities
As described in Note 1 of the Notes to Consolidated Financial Statements in
our 2007 Form 10-K, investments are reviewed quarterly for indicators of OTTI.
This determination requires significant judgment. In making this judgment, we
evaluate, among other factors, the expected cash flows of the security, the
duration and extent to which the fair value of an investment is less than its
cost, the historical and implicit volatility of the security, and our intent and
ability to hold the investment until recovery, which may be maturity.
During the current quarter, we recognized OTTI of $76.6 million in our Alt-A
mortgage loan-backed portfolio (see "Investment Portfolio" discussion within the
"Credit Risk" section). Given the continued disruption in the financial markets,
we may be required to recognize additional OTTI losses in future periods with
respect to these or other securities held in our available-for-sale portfolio.
Also, we have experienced an increase in unrealized losses primarily as a result
of wider liquidity spreads on our asset-backed securities. At September 30,
2008, unrealized losses on our asset-backed securities totaled $209.2 million,
up from unrealized losses of $35.2 million at December 31, 2007 and unrealized
losses of $4.2 million at September 30, 2007.
The amount and timing of any additional impairment recognized will depend on
the severity and duration of the decline in fair value of the securities, our
estimation of the anticipated recovery period, and the expected cash flows of
the security. (See Note 4 in the Notes to Unaudited Condensed Consolidated
Financial Statements for additional discussion.)
Recent Accounting Pronouncements and Developments
Note 2 to the Unaudited Condensed Consolidated Financial Statements discusses
new accounting policies adopted during 2008 and the expected impact of
accounting policies recently issued but not yet required to be adopted. To the
extent the adoption of new accounting standards materially affect financial
condition, results of operations, or liquidity, the impacts are discussed in the
applicable section of this MD&A and the Notes to the Unaudited Condensed
Consolidated Financial Statements.
Acquisition of Sky Financial
The merger with Sky Financial was completed on July 1, 2007. At the time of
acquisition, Sky Financial had assets of $16.8 billion, including $13.3 billion
of loans, and total deposits of $12.9 billion. The impact of this acquisition
has been included in our consolidated results since July 1, 2007. As a result of
this acquisition, we have a significant loan
relationship with Franklin. This relationship is discussed in greater detail in
the "Significant Items" and "Commercial Credit" sections of this report.
Given the significant impact of the merger on year-to-date reported results,
we believe that an understanding of the impacts of the merger and certain
post-merger restructuring activities is necessary to better understand the
underlying performance trends. When comparing post-merger period results to
premerger periods, we use the following terms when discussing financial
performance:
• "Merger-related" refers to amounts and percentage changes representing the
impact attributable to the merger.
• "Merger and restructuring costs" represent non-interest expenses primarily associated with merger integration activities, including severance expense for key executive personnel.
• "Non-merger-related" refers to performance not attributable to the merger, and includes "merger efficiencies", which represent non-interest expense reductions realized as a result of the merger.
After completion of the merger, we combined Sky Financial's operations with
ours, and as such, we could no longer separately monitor the subsequent
individual results of Sky Financial. As a result, the following methodologies
were implemented to estimate the approximate effect of the Sky Financial merger
used to determine "merger-related" impacts. Certain tables and comments
contained within our discussion and analysis provide detail of changes to
reported results to quantify the estimated impact of the Sky Financial merger
using this methodology. Only year-to-date comparisons are impacted by the Sky
Financial acquisition in this MD&A, as all quarterly periods presented are
post-merger.
Balance Sheet Items
For average loans and leases, as well as average deposits, Sky Financial's
balances as of June 30, 2007, adjusted for purchase accounting adjustments, and
transfers of loans to loans held-for-sale, were used in the comparison. To
estimate the impact on 2008 year-to-date average balances, it was assumed that
the June 30, 2007 balances, as adjusted, remained constant over time.
Income Statement Items
Sky Financial's actual results for the first six months of 2007, adjusted for
the impact of unusual items and purchase accounting adjustments, were
determined. This six-month adjusted amount was divided by two to estimate a
quarterly impact. The quarterly amount was then multiplied by three to arrive at
a year-to-date amount. This methodology does not adjust for any market related
changes, or seasonal factors in Sky Financial's 2007 six-month results. Nor does
it consider any revenue or expense synergies realized since the merger date. The
one exception to this methodology of holding the estimated annual impact
constant relates to the amortization of intangibles expense where the amount is
known and is therefore used.
DISCUSSION OF RESULTS OF OPERATIONS
This section provides a review of financial performance from a consolidated
perspective. It also includes a "Significant Items" section that summarizes key
issues important for a complete understanding of performance trends. Key
consolidated balance sheet and income statement trends are discussed in this
section. All earnings per share data are reported on a diluted basis. For
additional insight on financial performance, please read this section in
conjunction with the "Lines of Business" discussion.
Summary
We reported 2008 third quarter net income of $75.1 million representing
earnings per common share of $0.17. These results compared with net income of
$101.4 million, or $0.25 per common share, in the 2008 second quarter.
Comparisons with the prior quarter were significantly impacted by a number of
factors that are discussed later in the "Significant Items" section.
During the 2008 third quarter, the primary focus within our industry
continued to be credit quality. The economy remained weak in our markets and
continued to put stress on our borrowers. Our expectation is that the economy
will remain under stress, and that no improvement will be seen until well into
2009.
Given the current economic conditions, the decline in credit quality
performance during the current quarter was anticipated, and the results were
consistent with our expectations. Net charge-offs and provision levels continued
to be elevated, however the increases were manageable. During the 2008 third
quarter, the allowance for credit losses (ACL) increased 10 basis points from
the prior quarter to 1.90% of total loans and leases. Nonaccrual loans (NALs)
increased $50.9 million, or 10%, reflecting increased NALs in our commercial
real estate (CRE) loans to single family home builders, and within our
commercial and industrial (C&I) portfolio related to businesses that support
residential development.
Our period end capital levels were strong. Our tangible equity ratio improved
8 basis points to 5.98% compared with the prior quarter, and is near our
6.00%-6.25% targeted range. This quarter's performance permitted us to build
capital levels even more, and we believe that we are well positioned given the
current stresses in the financial markets. We expect our capital position will
be strengthened further with our participation in the Department of Treasury's
voluntary CPP under TARP (see "Risk Factors" discussion within the
"Introduction" section). Additionally, our period-end liquidity position was
strong, as we have conservatively managed our liquidity position at both the
parent company and bank levels. At September 30, 2008, the parent company had
sufficient cash for operations and does not have any debt maturities for several
years. Further, the Bank has a very manageable level of debt maturities during
the next 12-month period.
The loan restructuring associated with our relationship with Franklin,
completed during the 2007 fourth quarter, continued to perform consistent with
the terms of the restructuring agreement. Cash flows exceeded the required debt
service, the loans continued to perform with interest accruing, and there were
no charge-offs or related provision for credit losses related to this credit
during the quarter. Our exposure to Franklin declined $36 million, or 3%,
compared with the prior quarter. We remain comfortable with our credit
assumptions regarding the overall performance of this portfolio.
Fully taxable net interest income in the 2008 third quarter decreased
$1.4 million, or less than 1%, compared with the prior quarter. This decrease
was primarily the result of a $0.6 billion, or 1%, decline in average total
earning assets, as the net interest margin was unchanged from the prior quarter
at 3.29%.
Non-interest income in the 2008 third quarter decreased $68.6 million, or
29%, compared with the prior quarter. Comparisons with the prior quarter were
affected by Significant Items (see "Significant Items") that resulted in a net
charge of $58.5 million. Mortgage banking income, after considering the impact
of MSR hedging results (see "Significant Items"), declined 51% primarily
relating to lower origination activity, and trust services income declined 6%
reflecting the impact of lower market values on asset management revenues.
Expenses continue to be well controlled, with our efficiency ratio improving
to 50.3% for the current quarter. Non-interest expense in the 2008 third quarter
decreased $38.8 million, or 10%, compared with the prior quarter. Comparisons
with the prior quarter were affected by Significant Items (see "Significant
Items") that resulted in a net positive impact of $19.2 million, and reduced
restructuring/merger costs that resulted in a net positive impact of
$14.6 million. Considering the impact of both of these items, the remaining
components of non-interest expense decreased $5.1 million, or 1%, primarily
reflecting a decline in personnel expense due to merger efficiencies.
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