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| HBAN > SEC Filings for HBAN > Form 10-Q on 11-May-2009 | All Recent SEC Filings |
11-May-2009
Quarterly Report
INTRODUCTION
Huntington Bancshares Incorporated (we or our) is a multi-state diversified
financial holding company organized under Maryland law in 1966 and headquartered
in Columbus, Ohio. Through our subsidiaries, including our bank subsidiary, The
Huntington National Bank (the Bank), organized in 1866, we provide full-service
commercial and consumer banking services, mortgage banking services, automobile
financing, equipment leasing, investment management, trust services, brokerage
services, customized insurance service programs, and other financial products
and services. Our banking offices are located in Ohio, Michigan, Pennsylvania,
Indiana, West Virginia, and Kentucky. Selected financial service activities are
also conducted in other states including Private Financial Group (PFG) offices
in Florida, and Mortgage Banking offices in Maryland and New Jersey.
International banking services are available through the headquarters office in
Columbus and a limited purpose office located in both the Cayman Islands and
Hong Kong.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A) provides information we believe necessary for
understanding our financial condition, changes in financial condition, results
of operations, and cash flows. This MD&A provides updates to the discussion and
analysis included in our Annual Report on Form 10-K for the year ended
December 31, 2008 (2008 Form 10-K). This MD&A should be read in conjunction with
our 2008 Form 10-K, the financial statements, notes, and other information
contained in this report.
Our discussion is divided into key segments:
• Introduction - Provides overview comments on important matters including
risk factors, acquisitions, and other items. These are essential for
understanding our performance and prospects.
• Discussion of Results of Operations - Reviews financial performance from a consolidated company perspective. It also includes a "Significant Items" section that summarizes key issues helpful for understanding performance trends. Key consolidated average balance sheet and income statement trends are also discussed in this section.
• Risk Management and Capital - Discusses credit, market, liquidity, and operational risks, including how these are managed, as well as performance trends. It also includes a discussion of liquidity policies, how we obtain funding, and related performance. In addition, there is a discussion of 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, projections, and statements, which
are subject to numerous assumptions, risks, and uncertainties. Statements that
do not describe historical or current facts, including statements about beliefs
and expectations, are forward-looking statements. The forward-looking statements
are intended to be subject to the safe harbor provided by Section 27A of the
Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act.
Actual results could differ materially from those contained or implied by such
statements for a variety of factors including: (1) 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; (2) changes in
economic conditions; (3) movements in interest rates; (4) competitive pressures
on product pricing and services; (5) success and timing of other business
strategies; (6) the nature, extent, and timing of governmental actions and
reforms, including existing and potential future restrictions and limitations
imposed in connection with the Troubled Asset Relief Program (TARP) voluntary
Capital Purchase Plan (CPP) or otherwise under the Emergency Economic
Stabilization Act of 2008; and (7) extended disruption of vital infrastructure.
Additional factors that could cause results to differ materially from those
described above can be found in our 2008 Form 10-K, and documents subsequently
filed by us with the Securities and Exchange Commission (SEC). All forward-
looking statements included in this filing are based on information available at
the time of the filing. We assume no obligation to update any forward-looking
statement.
Risk Factors
We, like other financial companies, are subject to a number of risks that may
adversely affect our financial condition or results of operation, many of which
are outside of our direct control, though efforts are made to manage those risks
while optimizing returns. Among the risks assumed are: (1) credit risk, which is
the risk of loss due to loan and lease customers or other counterparties not
being able to meet their financial obligations under agreed upon terms, (2)
market risk, which is the risk of loss due to changes in the market value of
assets and liabilities due to changes in market interest rates, foreign exchange
rates, equity prices, and credit spreads, (3) liquidity risk, which is the risk
of loss due to the possibility that funds may not be available to satisfy
current or future obligations resulting from 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.
More information on risk is set forth under the heading "Risk Factors" included
in Item 1A of our 2008 Form 10-K. Additional information regarding risk factors
can also be found in the "Risk Management and Capital" discussion.
Update to Risk Factors
During the first quarter of 2009, our commercial and residential real estate and
real estate-related portfolios continued to be affected by the ongoing reduction
in real estate values and reduced levels of sales and, more generally, all of
our loan portfolios have been affected by the sustained economic weakness of our
Midwest markets and the impact of higher unemployment rates.
As described in the Credit Risk discussion, credit quality performance continued
to be under pressure during the first quarter of 2009, with nonaccrual loans
(NALs) and nonperforming assets (NPAs) both increasing at March 31, 2009,
compared with December 31, 2008, and March 31, 2008. The allowance for loan and
lease losses (ALLL) of $838.5 million at March 31, 2009, was 2.12% of period-end
loans and leases and 54% of period-end nonaccrual loans and leases.
Our business depends on the creditworthiness of our customers and, in some
cases, the value of the assets securing our loans to them. Our commercial
portfolio, as well as our real estate-related portfolios, have continued to be
negatively affected by the ongoing reduction in real estate values and reduced
levels of sales and leasing activities. More generally, all of our loan
portfolios, particularly our construction and commercial real estate loans, have
been affected by the sustained economic weakness of our Midwest markets and the
impact of higher unemployment rates. We periodically review the ALLL for
adequacy considering economic conditions and trends, collateral values, and
credit quality indicators, including past charge-off experience and levels of
past due loans and NPAs. There is no certainty that the ALLL will be adequate
over time to cover credit losses in the portfolio because of continued adverse
changes in the economy, market conditions, or events adversely affecting
specific customers, industries or markets. If the credit quality of the customer
base materially decreases, if the risk profile of a market, industry or group of
customers changes materially, or if the ALLL is not adequate, our business,
financial condition, liquidity, capital, and results of operations could be
materially adversely affected.
Bank regulators periodically review our ALLL and may require us to increase our
provision for loan and lease losses or loan charge-offs. Any increase in our
ALLL or loan charge-offs as required by these regulatory authorities could have
a material adverse effect on our results of operations and our financial
condition.
In particular, an increase in our ALLL could result in a reduction in the amount
of our tangible common equity (TCE). Given the focus on TCE, we may be required
to raise additional capital through the issuance of common stock as a result of
an increase in our ALLL. The issuance of additional common stock or other
factors could have a dilutive effect on the existing holders of our common
stock, and adversely affect the market price of our common stock.
Legislative and regulatory actions taken now or in the future to address the
current liquidity and credit crisis in the financial industry may significantly
affect our financial condition, results of operation, liquidity, or stock price.
Current economic conditions, particularly in the financial markets, have
resulted in government regulatory agencies and political bodies placing
increased focus on and scrutiny of the financial services industry. The U.S.
Government has intervened on an unprecedented scale, responding to what has been
commonly referred to as the financial crisis. In addition to the U.S. Treasury
Department's CPP under the TARP announced last fall and the new Capital
Assistance Program (CAP) announced this spring, the U.S. Government has taken
steps that include enhancing the liquidity support available to financial
institutions, establishing a commercial paper funding facility, temporarily
guaranteeing money market funds and certain types of debt issuances, and
increasing insurance on bank deposits. The U.S. Congress, through the Emergency
Economic Stabilization Act of 2008 and the American Recovery and Reinvestment
Act of 2009, has imposed a number of restrictions and limitations on the
operations of financial services firms participating in the federal programs.
These programs subject us and other financial institutions that participate in
them to additional restrictions, oversight, and costs that may have an adverse
impact on our business, financial condition, results of operations, or the price
of our common stock. In addition, new proposals for legislation continue to be
introduced in the U.S. Congress that could further substantially increase
regulation of the financial services industry and impose restrictions on the
operations and general ability of firms within the industry to conduct business
consistent with historical practices, including as related to compensation,
interest rates, the impact of bankruptcy proceedings on consumer real property
mortgages and otherwise. Federal and state regulatory agencies also frequently
adopt changes to their regulations and/or change the manner in which existing
regulations are applied. We cannot predict the substance or impact of pending or
future legislation, regulation or its application. Compliance with such current
and potential regulation and scrutiny may significantly increase our costs,
impede the efficiency of our internal business processes, negatively impact the
recoverability of certain of our recorded assets, require us to increase our
regulatory capital, and limit our ability to pursue business opportunities in an
efficient manner.
We may raise additional capital, which could have a dilutive effect on the
existing holders of our common stock and adversely affect the market price of
our common stock.
We are not restricted from issuing additional shares of common stock or
securities that are convertible into or exchangeable for, or that represent the
right to receive, common stock. We continually evaluate opportunities to access
capital markets taking into account our regulatory capital ratios, financial
condition, and other relevant considerations, and anticipate that, subject to
market conditions, we are likely to take further capital actions. Such actions,
with regulatory approval when required, may include opportunistically retiring
our outstanding securities, including our subordinated debt, trust preferred
securities, and preferred shares in open market transactions, privately
negotiated transactions, or public offers for cash or common shares, as well as
the issuance of additional shares of common stock in public or private
transactions in order to increase our capital levels above our already
"well-capitalized" levels, as defined by the federal bank regulatory agencies,
as well as other regulatory capital targets.
In addition, both Huntington and the Bank are highly regulated, and our
regulators could require us to raise additional common equity in the future,
whether under the CAP or otherwise. While we were not one of the 19 institutions
required to conduct a forward-looking capital assessment, or "stress test",
under the Supervisory Capital Assessment Program (SCAP), it is possible that the
U.S. Treasury could extend the SCAP assessment (and related potential
requirement to raise additional capital privately or through the CAP) to other
institutions, including us. Alternatively, we could voluntarily apply to
participate in CAP, although we currently do not intend to apply. Furthermore,
both our regulators and we regularly perform a variety of analyses of our
assets, including the preparation of stress case scenarios, and as a result of
those assessments we could determine, or our regulators could require us, to
raise additional capital. Any such capital raise could include, among other
things, the potential issuance of common equity to the public, the potential
issuance of common equity to the government under the CAP, or the conversion of
our existing Series B Preferred Stock to common equity. There could also be
market perceptions that we need to raise additional capital, whether as a result
of public disclosures that may be made regarding the SCAP stress test
methodology or otherwise, and, regardless of the outcome of any stress test or
other stress case analysis, such perceptions could have an adverse effect on the
price of our common stock.
The issuance of any additional shares of common stock or securities convertible
into or exchangeable for common stock or that represent the right to receive
common stock, or the exercise of such securities, could be substantially
dilutive to existing common stockholders. Holders of our shares of common stock
have no preemptive rights that entitle holders to purchase their pro rata share
of any offering of shares of any class or series and, therefore, such sales or
offerings could result in increased dilution to existing stockholders. The
market price of our common stock could decline as a result of sales of shares of
our common stock or securities convertible into or exchangeable for common stock
in anticipation of such sales.
We still face risk relating to the Franklin Credit Management (Franklin)
relationship not withstanding the restructuring announced on March 31, 2009.
The restructuring resulted in a $159.9 million net deferred tax asset equal to
the amount of income and equity that was included in our operating results for
the 2009 first quarter. While we believe that our position regarding the
deferred tax asset and related income recognition is correct, that position
could be challenged.
Recent Accounting Pronouncements and Developments
Note 2 to the Unaudited Condensed Consolidated Financial Statements discusses
new accounting pronouncements adopted during 2009 and the expected impact of
accounting pronouncements recently issued but not yet required to be adopted. To
the extent that we believe the adoption of new accounting standards will
materially affect our financial condition, results of operations, or liquidity,
the impacts or potential impacts are discussed in the applicable section of this
MD&A and the Notes to the Unaudited Condensed Consolidated Financial Statements.
Critical Accounting Policies and Use of Significant Estimates
Our financial statements are prepared in accordance with generally accepted
accounting principles 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 2008 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 to understand and evaluate our company, financial
position, results of operations, and cash flows.
An accounting estimate requires assumptions about uncertain matters that could
have a material effect on the financial statements if a different amount within
a range of estimates were used or if estimates changed from period to period.
Estimates are made under facts and circumstances at a point in time, and changes
in those facts and circumstances could produce results that differ from when
those estimates were made. The most significant accounting estimates and their
related application are discussed in our 2008 Form 10-K.
The following discussion provides updates of our accounting estimates related to
the fair value measurements of certain portfolios within our investment
securities portfolio, goodwill, and Franklin loans.
Securities and Other-Than-Temporary Impairment (OTTI)
(This section should be read in conjunction with the "Investment Securities
Portfolio" discussion.)
In April 2009, the Financial Accounting Standards Board (FASB) issued two FASB
Staff Positions (FSPs) that could impact estimates and assumptions utilized by
us in determining the fair values of securities. The first, FSP Financial
Accounting Standard (FAS) 157-4, "Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly," reaffirms the exit price fair
value measurement guidance in Statement No. 157, "Fair Value Measurements," and
also provides additional guidance for estimating fair value in accordance with
Statement No. 157 when the volume and level of activity for the asset or
liability have significantly decreased.
The second, FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of
Other-Than-Temporary Impairments," amends the other-than-temporary impairment
(OTTI) guidance in US GAAP for debt securities. The pronouncement shifts the
focus from an entity's intent to hold until recovery to its intent to sell. We
would recognize OTTI through earnings on those debt securities that: (a) have a
fair value less than its book value, and (b) we intend to sell (or we cannot
assert that it is more likely than not that we will not have to sell before
recovery). The amount of OTTI recognized would be the difference between the
fair value and book value of the securities.
If we do not intend to sell a debt security, but it is probable that we will not
collect all amounts due according to the debt's contractual terms, we would
separate the impairment into credit and noncredit components. The credit
component of the impairment, measured as the difference between amortized cost
and the present value of expected cash flows discounted at the security's
effective interest rate, would be recognized in earnings. The noncredit
component would be recognized in other comprehensive income (OCI), separately
from other unrealized gains and losses on available-for-sale securities.
Both FSPs are effective for interim reporting periods ending after June 15,
2009. The adoption of FSP FAS 115-2 and FAS 124-2 could require an adjustment to
retained earnings and OCI at the beginning of the period of adoption to
reclassify noncredit related impairment to OCI for securities. The adjustment
would only be applicable to noncredit OTTI for debt securities that we do not
have the intent to sell. Noncredit OTTI losses related to debt securities that
we intend to sell (or for which we cannot assert that it is more likely than not
that we will not have to sell the securities before recovery) will not be
reclassified. We are currently evaluating the impact that the FSPs could have.
OTTI ANALYSIS ON CERTAIN SECURITIES PORTFOLIOS
Alt-A mortgage-backed and private-label collateralized mortgage obligation (CMO)
securities represent securities collateralized by first-lien residential
mortgage loans. As the lowest level input that is significant to the fair value
measurement of these securities in its entirety was a Level 3 input, we
classified all securities within these portfolios as Level 3 on the fair value
hierarchy. The securities were priced with the assistance of an outside
third-party consultant using a discounted cash flow approach and the independent
third-party's proprietary pricing model. The model used inputs such as estimated
prepayment speeds, losses, recoveries, default rates that were implied by the
underlying performance of collateral in the structure or similar structures,
discount rates that were implied by market prices for similar securities,
collateral structure types, and house price depreciation/appreciation rates that
were based upon macroeconomic forecasts.
We analyzed both our Alt-A mortgage-backed and private-label CMO securities
portfolios to determine if the securities in these portfolios were
other-than-temporarily-impaired. Using the guidance in FSP EITF 99-20-1, we used
the analysis to determine whether we believed it probable that all contractual
cash flows would not be collected. All securities in these portfolios remained
current with respect to interest and principal at March 31, 2009.
Our analysis indicated, as of March 31, 2009, a total of 14 Alt-A
mortgage-backed securities and one private-label CMO would experience loss of
principal. The future expected losses of principal on these
other-than-temporarily impaired securities ranged from 0.1% to 86.7% of the par
value. The average amount of future principal loss was 6.3% of the par value.
These losses were projected to occur beginning anywhere from 8 months to as many
as 235 months in the future. We measured the amount of impairment on these
securities using the fair value of the security in the scenario we considered to
be most likely, using discount rates ranging from 10% to 16%, depending on both
the potential variability of outcomes and the expected duration of cash flows
for each security. As a result, in the 2009 first quarter, we recorded
$1.5 million of OTTI in our Alt-A mortgage-backed securities portfolio
representing additional impairment on one security that was previously impaired.
No OTTI was recorded for our private-label CMO securities in the 2009 first
quarter.
Pooled-trust-preferred securities represent collateralized debt obligations
(CDOs) backed by a pool of debt securities issued by financial institutions. As
the lowest level input that is significant to the fair value measurement of
these securities in its entirety was a Level 3 input, we classified all
securities within this portfolio as Level 3 on the fair value hierarchy. The
collateral generally consisted of trust preferred securities and subordinated
debt securities issued by banks, bank holding companies, and insurance
companies. The first and second-tier bank trust preferred securities and the
insurance company securities were priced with the assistance of an outside
third-party consultant using a discounted cash flow approach, and the
independent third-party's proprietary pricing models. The model used inputs such
as estimated default and deferral rates that were implied from the underlying
performance of the issuers in the structure, and discount rates that were
implied by market prices for similar securities and collateral structure types.
Cash flow analyses of the first and second-tier bank trust preferred securities
issued by banks and bank holding companies were conducted to test for any OTTI.
In accordance with FSP EITF 99-20-1, OTTI was recorded in certain securities
within these portfolios, as it was probable that all contractual cash flows
would not be collected. The discount rate used to calculate the cash flows
ranged from 12%-15%, and an illiquidity premium due to the lack of an active
market for these securities. We assumed that all issuers currently deferring
interest payments would ultimately default, and we assumed a 10% recovery rate
on such defaults. In addition, future defaults were estimated based upon an
analysis of the financial strength of each respective issuer. As a result of
this testing, we recognized OTTI of $2.4 million in the pooled-trust-preferred
securities portfolio in the 2009 first quarter.
Please refer to the "Investment Securities Portfolio" discussion for additional
information regarding OTTI.
Goodwill
Goodwill is tested for impairment annually, as of October 1, using a two-step
process that begins with an estimation of the fair value of a reporting unit.
Goodwill impairment exists when a reporting unit's carrying value of goodwill
exceeds its implied fair value. 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. During the 2009 first quarter, our stock price
declined 78%, from $7.66 per common share at December 31, 2008, to $1.66 per
common share at March 31, 2009. Peer banks also experienced similar declines in
market capitalization. This decline primarily reflected the continuing economic
slowdown and increased market concern surrounding financial institutions' credit
risks and capital positions, as well as uncertainty related to increased
regulatory supervision and intervention. We determined that these changes would
more-likely-than-not reduce the fair value of certain reporting units below
their carrying amounts. Therefore, we performed an interim goodwill impairment
test during the 2009 first quarter, which is a two-step process. An independent
third party was engaged to assist with the impairment assessment. We had
previously performed goodwill impairment tests at June 30, October 1, and
December 31, 2008, and concluded no impairment existed at those dates.
Significant judgment is applied when goodwill is assessed for impairment. This
judgment includes developing cash flow projections, selecting appropriate
discount rates, identifying relevant market comparables, incorporating general
economic and market conditions and selecting an appropriate control premium. The
selection and weighting of the various fair value techniques may result in a
higher or lower fair value. Judgment is applied in determining the weightings
that are most representative of fair value. The assumptions used in the goodwill
impairment assessment and the application of these estimates and assumptions are
discussed below.
. . .
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