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| HBAN > SEC Filings for HBAN > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
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. 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.
• Business Segment Discussion - Provides an overview of financial performance for each of our major business segments 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 this 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
All of our loan portfolios, particularly our construction and commercial real
estate (CRE) loans, may continue to be affected by the sustained economic
weakness of our Midwest markets and the impact of higher unemployment rates.
This may significantly adversely affect our business, financial condition,
liquidity, capital, and results of operation.
As described in the "Credit Risk" discussion, credit quality performance
continued to be under pressure during the first six-month period of 2009, with
nonaccrual loans and leases (NALs) and nonperforming assets (NPAs) both
increasing at June 30, 2009, compared with December 31, 2008, and June 30, 2008.
The allowance for credit losses (ACL) of $964.8 million at June 30, 2009, was
2.51% of period-end loans and leases and 53% of period-end NALs.
The majority of our credit risk is associated with lending activities, as the
acceptance and management of credit risk is central to profitable lending.
Credit risk is mitigated through a combination of credit policies and processes,
market risk management activities, and portfolio diversification. However,
adverse changes in our borrowers ability to meet their financial obligations
under agreed upon terms and, in some cases, to the value of the assets securing
our loans to them may increase our credit risk. 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. We periodically review the ACL 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 ACL 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 ACL is not adequate, our business, financial
condition, liquidity, capital, and results of operations could be materially
adversely affected.
Bank regulators periodically review our ACL and may require us to increase our
provision for loan and lease losses or loan charge-offs. Any increase in our ACL
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 ACL could result in a reduction in the amount
of our tangible common equity (TCE) and/or our Tier 1 common equity. Given the
focus on these measurements, we may be required to raise additional capital
through the issuance of common stock as a result of an increase in our ACL. The
issuance of additional common stock or other actions 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 in the fall of 2008 and the new
Capital Assistance Program (CAP) announced in spring of 2009, 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 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 authorized 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 issuing 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, and other regulatory capital targets.
During the 2009 second quarter, the Federal Reserve conducted a Supervisory
Capital Assessment Program (SCAP) on the country's 19 largest bank holding
companies to determine the amount of capital required to absorb losses that
could arise under "baseline" and "more adverse" economic scenarios. While we
were not one of these 19 institutions required to conduct a forward-looking
capital assessment, or "stress test", we voluntarily conducted our own analysis
and recognized a need to raise additional capital to improve certain capital
ratios, including our Tier 1 common equity risk based ratio. During the first
six-month period of 2009, we issued an additional 201.6 million shares of common
stock. The issuance of these additional shares of common stock was dilutive to
existing common shareholders. (See the "Capital" section located within the
"Risk Management and Capital" section for additional information).
Both Huntington and the Bank are highly regulated, and we, as well as our
regulators, continue to regularly perform a variety of capital analyses,
including the preparation of stress case scenarios. As a result of those
assessments, we could determine, or our regulators could require us, to raise
additional capital in the future. Any such capital raise could include, among
other things, the potential issuance of additional common equity to the public,
the potential issuance of common equity to the government under the CAP, or the
additional conversions of our existing Series B Preferred Stock to common
equity. There could also be market perceptions that we need to raise additional
capital, 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.
Furthermore, in order to improve our capital ratios above our already adequately
capitalized levels, we can decrease the amount of our risk-weighted assets,
increase capital, or a combination of both. If it is determined that additional
capital is required in order to improve or maintain our capital ratios, we may
accomplish this through the issuance of additional 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 shareholders. Shareholders of our 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 shareholders. 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 are subject to ongoing tax examinations in various jurisdictions. The
Internal Revenue Service and other taxing jurisdictions may propose various
adjustments to our previously filed tax returns. It is possible that the
ultimate resolution of such proposed adjustments, if unfavorable, may be
material to the results of operations in the period it occurs.
The calculation of our provision for federal and state and local income taxes is
complex and requires the use of estimates and judgments. We have two accruals
for income taxes: our federal income tax receivable represents the estimated
amount currently due from the federal government, net of any reserve for
potential audit issues, and is reported as a component of "accrued income and
other assets" and state and local tax reserves for potential audit issues are
reported as a component of "other liabilities" in our consolidated balance
sheet; our deferred federal and state and local income tax asset or liability
represents the estimated impact of temporary differences between how we
recognize our assets and liabilities under GAAP, and how such assets and
liabilities are recognized under federal and state and local tax law.
In the ordinary course of business, we operate in various taxing jurisdictions
and are subject to income and nonincome taxes. The effective tax rate is based
in part on our interpretation of the relevant current tax laws. We believe the
aggregate liabilities related to taxes are appropriately reflected in the
consolidated financial statements. We review the appropriate tax treatment of
all transactions taking into consideration statutory, judicial, and regulatory
guidance in the context of our tax positions. In addition, we rely on various
tax opinions, recent tax audits, and historical experience.
From time to time, we engage in business transactions that may have an effect on
our tax liabilities. Where appropriate, we have obtained opinions of outside
experts and have assessed the relative merits and risks of the appropriate tax
treatment of business transactions taking into account statutory, judicial, and
regulatory guidance in the context of the tax position. However, changes to our
estimates of accrued taxes can occur due to changes in tax rates, implementation
of new business strategies, resolution of issues with taxing authorities
regarding previously taken tax positions and newly enacted statutory, judicial,
and regulatory guidance. Such changes could affect the amount of our accrued
taxes and could be material to our financial position and/or results of
operations.
During the 2009 second quarter, the State of Ohio completed the audit of our
2001, 2002, and 2003 corporate franchise tax returns. During 2008, the Internal
Revenue Service (IRS) completed the audit of our consolidated federal income tax
returns for tax years 2004 and 2005. In addition, we are subject to ongoing tax
examinations in various other state and local jurisdictions. Both the IRS and
various state tax officials have proposed adjustments to our previously filed
tax returns. We believe that the tax positions taken by us related to such
proposed adjustments were correct and supported by applicable statutes,
regulations, and judicial authority, and intend to vigorously defend them. It is
possible that the ultimate resolution of the proposed adjustments, if
unfavorable, may be material to the results of operations in the period it
occurs. However, although no assurances can be given, we believe that the
resolution of these examinations will not, individually or in the aggregate,
have a material adverse impact on our consolidated financial position.
Furthermore, we still face risk relating to the Franklin relationship not
withstanding the restructuring announced on March 31, 2009. The Franklin
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
subject to challenge.
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 MD&A, 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.)
Effective with the 2009 second quarter, we adopted two FASB Staff Positions
(FSPs) that 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," amended the
other-than-temporary impairment (OTTI) guidance in GAAP for debt securities.
We 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 is 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 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, is recognized in earnings. The noncredit component is recognized in other
comprehensive income (OCI), separately from other unrealized gains and losses on
available-for-sale securities.
The adoption of FSP FAS 115-2 and FAS 124-2 required an after-tax adjustment of
$3.5 million to increase retained earnings, with an equal and offsetting
adjustment to OCI, that was recorded at the beginning of the 2009 second quarter
to reclassify noncredit related impairment to OCI for previously impaired
securities. The adjustment was applicable only to noncredit OTTI relating to the
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) were not reclassified.
OTTI ANALYSIS ON CERTAIN SECURITIES PORTFOLIOS
Our three highest risk segments of our investment portfolio are the Alt-A
mortgage backed, pooled-trust-preferred, and private-label collateralized
mortgage obligation (CMO) portfolios. The Alt-A mortgage backed securities and
pooled-trust-preferred securities are located within the asset-backed securities
portfolio. The performance of the underlying securities in each of these
segments continued to reflect the economic environment. Each of these securities
in these three segments is subjected to a monthly review of the projected cash
flows, supporting our impairment analysis. These reviews are supported with
analysis from independent third parties. (See the "Securities and
Other-Than-Temporary Impairment" section located within the "Critical Accounting
Policies and Use of Significant Estimates" section for additional information.)
These three segments, and the results of our impairment analysis for each
segment, are discussed in further detail below:
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 in 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. 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 June 30, 2009.
. . .
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