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HBAN > SEC Filings for HBAN > Form 10-K on 14-Feb-2014All Recent SEC Filings




Annual Report

Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations


We are a multi-state diversified regional bank holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through the Bank, we have 148 years of servicing the financial needs of our customers. Through our subsidiaries, we provide full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, brokerage services, insurance service programs, and other financial products and services. Our 695 branches are located in Ohio, Michigan, Pennsylvania, Indiana, West Virginia, and Kentucky. Selected financial services and other activities are also conducted in various other states. International banking services are available through the headquarters office in Columbus, Ohio and a limited purpose office located in the Cayman Islands and another limited purpose office located in Hong Kong. Our foreign banking activities, in total or with any individual country, are not significant.

The following MD&A provides information we believe necessary for understanding our financial condition, changes in financial condition, results of operations, and cash flows. The MD&A should be read in conjunction with the Consolidated Financial Statements, Notes to Consolidated Financial Statements, and other information contained in this report.

Our discussion is divided into key segments:

• Executive Overview - Provides a summary of our current financial performance, and business overview, including our thoughts on the impact of the economy, legislative and regulatory initiatives, and recent industry developments. This section also provides our outlook regarding our 2014 expectations.

• Discussion of Results of Operations-Reviews financial performance from a consolidated 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, operational risks, and compliance 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.

• Results for the Fourth Quarter - Provides a discussion of results for the 2013 fourth quarter compared with the 2012 fourth quarter.

• Additional Disclosures - Provides comments on important matters including forward-looking statements, critical accounting policies and use of significant estimates, recent accounting pronouncements and developments, and acquisitions.


2013 Financial Performance Review

In 2013, we reported net income of $638.7 million, or $0.72 per common share, relatively unchanged from the prior year. This resulted in a 1.13% return on average assets and a 12.7% return on average tangible common equity. In addition, we grew our base of consumer and business customers while our efficiency ratio decreased to 62.9% in 2013 from 63.4% in 2012. Results from our strategic business investments and OCR sales approach continued in 2013. (Also, see Significant Items Influencing Financial Performance Comparisons within the Discussion of Results of Operations.)

Fully-taxable equivalent net interest income was $1.7 billion in 2013, an increase of $1.0 million, or less than 1%, compared with 2012. This reflected the impact of 4% loan growth, offset by a 5 basis point decline in the net interest margin to 3.36%, as well as a 7% reduction in other earning assets, the majority of which were loans held for sale. The loan growth reflected an increase in average C&I loans due to continued growth within the middle market healthcare vertical, equipment finance, and dealer floorplan loans. Also, our average automobile loans increased, as the growth in originations remained strong and we kept these loans on our balance sheet instead of selling them through securitizations. As expected, our CRE portfolio declined, reflecting continued runoff as acceptable returns for new originations were balanced against internal concentration limits and increased competition for projects sponsored by high quality developers. Average loans held-for-sale decreased, reflecting the impact of automobile securitizations completed in 2012 and no such securitizations in 2013.

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Noninterest income was $1.0 billion in 2013, a 9% decrease compared with 2012. Mortgage banking income was down $64.2 million due to a reduction in volume, lower gain on sale margin, and a higher percentage of originations held on the balance sheet. In addition, gains on sale of loans were down $40.0 million due to no auto securitizations in 2013. Service charges increased $9.6 million in 2013 despite a decrease of approximately $28 million due to a change that we made in February 2013 on posting order for our consumer transaction accounts.

Noninterest expense was $1.8 billion in 2013, a 4% decrease compared with 2012. The decrease was primarily due to lower marketing, deposit and other insurance, professional services and other expense as we actively managed the pace and size of investment. Other expense declined due to lower mortgage repurchase and warranty, and OREO and foreclosure expenses. This was partially offset by franchise repositioning expense related significant items included in net occupancy ($12.1 million), personnel costs ($6.7 million), equipment ($2.4 million), outside data processing and other services ($1.4 million), and other expense ($1.0 million). The increase in personnel costs primarily related to the increase in the number of average full-time equivalent employees was partially offset by a significant item of $33.9 million from the pension curtailment gain.

Most credit quality related metrics in 2013 reflected continued improvement. NALs declined $85.6 million, or 21%, from 2012 to $322.1 million, or 0.75% of total loans and leases. NPAs declined $93.6 million, or 21%, compared to a year-ago to $352.2 million, or 0.82% of total loans and leases, OREO, and other NPAs. The decreases primarily reflected meaningful improvement in both CRE and C&I NALs. The provision for credit losses decreased $57.3 million, or 39%, from 2012 due to the continued decline in classified, criticized, and nonaccrual loans and included the implementation of enhancements to our ALLL model. NCOs decreased $153.8 million, or 45%, from the prior year to $188.7 million. NCOs were an annualized 0.45% of average loans and leases in the current year compared to 0.85% in 2012. Within the consumer portfolio, NCOs related to Chapter 7 bankruptcy loans amounted to $22.8 million in 2013 and $34.6 million in 2012. The ACL as a percentage of total loans and leases decreased to 1.65% from 1.99% a year ago, while the ACL as a percentage of period-end total NALs increased to 221% from 199%.

The tangible common equity to tangible assets ratio at December 31, 2013, was 8.83%, up 7 basis points from a year ago. Our Tier 1 common risk-based capital ratio at year end was 10.90%, up from 10.48% at the end of 2012. The regulatory Tier 1 risk-based capital ratio at December 31, 2013, was 12.28%, up from 12.02% at December 31, 2012. The increase in the regulatory Tier 1 risk-based capital ratio reflected the increase in retained earnings, partially offset by the redemption of $50 million of qualifying REIT preferred securities in the 2013 fourth quarter, and growth in risk-weighted assets. All capital ratios were impacted by the repurchase of 17 million common shares over the last four quarters, none of which were repurchased during the 2013 fourth quarter. We have the ability to repurchase up to $136 million additional shares of common stock through the first quarter of 2014. We intend to continue disciplined repurchase activity consistent with our annual capital plan, our capital return objectives, and market conditions.

Business Overview


Our general business objectives are: (1) grow net interest income and fee income, (2) increase cross-sell and share-of-wallet across all business segments, (3) improve efficiency ratio, (4) continue to strengthen risk management, including sustained improvements in credit metrics, and (5) maintain strong capital and liquidity positions.

In 2013, we grew our base of consumer and business customers, while achieving positive operating leverage. Our performance in the second half of 2013 demonstrates strong business momentum, positioning us well for 2014. Highlights of our financial strength in 2013 include a strong balance sheet, ongoing deposit growth and quality loan growth in commercial and auto lending. Our deposit and lending growth is the result of focused execution and key strategic investments made over the last four years. We have done all of this while decreasing expenses by 4 percent, year over year, as the result of disciplined expense management.

We continue to face strong competition from other banks and financial service firms in our markets. To address these challenges, the cornerstone of our strategy has been to invest in the franchise in order to grow our market share and share-of-wallet. In this regard, our OCR methodology continued to deliver success in 2013. Consumer checking account households grew by 96 thousand households, or 8%, over the last year. Commercial relationships grew at a rate of 6% and have increased by 9 thousand commercial customers since 2012. Our "Fair Play" philosophy, combined with continued OCR success, positively impacted results in 2013.


The environment in 2013 was different than we thought it would be when we started the year, as the economic, interest rate, and political environments were more challenging. Currently, we are seeing good momentum going into 2014, as customers seem to have a slightly better mindset as the political environment seems to be less of an issue and the general economic outlook is more positive as evidenced by the following:

• Although slower than the national growth rate of 1.74%, aggregate employment growth in our footprint states remained positive at 0.89% over the 12 month period ended October 2013.

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• According to the Philadelphia FRB Coincident Economic Activity Index, Michigan, Indiana, and Ohio outperformed the nation in the economic recovery to date and prospects for growth over the next six months appear positive.

• Industrial vacancy rates have shown declining trends in our large footprint MSAs.

• Consistent with long-term trends, housing prices have been rising broadly across our footprint over 2013 and have tended to be more stable than the national average.

Legislative and Regulatory

A comprehensive discussion of legislative and regulatory matters affecting us can be found in the Regulatory Matters section included in Item 1 of this Form 10-K.

2014 Expectations

Net interest income is expected to moderately increase. We anticipate an increase in earning assets as total loans moderately grow and investment securities remain near current levels. However, those benefits to net interest income are expected to be mostly offset by continued downward pressure on NIM. While we are maintaining a disciplined approach to loan pricing, asset yields remain under pressure but the continued opportunity of deposit repricing remains, albeit closer to current levels.

The C&I portfolio is expected to grow consistent with the anticipated increase in customer activity. Our C&I loan pipeline remains robust with much of this reflecting the positive impact from our investments in specialized commercial verticals, automotive dealer relationships, focused OCR sales process, and continued support of middle market and small business lending. Automobile loan originations remain strong, and we currently do not anticipate any automobile securitizations in the near future. Residential mortgages, home equity, and CRE loan balances are expected to increase modestly.

We anticipate the increase in total loans will modestly outpace growth in total deposits. This reflects our continued focus on the overall cost of funds, through the issuance of long-term debt, as well as the continued shift towards low- and no-cost demand deposits and money market deposit accounts.

Noninterest income, excluding the impact of any net MSR activity, is expected to be slightly lower than recent levels, due to the anticipated decline in mortgage banking revenues and the continued refinement of products under our Fair Play philosophy.

Noninterest expense, excluding the net $10 million of benefit from Significant Items we experienced in 2013, is expected to remain around current levels. We are committed to delivering positive operating leverage for the 2014 full year.

NPAs are expected to show continued improvement. This year, NCOs represented the mid-point of our expected normalized range of 35 to 55 basis points. The level of provision for credit losses was below our long-term expectation, and we continue to expect moderate quarterly volatility.

The effective tax rate for 2014 is expected to be in the range of 25% to 28%, primarily reflecting the impacts of tax-exempt income, tax-advantaged investments, and general business credits.

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Table 2-Selected Annual Income Statements (1)

                                                                                                         Year Ended December 31,
                                                                                  Change from 2012                                    Change from 2011
(dollar amounts in thousands, except per share amounts)        2013            Amount          Percent            2012             Amount          Percent           2011
Interest income                                             $ 1,860,637      $  (69,626 )            (4 )%     $ 1,930,263       $  (39,963 )            (2 )%    $ 1,970,226
Interest expense                                                156,029         (63,710 )           (29 )          219,739         (121,317 )           (36 )         341,056

Net interest income                                           1,704,608          (5,916 )            -           1,710,524           81,354               5         1,629,170
Provision for credit losses                                      90,045         (57,343 )           (39 )          147,388          (26,671 )           (15 )         174,059

Net interest income after provision for credit losses         1,614,563          51,427               3          1,563,136          108,025               7         1,455,111

Service charges on deposit accounts                             271,802           9,623               4            262,179           18,672               8           243,507
Mortgage banking income                                         126,855         (64,237 )           (34 )          191,092          107,684             129            83,408
Trust services                                                  123,007           1,110               1            121,897            2,515               2           119,382
Electronic banking                                               92,591          10,301              13             82,290          (29,407 )           (26 )         111,697
Insurance income                                                 69,264          (2,055 )            (3 )           71,319            1,849               3            69,470
Brokerage income                                                 69,189          (3,037 )            (4 )           72,226           (8,141 )           (10 )          80,367
Bank owned life insurance income                                 56,419             377               1             56,042           (6,294 )           (10 )          62,336
Capital markets fees                                             45,220          (2,940 )            (6 )           48,160           11,620              32            36,540
Gain on sale of loans                                            18,171         (40,011 )           (69 )           58,182           26,238              82            31,944
Securities gains (losses)                                           418          (4,351 )           (91 )            4,769            8,450            N.R.            (3,681 )
Other income                                                    125,059          (4,642 )            (4 )          129,701          (15,952 )           (11 )         145,653

Total noninterest income                                        997,995         (99,862 )            (9 )        1,097,857          117,234              12           980,623

Personnel costs                                               1,001,637          13,444               1            988,193           95,659              11           892,534
Outside data processing and other services                      199,547           9,292               5            190,255            1,081               1           189,174
Net occupancy                                                   125,344          14,184              13            111,160            2,031               2           109,129
Equipment                                                       106,793           3,846               4            102,947           10,403              11            92,544
Marketing                                                        51,185         (13,078 )           (20 )           64,263           (1,297 )            (2 )          65,560
Deposit and other insurance expense                              50,161         (18,169 )           (27 )           68,330           (9,362 )           (12 )          77,692
Amortization of intangibles                                      41,364          (5,185 )           (11 )           46,549           (6,769 )           (13 )          53,318
Professional services                                            40,587         (25,171 )           (38 )           65,758           (2,858 )            (4 )          68,616
Gain on early extinguishment of debt                                 -              798             N.R               (798 )          8,899             (92 )          (9,697 )
Other expense                                                   141,385         (57,834 )           (29 )          199,219            9,589               5           189,630

Total noninterest expense                                     1,758,003         (77,873 )            (4 )        1,835,876          107,376               6         1,728,500

Income before income taxes                                      854,555          29,438               4            825,117          117,883              17           707,234
Provision for income taxes                                      215,814          31,719              17            184,095           19,474              12           164,621

Net income                                                  $   638,741      $   (2,281 )             - %      $   641,022       $   98,409              18 %     $   542,613

Dividends on preferred shares                                    31,869            (120 )            -              31,989            1,176               4            30,813

Net income applicable to common shares                      $   606,872      $   (2,161 )             - %      $   609,033       $   97,233              19 %     $   511,800

Average common shares-basic                                     834,205         (23,757 )            (3 )%         857,962           (5,729 )            (1 )%        863,691
Average common shares-diluted(2)                                843,974         (19,428 )            (2 )          863,402           (4,222 )            -            867,624
Per common share:
Net income-basic                                            $      0.73      $     0.02               3 %      $      0.71       $     0.12              20 %     $      0.59
Net income-diluted                                                 0.72            0.01               1               0.71             0.12              20              0.59
Cash dividends declared                                            0.19            0.03              19               0.16             0.06              60              0.10
Net interest income                                         $ 1,704,608      $   (5,916 )             - %      $ 1,710,524       $   81,354               5 %     $ 1,629,170
FTE adjustment                                                   27,340           6,934              34             20,406            5,490              37            14,916

Net interest income(3)                                        1,731,948           1,018              -           1,730,930           86,844               5         1,644,086
Noninterest income                                              997,995         (99,862 )            (9 )        1,097,857          117,234              12           980,623

Total revenue(3)                                            $ 2,729,943      $  (98,844 )            (3 )%     $ 2,828,787       $  204,078               8 %     $ 2,624,709

N.R. - Not relevant, as denominator of calculation is a loss in prior period compared with income in current period.

(1) Comparisons for presented periods are impacted by a number of factors. Refer to "Significant Items".

(2) Net income excluding expense for amortization of intangibles for the period divided by average tangible common shareholders' equity. Average tangible common shareholders' equity equals average total common shareholders' equity less average intangible assets and goodwill. Expense for amortization of intangibles and average intangible assets are net of deferred tax liability, and calculated assuming a 35% tax rate.

(3) On a fully-taxable equivalent (FTE) basis assuming a 35% tax rate.

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This section provides a review of financial performance from a consolidated perspective. It also includes a Significant Items section that summarizes key issues important for a complete understanding of performance trends. Key consolidated balance sheet and income statement trends are discussed. All earnings per share data is reported on a diluted basis. For additional insight on financial performance, please read this section in conjunction with the Business Segment Discussion.

Significant Items

Definition of Significant Items

From time-to-time, revenue, expenses, or taxes, are impacted by items judged by us to be outside of ordinary banking activities and / or by items that, while they may be associated with ordinary banking activities, are so unusually large that their outsized impact is believed by us at that time to be infrequent or short-term in nature. We refer to such items as Significant Items. Most often, these Significant Items result from factors originating outside the company;
e.g., regulatory actions / assessments, windfall gains, changes in accounting principles, one-time tax assessments / refunds, litigation actions, etc. In other cases they may result from our decisions associated with significant corporate actions out of the ordinary course of business; e.g., merger / restructuring charges, recapitalization actions, goodwill impairment, etc.

Even though certain revenue and expense items are naturally subject to more volatility than others due to changes in market and economic environment conditions, as a general rule volatility alone does not define a Significant Item. For example, changes in the provision for credit losses, gains / losses from investment activities, asset valuation writedowns, etc., reflect ordinary banking activities and are, therefore, typically excluded from consideration as a Significant Item.

We believe the disclosure of Significant Items provides a better understanding of our performance and trends to ascertain which of such items, if any, to include or exclude from an analysis of our performance; i.e., within the context of determining how that performance differed from expectations, as well as how, if at all, to adjust estimates of future performance accordingly. To this end, we adopted a practice of listing Significant Items in our external disclosure documents; e.g., earnings press releases, investor presentations, Forms 10-Q and 10-K.

Significant Items for any particular period are not intended to be a complete list of items that may materially impact current or future period performance.

Significant Items Influencing Financial Performance Comparisons

Earnings comparisons among the three years ended December 31, 2013, 2012, and 2011 were impacted by a number of Significant Items summarized below.

1. Pension Curtailment Gain. During the 2013 third quarter, a $33.9 million pension curtailment gain was recorded in personnel costs. This resulted in a positive impact of $0.03 per common share for 2013.

2. Franchise Repositioning Related Expense. During 2013, $23.5 million of franchise repositioning related expense was recorded. This resulted in a negative impact of $0.02 per common share for 2013.

3. State deferred tax asset valuation allowance adjustment. During 2012, a valuation allowance of $21.3 million (net of tax) was released for the portion of the deferred tax asset and state net operating loss carryforwards expected to be realized. This resulted in a positive impact of $0.02 per common share for 2012. Additional information can be found in the Provision for Income Taxes section within this MD&A.

4. Bargain Purchase Gain. During 2012, an $11.2 million bargain purchase gain associated with the FDIC-assisted Fidelity Bank acquisition was recorded in noninterest income. This resulted in a positive impact of $0.01 per common share for 2012.

5. Litigation Reserve. $23.5 million and $17.0 million of additions to litigation reserves were recorded as other noninterest expense in 2012 and 2011, respectively. This resulted in a negative impact of $0.02 per common share in 2012 and $0.01 per common share in 2011.

6. Visa®. Prior to the Visa® IPO occurring in March 2008, Visa® was owned by its member banks, which included the Bank. As a result of this ownership, we received Class B shares of Visa® stock at the time of the Visa® IPO. In 2009, we sold these Visa® stock shares, resulting in a $31.4 million pretax gain ($.04 per common share). This amount was recorded to noninterest income. In 2011, a $6.4 million derivative loss due to an increase in the liability associated with the sale of these shares was recorded to noninterest income.

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7. Early Extinguishment of Debt. The positive impact relating to the early extinguishment of debt on our reported results was $9.7 million ($0.01 per common share) in 2011.

The following table reflects the earnings impact of the above-mentioned Significant Items for periods affected by this Results of Operations discussion:

Table 3-Significant Items Influencing Earnings Performance Comparison (1)

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