Huntington Bancshares Incorporated — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited. Huntington is a Midwest-focused regional bank offering commercial and consumer banking, mortgage, auto finance, wealth, and related services.
Business context and reporting period
- Huntington completed its approximately $3.7 billion acquisition of FirstMerit on August 16, 2016. The deal expanded the company’s footprint to eight Midwestern states and added significant loans, deposits, employees, and goodwill; results include FirstMerit only from the acquisition date.
- Acquisition-related expenses were $159 million pretax in Q3 and $186 million for the first nine months. Accordingly, reported comparisons and growth rates are materially affected by the merger and are not fully like-for-like.
Key financial metrics
| Metric | Q3 2016 | Comparable period / context |
|---|---|---|
| Net interest income | $625 million reported; $636 million FTE | Reported $495 million in Q3 2015; FTE up 26% year over year |
| Net interest margin | 3.18% | 3.16% in Q3 2015; up 12 basis points sequentially. Includes 12 basis points of purchase-accounting benefit. |
| Noninterest income | $302 million | Up 19% year over year |
| Noninterest expense | $712 million reported; $553 million excluding identified significant items | Reported up 35%; adjusted expense up 14% year over year |
| Net income / diluted EPS | $127 million / $0.11 | $153 million / $0.18 in Q3 2015. Merger expense reduced Q3 earnings by about $107 million after tax, or $0.11 per share. |
| Credit provision / net charge-offs | $64 million / $40 million | Provision up 184% year over year; annualized net charge-offs were 0.26% of average loans versus 0.13%. |
| Efficiency ratio | 75.0% | 69.1% in Q3 2015; reported ratio reflects merger costs. |
| Cash flows, first nine months | $686 million operating; $(2.86) billion investing; $2.99 billion financing | Cash and cash equivalents ended at $1.66 billion, up from $847 million at year-end 2015. |
For the first nine months, net income was $473 million, down 8% year over year, and diluted EPS was $0.50 versus $0.60. FTE revenue was $2.48 billion, up 10%; reported noninterest expense rose 17% and credit-loss provision rose 83%.
Balance sheet, debt, liquidity, and capital
- At September 30, total assets were $100.8 billion, loans and leases $66.3 billion, and deposits $77.4 billion, compared with $71.0 billion, $50.3 billion, and $55.3 billion, respectively, at December 31, 2015. The acquisition is a major driver of this expansion.
- Long-term debt was $9.0 billion and short-term borrowings $2.15 billion, versus $7.04 billion and $615 million at year-end. Core deposits were 94% of deposits; unpledged investment securities totaled $11.3 billion. Management said the Bank had sufficient liquidity for the foreseeable future and expected compliance with the Modified LCR transition requirements.
- Common equity tier 1 capital ratio was 9.09%, down from 9.72% a year earlier; total risk-based capital ratio was 12.56%. Huntington reported regulatory capital ratios above well-capitalized standards. The tangible common equity to tangible assets ratio was 7.14%, versus 7.89% a year earlier.
- Capital ratios and tangible-equity measures reflect the acquisition’s goodwill, stock issuance, and related balance-sheet growth. The company issued about $2.8 billion of common stock and $100 million of preferred stock in connection with the merger; separate preferred issuances also supported capital during 2016.
Material changes versus comparable periods
- Q3 FTE net interest income rose 26% year over year, supported by 26% growth in average earning assets, primarily acquisition-related, and a 2-basis-point margin improvement. Funding costs rose 10 basis points year over year, partly offsetting higher asset yields.
- Fee income growth was led by mortgage banking (+114%), deposit service charges (+16%), and cards and payment processing (+21%). Mortgage banking benefited from higher origination volume and net mortgage-servicing-rights activity.
- Reported expenses rose substantially with merger and integration costs, added employees, and technology spending. Excluding significant items, adjusted quarterly expense still increased 14% year over year.
- Nonperforming assets were $476 million, down 3% from Q2 2016 but up from $399 million at year-end 2015. The increase from year-end included acquired commercial real estate owned assets and higher C&I nonaccrual loans, including energy-related exposures.
- The allowance for credit losses was $705 million, or 1.06% of loans, compared with 1.33% at year-end 2015. Management attributed the lower ratio primarily to acquired loans being recorded at fair value without an acquired allowance at closing.
Guidance, commentary, risks, and unusual items
- 2016 outlook, excluding significant items: management expected full-year revenue growth of 16%–18%, noninterest expense growth of 13%–15%, a 24%–25% effective tax rate, and positive operating leverage for a fourth consecutive year. It expected asset-quality measures near current levels with moderate quarterly volatility and full-year net charge-offs below its long-term normalized range of 35–55 basis points.
- Management considered a near-term Federal Reserve rate increase likely and incrementally beneficial to earnings. Interest-rate models showed greater asset sensitivity than at year-end 2015; modeled NII increased 3.1% under a +100-basis-point scenario and 6.0% under +200 basis points. These are model estimates dependent on assumptions, not forecasts.
- Credit risks include energy-sector weakness, particularly exploration and production and coal borrowers, and expected volatility in commercial credit metrics. E&P exposure was less than 1% of total loans; management reported some improvement in the energy portfolio risk profile during the prior six months. Consumer charge-offs remained within management’s expected range.
- The FirstMerit integration is a significant execution risk. Acquisition accounting valuations remained subject to review, although management did not expect material adjustments. Huntington also planned to sell 13 acquired branches to resolve DOJ competitive concerns; approximately $712 million of deposits and $112 million of loans were classified for transfer, with closing expected in Q4 2016.
- Legal matters include the appealed Cyberco judgment of approximately $72 million plus costs and interest, a West Virginia mortgage-fee class action set for trial in January 2017, and FirstMerit overdraft litigation. Management estimated reasonably possible legal losses above accrued amounts at $0–$50 million, while noting some matters could not be estimated and an unfavorable resolution could be material in a particular period.
- Other notable items include a $150 million voluntary pension-plan contribution and a continued suspension of the share-repurchase program. The board declared a common dividend increase to $0.08 per share beginning in Q4 2016.
Most important facts for investors to verify
- Whether FirstMerit integration costs decline as planned, expected cost savings and revenue benefits materialize, and management achieves its 2016 guidance.
- Underlying earnings and efficiency trends excluding merger costs and purchase-accounting benefits, including the durability of the margin improvement.
- Credit performance and reserve adequacy as acquired loans season, especially C&I energy exposure, consumer charge-offs, and the effect of loans transferred to held-for-sale.
- Capital and funding implications of acquisition-related goodwill, debt, preferred dividends, branch divestitures, and the increased common dividend.
- Developments in the identified litigation matters and any change to the estimated range of reasonably possible losses.