Huntington Bancshares Incorporated — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Huntington is a regional bank holding company operating primarily in Ohio, Michigan, Pennsylvania, Indiana, Kentucky, and West Virginia.
Financial results and condition
- Q2 earnings: Net income was $48.8 million, or $0.03 per diluted share, versus a $125.1 million net loss in Q2 2009. Pretax income was $62.1 million.
- Revenue and margin: Fully taxable-equivalent (FTE) revenue was $671.8 million, up 9% year over year and 5% sequentially. Net interest income was $399.7 million; FTE net interest income was $402.1 million, up 15% year over year. Net interest margin was 3.46%, versus 3.10% a year earlier and 3.47% in Q1.
- Fees and expenses: Noninterest income was $269.6 million, up 1% year over year; mortgage banking income rose to $45.5 million, with results affected by mortgage-servicing-rights (MSR) valuation and hedging. Noninterest expense was $413.8 million, up 22% year over year, including higher personnel, marketing, and professional-services costs. The comparison is affected by a $73.0 million debt-extinguishment gain and a $23.6 million FDIC special assessment in Q2 2009.
- Credit costs: Provision for credit losses was $193.4 million, down 53% year over year and 18% sequentially. Net charge-offs (NCOs) were $279.2 million, or 3.01% annualized; this included $80.0 million related to Franklin. Excluding Franklin, NCOs were $199.2 million, down $27.8 million from Q1.
- Six-month results: Net income was $88.5 million, or $0.04 per diluted share, compared with a $2.56 billion net loss in the first half of 2009. The prior-year loss included $2.61 billion of goodwill impairment. FTE revenue was $1.31 billion, up 9%; provision expense was $428.4 million, down 39%.
- Balance sheet and funding: At June 30, total assets were $51.8 billion, loans and leases $37.0 billion, deposits $39.8 billion, and shareholders’ equity $5.44 billion. Average loans were down 5% year over year, while average core deposits rose 10%. Period-end deposits were down from $40.5 billion at December 31, 2009.
- Cash flow: For the first half, operating activities provided $784.6 million; investing activities used $563.2 million and financing activities used $617.0 million. Cash and cash equivalents decreased $395.6 million to $1.13 billion.
- Debt and liquidity: Period-end short-term borrowings were $1.09 billion, FHLB advances $599.8 million, other long-term debt $2.57 billion, and subordinated notes $1.20 billion. The Bank had $7.1 billion of unused Federal Reserve and FHLB borrowing capacity. Parent-company cash and equivalents were $933.5 million.
- Capital: Consolidated Tier 1 and total risk-based capital ratios were 12.51% and 14.79%; Tier 1 common was 7.06% and tangible common equity was 6.12%. Management reported capital above “well-capitalized” thresholds. Common dividends remained $0.01 per share per quarter.
Material changes and management commentary
- Credit measures improved quarter over quarter: nonperforming assets (NPAs) fell 17% to $1.58 billion, new NPAs declined 28% to $171.6 million, and the allowance for credit losses covered 120% of nonaccrual loans, versus 87% in Q1. The NPA decline includes Franklin loans reclassified to held-for-sale, so it is not solely an improvement in underlying credit performance.
- Franklin-related loans were transferred to held-for-sale at a lower-of-cost-or-fair-value amount of $323.4 million, generating $75.5 million of charge-offs. On July 20, 2010, Huntington sold $274.2 million of Franklin residential mortgages. The remaining Franklin portfolio was primarily home equity loans and OREO.
- Loan trends diverged: average commercial loans fell 14% year over year, including a 20% decline in CRE; average consumer loans rose 7%, led by automobile lending. Automobile originations were $943.6 million in Q2, a quarterly record reported by management.
- Management expected the economy to remain relatively unchanged through year-end, with a slower recovery than previously anticipated. It forecast second-half pretax, pre-provision income broadly consistent with Q2 and a net interest margin approximating first-half performance. Management expected modest C&I and continued automobile growth, continued CRE contraction, generally flat home equity and residential mortgages, and relatively stable expenses.
- Management expected NPAs and nonperforming loans to continue declining; NCOs and provision expense were expected to be generally consistent with Q2 excluding Franklin. Home-price weakness, a weak economy, and elevated residential-property credit losses remain important uncertainties.
Risks, contingencies, and unusual items
- Regulation and revenue: Regulation E opt-in requirements may reduce overdraft fees; Huntington estimated related fees at about $90 million annually, with the ultimate effect not yet determinable. Dodd-Frank may affect debit-card interchange fees, also about $90 million annually, and the future regulatory treatment of trust-preferred securities. Huntington had $569.9 million of trust-preferred securities; disallowance was estimated to reduce Tier 1 risk-based capital by about 134 basis points. The company opted out of the FDIC Transaction Account Guarantee Program effective July 1, 2010.
- Credit and securities: CRE noncore loans were $3.2 billion, with 19% classified as nonaccrual. Retail-property and homebuilder exposures remained stressed. Huntington recorded $9.3 million of credit-related other-than-temporary impairment on securities in the first half and cautioned that further losses may occur. Certain Alt-A, private-label CMO, and pooled trust-preferred securities rely on less observable valuation inputs.
- Tax and legal: The company reported a $389.8 million net deferred tax asset. IRS and state tax examinations include proposed adjustments that could materially affect results in the period resolved, although management did not expect a material adverse impact on consolidated financial position. A proposed $1.45 million settlement of an ERISA class action remained subject to definitive documentation and court approval; outcomes in certain derivative litigation were not reasonably estimable.
- Other unusual matters: Adoption of updated consolidation guidance brought a previously off-balance-sheet automobile securitization onto the balance sheet from January 1, 2010, increasing assets by $621.6 million and liabilities by $629.3 million at adoption. First-half earnings comparisons are also distorted by 2009 goodwill impairment and other significant items.
Important facts for investors to verify
- Whether credit improvement persists after separating Franklin reclassifications, charge-offs, and the subsequent loan sale from underlying portfolio trends.
- Whether Q2 earnings and FTE revenue are sustainable given provision needs, MSR valuation and hedging volatility, and anticipated Regulation E and interchange-fee changes.
- Trends in noncore CRE, residential mortgage and home equity delinquencies, NCOs, and allowance coverage as the economic and housing outlook evolves.
- Capital and liquidity effects of TARP repayment plans, trust-preferred capital rules, deposit changes after TAGP exit, and Dodd-Frank implementation.
- Resolution and financial impact of tax examinations and pending legal matters; the filing does not provide a clear estimate for certain potential losses.