Huntington Bancshares Incorporated — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. The filing is unaudited. Huntington is a regional bank holding company headquartered in Columbus, Ohio, operating across six states and providing commercial, consumer, mortgage, auto-finance, wealth-management, and related services.
Financial and operating results
| Metric | Q3 2010 | Comparison |
|---|---|---|
| Net income | $100.9 million; diluted EPS $0.10 | $48.8 million and $0.03 EPS in Q2 2010; net loss of $166.2 million and $(0.33) EPS in Q3 2009 |
| Total revenue, fully taxable-equivalent (FTE) | $679.7 million | Up 1% from Q2 2010 ($671.8 million) and up from Q3 2009 ($623.0 million) |
| FTE net interest income / net interest margin | $412.6 million / 3.45% | Net interest income up 3% sequentially; margin was 3.46% in Q2 and 3.20% in Q3 2009 |
| Provision for credit losses | $119.2 million | Down 38% sequentially and 75% year over year |
| Noninterest income / expense | $267.1 million / $427.3 million | Income down 1% sequentially; expense up 3% sequentially and 7% year over year |
| Net charge-offs (NCOs) | $184.5 million; annualized 1.98% of average loans and leases | $279.2 million and 3.01% in Q2; Q2 included $80.0 million of Franklin-related NCOs |
For the first nine months, net income was $189.4 million ($0.14 diluted EPS), versus a net loss of $2.724 billion in 2009, which included a $2.607 billion goodwill impairment. FTE revenue was $1.989 billion, up 9%; FTE net interest income increased 14%, while provision expense fell 54%. Nine-month noninterest income rose 2%. Comparisons are affected by significant prior-period items and should not be read as underlying growth rates without adjustment.
Q3 pretax, pre-provision income, a company-defined non-GAAP measure, was $265.2 million, down 2% sequentially. The efficiency ratio was 60.6%, versus 59.4% in Q2 and 61.4% a year earlier.
Balance sheet, liquidity, debt, and capital
- At September 30, total assets were $53.25 billion; loans and leases were $37.50 billion; deposits were $41.07 billion; and shareholders’ equity was $5.57 billion. Deposits were up from $40.49 billion at year-end 2009. Average core deposits increased 8% year over year, while average loans and leases declined 2%.
- Loan mix continued to shift: commercial loans declined, with average commercial real estate (CRE) loans down 20% year over year, while average auto loans and leases rose 59%. Auto originations exceeded $1.0 billion in Q3.
- Period-end cash and due from banks was $1.14 billion. For the first nine months, operating cash flow was $866 million, investing cash flow was $(1.835) billion, financing cash flow was $586 million, and cash and cash equivalents declined $382 million.
- Period-end debt included $1.86 billion of short-term borrowings, $23.6 million of Federal Home Loan Bank advances, $2.39 billion of other long-term debt, and $1.20 billion of subordinated notes. Parent-company cash and cash equivalents were $859 million, down from $1.38 billion at year-end 2009, partly reflecting a $400 million capital contribution to the Bank.
- Unused Federal Reserve and FHLB borrowing capacity was $8.5 billion. Management said the Bank and parent had sufficient liquidity for the foreseeable future. The Bank’s ability to pay dividends to the parent was restricted absent regulatory approval.
- Consolidated Tier 1 and total risk-based capital ratios were 12.82% and 15.08%; Bank ratios were 8.28% and 12.69%. The company reported tangible common equity of 6.20% and Tier 1 common risk-based capital of 7.39%. Management said capital exceeded well-capitalized thresholds.
Material changes, outlook, and risks
- Credit improvement, but continued economic stress: Nonperforming assets fell to $1.105 billion from $1.583 billion at June 30; nonaccrual loans were $981.8 million, or 2.62% of loans. The allowance for credit losses was $1.376 billion, or 3.67% of loans, and covered nonaccrual loans by 140%, up from 120% in Q2. Management also reported higher Q3 inflows of new nonperforming assets and criticized commercial loans, describing the recovery as fragile.
- Franklin relationship: The remaining Franklin residential mortgage and home-equity loans, transferred to held-for-sale in Q2 at a reduced carrying value, were sold in Q3 at essentially book value. Only $15.3 million of Franklin-related OREO remained at quarter-end.
- Fee and expense pressures: Regulation E restrictions on overdraft fees took effect July 1, 2010; Huntington also voluntarily reduced certain overdraft and nonsufficient-funds fees and introduced 24-Hour Grace. Management cited approximately $90 million of annual fees before the regulatory change. Personnel and marketing costs increased as the company invested in growth initiatives.
- Management outlook: Huntington expected a relatively stable but weak economy for the remainder of 2010. It anticipated pretax pre-provision income in line with recent results, a flat-to-slightly-lower net interest margin, expenses near Q3 levels, modest C&I growth, continued CRE decline, and strong auto growth. Management expected continued improvement in NCOs, nonperforming assets, and credit-loss provisions; deposit-fee and mortgage-banking revenue remained risks. No precise earnings or revenue guidance was provided.
- Regulatory and capital matters: The company was assessing Dodd-Frank impacts, including possible reductions in debit interchange revenue; it could not yet estimate the effect. Disallowance of $569.9 million in trust-preferred securities could reduce the Tier 1 risk-based capital ratio by about 133 basis points, with a phase-in beginning in 2013. Management’s preliminary estimate of Basel III effects was negligible, subject to regulatory clarification. Huntington intended to repay its $1.4 billion TARP investment when prudent, but gave no timetable and said it was not anticipating a common-dividend increase in the foreseeable future.
- Other exposures and contingencies: Huntington recorded $12.0 million of credit-related other-than-temporary impairment losses on securities in the first nine months and warned further losses could occur. It had $18.0 million reserved for mortgage-loan repurchase and representation-and-warranty exposure, up from $5.9 million at year-end 2009. Tax authorities had proposed adjustments to prior returns; management intended to contest them. A proposed $1.45 million settlement of an ERISA class action remained subject to definitive documentation and court approval. Other derivative and shareholder-related litigation was described; management could not estimate potential loss for certain matters.
- Unusual accounting item: Adoption of revised consolidation guidance brought a previously off-balance-sheet auto-loan securitization onto the balance sheet in January 2010, adding assets and liabilities and recording a $7.7 million negative cumulative-effect adjustment. This affects loan and balance-sheet comparisons.
- Management stated disclosure controls and procedures were effective at September 30, 2010, with no significant quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether improvement in credit measures persists, especially given higher Q3 inflows, stressed CRE exposures, and continued weakness in housing and employment.
- How much of earnings improvement reflects lower credit provisions versus sustainable revenue growth, and the impact of prior-period goodwill impairment and Franklin-related items.
- Whether the allowance remains adequate as asset quality, collateral values, and economic conditions evolve; review the assumptions behind securities valuations and potential impairment.
- The realized effect of Regulation E, voluntary fee reductions, Dodd-Frank interchange rules, and other regulatory changes on fee income, capital, and costs.
- Liquidity and funding trends, including the decline in cash, increased short-term borrowings, deposit mix, and restrictions on Bank dividends to the parent.
- The path to TARP repayment, capital treatment of trust-preferred securities, and the effect of future regulatory capital rules.
- Potential outcomes and reserves for loan repurchases, tax examinations, and pending litigation. The filing’s FTE revenue, pretax pre-provision income, and tangible-capital ratios are non-GAAP measures; review their reconciliations and definitions.