Huntington Bancshares Incorporated — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; fourth-quarter results are also summarized. Huntington is a Midwest regional bank holding company. It completed its approximately $3.7 billion acquisition of FirstMerit on August 16, 2016, expanding its footprint to eight states. The acquisition materially affects year-over-year comparisons because FirstMerit’s results are included only from the acquisition date.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net interest income (GAAP) | $2.369 billion | $1.951 billion |
| Net interest income (fully taxable equivalent, FTE) | $2.412 billion, up 22% | $1.983 billion |
| FTE total revenue | $3.561 billion, up 18% | $3.022 billion |
| Provision for credit losses | $191 million, up 91% | $100 million |
| Noninterest income | $1.150 billion, up 11% | $1.039 billion |
| Noninterest expense | $2.408 billion, up 22% | $1.976 billion |
| Net income | $712 million, up 3% | $693 million |
| Net income applicable to common shares | $647 million | $661 million |
| Diluted earnings per common share | $0.70, down 14% | $0.81 |
| Net interest margin | 3.16%, up 1 basis point | 3.15% |
| Efficiency ratio | 66.8% | 64.5% |
Reported 2016 earnings included $282 million of pretax FirstMerit acquisition-related expense, a negative $0.20 per common share after tax, and a $42 million pretax reduction in litigation reserves, a positive $0.03 per share after tax. Management reported adjusted noninterest expense of $2.169 billion, up 13% from 2015, excluding specified significant items. Average earning assets grew 21%; average loans and leases grew 18%. Fee growth was led by deposit service charges, card and payment processing, and mortgage banking.
Fourth quarter: Net income was $239 million, up 34% year over year; diluted EPS was $0.20 versus $0.21. GAAP net interest income was $735 million and FTE net interest income was $748 million; FTE NIM was 3.25%, compared with 3.09% a year earlier. The quarter included $42 million of litigation-reserve reduction and $96 million of acquisition-related expense. Provision for credit losses was $75 million versus $36 million; reported noninterest expense was $681 million versus $499 million.
Balance sheet, liquidity, and capital at December 31, 2016: Total assets were $99.7 billion, deposits $75.6 billion, loans and leases $67.0 billion, short-term borrowings $3.7 billion, and long-term debt $8.3 billion. Shareholders’ equity was $10.3 billion. Core deposits were approximately 94% of deposits; unpledged investment securities totaled $15.0 billion, and unused Federal Reserve and FHLB borrowing capacity was $14.1 billion. The filing states the Bank had sufficient liquidity to meet obligations and comply with its applicable LCR requirement.
- Consolidated regulatory capital ratios: CET1 9.56%, Tier 1 risk-based 10.92%, total risk-based 13.05%, and Tier 1 leverage 8.70%. Huntington and the Bank exceeded well-capitalized thresholds.
- Tangible common equity to tangible assets was 7.16%, down from 7.82% in 2015. FirstMerit-related goodwill and share issuance affected capital measures.
- Cash and cash equivalents increased $538 million to $1.385 billion. Operating cash flow was $1.215 billion; investing cash flow was negative $3.445 billion and financing cash flow was positive $2.768 billion.
- The quarterly common dividend increased to $0.08 per share in the fourth quarter. No common shares were repurchased in 2016; the share repurchase program remained suspended.
Material changes versus the prior period
- FirstMerit added substantial scale: period-end assets rose from $71.0 billion to $99.7 billion, loans and leases from $50.3 billion to $67.0 billion, and deposits from $55.3 billion to $75.6 billion. The merger also added $1.3 billion of goodwill and involved issuance of approximately $2.8 billion of common stock.
- Net income rose modestly, but common net income and diluted EPS declined as preferred dividends increased and the common share count expanded. Average diluted shares rose 12%.
- Provision expense rose to $191 million, reflecting portfolio growth, reserve building as acquired loans transitioned to originated status, and adoption of Huntington’s reserving methodology for FirstMerit loans. Net charge-offs were $109 million, or 0.19% of average loans, versus $88 million, or 0.18%, in 2015.
- Nonperforming assets were $481 million, or 0.72% of loans and leases plus OREO, versus $399 million and 0.79% a year earlier. Commercial and industrial nonaccruals increased, particularly in energy-related portfolios; management said energy performance had stabilized since the first quarter.
- The allowance for credit losses was $736 million. Its ratio to loans and leases declined to 1.10% from 1.33%, primarily because acquired loans were recorded at fair value without an acquisition-date allowance.
- Long-term debt increased from $7.0 billion to $8.3 billion; short-term borrowings increased from $0.6 billion to $3.7 billion. The company issued $2.0 billion of senior debt during 2016.
Outlook, commentary, and risks
Management expressed optimism that improved consumer confidence and employment would support economic growth in its markets. It expected to realize the full financial benefits of FirstMerit integration in the second half of 2017, meet its cost-savings commitment, and pursue revenue synergies and organic growth. Management expected minor benefit from the Federal Reserve’s December 2016 rate action and said additional 2017 rate increases would be additive to earnings. The filing gives no specific 2017 earnings or revenue guidance.
- Integration and execution: Benefits are not assured; systems, employees, and operations must be integrated while retaining customers and controlling costs. The DOJ-related divestiture of 13 acquired branches transferred $620 million of deposits and $106 million of loans.
- Credit and economic exposure: The Midwest footprint is exposed to industrial and manufacturing conditions. Energy-related C&I exposures and rising commercial problem loans warrant monitoring; management identified oil and gas exploration and production as a volatile portfolio segment.
- Interest-rate and securities risk: Results depend on the repricing of assets and liabilities, deposit costs, and mortgage prepayments. The investment portfolio includes significant mortgage-backed securities; unrealized losses can affect OCI and equity. Management’s modeled NII sensitivity was positive in +100 and +200 basis-point scenarios, but actual results may differ.
- Legal matters: Management estimated up to $65 million of reasonably possible litigation losses in excess of accrued amounts. In the Cyberco litigation, the company released approximately $42 million of reserves in Q4; on February 8, 2017, the appellate court reversed the district court decision in part and remanded the case for further proceedings. The FirstMerit overdraft settlement was approximately $9 million cash plus $7 million of debt forgiveness, subject to final court approval.
- Regulatory and funding constraints: Capital distributions are subject to Federal Reserve oversight and CCAR. The 2016 capital plan received no objection; the 2017 plan was due in April 2017. The company also faces enhanced capital, liquidity, stress-testing, consumer-compliance, and resolution-planning requirements.
- Other risks: Cybersecurity, third-party service providers, model assumptions, fair-value estimates, goodwill impairment, and competition—including from financial technology firms—could adversely affect results. Management and the independent auditor concluded internal control over financial reporting was effective at year-end.
Important facts for investors to verify
- Whether FirstMerit integration delivers the promised cost savings in the second half of 2017, and how much merger-related expense remains.
- Whether credit costs, C&I nonaccruals, and energy exposure remain controlled as the acquired portfolio seasons; interpret allowance coverage in light of purchase accounting.
- How common earnings per share and tangible book value evolve after the merger-related share issuance and increase in preferred dividends.
- Whether deposit growth and funding costs support NIM, and whether the company maintains liquidity and regulatory capital buffers under stress.
- The outcome and potential financial impact of the Cyberco remand and other pending litigation, including final approval of the FirstMerit overdraft settlement.
- Whether reported and adjusted expense trends, loan growth, and credit quality support management’s integration and organic-growth outlook.