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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file Number 000-33243
HUNTINGTON PREFERRED CAPITAL, INC.
----------------------------------
(Exact name of registrant as specified in its charter)
OHIO 31-1356967
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
HUNTINGTON CENTER, 41 S. HIGH STREET, COLUMBUS, OH 43287
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (614) 480-8300
--------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
NONCUMULATIVE EXCHANGEABLE PREFERRED SECURITIES, CLASS C (LIQUIDATION
---------------------------------------------------------------------
AMOUNT $25.00 EACH)
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
All common stock is held by affiliates of the registrant as of December 31,
2001. As of February 28, 2002, 14,000,000 shares of common stock without par
value were outstanding.
The aggregate market value of the common stock held by non-affiliates of
the registrant as of the close of business on February 28, 2002: N/A
Documents Incorporated By Reference
- -----------------------------------
Part III of this Form 10-K incorporates by reference certain information
from the registrant's definitive Information Statement for the 2002 Annual
Shareholders' Meeting.
HUNTINGTON PREFERRED CAPITAL, INC.
INDEX
Part I.
Item 1. Business 3
Item 2. Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Part II.
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters 18
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 28
Item 8. Financial Statements and Supplementary Data 28
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 29
Part III.
Item 10. Directors and Executive Officers of the Registrant 29
Item 11. Executive Compensation 29
Item 12. Security Ownership of Certain Beneficial Owners
and Management 29
Item 13. Certain Relationships and Related Transactions 29
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 29
Signatures 30
Audited Financial Statements
Report of Management and Report of Independent Auditors F-1
Consolidated Balance Sheets --
December 31, 2001 and 2000 F-2
Consolidated Statements of Income --
Twelve Months Ended December 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Changes in Shareholders' Equity --
Twelve Months Ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Cash Flows --
Twelve Months Ended December 31, 2001, 2000 and 1999 F-5
Notes to Consolidated Financial Statements F-6
HUNTINGTON PREFERRED CAPITAL, INC.
Part I
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ITEM 1: BUSINESS
GENERAL
Huntington Preferred Capital, Inc. (HPCI) is an Ohio corporation
incorporated in July 1992 under the name Airbase Realty, Inc. The name was
changed to Huntington Preferred Capital, Inc. in May 2001. HPCI's principal
business objective is to acquire, hold, and manage mortgage assets and other
authorized investments that will generate net income for distribution to its
shareholders. Since May 1998, HPCI has been operating as a real estate
investment trust (REIT) for federal income tax purposes. HPCI has one wholly
owned subsidiary, HPCLI, Inc. (HPCLI), an Ohio corporation, which holds certain
non-interest-earning assets.
HPCI is consolidated as a direct subsidiary of Huntington Preferred
Capital Holdings, Inc. (Holdings), an Indiana corporation that is consolidated
as a subsidiary of The Huntington National Bank (the Bank). The Bank is an
interstate national banking association organized under the laws of the United
States and headquartered in Columbus, Ohio. The Bank is the only bank subsidiary
of Huntington Bancshares Incorporated (Huntington). The Bank owns 99.9% of the
outstanding shares of Holdings and Huntington owns the remaining 0.1%. Holdings
owns 99.87% of HPCI's common shares, 88.9% of HPCI's Class A preferred
securities, and 100% of HPCI's Class D preferred securities. Huntington owns the
remaining portion of HPCI's common shares. The remaining portion of HPCI's Class
A preferred securities are restricted and owned by past and present employees
of Huntington. HPCI's Class B preferred securities are owned by HPC Holdings-II,
Inc., a non-bank subsidiary of Huntington. All of HPCI's Class C preferred
securities were sold to Holdings, which were subsequently sold by Holdings to
the public in an underwritten public offering that closed on November 7, 2001.
The following chart outlines the relationship among affiliated entities at
December 31, 2001.
--------------------------------------------
| Huntington Bancshares Incorporated |
--------------------------------------------
|
-------------------- --------------|---------------------
| | | |
| 100% Common | | | 100% Common
- ------------------------ | | ----------------------
| The Huntington | | | | HPC Holdings-II, |
| National Bank | | | | Inc. |
- ------------------------ | | ----------------------
| | 0.1% Common | |
| 99.9% Common | | | 100% B Preferred
------------------- | |
| | | Public and Private Preferred Shareholders
---------------------- | | |
|Huntington Preferred | |0.13% Common | |
| Capital Holdings, | | | | 11.1% A Preferred
| Inc. | | | | 100% C Preferred
---------------------- | | |
| | | |
| 99.87% Common | | |
| 88.9% A Preferred | | |
| 100% D Preferred* | | |
------------------------|-------------------- -----------------------------
|
-----------------------
|Huntington Preferred |
| Capital, Inc. |
-----------------------
|
|100% Common
----------------------
| HPCLI, Inc. |
----------------------
- --------
*Holdings may sell to third party investors at some future date.
HPCI's Class B, Class C, and Class D preferred securities will be
exchanged, without any approval or action on the part of the security holders,
for Class B, Class C, and Class D preferred securities of the Bank, if such an
exchange is directed by the Office of the Comptroller of the Currency (OCC) in
the event the Bank becomes or may in the near term become undercapitalized or
if the Bank is placed in conservatorship or receivership. The preferred
securities of the Bank have substantially equivalent terms as to dividends,
liquidation preference, and redemption as
3
to the preferred securities of HPCI. The Bank's financial statements and those
of Huntington's are substantially the same. The financial statements of
Huntington are available to the public over the Internet at the web site of the
Securities and Exchange Commission (SEC) at http://www.sec.gov or at the SEC's
public reference rooms at 450 Fifth Street, N.W., Washington, D.C. 20549.
In July 2001, Huntington announced a comprehensive strategic and
financial restructuring plan designed to refocus its operations on core
activities in the Midwest. As part of the plan, in September 2001, Huntington
entered into an agreement for the sale of its Florida retail and commercial
operations. The sale closed on February 15, 2002. On December 31, 2001, in
anticipation of the eventual sale of the Florida operations by Huntington, HPCI
completed its distribution of participation interests in Florida-related loans
to its common shareholders, Holdings and Huntington. This distribution
approximated $1.3 billion and consisted of cash and the net book value of
participation interests in loans that were included in the sale, including the
related accrued interest and allowance for loan losses, representing
approximately 17% of HPCI's total assets as of December 31, 2001.
GENERAL DESCRIPTION OF ASSETS
The Internal Revenue Code requires a REIT to invest at least 75% of the
total value of its assets in real estate assets, which includes residential
mortgage loans and commercial mortgage loans, including participation interests
in residential or commercial mortgage loans, mortgage-backed securities eligible
to be held by REITs, cash, cash equivalents which includes receivables,
government securities, and other real estate assets (REIT Qualified Assets).
REITs may invest up to 25% of the value of its total assets in
non-mortgage-related securities as defined in the Investment Company Act. Under
the Investment Company Act, the term "security" is defined broadly to include,
among other things, any note, stock, treasury stock, debenture, evidence of
indebtedness, or certificate of interest or participation in any profit sharing
agreement or a group or index of securities. The Internal Revenue Code also
requires that the value of any one issuer's securities, other than those
securities included in the 75% test, may not exceed 5% by value of the total
assets of the REIT. In addition, under the Internal Revenue Code, the REIT may
not own more than 10% of the voting securities nor more than 10% of the value of
the outstanding securities of any one issuer, other than those securities
included in the 75% test and the securities of wholly-owned, qualified REIT
subsidiaries.
As of December 31, 2001, 84.5% of HPCI's assets were invested in REIT
Qualifying Assets and 15.5% were invested in commercial and consumer loans and
other assets that were not REIT Qualifying Assets. HPCI does not hold any
securities nor intends to hold securities in any one issuer that exceed 5% of
its total assets or more than 10% of the voting securities of any one issuer
other than its permitted investment in its wholly owned subsidiary, HPCLI.
HPCI's assets consisted of the following at December 31, 2001:
- ----------------------------------------------------------------------------------------------------------
Percentage
of Total
(in thousands of dollars) Amount Assets
- ----------------------------------------------------------------------------------------------------------
Loan participation interests:
Commercial mortgage $ 3,678,061 62.5%
Commercial 646,509 11.0%
Consumer secured by real property 637,375 10.8%
Residential mortgage 270,671 4.6%
Consumer not secured by real property 146,360 2.5%
Allowance for loan losses (164,690) -2.8%
Interest bearing deposits with The Huntington National Bank 364,912 6.2%
Other assets 304,344 5.2%
Commercial and Commercial Mortgage Loans. HPCI owns participation
interests in commercial loans secured by non-real property such as industrial
equipment, aircraft, livestock, furniture and fixtures, and inventory.
Participation interests acquired in commercial mortgage loans are secured by
real property such as office buildings, multi-family properties of five units or
more, industrial, warehouse, and self-storage properties, office and industrial
condominiums, retail space, strip shopping centers, mixed use commercial
properties, mobile home parks, nursing homes, hotels and motels, churches, and
farms. Commercial and commercial mortgage loans may not be fully amortizing.
This means that the loans may have a significant principal balance or "balloon"
payment due on maturity. Additionally, there is no requirement regarding the
percentage of any commercial or commercial real
4
estate property that must be leased at the time HPCI acquires a participation
interest in a commercial or commercial mortgage loan secured by such property
nor are commercial loans required to have third party guarantees.
The credit quality of a commercial or commercial mortgage loan may
depend on, among other factors, the existence and structure of underlying
leases; the physical condition of the property, including whether any
maintenance has been deferred; the creditworthiness of tenants; the historical
and anticipated level of vacancies; rents on the property and on other
comparable properties located in the same region; potential or existing
environmental risks; the availability of credit to refinance the loan at or
prior to maturity; and, the local and regional economic climate in general.
Foreclosures of defaulted commercial or commercial mortgage loans generally are
subject to a number of complicating factors, including environmental
considerations, which are not generally present in foreclosures of residential
mortgage loans.
At December 31, 2001, $2.9 billion, or 67.7%, of the commercial and
commercial mortgage loans underlying HPCI's participation interests in such
loans were secured by a first mortgage or first lien.
Consumer Loans. HPCI owns participation interests in consumer loans
secured by automobiles, trucks, equipment, or a first or junior mortgage
primarily on the borrower's primary residence. Many of these mortgage loans were
made for reasons such as home improvements, acquisition of furniture and
fixtures, and debt consolidation. These loans are predominately repaid on an
installment basis and income is accrued based on the outstanding balance of the
loan over terms that range from 6 to 360 months. Of the loans underlying the
consumer loan participations, most bear interest at fixed rates.
Residential Mortgage Loans. HPCI owns participation interests in
adjustable rate, fixed rate, conforming, and nonconforming residential mortgage
loans. Conforming residential mortgage loans comply with the requirements for
inclusion in a loan guarantee or purchase program sponsored by either the FHLMC
or FNMA. Under current regulations, the maximum principal balance allowed on
conforming residential mortgage loans ranges from $275,000 for one-unit
residential loans to $528,700 for four-unit residential loans. Nonconforming
residential mortgage loans are residential mortgage loans that do not qualify in
one or more respects for purchase by FNMA or FHLMC under their standard
programs. A majority of the nonconforming residential mortgage loans underlying
the participation interests acquired by HPCI to date are nonconforming because
they have original principal balances which exceeded the requirements for FHLMC
or FNMA programs, the original terms are shorter than the minimum requirements
for FHLMC or FNMA programs at the time of origination, the original balances are
less than the minimum requirements for FHLMC or FNMA programs, or generally
because they vary in certain other respects from the requirements of such
programs other than the requirements relating to creditworthiness of the
mortgagors. A substantial portion of nonconforming residential mortgage loans
are expected to meet the requirements for sale to national private mortgage
conduit programs or other investors in the secondary mortgage market.
Each residential mortgage loan is evidenced by a promissory note
secured by a mortgage or deed of trust or other similar security instrument
creating a first or second lien on single-family residential properties.
Residential real estate properties underlying residential mortgage loans consist
of individual dwelling units, individual condominium units, two- to four-family
dwelling units, and townhouses.
Geographic Distribution. The following table shows the geographic
location of the properties securing the loans underlying HPCI's loan
participations at December 31, 2001:
- --------------------------------------------------------------------------------------------------------------
Percentage by
Aggregate Aggregate
Number Principal Principal
State (in thousands of dollars) of Loans Balance Balance
- --------------------------------------------------------------------------------------------------------------
Ohio 37,061 $3,016,059 56.1%
Michigan 13,841 1,559,722 29.0%
Indiana 2,407 339,101 6.3%
Kentucky 1,887 228,597 4.2%
- --------------------------------------------------------------------------------------------------------------
55,196 5,143,479 95.6%
All other locations 652 235,497 4.4%
- --------------------------------------------------------------------------------------------------------------
Total loan participation interests 55,848 $5,378,976 100.0%
==============================================================================================================
5
Principal Balances. The following table shows data with respect to the
principal balance of the loans underlying HPCI's loan participations at December
31, 2001:
- -----------------------------------------------------------------------------------------------------------------------------------
Aggregate Percentage by
Principal Aggregate
Number Balance Principal
Size of Loans (000s) Balance
- -----------------------------------------------------------------------------------------------------------------------------------
Less than $50,000 44,655 $ 719,453 13.4%
Greater than $50,000 to $100,000 4,483 309,787 5.8%
Greater than $100,000 to $250,000 3,237 511,603 9.5%
Greater than $250,000 to $500,000 1,629 572,089 10.6%
Greater than $500,000 to $1,000,000 933 655,295 12.2%
Greater than $1,000,000 to $3,000,000 662 1,095,969 20.4%
Greater than $3,000,000 to $5,000,000 142 541,638 10.1%
Greater than $5,000,000 to $10,000,000 76 508,114 9.4%
Greater than $10,000,000 31 465,028 8.6%
- -----------------------------------------------------------------------------------------------------------------------------------
Total loan participation interests 55,848 $ 5,378,976 100.0%
===================================================================================================================================
Interest Rate. Some of the loans underlying HPCI's loan participations
bear interest at fixed rates and some bear interest at variable rates based on
indices such as LIBOR and the prime rate. The following table shows data with
respect to interest rates of the loans underlying HPCI's loan participations at
December 31, 2001:
- ---------------------------------------------------------------------------------------------------------------------------
Fixed Rate Variable Rate
------------------------------------------------------------------------------------------------
Percentage by Percentage by
Aggregate Aggregate Aggregate Aggregate
(in thousands of Number Principal Principal Number Principal Principal
dollars) of Loans Balance Balance of Loans Balance Balance
- ---------------------------------------------------------------------------------------------------------------------------
under 5.00% 62 $ 26,255 1.7% 1,325 $ 1,852,541 48.3%
5.00% to 5.99% 203 17,628 1.1% 1,319 479,050 12.5%
6.00% to 6.99% 599 82,898 5.4% 1,594 418,522 10.9%
7.00% to 7.99% 4,696 417,711 27.0% 2,319 528,610 13.8%
8.00% to 8.99% 9,526 457,466 29.6% 2,445 321,821 8.4%
9.00% to 9.99% 7,706 288,387 18.7% 1,568 118,376 3.1%
10.00% to 10.99% 5,511 156,722 10.1% 357 12,375 0.3%
11.00% to 11.99% 2,380 56,637 3.7% 85 1,582 0.0%
over 12.00% 1,666 41,104 2.7% 12,487 101,291 2.7%
- ---------------------------------------------------------------------------------------------------------------------------
Total 32,349 $1,544,808 100.0% 23,499 $ 3,834,168 100.0%
===========================================================================================================================
Loan Delinquencies. The following table provides delinquency
information for the loans underlying HPCI's loan participations at December 31,
2001.
- --------------------------------------------------------------------------------------------------------------------------
Fixed Rate Variable Rate
-----------------------------------------------------------------------------------------------
Percentage by Percentage by
Aggregate Aggregate Aggregate Aggregate
(in thousands of Number Principal Principal Number Principal Principal
dollars) of Loans Balance Balance of Loans Balance Balance
- --------------------------------------------------------------------------------------------------------------------------
Current 26,683 $ 1,322,127 85.6% 15,545 $ 3,356,587 87.5%
1 to 30 days 3,702 139,496 9.0% 5,272 325,962 8.5%
31 to 60 days 815 24,121 1.6% 1,533 58,570 1.5%
61 to 90 days 371 7,141 0.5% 470 11,450 0.3%
over 90 days 778 51,923 3.3% 679 81,599 2.2%
- --------------------------------------------------------------------------------------------------------------------------
Total 32,349 $ 1,544,808 100.0% 23,499 $ 3,834,168 100.0%
===========================================================================================================================
6
Other Assets. Cash and due from the Bank represent cash received by the
Bank from borrowers for the payment of principal and interest on the underlying
loans deposited in a demand deposit account of the Bank. Interest bearing
deposits in the Bank consist of available funds invested nightly in an
investment product that provides HPCI with a market return for overnight loans.
These funds are available for the acquisition of additional participation
interests. Due from Holdings represents unsettled cash transactions involving
HPCI's participation interests in loans that occur in the ordinary course of
business. Other assets include premises and equipment related to real property
located in Indiana and also accrued interest on the loans underlying its loan
participation interests, which is calculated by the Bank's loan accounting
systems.
DIVIDEND POLICY AND RESTRICTIONS
HPCI expects to pay an aggregate amount of dividends with respect to
the outstanding shares of its capital stock equal to substantially all of its
REIT taxable income, which excludes capital gains. In order to remain qualified
as a REIT, HPCI must distribute annually at least 90% of its REIT taxable income
to shareholders. Dividends are declared at the discretion of the board of
directors after considering its distributable funds, financial condition, and
capital needs, the impact of current and pending legislation and regulations,
economic conditions, tax considerations, its continued qualification as a REIT,
and other factors. Although there can be no assurances, HPCI expects that both
its cash available for distribution and its REIT taxable income will be in
excess of amounts needed to pay dividends on the preferred securities in the
foreseeable future because substantially all of HPCI's mortgage assets and other
authorized investments are interest-bearing; all outstanding preferred
securities represent in the aggregate only approximately 14% of HPCI's
capitalization; HPCI does not anticipate incurring any indebtedness other than
permitted indebtedness; which includes acting as a co-borrower or guarantor of
certain obligations of the Bank that HPCI does not anticipate will involve a
pledge of more than 25% of its assets; and, HPCI expects its interest-earning
assets will continue to exceed the liquidation preference of its preferred
securities.
Payment of dividends on the preferred securities could also be subject
to regulatory limitations if the Bank becomes "undercapitalized" for purposes of
regulations issued by the OCC. Under these regulations, the Bank will be deemed
"undercapitalized" if it has a total risk-based capital ratio of less than 8.0%;
a Tier 1 risk-based capital ratio of less than 4.0%; and a leverage ratio of
less than 4.0% or less than 3% if the institution has been awarded the highest
supervisory rating. At December 31, 2001, the Bank's total risk-based capital
ratio was 10.29%, its Tier 1 risk-based capital ratio was 6.34%, and its
leverage ratio was 6.58%. The Bank currently intends to maintain its capital
ratios in excess of the "well-capitalized" levels under these regulations.
However, there can be no assurance that the Bank will be able to maintain its
capital in excess of the "well-capitalized" levels. The exercise of the OCC's
power to restrict dividends on preferred securities would, however, also have
the effect of restricting the payment of dividends on common shares. The
inability to pay dividends on common shares would prevent HPCI from meeting the
statutory requirement for a REIT to distribute 90% of its taxable income and,
therefore, would cause HPCI to fail to qualify for the favorable tax treatment
accorded to REITs.
CONFLICT OF INTERESTS AND RELATED POLICIES
The Bank continues to control 98.5% of the voting power of HPCI's
outstanding securities. Accordingly, the Bank will continue to have the right to
elect all of HPCI's directors, including its independent directors, unless HPCI
fails to pay dividends on its Class C and Class D preferred securities. In
addition, all of HPCI's officers and six of its nine directors are also officers
and directors of the Bank or its affiliates. Because of the nature of HPCI's
relationship with Holdings and the Bank, conflicts of interest have arisen and
may arise in the future with respect to certain transactions, including without
limitation, HPCI's acquisition of assets from the Bank, HPCI's disposition of
assets to the Bank, servicing of the loans underlying HPCI's participation
interests, particularly with respect to loans placed on nonaccrual status, as
well as the modification of the participation agreement between the Bank and
Holdings and the subparticipation agreement between Holdings and HPCI. Any
future modification of these agreements will require the approval of a majority
of HPCI's independent directors. HPCI's board of directors also has broad
discretion to revise its investment and operating strategy without shareholder
approval.
It is the intention of HPCI and the Bank that any agreements and
transactions between them be fair to all parties and consistent with market
terms for such types of transactions. The requirement in HPCI's articles of
incorporation that certain actions be approved by a majority of HPCI's
independent directors also is intended to ensure fair dealings among HPCI,
Holdings, and the Bank. HPCI's independent directors serve on its audit
committee and review transactions among HPCI, Holdings, the Bank, and their
respective affiliates.
There are no provisions in HPCI's articles of incorporation limiting
any of its officers, directors, shareholders, or affiliates from having any
direct or indirect pecuniary interest in any asset to be acquired or
7
disposed of by HPCI or in any transaction in which it has an interest or from
engaging in acquiring, holding, and managing its assets. It is expected that the
Bank will have direct interests in transactions with HPCI including, without
limitation, the sale of assets to HPCI; however, it is not anticipated that any
of HPCI's officers or directors will have any interests in such assets, other
than as borrowers or guarantors of loans underlying HPCI's participation
interests, in which case such loans would be on substantially the same terms,
including interest rates and collateral on loans, as those prevailing at the
time for comparable transaction with others and would not involve more than the
normal risk of collectibility or present other unfavorable features.
OTHER MANAGEMENT POLICIES AND PROGRAMS
General. In administering HPCI's participation interests and other
authorized investments, the Bank has a high degree of autonomy. HPCI, however,
has certain policies to guide its administration with respect to the Bank's
underwriting standards, the acquisition and disposition of assets, credit risk
management, and certain other activities. These policies, which are discussed
below, may be amended or revised from time to time at the discretion of HPCI's
board of directors, subject in certain circumstances to the approval of a
majority of HPCI's independent directors, but without a vote of its
shareholders.
Underwriting Standards. The Bank has represented to Holdings, and
Holdings has represented to HPCI, that most of the loans underlying HPCI's
participation interests were originated generally in accordance with
underwriting policies customarily employed by the Bank during the period in
which the loans were originated. The Bank emphasizes "in-market" lending, which
means lending to borrowers which are located where the Bank or its affiliates
have branches or loan origination offices. The Bank avoids transactions
perceived to have unacceptably high risk, as well as excessive industry and
other concentrations.
Some of the loans, however, were acquired by the Bank in connection
with the acquisition of other financial institutions. Prior to acquiring any
financial institution, the Bank performed a number of due diligence procedures
to, among other things, assess the overall quality of the target institution's
loan portfolio. These procedures included the examination of underwriting
standards used in the origination of loan products by the target institution,
the review of loan documents and the contents of selected loan files, and the
verification of the past due status and payment histories of selected borrowers.
Through its due diligence procedures, the Bank obtained a sufficient level of
comfort pertaining to the underwriting standards used by the target institution
and their influence on the quality of the portfolio. Even though the Bank did
not and does not warrant those standards, the Bank found them acceptable in
comparison to HPCI's underwriting standards in cases where the Bank had made a
favorable decision to acquire the institution as a whole.
Asset Acquisition And Disposition Policies. Consistent with Holding's
policy, it is HPCI's policy to purchase from the Bank participation interests
generally in loans that:
- are performing, meaning they have no more than two payments past
due, if any,
- are in accruing status,
- are secured by real property such that they are REIT qualifying,
and
- have not been previously sold, securitized, or charged-off either
in whole or in part.
HPCI's policy also allows for investment in assets that are not REIT-Qualified
Assets up to but not exceeding the statutory limitations imposed on
organizations that qualify as REITs. In the past, Holdings has purchased from
the Bank and sold to HPCI participation interests in loans not secured by real
property because of available proceeds from loan repayments and pay-offs.
Management, under this policy, also has the discretion to purchase other assets
to maximize its return to shareholders.
It is anticipated that from time to time HPCI will receive
participation interests in additional mortgage loans from the Bank on a basis
consistent with secondary market standards pursuant to the loan participation
and subparticipation agreements, out of proceeds received in connection with the
repayment or disposition of loan participation interests in HPCI's portfolio.
Although HPCI is permitted to do so, it has no present plans or intentions to
purchase loans or loan participation interests from unaffiliated third parties.
It is currently anticipated that participation interests in additional loans
acquired by HPCI will be of the types described above under the heading "General
Description of Assets," although HPCI is not precluded from purchasing
additional types of loans or loan participation interests.
HPCI may continue to acquire from time to time limited amounts of
participation interests in loans that are not commercial or residential loans,
such as automobile loans and equipment loans, or other authorized investments.
8
Although currently there is no intention to acquire any mortgage-backed
securities representing interests in or obligations backed by pools of mortgage
loans that will be secured by single-family residential, multi-family, or
commercial real estate properties located throughout the United States, HPCI is
not restricted from doing so. HPCI does not intend to acquire any interest-only
or principal-only mortgage-backed securities. HPCI also will not be precluded
from investing in mortgage-backed securities when the Bank is the sponsor or
issuer. At December 31, 2001, HPCI did not hold any mortgage-backed securities.
HPCI currently anticipates that it will not acquire the right to
service any loan underlying a participation interest that it acquires in the
future and that the Bank will act as servicer of any such additional loans. HPCI
anticipates that any servicing arrangement that it enters into in the future
with the Bank will contain fees and other terms that would be substantially
equivalent to or more favorable to HPCI than those that would be contained in
servicing arrangements entered into with third parties unaffiliated with HPCI.
HPCI's current policy is not to acquire any participation interest in
any commercial mortgage loan that constitutes more than 5.0% of the total book
value of HPCI's mortgage assets at the time of acquisition. In addition, HPCI's
current policy prohibits the acquisition of any loan or any interest in a loan
other than an interest resulting from the acquisition of mortgage-backed
securities, which loan is collateralized by real estate located in West Virginia
or that is made to a municipality or other tax-exempt entity.
HPCI's current policy is to reinvest the proceeds of its assets in
other interest-earning assets such that its Funds from Operations (FFO) over any
period of four fiscal quarters will be anticipated to equal or exceed 150% of
the amount that would be required to pay full annual dividends on the Class A,
Class C, and Class D preferred securities, except as may be necessary to
maintain its status as a REIT. HPCI's articles of incorporation provide that it
cannot amend or change this policy with respect to the reinvestment of proceeds
without the consent or affirmative vote of the holders of at least two thirds of
the Class C preferred securities and two thirds of the Class D preferred
securities, voting as separate classes.
Credit Risk Management Policies. It is expected that participation
interests in each commercial or residential mortgage loan acquired in the future
will represent a first lien position and will be originated by the Bank, one of
its affiliates, or an unaffiliated third party in the ordinary course of its
real estate lending activities based on the underwriting standards generally
applied by or substantially similar to those applied by the Bank at the time of
origination for its own account. It is also expect that all loans will be
serviced by or through the Bank pursuant to the participation agreement and
subparticipation agreement, which require servicing in conformity with any loan
servicing guidelines promulgated by HPCI and, in the case of residential
mortgage loans, with FNMA and FHLMC guidelines and procedures.
Other Policies. HPCI intends to operate in a manner that will not
subject it to regulation under the Investment Company Act. HPCI does not intend
to:
- invest in the securities of other issuers for the purpose of
exercising control over such issuers;
- underwrite securities of other issuers;
- actively trade in loans or other investments;
- offer securities in exchange for property; or
- make loans to third parties, including, its officers, directors,
or other affiliates.
The Investment Company Act exempts entities that, directly or through
majority-owned subsidiaries, are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" (Qualifying Interests). Under current interpretations by the staff
of the SEC, in order to qualify for this exemption, HPCI, among other things,
must maintain at least 55% of its assets in Qualifying Interests and also may be
required to maintain an additional 25% in Qualifying Interests or other real
estate-related assets. The assets that HPCI may acquire therefore may be limited
by the provisions of the Investment Company Act. HPCI has established a policy
of limiting authorized investments which are not Qualifying Interests to no more
than 20% of the value of its total assets.
HPCI has no present intention of repurchasing any of its capital
securities, and any such action would be taken only in conformity with
applicable federal and state laws and regulations and the requirements for
qualifying as a REIT.
HPCI intends to distribute to its shareholders, in accordance with the
Securities and Exchange Act of 1934, as amended, annual reports containing
financial statements prepared in accordance with generally accepted
9
accounting principles and certified by its independent auditors. HPCI's articles
of incorporation provide that it will maintain its status as a reporting company
under the Exchange Act for so long as any of the Class C preferred securities
are outstanding and held by unaffiliated shareholders.
HPCI currently makes investments and operates its business in such a
manner consistent with the requirements of the Internal Revenue Code to qualify
as a REIT. However, future economic, market, legal, tax, or other considerations
may cause its board of directors, subject to approval by a majority of its
independent directors, to determine that it is in HPCI's best interest and the
best interest of its shareholders to revoke HPCI's REIT status. The Internal
Revenue Code prohibits HPCI from electing REIT status for the four taxable years
following the year of such revocation.
EMPLOYEES
HPCI has six executive officers and two additional officers, but no
other employees. Day-to-day activities and the servicing of the loans underlying
HPCI's participation interests are administered by the Bank. All of HPCI's
officers are also officers or employees of Huntington, the Bank, and/or
Holdings. HPCI maintains corporate records and audited financial statements that
are separate from those of Huntington, the Bank, and Holdings.
Although there are no restrictions or limitations contained in HPCI's
articles of incorporation or bylaws, HPCI does not anticipate that its officers
or directors will have any direct or indirect pecuniary interest in any asset to
be acquired or disposed of by HPCI or in any transaction in which HPCI has an
interest or will engage in acquiring, holding, and managing assets, other than
as borrowers or guarantors of loans underlying HPCI's participation interests,
in which case such loans would be on substantially the same terms, including
interest rates and collateral on loans, as those prevailing at the time for
comparable transaction with others and would not involve more than the normal
risk of collectibility or present other unfavorable features.
SERVICING
The loans underlying HPCI's participation interests are serviced by the
Bank pursuant to the terms of the participation agreement between the Bank and
Holdings and the subparticipation agreement between Holdings and HPCI. The Bank
has delegated servicing responsibility of the residential mortgage loans to The
Huntington Mortgage Company, a wholly-owned subsidiary of the Bank.
The participation and subparticipation agreements require the Bank to
service the loans underlying HPCI's participation interests in a manner
substantially the same as for similar work performed by the Bank for
transactions on its own behalf. The Bank or its affiliates collect and remit
principal and interest payments, maintain perfected collateral positions, and
submit and pursue insurance claims. The Bank and its affiliates also provide
accounting and reporting services required by HPCI for its participation
interests. HPCI also may direct the Bank to dispose of any loans that become
classified, placed in a non-performing status, or are renegotiated due to the
financial deterioration of the borrower. The Bank is required to pay all
expenses related to the performance of its duties under the participation and
subparticipation agreements, including any payment to its affiliates for
servicing the loans. The Bank or its affiliates may institute foreclosure
proceedings at the direction of HPCI, exercise any power of sale contained in
any mortgage or deed of trust, obtain a deed in lieu of foreclosure, or
otherwise acquire title to a mortgaged property underlying a mortgage loan by
operation of law or otherwise in accordance with the terms of the participation
and subparticipation agreement.
Under the participation and subparticipation agreements, the Bank has
the right in its discretion to give consents, waivers, and modifications of the
loan documents to the same extent as if the loans were wholly owned by the Bank;
provided, however, without the written consent of Holdings, the Bank may not
waive any payment default, extend the maturity of the loans, reduce the rate or
rates of interest with respect to the loans, forgive or reduce the principal sum
of the loans, increase the lending formula or advance rates, or amend or modify
the financial covenants contained in the loan documents in any way that would
make such financial covenants less restrictive.
The Bank has the right to accept payment or prepayment of the whole
principal sum and accrued interest in accordance with the terms of the loans,
waive prepayment charges in accordance with the Bank's policy for loans in which
no participation interest has been granted, and accept additional security for
the loans. No specific term is specified in the participation agreement and
subparticipation agreement; the agreements may be terminated by mutual agreement
of the parties at any time, without penalty. Due to the relationship among HPCI,
Holdings, and the Bank, it is not anticipated that these agreements will be
terminated by any party in the foreseeable future.
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The Bank, in its role as servicer under the terms of the loan
participation agreement, receives a loan servicing fee designed as a
reimbursement for costs incurred to service the underlying loan. The amount and
terms of the fee are determined by mutual agreement of the Bank, Holdings, and
HPCI from time to time during the term of the participation agreement and
subparticipation agreement. Periodically, a review and analysis of loan
servicing operations is conducted by the Bank. As a result, among other things,
the cost to service an individual loan is calculated and is used as a basis to
determine fair compensation for services rendered. The loan servicing fee is
subject to adjustment annually based upon the Bank's review and analysis at the
end of each calendar year during the term of the participation agreement.
HPCI paid servicing fees of $8.3 million for the year ended December 31,
2001, and $7.8 million for each of the years ended December 31, 2000 and 1999.
In 2001, the annual servicing fee with respect to the commercial mortgage,
commercial, and consumer loans was equal to the outstanding principal balance of
each loan multiplied to a fee of 0.125% and the annual servicing fee with
respect to residential mortgages is equal to 0.282% of the interest income
collected. Neither the participation agreement nor the subparticipation
agreement limits or caps the servicing fees that are paid to the Bank.
COMPETITION
Competition in the form of price and service from other banks and
financial companies such as savings and loans, credit unions, finance companies,
and brokerage firms is intense in most of the markets served by Huntington and
its subsidiaries. Mergers between and the expansion of financial institutions
both within and outside Ohio have provided significant competitive pressure in
major markets. Since 1995, when federal interstate banking legislation became
effective that made it permissible for bank holding companies in any state to
acquire banks in any other state, and for banks to establish interstate branches
(subject to certain limitations by individual states), actual or potential
competition in each of Huntington's markets has been intensified. This
competition impacts Huntington's ability to attract new business, particularly
in the form of loans secured by real estate, and, therefore, also affects HPCI's
availability to invest in participation interests in such loans.
REGULATORY MATTERS
HPCI is an indirect subsidiary of the Bank and therefore, regulatory
authorities have the right to examine HPCI and its activities and, under certain
circumstances, to impose restrictions on the Bank or HPCI. The Bank is subject
to examination and supervision by the OCC. In addition to the impact of federal
and state regulation, the Bank is affected significantly by the actions of the
Federal Reserve Board as it attempts to control the money supply and credit
availability in order to influence the economy.
BUSINESS RISKS
Like all other REITs, HPCI's business and results of operations are
subject to a number of risks, many of which are outside of its control. In
addition to the other information in this report, readers should carefully
consider that the following important factors, among others, could materially
impact HPCI's business and future results of operations.
A DECLINE IN THE BANK'S CAPITAL LEVELS MAY RESULT IN PREFERRED SECURITIES BEING
SUBJECT TO A CONDITIONAL EXCHANGE INTO BANK PREFERRED SECURITIES AT A TIME WHEN
THE BANK'S FINANCIAL CONDITION IS DETERIORATING. CONSEQUENTLY, THE LIKELIHOOD OF
DIVIDEND PAYMENTS, AS WELL AS THE LIQUIDATION PREFERENCE, TAXATION, VOTING
RIGHTS, AND LIQUIDITY OF SECURITIES WOULD BE NEGATIVELY IMPACTED.
The returns from a shareholder's investment in HPCI's preferred
securities will be dependent to a significant extent on the performance and
capital of the Bank. A decline in the performance and capital levels of the Bank
or the placement of the Bank into conservatorship or receivership could result
in the exchange, if so directed by the OCC, of HPCI's preferred securities for
Bank preferred securities, without shareholder approval or any shareholder
action. This would represent an investment in the Bank and not in HPCI. Under
these circumstances, there would likely be a significant loss associated with
this investment. Also, since preferred shareholders of HPCI would become
preferred shareholders of the Bank at a time when the Bank's financial condition
has deteriorated, it is unlikely that the Bank would be in a financial position
to make any dividend payments on the Bank preferred securities.
In the event of a liquidation of the Bank, the claims of depositors and
creditors of the Bank would be entitled to priority in payment over the claims
of holders of equity interests such as the Bank preferred securities,
11
and, therefore, preferred shareholders likely would receive substantially less
than would have been received had the preferred securities not been exchanged
for Bank preferred securities.
The exchange of the preferred securities for Bank preferred securities
would most likely be a taxable event to shareholders under the Internal Revenue
Code and, in that event, shareholders would incur a gain or loss, as the case
may be, measured by the difference between the basis in the preferred securities
and the fair market value of the Bank preferred securities received in the
exchange.
Although the terms of the Bank preferred securities are substantially
similar to the terms of HPCI's preferred securities, there are differences, such
as the Bank preferred securities do not have any voting rights or any right to
elect independent directors if dividends are missed. In addition, the Bank
preferred securities will not be listed on the NASDAQ Stock Market or any
exchange and a market for them may never develop.
BANK REGULATORS MAY LIMIT HPCI'S ABILITY TO IMPLEMENT ITS BUSINESS PLAN AND MAY
RESTRICT ITS ABILITY TO PAY DIVIDENDS.
Because HPCI is an indirect subsidiary of the Bank, regulatory
authorities will have the right to examine HPCI and its activities and, under
certain circumstances, to impose restrictions on the Bank or HPCI which could
impact HPCI's ability to conduct business pursuant to its business plan and
which could adversely effect its financial condition and results of operations.
If the OCC determines that the Bank's relationship with HPCI results in
an unsafe and unsound banking practice, the OCC and other regulators of the Bank
have the authority to restrict HPCI's ability to transfer assets, restrict its
ability to make distributions to shareholders or redeem preferred securities, or
to require the Bank to sever its relationship with HPCI or divest its ownership
in HPCI. Certain of these actions by the OCC would likely result in HPCI's
failure to qualify as a REIT.
Payment of dividends on the preferred securities could also be subject
to regulatory limitations if the Bank becomes "undercapitalized" for purposes of
regulations issued by the OCC. Under these regulations, the Bank will be deemed
"undercapitalized" if it has a total risk-based capital ratio of less than 8.0%;
a Tier 1 risk-based capital ratio of less than 4.0%; and a leverage ratio of
less than 4.0% or less than 3% if the institution has been awarded the highest
supervisory rating. At December 31, 2001, the Bank's total risk-based capital
ratio was 10.29%, its Tier 1 risk-based capital ratio was 6.34%, and its
leverage ratio was 6.58%. The Bank currently intends to maintain its capital
ratios in excess of the "well-capitalized" levels under these regulations.
However, there can be no assurance that the Bank will be able to maintain its
capital in excess of the "well-capitalized" levels. The exercise of the OCC's
power to restrict dividends on preferred securities would, however, also have
the effect of restricting the payment of dividends on common shares. The
inability to pay dividends on common shares would prevent HPCI from meeting the
statutory requirement for a REIT to distribute 90% of its taxable income and,
therefore, would cause HPCI to fail to qualify for the favorable tax treatment
accorded to REITs.
If HPCI had to be treated for tax purposes in the same manner as the
other consolidated subsidiaries of the Bank rather than as a REIT, the loss of
tax benefits would directly and immediately affect the Bank. In addition,
because HPCI holds a substantial part of the Bank's mortgage assets and HPCI's
dividend flow is a substantial part of the Bank's total income, HPCI's inability
to transmit resources to the Bank by means of dividends would deprive the Bank
of liquidity necessary for the efficient and profitable management of its loan
and investment portfolios, thus adversely affecting the Bank's financial
condition.
Legal and regulatory limitations on the payment of dividends by the
Bank could also affect HPCI's ability to pay dividends to unaffiliated third
parties, including the preferred shareholders. Since HPCI and Holdings are
members of the Bank's consolidated group, payment of common and preferred
dividends by the Bank and/or any member of its consolidated group to
unaffiliated third parties, including payment of dividends to the shareholders
of preferred securities, would require regulatory approval if aggregate
dividends on a consolidated basis exceed certain limitations. Regulatory
approval is required prior to the Bank's declaration of any dividends in excess
of available retained earnings. The amount of dividends that may be declared
without regulatory approval is further limited to the sum of net income for the
current year and retained net income for the preceding two years, less any
required transfers to surplus or common stock.
12
DIVIDENDS ARE NOT CUMULATIVE AND THEREFORE, PREFERRED SHAREHOLDERS ARE NOT
ENTITLED TO RECEIVE DIVIDENDS UNLESS DECLARED BY HPCI'S BOARD OF DIRECTORS.
Dividends on the preferred securities are not cumulative. Consequently,
if the board of directors does not declare a dividend on the preferred
securities for any quarterly period, including if prevented by bank regulators,
preferred shareholders will not be entitled to receive that dividend whether or
not funds are or subsequently become available. The board of directors may
determine that it would be in HPCI's best interests to pay less than the full
amount of the stated dividends on the preferred securities or no dividends for
any quarter even though funds are available. Factors that would generally be
considered by the board of directors in making this determination are the amount
of distributable funds, HPCI's financial condition and capital needs, the impact
of current and pending legislation and regulations, economic conditions, tax
considerations, and HPCI's continued qualification as a REIT. If full dividends
on the Class A, Class C, and Class D preferred securities have not been paid for
six full dividend periods, the holders of the Class C and Class D preferred
securities, voting together as one class, will have the right to elect two
independent directors in addition to those already on the board.
HPCI IS DEPENDENT IN VIRTUALLY EVERY PHASE OF ITS OPERATIONS ON THE DILIGENCE
AND SKILL OF THE OFFICERS AND EMPLOYEES OF THE BANK, AND ITS RELATIONSHIP WITH
THE BANK MAY CREATE POTENTIAL CONFLICTS OF INTEREST.
The Bank is involved in virtually every aspect of HPCI's existence. All
of its officers and six of its nine directors are also officers or directors of
the Bank or its affiliates. Officers that are common with the Bank devote less
than 5% of their time to managing HPCI's business. The Bank has the right to
elect all of HPCI's directors, including independent directors, except under
limited circumstances if it fails to pay future dividends. The Bank and its
affiliates have interests that are not identical to HPCI's and, therefore,
conflicts of interest could arise in the future with respect to transactions
between or among the Bank, Holdings, and HPCI.
The Bank administers HPCI's day-to-day activities under the terms of a
participation agreement between the Bank and Holdings and a subparticipation
agreement between Holdings and HPCI. The parties to the participation agreement
and the subparticipation agreement are all affiliated. Accordingly, these
agreements were not the result of arms-length negotiations and may be modified
at any time in the future. Although the modification of the participation
agreement or subparticipation agreement requires the approval of a majority of
independent directors, the Bank, through its ownership of substantially all of
Holdings' common stock and Holdings' ownership of substantially all of HPCI's
common stock, controls the election of all of the directors, including
independent directors. HPCI cannot assure shareholders that such modifications
will be on terms as favorable to it as those that could have been obtained from
unaffiliated third parties.
Huntington, the owner of all the Bank's common shares, may have
investment goals and strategies that differ from those of the holders of HPCI's
preferred securities. In addition, neither Huntington nor the Bank has a policy
addressing the treatment of new business opportunities. Thus, new business
opportunities identified by Huntington or the Bank may be directed to affiliates
other than HPCI. HPCI's board of directors has broad discretion to revise its
investment and operating strategy without shareholder approval. The Bank,
through its ownership of substantially all of Holdings' common stock and
Holdings' ownership of substantially all of HPCI's common stock, controls the
election of all of HPCI's directors, including independent directors.
Consequently, HPCI's investment and operating strategies will largely be
directed by Huntington and the Bank.
HPCI is dependent on the diligence and skill of the officers and
employees of the Bank for the selection and structuring of the loans underlying
its participation interests and other authorized investments. The Bank selected
the amount, type, and price of loan participation interests and other assets
that were acquired from the Bank and its affiliates. In the immediate future,
HPCI anticipates acquiring all or substantially all of its assets from the Bank
or its affiliates. Although these acquisitions are made within investment
policies, neither HPCI nor the Bank obtained any third-party valuations. HPCI
does not intend to do so in the future. Although HPCI's board of directors has
adopted certain policies to guide the acquisition and disposition of assets,
these policies may be revised or exceptions may be approved from time to time at
the discretion of the board of directors without a vote of shareholders. Changes
in or exceptions made to these policies could permit the acquisition of lower
quality assets.
HPCI is dependent on the Bank and others for monitoring and servicing
the loans underlying its participation interests. Conflicts could arise as part
of such servicing, particularly with respect to loans that are placed on
nonaccrual status. While HPCI believes that the Bank will diligently pursue
collection of any non-performing assets, HPCI cannot assure shareholders that
this will occur. HPCI's ability to make timely payments of dividends on the
preferred and common securities will depend in part upon the Bank's prompt
collection efforts on its behalf. HPCI pays substantial servicing fees to the
Bank through Holdings. HPCI paid servicing fees of $8.3 million in 2001, and
$7.8 million in each of the years ended December 31, 2000 and 1999.
13
The Bank may seek to exercise its influence over HPCI's affairs so as
to cause the sale of its assets and their replacement by lesser quality assets
acquired from the Bank or elsewhere. This could adversely affect HPCI's business
and its ability to make timely payment of dividends on the preferred and common
securities.
HPCI'S ASSETS MAY BE USED TO GUARANTEE CERTAIN OF THE BANK'S OBLIGATIONS THAT
WILL HAVE A PREFERENCE OVER THE HOLDERS OF HPCI'S PREFERRED SECURITIES.
The Bank is eligible to obtain advances from various federal agencies,
such as the Federal Home Loan Bank (FHLB). HPCI may in the future be asked to
act as co-borrower or guarantee the Bank's obligations under such advances
and/or pledge all or a portion of its assets in connection with those advances.
Any such borrowing, guarantee, or pledge would rank senior to preferred
securities upon liquidation. Accordingly, any governmental agencies that make
advances to the Bank where HPCI has acted as co-borrower or guarantor or has
pledged its assets as collateral will have a preference over the holders of
HPCI's preferred securities. These holders would receive their liquidation
preference only to the extent there are assets available after satisfaction of
HPCI's indebtedness, if any. To date, HPCI has never acted as co-borrower or
guarantor of any of the Bank's obligations under such advances or otherwise and
has never pledged any of its assets. The Bank, however, has obtained a line of
credit from the FHLB. At any one time, advances under this line are not to
exceed $800 million in the aggregate. It is expected that up to 25% of HPCI's
assets could serve as collateral for such advances. Any agreement setting forth
these obligations will be approved by HPCI's directors. A default by the Bank on
its obligations to the FHLB could adversely affect HPCI's business and its
ability to make timely dividend payments on preferred and common securities.
NEW, OR CHANGES IN EXISTING, TAX, ACCOUNTING, AND REGULATORY LAWS, REGULATIONS,
RULES, AND STANDARDS COULD SIGNIFICANTLY IMPACT STRATEGIC INITIATIVES, RESULTS
OF OPERATIONS, FINANCIAL CONDITION, AND ABILITY TO PAY DIVIDENDS.
Governmental regulations may sometimes impose significant limitations
on HPCI's operations. These regulations, along with the currently existing tax
and accounting laws, regulations, rules, and standards, control the methods by
which financial institutions and their subsidiaries conduct business; implement
strategic initiatives, as well as past, present, and contemplated tax planning;
and govern financial disclosures. These laws, regulations, rules, and standards
are constantly evolving and may change significantly over time. Current events
that may not have a direct impact on HPCI, such as the Enron Corporation
bankruptcy and the September 11, 2001 terrorist attacks, may result in
legislators, regulators, and authoritative bodies, such as the Financial
Accounting Standards Board, to respond by adopting substantive revisions to the
laws, regulations, rules, and standards. The nature, extent, and timing of the
adoption of significant new laws, changes in existing laws, or repeal of
existing laws may have a material impact on HPCI's business, results of
operations, financial condition, and ability to pay dividends; however, it is
impossible to predict at this time the extent to which any such adoption,
change, or repeal would impact HPCI.
THE EXTENDED DISRUPTION OF HUNTINGTON'S VITAL INFRASTRUCTURE COULD NEGATIVELY
IMPACT HPCI'S BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION, AND ABILITY
TO PAY DIVIDENDS.
HPCI's operations depend upon, among other things, Huntington's
infrastructure, including its equipment and facilities. Extended disruption of
Huntington's vital infrastructure by fire, power loss, natural disaster,
telecommunications failure, computer hacking and viruses, terrorist activity or
the domestic and foreign response to such activity, or other events outside of
Huntington's control could have a material adverse impact on the financial
services industry as a whole and on HPCI's business, results of operations,
financial condition, and ability to pay dividends in particular.
HPCI HAS NO CONTROL OVER CHANGES IN INTEREST RATES AND SUCH CHANGES COULD
NEGATIVELY IMPACT ITS FINANCIAL CONDITION, RESULTS OF OPERATIONS, AND ABILITY TO
PAY DIVIDENDS.
HPCI's income consists primarily of interest payments on the loans
underlying its participation interests. At December 31, 2001, 28.7% of the loans
underlying its participation interests, as measured by the aggregate outstanding
principal amount, bore interest at fixed rates and the remainder bore interest
at adjustable rates. Adjustable-rate loans decrease the risks to a lender
associated with changes in interest rates but involve other risks. As interest
rates rise, the payment by the borrower rises to the extent permitted by the
terms of the loan, and the increased payment increases the potential for
default. At the same time, the marketability of the underlying property may be
adversely affected by higher interest rates. In a declining interest rate
environment, there may be an increase in prepayments on the loans underlying
HPCI's participation interests as the borrowers refinance their mortgages at
lower interest rates. Under these circumstances, HPCI may find it more difficult
to acquire additional participation
14
interests with rates sufficient to support the payment of the dividends on the
preferred securities. Because the rate at which dividends are required to be
paid on the Class A and C preferred securities is fixed, there can be no
assurance that a declining interest rate environment would not adversely affect
HPCI's ability to pay full, or even partial, dividends on its preferred
securities.
THE LOANS UNDERLYING PARTICIPATION INTERESTS ARE SUBJECT TO LOCAL ECONOMIC
CONDITIONS THAT COULD NEGATIVELY AFFECT THE VALUE OF THE COLLATERAL SECURING
SUCH LOANS AND/OR THE RESULTS OF HPCI'S OPERATIONS.
The value of the collateral underlying HPCI's loans and/or the results
of its operations could be affected by various conditions in the economy, all of
which are beyond its control. These include local and other economic conditions
affecting real estate and other collateral values; the continued financial
stability of a borrower and the borrower's ability to make loan principal and
interest payments, which may be adversely affected by job loss, recession,
divorce, illness, or personal bankruptcy. These also include the ability of
tenants to make lease payments; the ability of a property to attract and retain
tenants, which may be affected by conditions such as an oversupply of space or a
reduction in demand for rental space in the area, the attractiveness of
properties to tenants, competition from other available space, and the ability
of the owner to pay leasing commissions, provide adequate maintenance and
insurance, pay tenant improvement costs, and make other tenant concessions.
Furthermore, interest rate levels and the availability of credit to refinance
loans at or prior to maturity and increased operating costs, including energy
costs, real estate taxes, and costs of compliance with environmental controls
and regulations are also various conditions in the economy that effect the value
of the underlying collateral and the result of HPCI's operations.
THE LOANS UNDERLYING HPCI'S PARTICIPATION INTERESTS ARE CONCENTRATED IN FOUR
STATES, AND ADVERSE CONDITIONS IN THOSE STATES, IN PARTICULAR, COULD NEGATIVELY
IMPACT RESULT OF OPERATIONS.
At December 31, 2001, 95.6% of the properties underlying HPCI's loan
participation interests (as a percentage of loan principal balances) were
located in Ohio, Michigan, Indiana, and Kentucky. Because of the concentration
of its interests in those states, in the event of adverse economic conditions in
those states, HPCI would likely experience higher rates of loss and delinquency
on its loan participation interests than if the underlying loans were more
geographically diversified. Additionally, the loans underlying its loan
participation interests may be subject to a greater risk of default than other
comparable loans in the event of adverse economic, political, or business
developments or natural hazards that may affect Ohio, Michigan, Indiana, or
Kentucky and the ability of property owners in those states to make payments of
principal and interest on the underlying loans. In the event of any adverse
development or natural disaster, HPCI's ability to pay dividends on preferred
and common securities could be adversely affected.
HPCI'S ACQUISITION OF PARTICIPATION INTERESTS IN COMMERCIAL MORTGAGE LOANS
SUBJECTS IT TO RISKS THAT ARE NOT PRESENT IN PARTICIPATION INTERESTS IN
RESIDENTIAL MORTGAGE LOANS.
At December 31, 2001, 62.5% of HPCI's assets, as measured by aggregate
outstanding principal amount, consisted of participation interests in commercial
mortgage loans. Commercial mortgage loans generally tend to have shorter
maturities than residential mortgage loans and may not be fully amortizing,
meaning that they may have a significant principal balance or "balloon" payment
due on maturity. Commercial real estate properties tend to be unique and are
more difficult to value than single-family residential real estate properties.
They are also subject to relatively greater environmental risks and to the
corresponding burdens and costs of compliance with environmental laws and
regulations. Due to these risks, HPCI may experience higher rates of default on
its participation interests in commercial mortgage loans than if its
participation interests were more diversified and included a greater number of
underlying residential and other loans.
HPCI'S FINANCIAL STATEMENTS CONFORM WITH ACCOUNTING PRINCIPLES GENERALLY
ACCEPTED IN THE UNITED STATES, WHICH REQUIRE MANAGEMENT TO MAKE ESTIMATES AND
ASSUMPTIONS THAT AFFECT AMOUNTS REPORTED IN THE FINANCIAL STATEMENTS. ACTUAL
RESULTS COULD DIFFER FROM THOSE ESTIMATES.
HPCI's financial statements include estimates related to accruals of
income and expenses. These estimates are based on information available at the
time the estimates are made. Factors involved in these estimates could change in
the future leading to a change of those estimates, which could be material to
HPCI's results of operations or financial condition.
15
HPCI COULD SUFFER ADVERSE TAX CONSEQUENCES IF IT FAILED TO QUALIFY AS A REIT.
No assurance can be given that HPCI will be able to continue to operate
in such a manner so as to remain qualified as a REIT. Qualification as a REIT
involves the application of highly technical and complex tax law provisions for
which there are only limited judicial or administrative interpretations and
involves the determination of various factual matters and circumstances not
entirely within its control. No assurance can be given that new legislation or
new regulations, administrative interpretations, or court decisions will not
significantly change the tax laws in the future with respect to qualification as
a REIT or the federal income tax consequences of such qualification in a way
that would materially and adversely affect HPCI's ability to operate. Any such
new legislation, regulation, interpretation, or decision could be the basis of a
tax event that would permit HPCI to redeem all or any preferred securities. If
HPCI were to fail to qualify as a REIT, the dividends on preferred securities,
would not be deductible for federal income tax purposes. HPCI would face a
greater tax liability that could consequently result in a reduction in HPCI's
net earnings after taxes. A reduction in net earnings after taxes could
adversely affect its ability to add interest-earning assets to its portfolio and
pay dividends to its preferred security holders.
If in any taxable year HPCI fails to qualify as a REIT, unless it is
entitled to relief under certain statutory provisions, it would also be
disqualified from treatment as a REIT for the four taxable years following the
year its qualification was lost. As a result, the amount of funds available for
distribution to shareholders would be reduced for the year or years involved.
As a REIT, HPCI generally will be required each year to distribute as
dividends to its shareholders at least 90% of REIT taxable income, excluding
capital gains. Failure to comply with this requirement would result in earnings
being subject to tax at regular corporate rates. In addition, HPCI would be
subject to a 4% nondeductible excise tax on the amount by which certain
distributions considered as paid with respect to any calendar year are less than
the sum of 85% of ordinary income for the calendar year, 95% of capital gains
net income for the calendar year, and 100% of undistributed taxable income from
prior periods. Qualification as a REIT also involves application of other
specific provisions of the Internal Revenue Code. Two specific provisions are an
income test and an asset test. At least 75% of HPCI's gross income, excluding
gross income from prohibited transactions, for each taxable year must be derived
directly or indirectly from investments relating to real property or mortgages
on real property. Additionally, at least 75% of HPCI's total assets must be
represented by real estate assets. At December 31, 2001, HPCI had qualifying
income and qualifying assets that exceeded 75%.
Although HPCI intends to operate in a manner designed to qualify as a
REIT, future economic, market, legal, tax, or other considerations may cause it
to determine that it is in its best interests and the best interests of holders
of common and preferred securities to revoke the REIT election. As long as any
class of preferred securities are outstanding, any such determination may be
made without shareholder approval, but will require the approval of a majority
of independent directors.
ENVIRONMENTAL LIABILITIES ASSOCIATED WITH REAL PROPERTY SECURING LOANS
UNDERLYING HPCI'S PARTICIPATION INTERESTS COULD REDUCE THE FAIR MARKET VALUE OF
ITS PARTICIPATION INTERESTS AND MAKE THE PROPERTY MORE DIFFICULT TO SELL.
In its capacity as servicer, the Bank at the direction of HPCI may
be forced to foreclose on a defaulted commercial mortgage and/or residential
mortgage loan to recover its investment in the mortgage loan. The Bank may be
subject to environmental liabilities in connection with the underlying real
property, which could exceed the value of the real property. Although the Bank
exercises due diligence to discover potential environmental liabilities prior to
the acquisition of any property through foreclosure, hazardous substances or
wastes, contaminants, pollutants, or their sources may be discovered on
properties during the Bank's ownership or after a sale to a third party. Even
though HPCI may sell to the Bank, at fair value, the participation interest in
any loan at the time the real property securing that loan becomes foreclosed
property, the discovery of these liabilities, any associated costs for removal
of hazardous substances, wastes, contaminants, or pollutants, and the difficulty
in selling the underlying real estate, could have a material adverse effect on
the fair value of that loan and therefore HPCI may not recover any or all of its
investment in the underlying loan.
16
HPCI MAY REDEEM THE CLASS C AND CLASS D PREFERRED SECURITIES UPON THE OCCURRENCE
OF CERTAIN SPECIAL EVENTS.
At any time following the occurrence of certain special events, HPCI
will have the right to redeem the Class C and Class D preferred securities in
whole, subject to the prior written approval of the OCC. The occurrence of such
an event will not, however, give a preferred shareholder any right to request
that such Class C or Class D preferred securities be redeemed. A special event
includes:
- a tax event which occurs when HPCI receives an opinion of counsel
to the effect that, as a result of a judicial decision or
administrative pronouncement, ruling, or other action or as a
result of certain changes in the tax laws, regulations, or
related interpretations, there is a significant risk that
dividends with respect to HPCI's capital stock will not be fully
deductible by HPCI or it will be subject to a significant amount
of additional taxes or governmental charges;
- an investment company event which occurs when HPCI receives an
opinion of counsel to the effect that, as a result of certain
changes in the applicable laws, regulations, or related
interpretations, there is a significant risk that HPCI will be
considered an investment company under the Investment Company Act
of 1940; and
- a regulatory capital event which occurs when, as a result of
certain changes in the applicable laws, regulations, or related
interpretations, there is a significant risk that HPCI's Class C
preferred securities will no longer constitute Tier 1 capital of
the Bank (other than as a result of limitations on the portion of
Tier 1 capital that may consist of minority interests in
subsidiaries of the Bank).
GUIDE 3 INFORMATION
Information required by Industry Guide 3 relating to statistical
disclosure by real estate investment trusts is set forth in Items 7 and 8.
ITEM 2: PROPERTIES
HPCI does not own any material physical property or real estate.
ITEM 3: LEGAL PROCEEDINGS
HPCI is not the subject of any material litigation. HPCI is not
currently involved in nor, to management's knowledge, is currently threatened
with any material litigation with respect to the loans underlying its
participation interests other than routine litigation arising in the ordinary
course of business.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
period covered by this report.
17
Part II
-------
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
In February 2001, Huntington purchased 18,667 common shares of HPCI
from Holdings (restated to reflect the April 2001 18,666.66667-for-1 stock
split) for approximately $8.4 million and one common share of Holdings from the
Bank for approximately $6.7 million. Huntington owns 0.1% and Holdings owns
99.9% of the issued and outstanding common shares of HPCI. There is no
established public trading market for HPCI's common stock. During 2001, 2000,
and 1999, dividends of $539.2 million, $458.3 million, and $413.8 million were
paid to common shareholders, respectively.
Information regarding restrictions on dividends, as required by this
item, is set forth in Item 1 "Dividend Policy and Restrictions".
ITEM 6. SELECTED FINANCIAL DATA
The data presented below represents selected financial data relative to
HPCI for, and as of the end of, the years ended December 31, 2001, 2000, and
1999 (in thousands of dollars):
- -------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------
STATEMENTS OF INCOME:
Net interest income $ 477,738 $ 489,100 $ 491,203
Non-interest income 1,646 --- ---
Non-interest expense 10,015 7,983 8,234
Net income before preferred dividends 468,972 481,117 482,969
Dividends on preferred stock 21,827 80 80
Net income applicable to common shares 447,145 481,037 482,889
Average yield on earning assets 6.76% 7.36% 7.74%
BALANCE SHEETS:
Loan Participation interests, net of
allowance for loan losses $5,214,286 $5,744,822 $5,939,286
All other assets 86,752 48,625 39,546
Total assets 5,883,542 6,833,624 6,213,038
Total shareholders' equity 5,883,511 6,833,624 6,212,308
18
ITEM 7. MANAGEMENTS'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
Huntington Preferred Capital, Inc. (HPCI or "the company") is an Ohio
corporation that was incorporated in July 1992 under the name Airbase Realty,
Inc. The company changed its name to Huntington Preferred Capital, Inc. in May
2001. The company's principal business objective is to acquire, hold, and manage
mortgage assets and other authorized investments that will generate net income
for distribution to its shareholders. Since May 1998, the company has been
operating as a real estate investment trust (REIT), for federal income tax
purposes.
The company is a subsidiary of Huntington Preferred Capital Holdings,
Inc. (Holdings), which is owned by The Huntington National Bank (the Bank) and
Huntington Bancshares Incorporated (Huntington). All of HPCI's day-to-day
activities and the servicing of the loans underlying its participation interests
are administered by the Bank. HPCI has one wholly-owned subsidiary, HPCLI, Inc.
(HPCLI).
A participation agreement between the Bank and Holdings and a
subparticipation agreement between Holdings and HPCI require the Bank to service
HPCI's loan portfolio in a manner substantially the same as for similar work
performed by the Bank for transactions on its own behalf. The Bank collects and
remits principal and interest payments, maintains perfected collateral
positions, and submits and pursues insurance claims. The Bank also provides to
HPCI accounting and reporting services as required. The Bank is required to pay
all expenses related to the performance of its duties under the participation
and subparticipation agreements. These participation interests were all acquired
from Holdings and Holdings acquired them from the Bank.
FORWARD-LOOKING STATEMENTS
This report, including management's discussion and analysis of
financial condition and results of operations, contains forward-looking
statements about HPCI, including descriptions of products or services, plans, or
objectives of its management for future operations, and forecasts of its
revenues, earnings, or other measures of economic performance. Forward-looking
statements can be identified by the fact that they do not relate strictly to
historical or current facts.
By their nature, forward-looking statements are subject to numerous
assumptions, risks, and uncertainties. A number of factors, including but not
limited to, those set forth under the heading "Business Risks" included in Item
1 of this report and other factors described from time to time in HPCI's other
filings with the Securities and Exchange Commission, could cause actual
conditions, events, or results to differ significantly from those described in
the forward-looking statements.
Forward-looking statements speak only as of the date they are made.
HPCI does not update forward-looking statements to reflect circumstances or
events that occur after the date the forward-looking statements are made or to
reflect the occurrence of unanticipated events.
The following discussion and analysis, the purpose of which is to
provide investors and others with information that the company's management
believes to be necessary for an understanding of its financial condition,
changes in financial condition, and results of operations, should be read in
conjunction with the financial statements, notes, and other information
contained in this document.
SIGNIFICANT ACCOUNTING POLICIES
Note 3 to HPCI's consolidated financial statements lists significant
accounting policies used in the development and presentation of its financial
statements. This discussion and analysis, the significant accounting policies,
and other financial statement disclosures identify and address key variables and
other qualitative and quantitative factors that are necessary for an
understanding and evaluation of HPCI and its results of operations.
ISSUANCE OF PREFERRED SECURITIES
In October 2001, HPCI issued to Holdings 2,000,000 shares of Class C
preferred securities and 14,000,000 shares of Class D preferred securities and
made a capital contribution of common equity in exchange for $452.6 million of
gross participation interests in certain loans, $86.5 million of related
specific loan loss reserves, $45.4 million of net leasehold improvements, and
$3.5 million of accrued interest. These participation interests were in
19
commercial, commercial real estate, and consumer loans. The underlying consumer
loans included a combination of automobile, truck, and equipment loans. HPCI
intends to hold these participation interests as long-term investments.
Approximately 24% of these participation interests were non-performing in
nature. The company transferred the leasehold improvements to HPCLI in exchange
for its common shares. Holdings subsequently sold all of the Class C preferred
securities in an underwritten public offering. HPCI did not receive any of
Holdings' proceeds from the sale.
DISTRIBUTION OF FLORIDA LOAN PARTICIPATION INTERESTS
On July 12, 2001, Huntington announced a comprehensive strategic and
financial restructuring plan, which included, among other things, divesting its
Florida retail and corporate banking businesses. On September 26, 2001,
Huntington announced that it had entered into an agreement to sell its Florida
operations to SunTrust Banks, Inc. (SunTrust). On December 31, 2001, in
anticipation of the eventual sale of the Florida operations by Huntington, HPCI
completed its $1.3 billion distribution to common shareholders, Holdings and
Huntington. This distribution consisted of cash and the net book value of
participation interests in loans that were included in the sale to SunTrust,
including the related accrued interest and allowance for loan losses,
representing approximately 17% of HPCI's total assets as of December 31, 2001.
OVERVIEW
HPCI's income is primarily derived from its participation interests in
loans acquired from the Bank through Holdings. Income varies based on the level
of these assets and their relative interest rates. The cash flows from these
assets are used to satisfy HPCI's preferred dividend obligations. The preferred
stock is considered equity and therefore, the dividends are not reflected as
interest expense.
HPCI reported net income available to common shareholders of $447.1
million for 2001, compared with $481.0 million and $482.9 million for 2000 and
1999, respectively. Average assets approximate average shareholders' equity
(including preferred stock) and therefore, return on average assets (ROA) and
return on average equity (ROE) were the same for all annual periods presented.
ROA and ROE were 6.35% for 2001, versus 7.26% for 2000, and 7.68% for 1999.
At December 31, 2001 and 2000, HPCI had total assets and total equity
(including preferred stock) of $5.9 billion and $6.8 billion, respectively. At
the most recent year end, an aggregate of $5.4 billion, or 91.4%, of total
assets consisted of 99% participation interests in loans. Before the allowance
for loan losses, participation interests in commercial and commercial mortgage
loans was $4.3 billion, or 73.5% of total assets, $0.8 billion, or 13.3%, in
consumer loans, and $270.7 million, or 4.6%, in residential mortgage loans.
- ------------------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------
Gross loan participation interests:
Commercial $ 646,509 $ 614,956 $ 813,809 $1,110,669
Consumer 783,735 971,594 791,396 698,328
Residential mortgage 270,671 355,571 749,563 903,076
Commercial mortgage 3,678,061 3,894,527 3,688,669 3,226,583
- ------------------------------------------------------------------------------------------------------------------
Total $5,378,976 $5,836,648 $6,043,437 $5,938,656
==================================================================================================================
Interest-bearing and non-interest bearing cash balances on deposit with
the Bank were $364.9 million and $880.2 million at December 31, 2001 and 2000,
respectively. Interest bearing balances are invested overnight or in Eurodollar
deposits with the Bank for a term of not more than 30 days. Amounts due from
Holdings at December 31, 2001 and 2000, were $217.6 million and $159.9 million,
respectively. These represent amounts due from or due to Holdings and/or the
Bank that arise in the ordinary course of business for unsettled transactions
involving participation interests, fees, and other related costs.
Shareholders' equity (including preferred stock) declined from $6.8
billion at December 31, 2000, to $5.9 billion at December 31, 2001, reflecting
the $1.3 billion distribution of the Florida-related participations and the
aggregate dividend payments on the common and preferred securities during the
recent year offset by the $400 million received from the issuance of the Class C
and D preferred securities in 2001.
20
RESULTS OF OPERATIONS
NET INTEREST INCOME
HPCI's primary source of revenue is interest income on its
participation interests in loans. At present, HPCI does not have any
interest-bearing liabilities and no related interest expense. HPCI's cash flows
from its participation interests in loans provide sufficient funding such that
outside borrowings are not required. Net interest income is impacted by changes
in the level of interest rates and earning assets. The yield on earning assets
is the percentage of interest income to average earning assets.
HPCI's average balances, interest income, and yields are presented
below for the twelve-month periods ended December 31:
- ----------------------------------------------------------------------------------------------------------------------
2001 2000
-------------------------------------- -------------------------------------
Average Average
(in millions of dollars) Balance Income Yield Balance Income Yield
- ----------------------------------------------------------------------------------------------------------------------
Loan participation interests:
Commercial $ 560.1 $ 35.2 6.28 % $ 721.9 $ 53.5 7.41 %
Consumer 1,068.0 100.8 9.43 865.8 78.3 9.04
Residential mortgage 558.2 41.2 7.38 689.2 46.4 6.73
Commercial mortgage 4,182.5 264.8 6.33 3,809.1 273.7 7.19
- ----------------------------------------------------------------------------------------------------------------------
Total loan participations 6,368.8 442.0 6.94 6,086.0 451.9 7.43
- ----------------------------------------------------------------------------------------------------------------------
Interest bearing deposits
in banks 692.8 27.9 4.02 556.9 33.1 5.94
Fees 7.8 4.1
- ----------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $7,061.6 $ 477.7 6.76 % $6,642.9 $ 489.1 7.36 %
======================================================================================================================
- ----------------------------------------------------------------------------------------------------------------------
1999
-------------------------------------
Average
(in millions of dollars) Balance Income Yield
- ----------------------------------------------------------------------------------------------------------------------
Loan participation interests:
Commercial $ 963.6 $ 74.3 7.71 %
Consumer 724.7 65.8 9.08
Residential mortgage 811.2 59.6 7.35
Commercial mortgage 3,570.6 270.3 7.57
- ----------------------------------------------------------------------------------------------------------------------
Total loan participations 6,070.1 470.0 7.74
- ----------------------------------------------------------------------------------------------------------------------
Interest bearing deposits in banks 276.7 14.1 5.10
Fees 7.1
- ----------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $6,346.8 $ 491.2 7.74 %
======================================================================================================================
Net interest income was $477.7 million for the twelve months ended
December 31, 2001. Net interest income declined $11.4 million from the
immediately preceding year as the yield on earning assets contracted from 7.36%
for the year ended December 31, 2000 to 6.76% for the recent year. In the table
above, individual components include participations in non-accrual loans and
related interest received. For the twelve months ended December 31, 2001, the
amount of interest income that would have been recorded under original terms for
participations in loans classified as non-accrual was $5.1 million. Amounts
actually received and recorded as interest income for these participations
totaled $2.4 million.
The declines experienced during 2001 were due to decreases in interest
earned on participation interests as runoff from higher rate assets was replaced
by lower rate acquisitions, which was indicative of the changes in the interest
rate environment in the periods. The rate earned on participation interests
declined 49 basis points for 2001 while slightly higher fees helped to offset
some of this decline.
21
The table below shows changes in net interest income for the twelve
months due to volume and rate variances for each category of earning assets. The
change in interest not solely due to changes in volume or rates has been
allocated in proportion to the absolute dollar amounts of the change in volume
and rate.
- -------------------------------------------------------------------------------------------------------------------------
2001 2000
- -------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) From Increase (Decrease) From
Previous Year Due To: Previous Year Due To:
- -------------------------------------------------------------------------------------------------------------------------
Fully Tax Equivalent Basis (1) Yield/ Yield/
(in millions of dollars) Volume Rate Total Volume Rate Total
- -------------------------------------------------------------------------------------------------------------------------
Interest bearing deposits in
The Huntington National Bank $ 7.0 $ (12.3) $ (5.3) $ 16.3 $ 2.7 $ 19.0
Loan participation interests:
Commercial (11.1) (7.0) (18.1) (18.2) (3.2) (21.4)
Consumer 19.2 4.0 23.2 12.9 (0.6) 12.3
Residential mortgage (9.5) 4.5 (5.0) (8.6) (5.0) (13.6)
Commercial mortgage 25.7 (31.9) (6.2) 17.8 (16.2) 1.6
- -------------------------------------------------------------------------------------------------------------------------
TOTAL EARNING ASSETS 31.3 (42.7) (11.4) 20.2 (22.3) (2.1)
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 31.3 $ (42.7) $ (11.4) $ 20.2 $ (22.3) $ (2.1)
=========================================================================================================================
(1) Calculated assuming a 35% tax rate.
PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is the charge to pre-tax earnings
necessary to maintain the allowance for loan losses (ALL) at a level adequate to
absorb management's estimate of inherent losses in the loan portfolio. The
provision for loan losses was $371,000 for the year ended December 31, 2001. An
ALL is transferred from the Bank to Holdings and from Holdings to HPCI on
seasoned loans underlying the participations at the time the participations are
acquired.
The ALL was $164.7 million at December 31, 2001, up from $91.8 million
the end of 2000. This represents 3.06% of total 2001 loan participations
compared with 1.57% of total loan participations at the end of last year. The
ALL increased as a result of the acquisition of participation interests in
performing and non-performing loans in the fourth quarter of 2001, as mentioned
above, offset by the distribution of the participation interests in
Florida-related loans at the end of 2001. Non-performing loans were covered by
the ALL 0.83 times at the end of 2001, versus 2.2 times at the end of last year.
Additional information regarding the ALL and asset quality appears in the
"Credit Quality" section. The following table shows the activity in HPCI's ALL.
- -----------------------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF YEAR $ 91,826 $ 104,151 $ 87,799 $ --
Allowance of loan participations acquired, net 113,291 (9,434) 25,988 88,789
Distribution of participations in Florida-related
loans (18,604) -- -- --
Net loan losses
Commercial (2,321) (137) (1,203) (58)
Consumer (18,800) (2,589) (5,673) (531)
Residential mortgage -- -- -- --
Commercial mortgage (1,073) (165) (2,760) (401)
Provision for loan losses 371 -- -- --
- -----------------------------------------------------------------------------------------------------------------------
BALANCE, END OF YEAR $ 164,690 $ 91,826 $ 104,151 $ 87,799
=======================================================================================================================
Total net charge-offs in 2001 were 0.35%, up from 0.05% in 2000. Net
charge-offs related to participations in commercial loans were 0.04% in the
recent year versus 0.02% in 2000, while net charge-offs related to consumer
loans were 1.76% in 2001 compared with 0.30% in the preceding year. Net
charge-offs were 0.03% and 0.01% for participations in commercial mortgage loans
in 2001 and 2000, respectively. HPCI's management expects unfavorable trends in
credit quality and net charge-offs may continue at or above current levels in
all portfolios, particularly in the first half of 2002, until general economic
conditions begin to improve. Trends in credit quality typically lag in their
timing to changes in general economic conditions.
HPCI, through reliance on methods utilized by Huntington, allocates the
ALL to each loan or loan participation category based on an expected loss ratio
determined by continuous assessment of credit quality based
22
on portfolio risk characteristics and other relevant factors such as historical
performance, internal controls, and impacts from mergers and acquisitions. For
the commercial and commercial mortgage loan participations, expected loss
factors are assigned by credit grade at the individual underlying loan level.
The aggregation of these factors represents management's estimate of the
inherent loss. The portion of the allowance allocated to the more homogeneous
underlying consumer loan segments is determined by developing expected loss
ratios based on the risk characteristics of the various segments and giving
consideration to existing economic conditions and trends.
- ---------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------------
% OF % OF % OF
LOAN LOAN LOAN
PART. TO PART. TO PART. TO
(in thousands of dollars) ALL TOTAL ALL TOTAL ALL TOTAL
- ---------------------------------------------------------------------------------------------------------------------------
Commercial $103,119 12.0 % $ 38,327 10.5 % $ 38,270 13.5 %
Consumer 17,030 14.6 25,793 16.6 31,693 13.1
Residential mortgage 1,766 5.0 1,305 6.1 1,936 12.4
Commercial mortgage 33,886 68.4 12,381 66.8 12,923 61.0
- ----------------------------------------------------------------------------------------------------------------------------
Total Allocated 155,801 100.0 77,806 100.0 84,822 100.0
Total Unallocated 8,889 -- 14,020 -- 19,329 --
- ---------------------------------------------------------------------------------------------------------------------------
Total Allowance for Loan Losses $164,690 100.0 % $ 91,826 100.0 % $104,151 100.0 %
===========================================================================================================================
Projected loss ratios incorporate factors such as trends in past due
and non-accrual amounts, recent underlying loan loss experience, current
economic conditions, risk characteristics, and concentrations of various
underlying loan categories. Actual loss ratios experienced in the future,
however, could vary from those projected as an underlying loan's performance is
a function of not only economic factors but also other factors unique to each
customer. The diversity in size of the underlying commercial and commercial
mortgage loans can be significant as well. The dollar exposure could
significantly vary from estimated amounts due to diversity. Additionally, the
impact from recent economic events, including the recession and events of
September 11, 2001, on individual customers may not yet be known. To ensure
adequacy to a higher degree of confidence, a portion of the ALL is considered
unallocated. While amounts are allocated to various portfolio segments, the
total ALL, excluding impairment reserves prescribed under provisions of
Statement of Financial Accounting Standard No. 114, is available to absorb
losses from any segment of the portfolio.
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
Non-interest income was $1.6 million for 2001. This represents rental
income received from the Bank related to land and land improvements, and
buildings acquired in 2000, and leasehold improvements acquired by HPCI in 2001.
Non-interest expense was $10.0 million for 2001. Non-interest expense
for 2000 was $8.0 million and $8.2 million for 1999. Non-interest expense
includes fees paid to the Bank for servicing the loans underlying the
participation interests. On an annual basis, the service fee with respect to the
commercial mortgage, commercial, and consumer loans is equal to the outstanding
principal balance of each loan multiplied by a fee of 0.125% and the service fee
for residential mortgage loans is equal to 0.282% of the interest income
collected. The increase in 2001 was due largely to depreciation on premises and
equipment of $1.5 million.
PROVISION FOR INCOME TAXES
HPCI has elected to be treated as a REIT for Federal income tax
purposes and intends to maintain compliance with the provisions of the Code and
therefore is not subject to income taxes. HPCI's subsidiary, HPCLI, elected to
be treated as a taxable REIT subsidiary and therefore, a provision for income
taxes on its taxable income is included in the accompanying consolidated
financial statements.
INTEREST RATE RISK MANAGEMENT
HPCI's income consists primarily of interest income on participation
interests in commercial, consumer, residential mortgage, and commercial mortgage
loans. The company has not and does not intend to use any derivative products to
manage its interest rate risk. If there is a further decline in market interest
rates, the company may experience a reduction in interest income on its
participation interests and a corresponding decrease in funds available to be
distributed to shareholders. The reduction in interest income may result from
downward adjustments of the indices upon which the interest rates on loans are
based and from prepayments of loans with fixed interest
23
rates, resulting in reinvestment of the proceeds in lower-yielding participation
interests. Further information regarding market risk can be found under Item 7A
below.
CREDIT QUALITY
HPCI's exposure to credit risk is managed by personnel of the Bank
through its use of consistent underwriting standards that emphasize "in-market"
lending while avoiding highly leveraged transactions as well as excessive
industry and business activity concentrations. The Bank's credit administration
function employs extensive risk management techniques, including forecasting, to
ensure that loans adhere to corporate policy and problem loans are promptly
identified. These procedures provide executive management of the Bank and HPCI
with the information necessary to implement policy adjustments where necessary,
and take corrective actions on a proactive basis. These procedures also include
evaluating the adequacy of the ALL, which includes an analysis of specific
credits and the application of relevant reserve factors that represent relative
risk, based on portfolio trends, current and historic loss experience, and
prevailing economic conditions, to specific portfolio segments.
Concentration of credit risk generally arises with respect to
participation interests when a number of underlying loans have borrowers engaged
in similar business activities or activities in the same geographical region.
Concentration of credit risk indicates the relative sensitivity of performance
to both positive and negative developments affecting a particular industry.
HPCI's balance sheet exposure to geographic concentrations directly affects the
credit risk of the underlying loans within the participation interests. The
majority of the loans underlying the participation interests are located in
Ohio, Michigan, Indiana, and Kentucky. Borrowers obligated in loans underlying
HPCI's participation interests, however, do not represent a particular
concentration of similar business activity. At December 31, 2001, 95.6% of the
underlying loans in all participation interests consisted of loans located in
these four states. Consequently, the portfolio may experience a higher default
rate in the event of adverse economic, political, or business developments or
natural hazards in these states and may affect the ability of borrowers to make
payments of principal and interest on the underlying loans.
Certain industries have been identified as being particularly
vulnerable to the weakening economic environment such as hotels, restaurants,
amusements/recreation, insurance, and airlines. At December 31, 2001, these
industries comprised only 7% of the total underlying commercial and commercial
real estate loans.
Non-performing assets (NPAs), consist of participation interests in
underlying loans that are no longer accruing interest. Underlying commercial,
commercial mortgage, and residential mortgage loans are placed on non-accrual
status and stop accruing interest when collection of principal or interest is in
doubt or generally when the underlying loan is 90 days past due. When interest
accruals are suspended, accrued interest income is reversed with current year
accruals charged to earnings and prior year amounts generally charged off as a
credit loss. Consumer loans are not placed on non-accrual status; rather they
are charged off in accordance with regulatory statutes governing the Bank, which
is generally no more than 120 days.
- -------------------------------------------------------------------------------------------------------------------------------
NON-PERFORMING ASSETS AT DECEMBER 31,
--------------------------------------------------------------------
(in thousands of dollars) 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
Participation interests in non-accrual loans
Commercial $156,874 $ 16,025 $ 14,684 $ 4,880
Real Estate
Commercial 32,492 19,638 23,465 10,918
Residential 8,232 6,271 320 1,247
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL NON-PERFORMING ASSETS $197,598 $ 41,934 $ 38,469 $ 17,045
===============================================================================================================================
NON-PERFORMING ASSETS AS A % OF TOTAL
PARTICIPATION INTERESTS 3.67% 0.72% 0.64% 0.29%
ALLOWANCE FOR LOAN LOSSES AS A % OF NON-
PERFORMING ASSETS 83.35% 218.98% 270.74% 515.10%
Total NPAs were $197.6 million at December 31, 2001 and $41.9 million
at December 31, 2000. As of the same dates, the underlying non-performing loans
represented 3.67% and 0.72% of total participation interests. The increase in
the recent year was due to the aforementioned acquisition of participation
interests in performing and non-performing loans in the fourth quarter 2001 in
exchange for the capital contribution and issuance of preferred equity. The
amount of participation interests in non-performing Florida-related loans
distributed in 2001 approximated $4.6 million. Given the weakened economic
conditions, HPCI expects that NPAs may increase in
24
2002, particularly in the first half of the year. Typically, trends in credit
quality lag in their timing to changes in general economic conditions.
Underlying loans past due ninety days or more but continuing to accrue
interest were $24.3 at December 31, 2001, down from $32.3 million at the end of
the immediately preceding quarter.
Under the participation and subparticipation agreements, HPCI may
direct the Bank to dispose of any underlying loan that becomes classified, is
placed in a non-performing status, or is renegotiated due to the financial
deterioration of the borrower. The Bank may institute foreclosure proceedings,
exercise any power of sale contained in any mortgage or deed of trust, obtain a
deed in lieu of foreclosure, or otherwise acquire title to a property underlying
a mortgage loan by operation of law or otherwise in accordance with the terms of
the participation and subparticipation agreement. Any underlying loan is sold to
the Bank at fair market value where the security is either repossessed or goes
into foreclosure proceedings. The Bank then incurs all costs associated with
repossession and foreclosure.
LIQUIDITY AND CAPITAL RESOURCES
The objective of HPCI's liquidity management is to ensure the
availability of sufficient cash flows to meet all of its financial commitments
and to capitalize on opportunities for business expansion. In managing
liquidity, management takes into account various legal limitations placed on a
REIT.
HPCI's principal liquidity needs are to pay operating expenses and
dividends and acquire additional participation interests as the underlying loans
in its portfolio paydown or mature. Operating expenses and dividends are
expected to be funded through cash generated by operations, while the
acquisition of additional participation interests in loans is intended to be
funded with the proceeds obtained from repayment of principal balances by
individual borrowers. HPCI intends to pay dividends on its preferred stock and
common stock in amounts necessary to continue to preserve its status as a REIT
under the Internal Revenue Code.
As mentioned previously, HPCI issued to Holdings Class C and D
preferred securities and made a capital contribution of common equity in
exchange for the fair market value of participation interests in certain loans
and leasehold improvements in 2001, which approximated $400 million. The company
transferred the leasehold improvements to HPCLI in exchange for its common
shares. Holdings subsequently sold all of the Class C preferred securities in an
underwritten public offering. HPCI did not receive any of Holdings' proceeds
from the sale.
On December 31, 2001, HPCI distributed its participation interests in
Florida-related loans to its common shareholders, Holdings and Huntington, in
anticipation of the eventual sale of the Florida operations by Huntington. This
distribution, which approximated $1.3 billion, consisted of cash and the net
book value of participation interests in loans.
To the extent that the board of directors determines that additional
funding is required, management may raise such funds through additional equity
offerings, debt financings, or retention of cash flow, or a combination of these
methods. However, any cash flow retention must be consistent with the provisions
of the Internal Revenue Code requiring the distribution by a REIT of at least
90% of its REIT taxable income, excluding capital gains, and must take into
account taxes that would be imposed on undistributed income. Management does not
anticipate that additional funding will be required for at least the next twelve
months.
RESULTS FOR THE FOURTH QUARTER
Fourth quarter 2001 net income was $109.3 million. After the
declaration and payment of preferred stock dividends of $6.7 million, net income
applicable to common shares was $102.6 million. This compares with $124.0
million for the last quarter of 2000 after applicable preferred dividends. The
lower interest rate environment directly impacted the performance of the
company's portfolio of participation interests in loans in the recent year.
Total assets declined to $5.9 billion at December 31, 2001, compared
with $7.2 billion at September 30, 2001. HPCI completed its distribution of
participation interests in Florida-related loans to its common shareholders,
Holdings and Huntington, on December 31, 2001. This distribution approximated
$1.3 billion and consisted of cash and the net book value of participation
interests in loans, which were included in Huntington's sale of its Florida
operations to SunTrust, which subsequently closed February 15, 2002. This
decline was partially mitigated by an
25
early fourth quarter acquisition from the Bank through Holdings of
participation interests in performing and non-performing loans and leasehold
improvements in exchange for preferred equity, as previously mentioned. The
company transferred the leasehold improvements to HPCLI in exchange for its
common shares. As a result of these transactions, the allowance for loan losses
increased to 3.06% of total loan participation interests at year-end versus
1.44% at the end of the prior quarter. Net charge-offs in the fourth quarter
were $18.5 million, compared with $734,000 in the same period last year. The
increase was due to the general decline in economic conditions along with the
higher concentration of interests in non-performing loans. HPCI's management
expects unfavorable trends in credit quality to continue at or above current
levels, particularly in the first half of 2002.
As a result of the acquisition of leasehold improvements, HPCLI
received from the Bank rent of $1.6 million, which is reflected in non-interest
income. Non-interest expense included depreciation expense for all premises and
equipment, which amounted to $1.5 million for the last quarter of 2001.
Management fees for the fourth quarter 2001 paid by HPCI were $2.2 million,
compared with $1.8 million for the same period a year ago. HPCLI is a taxable
REIT subsidiary and therefore, a provision of $26,000 for income taxes applied
to its taxable income is reflected in the fourth quarter 2001 results.
HPCI declared and paid cash dividends of $80.00 per share on its Class
A preferred stock, paid $44.225 per share on its Class B preferred stock, paid
$0.4265625 per share on its Class C preferred stock, and paid $0.22885 per share
on its Class D preferred stock. The latter two classes of preferred stock were
issued in the fourth quarter 2001. HPCI paid these dividends, as required, on
December 31, 2001 to shareholders of record on December 21, 2001. HPCI also paid
common stock dividends of $539.2 million in 2001.
26
- --------------------------------------------------------------------------------
QUARTERLY STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
2001
-----------------------------------------------------------
(in thousands of dollars) FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------
Interest and fee income
Interest on loan participation interests
Commercial $ 7,529 $ 7,779 $ 8,923 $ 10,967
Consumer 28,349 25,102 24,189 23,127
Residential mortgage 9,259 10,438 12,232 9,272
Commercial mortgage 59,717 64,358 67,623 73,159
- --------------------------------------------------------------------------------------------------------------
104,854 107,677 112,967 116,525
- --------------------------------------------------------------------------------------------------------------
Fees from loan participation interests 2,198 1,909 2,366 1,384
Interest bearing deposits in banks 4,432 6,115 5,041 12,270
- --------------------------------------------------------------------------------------------------------------
TOTAL INTEREST AND FEE INCOME 111,484 115,701 120,374 130,179
- --------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 111,484 115,701 120,374 130,179
Provision for loan losses -- -- 371 --
- --------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR LOAN LOSSES 111,484 115,701 120,003 130,179
- --------------------------------------------------------------------------------------------------------------
Non-interest income
Rental income 1,603 15 14 14
Non-interest expense
Management fees 2,155 2,056 2,110 1,973
Depreciation 1,517 4 4 4
Other 54 42 42 54
- --------------------------------------------------------------------------------------------------------------
3,726 2,102 2,156 2,031
- --------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 109,361 113,614 117,861 128,162
Income taxes 26 -- -- --
- --------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE PREFERRED DIVIDENDS 109,335 113,614 117,861 128,162
DIVIDENDS ON PREFERRED STOCK 6,737 15,090 -- --
- --------------------------------------------------------------------------------------------------------------
NET INCOME APPLICABLE TO
COMMON SHARES $ 102,598 $ 98,524 $ 117,861 $ 128,162
==============================================================================================================
2000
---------------------------------------------------------
(in thousands of dollars) FOURTH THIRD SECOND FIRST
- --------------------------------------------------------------------------------------------------------------
Interest and fee income
Interest on loan participation interests
Commercial $ 12,448 $ 13,516 $ 13,550 $ 13,982
Consumer 21,947 20,180 18,496 17,704
Residential mortgage 5,248 10,568 15,008 15,597
Commercial mortgage 72,125 70,662 66,069 64,813
- --------------------------------------------------------------------------------------------------------------
111,768 114,926 113,123 112,096
- --------------------------------------------------------------------------------------------------------------
Fees from loan participation interests 1,210 967 1,073 842
Interest bearing deposits in banks 12,901 9,886 6,578 3,730
- --------------------------------------------------------------------------------------------------------------
TOTAL INTEREST AND FEE INCOME 125,879 125,779 120,774 116,668
- --------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 125,879 125,779 120,774 116,668
Provision for loan losses -- -- -- --
- --------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR LOAN LOSSES 125,879 125,779 120,774 116,668
- --------------------------------------------------------------------------------------------------------------
Non-interest income
Rental income -- -- -- --
Non-interest expense
Management fees 1,827 1,961 1,996 2,036
Depreciation -- -- -- --
Other 40 41 41 41
- --------------------------------------------------------------------------------------------------------------
1,867 2,002 2,037 2,077
- --------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 124,012 123,777 118,737 114,591
Income taxes -- -- -- --
- --------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE PREFERRED DIVIDENDS 124,012 123,777 118,737 114,591
DIVIDENDS ON PREFERRED STOCK 80 -- -- --
- --------------------------------------------------------------------------------------------------------------
NET INCOME APPLICABLE TO
COMMON SHARES $ 123,932 $ 123,777 $ 118,737 $ 114,591
===============================================================================================================
27
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The table below represents the maturity of HPCI's interest-earning
assets at December 31, 2001. Assets that immediately reprice are placed in the
overnight column.
- ---------------------------------------------------------------------------------------------------------------------------------
WITHIN ONE ONE TO THREE THREE TO FIVE OVER FIVE
(in thousands) OVERNIGHT YEAR YEARS YEARS YEARS TOTAL
- ---------------------------------------------------------------------------------------------------------------------------------
Interest bearing
deposits $ 364,912 $ -- $ -- $ -- $ -- $ 364,912
Loan participations:
Fixed rate -- 206,806 402,556 283,590 651,856 1,544,808
Variable rate 1,701,518 269,300 299,822 261,847 1,301,681 3,834,168
- -------------------------------------------------------------------------------------------------------------------------------
Total $2,066,430 $ 476,106 $ 702,378 $ 545,437 $1,953,537 $5,743,888
===============================================================================================================================
Interest rate risk is HPCI's primary market risk. As indicated
earlier, HPCI's income consists primarily of interest income from participation
interests in commercial, consumer, residential mortgage, and commercial mortgage
loans. If there is a decline in market interest rates resulting from downward
adjustments in the indices upon which the interest rates on loans are based,
HPCI may experience a reduction in interest income and a corresponding decrease
in funds available for distribution to shareholders. A decline in interest
income can also be realized from prepayments, including pay-offs, of loans with
fixed interest rates, resulting in reinvestment of proceeds in lower-yielding
participation interests. The borrower has the ability to prepay a loan with or
without premium or penalty depending on the provisions found in the underlying
loan agreements. The level of underlying loan prepayments is influenced by
several factors, including the interest rate environment, the real estate market
in particular geographic areas, the timing of transactions, and circumstances
related to individual borrowers and loans.
At December 31, 2001, approximately 28.7% of the loans underlying
the participation portfolio carried fixed interest rates. Such loans tend to
increase interest rate risk. At this same date, HPCI did not have any
interest-rate-sensitive liabilities.
Analysis of HPCI's interest earning assets is performed in
conjunction with, and is part of, Huntington's overall interest rate management
process. A key element used in Huntington's process is the use of an income
simulation model, which includes, among other things, assumptions for
prepayments. Based on the most recent simulation performed at December 31, 2001,
HPCI's experience and management's estimates, the results of the company's
sensitivity analysis indicated that 12-month net interest income would be
expected to increase by approximately 5.3% if rates rose 200 basis points above
December 31, 2001 implied forward expectations and would drop an estimated 5.2%,
in the event of a gradual 200 basis point decline from December 31, 2001 implied
forward expectations.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of HPCI at December
31, 2001 and 2000 and for the years ended December 31, 2001, 2000, and 1999 are
included in this report at the pages indicated.
Page
Independent Auditors' Report F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Income F-3
Consolidated Statements of Changes in Shareholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-6
28
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
any matter of accounting principles, practices or financial statement
disclosure.
Part III
--------
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is set forth under the caption
"Election of Directors" on pages 1 through 3 and under the caption "Section
16(a) Beneficial Ownership Reporting Compliance" on page 7 of HPCI's 2002
Information Statement, and is incorporated herein by reference.
ITEM 11: EXECUTIVE COMPENSATION
Information required by this item is set forth under the caption
"Compensation of Directors and Executive Officers" on page 4 of HPCI's 2002
Information Statement and is incorporated herein by reference.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the caption
"Ownership of Voting Stock" on page 5 of HPCI's 2002 Information
Statement and is incorporated herein by reference.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the caption
"Transactions with Directors and Officers", on page 4 and "Transactions with
Certain Beneficial Owners" on pages 6 and 7 of HPCI's 2002 Information Statement
and is incorporated herein by reference.
Part IV
-------
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) The report of independent auditors and consolidated financial
statements appearing in Item 8.
(2) HPCI is not filing separately financial statement schedules because of
the absence of conditions under which they are required or because the
required information is included in the consolidated financial
statements or the notes thereto.
(3) The exhibits required by this item are listed in the Exhibit Index on
page 31 of this Form 10- K.
(b) Reports on Form 8-K.
During the quarter ended December 31, 2001, HPCI filed one Current
Report on Form 8-K. This report, dated December 31, 2001, was filed
under Item 2, concerning HPCI's distribution of its participation
interests in Florida-related loans to its common shareholders.
(c) The exhibits to this Form 10-K are on page 31.
(d) See Item 14(a)(2) above.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 28th day of
March, 2002.
HUNTINGTON PREFERRED CAPITAL, INC.
(Registrant)
By: /s/ Michael J. McMennamin By: /s/ John D. Van Fleet
--------------------------------- ----------------------------------
Michael J. McMennamin John D. Van Fleet
President Vice President
(Principal Executive Officer) (Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 27th day of March, 2002.
Richard A. Cheap * Director
- -------------------------------------------
Richard A. Cheap
Stephen E. Dutton * Director
- -------------------------------------------
Stephen E. Dutton
R. Larry Hoover * Director
- -------------------------------------------
R. Larry Hoover
Edward J. Kane * Director
- -------------------------------------------
Edward J. Kane
Roger E. Kephart * Director
- -------------------------------------------
Roger E. Kephart
James D. Robbins * Director
- -------------------------------------------
James D. Robbins
Paul V. Sebert * Director
- -------------------------------------------
Paul V. Sebert
* /s/ Michael J. McMennamin
- -------------------------------------------------
Michael J. McMennamin
Attorney-in fact for each of the persons indicated
30
EXHIBIT INDEX
3 (i) Amended and Restated Articles of Incorporation (previously filed as
Exhibit 3(a)(ii) to Amendment No. 4 to Registration Statement of Form
S-11 (File No. 333-61182), filed with the Securities and Exchange
Commission on October 12, 2001, and incorporated herein by reference.)
3 (ii) Code of Regulations (previously filed as Exhibit 3(b) to the
Registrant's Registration Statement of Form S-11 (File No. 333-61182),
filed with the Securities and Exchange Commission on May 17, 2001, and
incorporated herein by reference.)
4 Specimen of certificate representing Class C preferred securities,
previously filed as Exhibit 4 to the Registrant's Amendment No. 1 to
Registration Statement of Form S-11 (File No. 333-61182), filed with
the Securities and Exchange Commission on May 31, 2001, and
incorporated herein by reference.
10 (a) Loan Participation Agreement, dated May 1, 1998 between The
Huntington National Bank and Huntington Preferred Capital Holdings,
Inc. (f/k/a Airbase Realty Holding Company) (previously filed as
Exhibit 10(a) to Registration Statement of Form S-11 (File No.
333-61182), filed with the Securities and Exchange Commission on May
17, 2001, and incorporated herein by reference.)
(b) Amendment to Loan Participation Agreement, dated March 1, 2001, between
The Huntington National Bank and Huntington Preferred Capital Holdings,
Inc. (f/k/a Airbase Realty Holding Company) (previously filed as
Exhibit 10(b) to Registration Statement of Form S-11 (File No.
333-61182), filed with the Securities and Exchange Commission on May
17, 2001, and incorporated herein by reference.)
(c) Loan Subparticipation Agreement, dated May 1, 1998, between Huntington
Preferred Capital Holdings, Inc. (f/k/a Airbase Realty Holding Company)
and Huntington Preferred Capital, Inc. (f/k/a Airbase Realty Company)
(previously filed as Exhibit 10(c) to Registration Statement of Form
S-11 (File No. 333-61182), filed with the Securities and Exchange
Commission on May 17, 2001, and incorporated herein by reference.)
(d) Amendment to Loan Subparticipation Agreement, dated March 1, 2001,
between Huntington Preferred Capital Holdings, Inc. (f/k/a Airbase
Realty Holding Company) and Huntington Preferred Capital, Inc. (f/k/a
Airbase Realty Company) (previously filed as Exhibit 10(d) to
Registration Statement of Form S-11 (File No. 333-61182), filed with
the Securities and Exchange Commission on May 17, 2001, and
incorporated herein by reference.)
(e) Amendment to Loan Subparticipation Agreement, dated May 16, 2001,
between Huntington Preferred Capital Holdings, Inc. and Huntington
Preferred Capital, Inc.
(f) Subscription Agreement, dated October 15, 2001, for the Class C
preferred securities between Huntington Preferred Capital, Inc.,
The Huntington National Bank, and Huntington Preferred Capital
Holdings, Inc.
(g) Subscription Agreement, dated October 15, 2001, for the Class D
preferred securities between Huntington Preferred Capital, Inc.,
The Huntington National Bank, and Huntington Preferred Capital
Holdings, Inc.
(h) Amendment to Loan Participation Agreement, dated March 27, 2002,
between The Huntington National Bank and Huntington Preferred Capital
Holdings, Inc.
(i) Amendment to Loan Subparticipation Agreement, dated March 27, 2002,
between Huntington Preferred Capital Holdings, Inc. and Huntington
Preferred Capital, Inc.
21 List of Subsidiary
24 Power of Attorney
REPORT OF MANAGEMENT
The management of HPCI is responsible for the financial information and
representations contained in the consolidated financial statements and other
sections of this report. The consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States. In all material respects, they reflect the substance of
transactions that should be included based on informed judgments, estimates, and
currently available information.
HPCI utilizes accounting and other control systems maintained by
Huntington Bancshares Incorporated that, in the opinion of management, provide
reasonable assurance that (1) transactions are properly recorded on the books
and records, and (2) that the assets are properly safeguarded. The systems of
internal accounting controls include the careful selection and training of
qualified personnel, appropriate segregation of responsibilities, communication
of written policies and procedures, and a broad program of internal audits. The
costs of the controls are balanced against the expected benefits. During 2001,
the Audit Committee of the Board of Directors met with management, Huntington's
internal auditors, and the independent auditors, Ernst & Young LLP, to review
the scope of the audits and to discuss the evaluation of internal accounting
controls and financial reporting matters. The independent and internal auditors
have free access to and meet confidentially with the Audit Committee to discuss
appropriate matters.
The independent auditors are responsible for expressing an informed
judgment as to whether the consolidated financial statements present fairly, in
accordance with accounting principles generally accepted in the United States,
the financial position, results of operations and cash flows of HPCI. They
obtained an understanding of HPCI's internal accounting controls and conducted
such tests and related procedures as they deemed necessary to provide reasonable
assurance, giving due consideration to materiality, that the consolidated
financial statements contain neither misleading nor erroneous data. Their report
appears below.
/s/ Michael J. McMennamin /s/ John D. Van Fleet
- -------------------------------- ------------------------------------------
Michael J. McMennamin John D. Van Fleet
President Vice President
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
Huntington Preferred Capital, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of Huntington
Preferred Capital, Inc. and Subsidiary as of December 31, 2001 and 2000, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Huntington
Preferred Capital, Inc. and Subsidiary at December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Columbus, Ohio
January 18, 2002
F-1
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- ---------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31,
(in thousands of dollars, except share data) 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from The Huntington National Bank $ -- $ 61,403
Interest bearing balances with The Huntington National Bank 364,912 818,872
Due from Huntington Preferred Capital Holdings, Inc. 217,592 159,902
Loan participation interests
Commercial 646,509 614,956
Consumer 783,735 971,594
Residential mortgage 270,671 355,571
Commercial mortgage 3,678,061 3,894,527
- ---------------------------------------------------------------------------------------------------------------------------------
5,378,976 5,836,648
Less allowance for loan losses 164,690 91,826
- ---------------------------------------------------------------------------------------------------------------------------------
Net loan participation interests 5,214,286 5,744,822
- ---------------------------------------------------------------------------------------------------------------------------------
Premises and equipment 44,641 --
Accrued income and other assets 42,111 48,625
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $5,883,542 $6,833,624
=================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and other liabilities $ 31 $ --
- ---------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 31 --
- ---------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred stock, Class A, 8.000% noncumulative, non-exchangeable; $1,000
par and liquidation value per share;
1,000 shares authorized, issued and outstanding in 2001 and 2000 1,000 1,000
Preferred stock, Class B, variable-rate noncumulative and
conditionally exchangeable; $1,000 par and liquidation
value per share; authorized 500,000 shares; 400,000 shares
issued and outstanding in 2001 and 2000 400,000 400,000
Preferred stock, Class C, 7.875% noncumulative and
conditionally exchangeable; $25 par and liquidation
value; authorized 2,000,000 shares; 2,000,000 shares issued and
outstanding in 2001 and no shares issued and outstanding in 2000 50,000 --
Preferred stock, Class D, variable-rate noncumulative and
conditionally exchangeable; $25 par and liquidation
value; authorized 14,000,000 shares; 14,000,000 shares issued
and outstanding in 2001 and no shares issued and outstanding in 2000 350,000 --
Preferred stock, $25 par value, 10,000,000 shares
authorized; no shares issued or outstanding in 2001 and 2000 -- --
Common stock - without par value; shares authorized, issued, and
outstanding: 14,000,000 in 2001; 750 in 2000 5,082,511 6,341,717
Retained earnings -- 90,907
- ---------------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 5,883,511 6,833,624
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $5,883,542 $6,833,624
=================================================================================================================================
See notes to consolidated financial statements.
F-2
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
TWELVE MONTHS ENDED DECEMBER 31,
------------------------------------------------------
(in thousands of dollars) 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------------
Interest and fee income
Interest on loan participation interests
Commercial $ 35,198 $ 53,496 $ 74,318
Consumer 100,767 78,327 65,832
Residential mortgage 41,201 46,421 59,599
Commercial mortgage 264,857 273,669 270,300
- -------------------------------------------------------------------------------------------------------------------------------
442,023 451,913 470,049
- -------------------------------------------------------------------------------------------------------------------------------
Fees from loan participation interests 7,857 4,092 7,043
Interest bearing deposits in banks 27,858 33,095 14,111
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST AND FEE INCOME 477,738 489,100 491,203
- -------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 477,738 489,100 491,203
Provision for loan losses 371 -- --
- -------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR LOAN LOSSES 477,367 489,100 491,203
- -------------------------------------------------------------------------------------------------------------------------------
Non-interest income 1,646 -- --
Non-interest expense 10,015 7,983 8,234
- -------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 468,998 481,117 482,969
Income taxes 26 -- --
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE PREFERRED DIVIDENDS 468,972 481,117 482,969
DIVIDENDS ON PREFERRED STOCK 21,827 80 80
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME APPLICABLE TO COMMON SHARES $ 447,145 $ 481,037 $ 482,889
===============================================================================================================================
See notes to consolidated financial statements.
F-3
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
PREFERRED, CLASS A PREFERRED, CLASS B PREFERRED, CLASS C
----------------------- -------------------- ----------------------
(in thousands of dollars, except per share data) SHARES STOCK SHARES STOCK SHARES STOCK
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 -- $ -- -- $ -- -- $ --
Comprehensive Income:
Net income
Total comprehensive income
Issuance of Class A preferred stock 1 1,000
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 1 1,000 -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income:
Net income
Total comprehensive income
Issuance of Class B preferred stock 400 400,000
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 1 1,000 400 400,000 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME:
NET INCOME
TOTAL COMPREHENSIVE INCOME
ISSUANCE OF CLASS C PREFERRED STOCK 2,000 50,000
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 1 $ 1,000 400 $400,000 2,000 $ 50,000
====================================================================================================================================
PREFERRED, CLASS D PREFERRED COMMON
--------------------------- -------------------- -----------------------
(in thousands of dollars, except per share data) SHARES STOCK SHARES STOCK SHARES STOCK
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 -- $ -- -- $ -- 1 $ 5,868,297
Comprehensive Income:
Net income
Total comprehensive income
Issuance of Class A preferred stock
Dividends declared on Class A preferred stock
($80 per share)
Dividends declared on common stock
Capital contribution in consideration
for the acquisition of loan participations, net 274,806
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 -- -- -- -- 1 6,143,103
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income:
Net income
Total comprehensive income
Issuance of Class B preferred stock
Dividends declared on Class A preferred stock
($80 per share)
Dividends declared on common stock
Capital contribution in consideration
for the acquisition of loan participations, net 198,614
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 -- -- -- -- 1 6,341,717
- ------------------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME:
NET INCOME
TOTAL COMPREHENSIVE INCOME
ISSUANCE OF CLASS C PREFERRED STOCK
ISSUANCE OF CLASS D PREFERRED STOCK 14,000 350,000
DIVIDENDS DECLARED ON CLASS A PREFERRED STOCK
($80 PER SHARE)
DIVIDENDS DECLARED ON CLASS B PREFERRED STOCK
($44.225 PER SHARE)
DIVIDENDS DECLARED ON CLASS C PREFERRED STOCK
($0.4265625 PER SHARE)
DIVIDENDS DECLARED ON CLASS D PREFERRED STOCK
($0.22885 PER SHARE)
DIVIDENDS DECLARED ON COMMON STOCK (1,118)
COMMON SHARES ISSUED IN 18,666.66667-TO-1 STOCK SPLIT 13,999
DISTRIBUTION OF PARTICIPATION INTERESTS IN FLORIDA LOANS (1,273,059)
CAPITAL CONTRIBUTION IN CONSIDERATION
FOR THE ACQUISITION OF LOAN PARTICIPATIONS, NET 14,971
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 14,000 $ 350,000 -- $ -- 14,000 $ 5,082,511
====================================================================================================================================
RETAINED
EARNINGS
(in thousands of dollars, except per share data) (DEFICIT) TOTAL
- ---------------------------------------------------------------------------------------
Balance, December 31, 1998 $ (924) $ 5,867,373
Comprehensive Income:
Net income 482,969 482,969
-----------
Total comprehensive income 482,969
-----------
Issuance of Class A preferred stock 1,000
Dividends declared on Class A preferred stock
($80 per share) (80) (80)
Dividends declared on common stock (413,760) (413,760)
Capital contribution in consideration
for the acquisition of loan participations, net 274,806
- ---------------------------------------------------------------------------------------
Balance, December 31, 1999 68,205 6,212,308
- ---------------------------------------------------------------------------------------
Comprehensive Income:
Net income 481,117 481,117
-----------
Total comprehensive income 481,117
-----------
Issuance of Class B preferred stock 400,000
Dividends declared on Class A preferred stock
($80 per share) (80) (80)
Dividends declared on common stock (458,335) (458,335)
Capital contribution in consideration
for the acquisition of loan participations, net 198,614
- ---------------------------------------------------------------------------------------
Balance, December 31, 2000 90,907 6,833,624
- ---------------------------------------------------------------------------------------
COMPREHENSIVE INCOME:
NET INCOME 468,972 468,972
-----------
TOTAL COMPREHENSIVE INCOME 468,972
-----------
ISSUANCE OF CLASS C PREFERRED STOCK 50,000
ISSUANCE OF CLASS D PREFERRED STOCK 350,000
DIVIDENDS DECLARED ON CLASS A PREFERRED STOCK
($80 PER SHARE) (80) (80)
DIVIDENDS DECLARED ON CLASS B PREFERRED STOCK
($44.225 PER SHARE) (17,690) (17,690)
DIVIDENDS DECLARED ON CLASS C PREFERRED STOCK
($0.4265625 PER SHARE) (853) (853)
DIVIDENDS DECLARED ON CLASS D PREFERRED STOCK
($0.22885 PER SHARE) (3,204) (3,204)
DIVIDENDS DECLARED ON COMMON STOCK (538,052) (539,170)
COMMON SHARES ISSUED IN 18,666.66667-TO-1 STOCK SPLIT --
DISTRIBUTION OF PARTICIPATION INTERESTS IN FLORIDA LOANS (1,273,059)
CAPITAL CONTRIBUTION IN CONSIDERATION
FOR THE ACQUISITION OF LOAN PARTICIPATIONS, NET 14,971
- ---------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 $ -- $ 5,883,511
=======================================================================================
F-4
See notes to consolidated financial statements.
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------------------------
(in thousands of dollars) 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $ 468,972 $ 481,117 $ 482,969
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 371 -- --
Depreciation expense 1,529 -- --
Increase in accrued interest and other assets (439,992) (456,704) (715,058)
Increase in due from/to Huntington
Preferred Capital Holdings, Inc. (57,690) (160,632) (955)
Increase in accounts payable and other
liabilities 31 -- --
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED FOR OPERATING ACTIVITIES (26,779) (136,219) (233,044)
- ------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Decrease (increase) in interest bearing deposits
in The Huntington National Bank 453,960 (751,801) (67,071)
Participation interests acquired (5,699,955) (6,747,027) (6,589,409)
Sales and repayments on loans underlying
participation interests 5,774,862 7,587,730 7,478,648
Purchase of premises and equipment (797) -- --
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 528,070 88,902 822,168
- ------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from issuance of Class A preferred
stock -- -- 1,000
Proceeds from issuance of Class B preferred
stock -- 400,000 --
Dividends paid on common stock (539,170) (458,335) (545,600)
Dividends paid on preferred stock (21,827) (80) (80)
Return of capital to Huntington
Bancshares Incorporated (1,697) -- --
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED FOR FINANCING ACTIVITIES (562,694) (58,415) (544,680)
- ------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND DUE FROM BANKS (61,403) (105,732) 44,444
CASH AND DUE FROM BANKS:
AT BEGINNING OF PERIOD 61,403 167,135 122,691
- ------------------------------------------------------------------------------------------------------------------------
AT END OF PERIOD $ -- $ 61,403 $ 167,135
========================================================================================================================
Supplemental information:
Net capital contributions from common
stockholder in the form of participation
interests in loans $ 14,971 $ 198,614 $ 274,806
Capital contributions from preferred
stockholders in the form of participation
interests in loans and leasehold improvements 400,000 -- --
Capital distribution to common stockholders
in the form of participation interests in loans (1,271,362) -- --
Income taxes paid -- -- --
Interest paid -- -- --
See notes to consolidated financial statements.
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Huntington Preferred Capital, Inc. (HPCI) is a real estate investment
trust (REIT) organized under Ohio law in 1992. HPCI is a subsidiary of
Huntington Preferred Capital Holdings, Inc. (Holdings), an Indiana corporation.
Holdings is a subsidiary of The Huntington National Bank (the Bank), a national
banking association organized under the laws of the United States and
headquartered in Columbus, Ohio. The Bank is a wholly owned subsidiary of
Huntington Bancshares Incorporated (Huntington). HPCI has one subsidiary, HPCLI,
Inc. (HPCLI), formed in March 2001 for the purpose of holding certain assets
(primarily leasehold improvements).
HPCI was initially formed to acquire, hold, and manage property acquired
by the Bank in foreclosure (Other Real Estate Owned or OREO property). All of
the OREO property was sold prior to May 1998 and HPCI has not held OREO property
since that time. In May 1998, HPCI began to acquire, hold, and manage
participation interests in mortgage assets and other authorized investments in a
manner so as to qualify as a REIT for federal income tax purposes under the
Internal Revenue Code of 1986, as amended. As a REIT, HPCI is generally not
subject to federal income tax on net income and capital gains that it
distributes to its shareholders.
Holdings has a loan participation agreement, as amended, with the Bank
that grants Holdings 99% participation interests in various commercial,
consumer, and mortgage loans identified from time to time by the Bank. HPCI has
a loan subparticipation agreement, as amended, with Holdings that grants a 100%
participation interests in Holdings' participation interests in those same
loans.
In January 1999, HPCI issued 1,000 Class A preferred securities, at a
liquidation preference of $1,000 per share. The Class A preferred securities are
non-voting and have a dividend rate of $80.00 per share per year. In December
2000, HPCI issued 400,000 Class B preferred securities, at a liquidation
preference of $1,000 per share. HPC Holdings-II, Inc., a non-bank subsidiary of
Huntington, owns all of the Class B preferred securities. The Class B preferred
securities have a variable dividend rate based on London Interbank Offered Rate
(LIBOR) which is determined quarterly.
In February 2001, Huntington purchased 18,667 common shares of HPCI from
Holdings (restated to reflect the April 2001 18,666.66667-for-1 stock split) for
approximately $8.4 million and one common share of Holdings from the Bank for
approximately $6.7 million. Huntington owns 0.1% and Holdings owns 99.9% of the
issued and outstanding common shares of HPCI.
2. ISSUANCE OF PREFERRED SECURITIES
In April 2001, HPCI created three new classes of preferred securities,
Class C and Class D preferred securities and blank check preferred securities.
HPCI issued the Class C and D preferred securities to Holdings and received
common equity in October 2001 in exchange for $452.6 million of participation
interests in performing and non-performing commercial loans, including
commercial real estate loans, and consumer loans, with $86.5 million of specific
loan loss reserves, $45.4 million of leasehold improvements, and $3.5 million of
accrued interest that Holdings had acquired from the Bank. The underlying
consumer loans included a combination of automobile, truck, and equipment loans.
The company transferred the leasehold improvements to HPCLI in exchange for its
common shares. Holdings then sold the Class C preferred securities to the public
in November 2001 for cash consideration of $25 per share. HPCI did not receive
any of Holdings' proceeds from the sale of the securities.
3. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The consolidated financial statements include the
accounts of HPCI and its subsidiary and are presented in conformity with
accounting principles generally accepted in the United States (GAAP). The
consolidated financial statements reflect all adjustments, consisting of normal
recurring accruals, which are, in the opinion of management, necessary for a
fair presentation of the consolidated financial position, the results of
operations, and cash flows for the periods presented. All significant
intercompany accounts and transactions have been eliminated in consolidation.
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The preparation of consolidated financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect amounts
reported in the financial statements. Actual results could differ from those
estimates.
LOAN PARTICIPATION INTERESTS: Participation interests in loans are
acquired from the Bank by Holdings at the Bank's carrying value, which is the
principal amount outstanding plus accrued interest, net of unearned income, if
any, less an allowance for loan losses. Similarly, participation interests in
loans are acquired from Holdings by HPCI at Holdings' carrying value.
Interest income is primarily accrued based on unpaid principal balances of
the underlying loans as earned. The underlying commercial and real estate loans
are placed on non-accrual status and stop accruing interest when collection of
principal or interest is in doubt. When interest accruals are suspended, accrued
interest income is reversed with current year accruals charged to earnings and
prior year amounts generally charged off as a credit loss. Consumer loans are
not placed on non-accrual status; rather they are charged off in accordance with
regulatory statutes governing the Bank. Consistent with these statutes, consumer
loans are charged off when the Bank, as servicer, determines that a loan is
doubtful of collection. Generally, this occurs when a loan is 120 days past due.
HPCI uses the cost recovery method in accounting for cash received on
non-accrual loans. Under this method, cash receipts are applied entirely against
principal until the loan has been collected in full, after which time any
additional cash receipts are recognized as interest income. When, in
management's judgment, the borrower's ability to make periodic interest and
principal payments resumes, the loan is returned to accrual status.
Net deferred loan fees and costs, when applicable, are amortized as an
adjustment of the related loan yields using the interest method.
ALLOWANCE FOR LOAN LOSSES: An allowance for loan losses (ALL) is
transferred to HPCI from the Bank through Holdings on seasoned loans underlying
the participations at the time the participations are acquired. The allowance
for loan losses reflects management's judgment as to the level considered
appropriate to absorb inherent losses in the loan participation portfolio. This
judgment is based on a review of individual loans underlying the participations,
historical loss experience of similar loans owned by the Bank, economic
conditions, portfolio trends, and other factors. When necessary, the allowance
for loan losses will be adjusted through a provision for loan losses charged to
earnings. Loan losses are charged against the allowance when management believes
the loan balance, or a portion thereof, is uncollectible. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses consists of an allocated portion and an
unallocated portion. The components of the allowance for loan losses represent
estimates developed pursuant to Statement of Financial Accounting Standard
(SFAS) No. 5, Accounting for Contingencies, and SFAS No. 114. The allocated
portion of the allowance for loan losses reflects expected losses resulting from
analyses developed through historical loss experience and specific credit
allocations at the individual loan level for commercial and commercial real
estate loan participations. The specific credit allocations are based on a
regular analysis of all underlying loans by credit rating. The historical loan
loss element is determined quantitatively using a loss migration analysis that
examines both the likelihood of default and the loss factor in event of default
by underlying loan category and internal credit rating. The loss migration
analysis is performed periodically and loss factors are updated regularly based
on actual experience. The allocated component of the allowance for loan losses
also includes management's determination of the amounts necessary for
concentrations and changes in portfolio mix and volume. The portion of the
allowance allocated to underlying homogeneous consumer loans is determined by
applying expected loss ratios to various segments of the loan portfolio giving
consideration to existing economic conditions and trends. The unallocated
portion of the allowance is determined based on management's assessment of
general economic conditions, as well as specific economic conditions in the
individual markets in which Huntington operates. This determination inherently
involves a higher degree of uncertainty and considers current risk factors that
may not have yet manifested themselves in HPCI's historical loss factors used to
determine the allocated portion of the allowance.
PREMISES AND EQUIPMENT: Premises and equipment, primarily leasehold
improvements, are stated at cost, less accumulated depreciation. Depreciation is
computed principally by the straight-line method over the estimated useful lives
of the related assets. Estimated useful lives employed are on average 30 years
for buildings, 10 to 20 years for building improvements, 10 years for land
improvements, 3 to 7 years for equipment, and 10 years for furniture and
fixtures.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EARNINGS PER SHARE: All of HPCI's common stock is owned by Huntington and
Holdings and therefore, earnings per common share information is not presented.
INCOME TAXES: HPCI has elected to be treated as a REIT for Federal income
tax purposes and intends to comply with the provisions of the Code. Accordingly,
HPCI will not be subject to Federal income tax to the extent it distributes its
earnings to stockholders and as long as certain asset, income and stock
ownership tests are met in accordance with the Code. As HPCI expects to maintain
its status as a REIT for Federal income tax purposes, only a provision for
income taxes is included in the accompanying financial statements for its
subsidiary's taxable income. HPCLI is a taxable REIT subsidiary for federal
income tax purposes.
STATEMENT OF CASH FLOWS: Cash and cash equivalents are defined as "Cash
and due from banks". There were no interest payments or Federal income tax
payments made in any year presented.
4. LOAN PARTICIPATION INTERESTS
At December 31, loan participation interests were comprised of the
following:
- -------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000
- -------------------------------------------------------------------------------------------------
Commercial $ 646,509 $ 614,956
Consumer 783,735 971,594
Residential real estate 270,671 355,571
Commercial real estate 3,678,061 3,894,527
- -------------------------------------------------------------------------------------------------
Total loan participations $5,378,976 $ 5,836,648
=================================================================================================
There are no underlying loans outstanding which would be considered a
concentration of lending in any particular industry, group of industries, or
business activity. Underlying loans are, however, concentrated in the four
states of Ohio, Michigan, Indiana, and Kentucky and comprise 95.6% of the
portfolio at December 31, 2001.
On July 12, 2001, Huntington announced a comprehensive strategic and
financial restructuring plan, which included divesting its Florida retail and
corporate banking businesses. On September 26, 2001, Huntington announced that
it has entered into an agreement to sell its Florida operations to SunTrust
Banks, Inc. On December 31, 2001, in anticipation of the eventual sale, HPCI
distributed participation interests in Florida-related loans to its common
shareholders, Holdings and Huntington. This distribution approximated $1.3
billion and consisted of cash and the net book value of participation interests
in loans, net of $18.6 million of ALL, which were included in the sale to
SunTrust, including the related accrued interest. This distribution represented
approximately 17% of HPCI's total assets as of December 31, 2001.
5. ALLOWANCE FOR LOAN LOSSES
A summary of the transactions in the allowance for loan losses follows for
each of the three years ended December 31:
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF YEAR $ 91,826 $ 104,151 $ 87,799
Allowance of loan participations acquired, net 113,291 (9,434) 25,988
Distribution of participations in Florida-related loans (18,604) --- ---
Net loan losses (22,194) (2,891) (9,636)
Provision for loan losses 371 --- ---
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF YEAR $ 164,690 $ 91,826 $ 104,151
================================================================================================================================
During October 2001, HPCI acquired participation interests in $452.6
million of performing and non-performing commercial and real estate loans from
Holdings, along with specific loan losses reserves of $86.5
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
million, $45.4 million of leasehold improvements, and $3.5 million of accrued
interest in exchange for its Class C and D preferred securities.
An underlying loan involved in a participation acquired by HPCI is
considered impaired when, based on current information and events, it is
determined that estimated cash flows are less than the cash flows estimated at
the date of purchase. A loan originated by the Bank is considered impaired when,
based on current information and events, it is probable that it will be unable
to collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower.
This includes the length of the delay, the reasons for the delay, the borrower's
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed. Loan impairment is measured on a loan-by-loan basis
by comparing the recorded investment in the loan to the present value of
expected future cash flows discounted at the loan's effective interest rate, the
loan's obtainable market price, or the fair value of the collateral if the loan
is collateral dependent. Loans totaling $197.6 million at December 31, 2001,
compared with $41.9 million at December 31, 2000, and $38.5 million at year-end
1999, which have been identified as impaired and were on nonaccrual status, have
been measured by the fair value of existing collateral. At December 31, 2001,
total participation interests in impaired loans was 3.7% of total loan
participations.
6. PREMISES AND EQUIPMENT
At December 31, 2001 and 2000, premises and equipment stated at cost were
comprised of the following:
- ----------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000
- ----------------------------------------------------------------------------------------------------------
Land and land improvements $ 365 $ --
Buildings 533 --
Leasehold improvements 110,967 --
- ----------------------------------------------------------------------------------------------------------
Total premises and equipment 111,865 --
Less accumulated depreciation and amortization 67,224 --
- ----------------------------------------------------------------------------------------------------------
NET PREMISES AND EQUIPMENT $ 44,641 $ --
==========================================================================================================
Depreciation expense charged to expense was:
TWELVE MONTHS ENDED
DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------------
Total depreciation of premises and equipment $ 1,529 $ -- $ ---
===========================================================================================================================
7. DIVIDENDS AND STOCK SPLIT
Holders of Class A preferred securities are entitled to receive, if, when
and as authorized and declared by the board of directors of HPCI out of funds
legally available, dividends at a rate of $80.00 per share per annum of the
initial liquidation preference ($1,000.00 per share). Dividends on the Class A
preferred securities, if authorized and declared, are payable annually in
December to holders of record on the respective record dates fixed for such
purpose by the board of directors in advance of payment. Dividends paid to the
holders of the Class A preferred securities totaled $80,000 in each of the years
ended December 31, 2001, 2000 and 1999.
The holder of the Class B preferred securities, HPC Holdings-II, Inc., is
entitled to receive dividends at a variable rate based on the three-month LIBOR
published on the first day of each calendar quarter. Dividends on the Class B
preferred securities are declared quarterly and payable annually and are
non-cumulative. The board of directors may declare dividends on Class B
preferred securities and may set apart funds for payment of dividends at the
time of declaration. Any dividend when and if declared by the board of directors
out of funds legally available
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
shall be payable annually on a date fixed by the board of directors. No
dividend, except payable in common shares, shall be declared or paid upon Class
B preferred securities unless dividend obligations are satisfied on the Class A
preferred securities. Dividends paid to the holder of the Class B preferred
securities totaled $17.7 million, or $44.225 per share, in the year ended
December 31, 2001.
For the Class C preferred securities issued October 15, 2001, dividends
are payable if, when, and as declared by the board of directors of HPCI. If
declared, dividends are payable quarterly in arrears. Dividends accrue in each
quarterly period from the first day of each period, whether or not dividends are
paid with respect to the preceding period. Dividends are not cumulative and if
no dividend is paid on the Class C preferred securities for a quarterly dividend
period, the payment of dividends (i) on HPCI's common stock and (ii) on other
HPCI-issued securities ranking junior to the Class C preferred securities will
be prohibited for that period and at least the following three quarterly
dividend periods. Dividends paid to the holders of the Class C preferred
securities totaled $853,000, or $0.4265625 per share, in the year ended December
31, 2001.
For the Class D preferred securities issued to Holdings on October 15,
2001, dividends are established at the beginning of each calendar quarter at a
variable rate equal to LIBOR plus 1.625%. Dividends on the Class D preferred
securities are paid quarterly in arrears when declared. Dividends are not
cumulative and if full dividends are not paid on the Class D preferred
securities for a quarterly dividend period, the payment of dividends on the
common shares or other shares ranking junior to the Class D preferred securities
will be prohibited for that period and at least the following three quarterly
dividend periods. Dividends paid to the holder of the Class D preferred
securities totaled $3.2 million, or $0.22885 per share, in the year ended
December 31, 2001.
For HPCI to meet its statutory requirement for a REIT to distribute 90% of
its taxable income to its shareholders, the holders of common shares received
dividends declared by the board of directors, subject to preferential dividend
rights of the outstanding preferred securities. Dividends on common stock
declared for each of the years ended December 31, 2001, 2000, and 1999, were
$539.2 million, $458.3 million, and $413.8 million, respectively.
In April 2001, the board of directors declared a 18,666.67-for-1 stock
split on its common stock outstanding. The result of the transaction increased
the number of authorized, issued, and outstanding common shares from 750 to 14
million.
8. RELATED PARTY TRANSACTIONS
HPCI holds a 100% subparticipation interest through an agreement with
Holdings and Holdings holds a 99% participation interest in loans originated by
the Bank and its subsidiaries. The participation and subparticipation interests
are in commercial, commercial mortgage, residential real estate, and consumer
loans secured by real property that were either directly underwritten by the
Bank and its subsidiaries or acquired by the Bank. HPCI expects to continue to
purchase such interests, net of ALL, in the future from Holdings. See note 4 for
the amount of the participations outstanding.
HPCI entered into servicing agreements with the Bank whereby the Bank
performs the servicing of the commercial, commercial mortgage, residential
mortgage, and consumer loans underlying the participations held by HPCI in
accordance with normal industry practice. The servicing fee the Bank charges is
0.125% per year of the outstanding principal balances of the commercial,
commercial mortgage, and consumer loans underlying the participation interests
and 0.282% per year of the interest income collected on the underlying
residential mortgages. Servicing fee expense paid to the Bank totaled $8.3
million for the year ended December 31, 2001, and $7.8 million for each of the
years ended December 31, 2000 and 1999. In its capacity as servicer, the Bank
collects and holds the commercial and mortgage loan payments received on behalf
of HPCI until the end of each month. At month end, the payments are transferred
to HPCI and accordingly, HPCI does not reflect any receivables for payments from
the Bank in the accompanying consolidated financial statements.
HPCI, Huntington, and the Bank share personnel to handle day-to-day
operations of the company such as accounting, financial analysis, tax reporting,
and other administrative functions. On a monthly basis, HPCI reimburses the Bank
and Huntington for the cost related to the time spent by employees for
performing these functions. The personnel costs were $162,000 for each of the
years ended December 31, 2001, 2000 and 1999.
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In February 2001, Huntington purchased 18,667 shares of the 14 million
outstanding common shares of HPCI from Holdings (after adjusting for the April
2001 18,666.67-for-1 stock split). For all previous periods presented in the
consolidated financial statements, Holdings was the owner of 100% of the
outstanding common stock of HPCI. Accordingly, Huntington received $719,000 in
common dividends in 2001 while Holdings received common dividends of $538.5
million for the twelve months ended December 31, 2001. Holdings received $458.3
million and $413.8 million for the years ended December 31, 2000 and 1999,
respectively.
Of the outstanding shares of Class A preferred securities, 88.9% are owned
by Holdings while present and past employees of Huntington and its subsidiaries
own 11.1%. The Class A preferred securities are non-voting and have a dividend
rate of $80.00 per share per year. All of the Class B preferred securities are
owned by HPC Holdings-II, Inc., a non-bank subsidiary of Huntington. The Class B
preferred securities have a variable dividend rate based on LIBOR, which is
determined quarterly. In 2001, the Class C preferred securities were sold to
Holdings, who sold them to the public. Various board members and executive
officers of HPCI purchased these shares in the open market. At December 31,
2001, a total of 3,700 shares, or 0.185%, were beneficially owned by the group
as a whole. Dividends on this class of stock are paid quarterly at a fixed rate
of 7.875%. All of the Class D preferred securities are owned by Holdings for
possible sale to the public in the future. The Class D preferred securities
have a variable dividend rate based on LIBOR plus 1.625% that is determined
quarterly. See note 7 for dividends paid on these preferred securities.
HPCI's premises and equipment were acquired from the Bank through
Holdings. Leasehold improvements were subsequently contributed to HPCLI for its
common shares. HPCLI charges rent to the Bank for use of applicable facilities
by the Bank. The amount of rental income received by HPCLI during 2001 was $1.6
million and is reflected as the only component of non-interest income in the
consolidated statements of income.
HPCI has a receivable due from Holdings amounting to $217.6 million and
$159.9 million at December 31, 2001 and 2000, respectively. These balances
represent unsettled cash transactions involving its participation interests that
occur in the ordinary course of business.
HPCI maintains and transacts all of its cash activity through a
non-interest bearing demand deposit account with the Bank. In addition, HPCI
invests available funds in Eurodollar deposits with the Bank for a term of not
more than 30 days, the following amounts were on deposit with the Bank:
- --------------------------------------------------------------------------------------
AT DECEMBER 31,
----------------------------------------
(in thousands of dollars) 2001 2000
- --------------------------------------------------------------------------------------
Non-interest bearing $ -- $ 61,403
Interest bearing 364,912 818,872
- --------------------------------------------------------------------------------------
Total $364,912 $880,275
======================================================================================
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by HPCI to estimate the
fair value of the classes of financial instruments:
Cash and due from The Huntington National Bank and interest bearing
deposits in The Huntington National Bank - The carrying value approximates the
fair value for cash and short-term investments.
Loan participation interests - Variable rate loans that reprice frequently
are based on carrying amounts, as adjusted for estimated credit losses. The fair
values for other loans are estimated using discounted cash flow analyses and
employ interest rates currently being offered for loans with similar terms. The
rates take into account the position of the yield curve, as well as an
adjustment for prepayment risk, operating costs, and profit. This value is also
reduced by an estimate of probable losses in the loan portfolio. Based upon the
calculations, the carrying values disclosed in the accompanying consolidated
financial statements approximate fair value.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of
operations for the years ended December 31, 2001 and 2000:
- --------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars) FIRST SECOND THIRD FOURTH
- --------------------------------------------------------------------------------------------------------------------------
2001
Net interest income $ 130,179 $ 120,374 $ 115,701 $ 111,484
Provision for loan losses -- 371 -- --
Non-interest income 14 14 15 1,603
Non-interest expense 2,031 2,156 2,102 3,726
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes 128,162 117,861 113,614 109,361
Income taxes -- -- -- 26
- --------------------------------------------------------------------------------------------------------------------------
Net income before preferred dividends 128,162 117,861 113,614 109,335
Dividends on preferred stock -- -- 15,090 6,737
- --------------------------------------------------------------------------------------------------------------------------
Net income applicable to common shareholders $ 128,162 $ 117,861 $ 98,524 $ 102,598
==========================================================================================================================
2000
Net interest income $ 116,668 $ 120,774 $ 125,779 $ 125,879
Provision for loan losses -- -- -- --
Non-interest income -- -- -- --
Non-interest expense 2,077 2,037 2,002 1,867
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes 114,591 118,737 123,777 124,012
Income taxes -- -- -- --
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Net income before preferred dividends 114,591 118,737 123,777 124,012
Dividends on preferred stock -- -- -- 80
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Net income applicable to common shareholders $ 114,591 $ 118,737 $ 123,777 $ 123,932
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11. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, there are various legal proceedings
pending against Huntington and its subsidiaries, including HPCI, Holdings and
the Bank. In the opinion of management, the aggregate liabilities, if any,
arising from such proceedings are not expected to have a material adverse effect
on HPCI's consolidated financial position.
The Bank is eligible to obtain advances from various federal agencies such
as the Federal Home Loan Bank (FHLB). In the future, HPCI may be asked to act as
co-borrower or guarantee the Bank's obligations under such advances and/or
pledge all or a portion of its assets in connection with those advances. Any
such borrowing, guarantee, or pledge would rank senior to HPCI's common and
preferred securities upon liquidation. At December 31, 2001, the Bank had $17.0
million in outstanding FHLB borrowings. At any one time, this line of credit and
advances are not to exceed $800 million in the aggregate from the FHLB. Although
HPCI may have up to 25% of its assets serve as collateral for such advances, to
date, HPCI has never acted as co-borrower or guarantor of any of the Bank's
obligations under such advances and has never pledged any assets. Any such
borrowing, guarantee, and/or pledge will not require HPCI to obtain the consent
of the holders of its common or preferred securities in order to complete the
Bank's transaction.
12. SEGMENT REPORTING
HPCI's operations consist of investing, monitoring, and evaluating its
participation interests. Accordingly, HPCI only operates in one segment. HPCI
has no external customers and transacts all of its business with the Bank
through Holdings.
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