SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004

or

oTransition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file Number 000-33243

Huntington Preferred Capital, Inc.

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)
(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. þ Yes o 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. o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

     All common stock is held by affiliates of the registrant as of December 31, 2004. As of February 28, 2005, 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 June 30, 2004: $0.00

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 2005 Annual Shareholders’ Meeting.

HUNTINGTON PREFERRED CAPITAL, INC.

INDEX

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Huntington Preferred Capital, Inc.

Part I

Item 1: Business

General

     Huntington Preferred Capital, Inc. (HPCI) was organized under Ohio law in 1992 and designated as a real estate investment trust (REIT) in 1998. HPCI’s common stock is owned by three related parties: HPC Holdings-III, Inc. (HPCH-III); Huntington Preferred Capital II, Inc. (HPCII); and Huntington Bancshares Incorporated (Huntington). HPCI and HPCII are subsidiaries of HPCH-III, which is a subsidiary of Huntington Preferred Capital Holdings, Inc. (Holdings). Holdings is a subsidiary of The Huntington National Bank (the Bank), a national bank association organized under the laws of the United States and headquartered in Columbus, Ohio. The Bank is a wholly owned subsidiary of Huntington, also headquartered in Columbus, Ohio. HPCI has one subsidiary, HPCLI, Inc. (HPCLI), a taxable REIT subsidiary formed in March 2001 for the purpose of holding certain assets (primarily leasehold improvements). The following chart outlines the relationship among affiliated entities at December 31, 2004:

Effective February 18, 2005, Huntington Preferred Capital Holdings, Inc. transferred 34% of the ownership of HPC Holdings-III, Inc. to Huntington Capital Financing LLC, an indirect subsidiary of the Bank.

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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 real estate loans and commercial real estate loans, including participation interests in residential or commercial real estate 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). As of December 31, 2004, 97.1% of HPCI’s assets were invested in REIT Qualified Assets and 2.9% were invested in commercial and consumer loans and other assets that were not REIT Qualified Assets. HPCI must satisfy other asset and income tests in order to remain qualified as a REIT. In addition, HPCI must satisfy other tests in order to maintain its exemption from the registration requirements of the Investment Company Act. Additional information regarding these tests is set forth in the “Qualification Tests” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report.

Commercial and Commercial Real Estate Loans

     HPCI owns participation interests in unsecured commercial loans and commercial loans secured by non-real property such as industrial equipment, livestock, furniture and fixtures, and inventory. Participation interests acquired in commercial real estate 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 real estate 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 estate property that must be leased at the time HPCI acquires a participation interest in a commercial or commercial real estate loan secured by such property nor are commercial loans required to have third party guarantees.

     The credit quality of a commercial or commercial real estate 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 real estate loans generally are subject to a number of complicating factors, including environmental considerations, which are not generally present in foreclosures of residential real estate loans.

     At December 31, 2004, $3.4 billion, or 89.6%, of the commercial and commercial real estate loans underlying HPCI’s participation interests in such loans were secured by a first mortgage or first lien and most bear variable or floating interest rates. The remaining balance is comprised of $0.3 billion of second, third, and fourth mortgages, and $0.1 billion of loans secured by non-real property.

Consumer Loans

     HPCI owns participation interests in consumer loans secured by automobiles, trucks, equipment, or a first or junior mortgage on the borrower’s primary residence. Many of these mortgage loans were made for reasons such as home improvements, acquisition of furniture and fixtures, or 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 Real Estate Loans

     HPCI owns participation interests in adjustable rate, fixed rate, conforming, and nonconforming residential real estate loans. Conforming residential real estate loans comply with the requirements for inclusion in a loan guarantee or purchase program sponsored by either the Federal Home Loan Mortgage Corporation (FHLMC) or Federal National Mortgage Association (FNMA). For 2005, the maximum principal balance allowed on conforming residential real estate loans ranges from $359,650 for one-unit residential loans to $691,600 for four-unit residential loans. Nonconforming residential real estate loans are residential real estate 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 real estate 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, or generally because they vary in

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certain other respects from the requirements of such programs other than the requirements relating to creditworthiness of the mortgagors.

     Each residential real estate 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 real estate 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 loans underlying HPCI’s loan participations at December 31, 2004:

Principal Balances

     The following table shows data with respect to the principal balance of the loans underlying HPCI’s loan participations at December 31, 2004:

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

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preferred securities in the foreseeable future because substantially all of HPCI’s real estate assets and other authorized investments are interest-bearing; all outstanding preferred securities represent, in the aggregate, only approximately 15.8% of HPCI’s capitalization; and 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. HPCI’s board has limited any such pledges to 25% of HPCI’s assets. In addition, HPCI expects its interest-earning assets will continue to exceed the liquidation preference of its preferred securities. For further discussion regarding co-borrower and guarantor obligations, see “Commitments and Contingencies” in the Notes to Financial Statements included in Part II, Item 8 of this report.

     Payment of dividends on the preferred securities could also be subject to regulatory limitations if the Bank fails to be “adequately capitalized” for purposes of regulations issued by The Office of the Comptroller of the Currency (OCC). 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. This could trigger a tax event which would give HPCI the right to redeem the Class C and Class D preferred securities as more described in the business section of this report. Capital ratios for the Bank as of December 31, 2004 and 2003 are as follows:

Conflict of Interests and Related Policies

     As of December 31, 2004, the Bank continued to control 98.6% of the voting power of HPCI’s outstanding securities. Accordingly, the Bank expects to 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 of Huntington or the Bank. Because of the nature of HPCI’s relationship with Holdings, HPCII, HPCH-III, 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 material agreements among HPCI, Holdings, the Bank, and their respective affiliates. HPCI’s independent directors have approved an agreement with the Bank with respect to the pledge of HPCI’s assets to collaterize the Bank’s borrowings from the Federal Home Loan Bank (FHLB) as more described in the business risk section of this report.

     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 financial interest in any asset to be acquired or 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

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time for comparable transactions with others and would not involve more than the normal risk of collectibility or present other unfavorable features. At December 31, 2004, there were no direct or indirect financial interests in any asset of HPCI by any of its officers or directors.

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 has 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 the loans underlying HPCI’s participation interests were originated 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 that 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 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

     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,
	•	are in accruing status,
	•	are not made to related parties of HPCI, Huntington, or the Bank,
	•	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 real estate 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. Although currently there is no intention to acquire any mortgage-backed securities representing interests in or

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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, 2004, 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 policy is not to acquire any participation interest in any commercial real estate loan that constitutes more than 5.0% of the total book value of HPCI’s real estate assets at the time of acquisition. In addition, HPCI’s policy prohibits the retention 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 policy is to reinvest the proceeds of its assets in other interest-earning assets such that its Funds from Operations (FFO), which represents cash flows from operations, 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. For each of the years ended December 31, 2004, 2003, and 2002, HPCI’s FFO were $273.6 million, $288.2 million, and $636.9 million, respectively. These significantly exceeded the minimum requirement, as full dividends on Class A, Class C, and Class D securities at 150% were $22.3 million, $21.0 million, and $24.2 million, for the same periods, respectively. 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 real estate 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 expected 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 real estate 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. Unless otherwise approved by its board of directors, 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 Securities and Exchange Commission, in order to qualify for this exemption, HPCI 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, which it monitors monthly, of limiting authorized investments that are not Qualifying Interests to no more than 20% of the value of its total assets.

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     HPCI is not prohibited by its Articles of Incorporation from repurchasing its capital securities; however, 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 distributes 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 accounting principles in the United States 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 five taxable years following the year of such revocation.

Employees

     At December 31, 2004, HPCI has five executive officers and two additional officers, but no 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 financial 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 (i) the participation agreement between the Bank and HPCI, (ii) the participation agreement between the Bank and Holdings and the subparticipation agreement between Holdings and HPCI, or (iii) the participation agreement between the Bank and Holdings and the subparticipation agreements between Holdings and HPC Holdings-III, Inc. and HPC Holdings-III, Inc. and HPCI.

     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. The Bank may, in accordance with HPCI’s guidelines, dispose of any loans that become classified, are 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, in accordance with HPCI’s guidelines, 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 mortgaged property underlying a real estate loan by operation of law or otherwise in accordance with the terms of the participation and subparticipation agreements.

     Under the participation and subparticipation agreements, the Bank has the right, in the exercise of its reasonable discretion and in accordance with prudent banking practices, 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, that the Bank shall not grant or agree to any (i) waiver of any payment default, (ii) extension of the maturity, (iii) reduction of the rate or rates of interest with respect to the loans, (iv) forgiveness or reduction of the principal sum of the loans, (v) increase the

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lending formula or advance rates, (vi) waiver of any right to elect to foreclose on any loan in default, or (vii) amendment or modification of the financial covenants contained in the loan documents that would make such financial covenants less restrictive with respect to any of the borrowers without the prior written consent of Holdings or HPCI, except that the Bank shall be permitted to grant or agree to any of such consents, waivers, or modifications pursuant to and in accordance with guidelines and limitations provided by Holdings or HPCI to the Bank in writing from time to time.

     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, HPC Holdings-III, Inc., Holdings, and the Bank, it is not anticipated that these agreements will be terminated by any party in the foreseeable future.

     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, HPC Holdings-III, Inc., 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 may be used as a guideline to determine fair compensation for services rendered. The servicing fee is determined by the mutual agreement of the parties from time to time during the term of the agreement and is subject to review and adjustment during the term of the participation agreement. Additional information regarding the servicing fee rates are set forth under the caption “Non-Interest Income and Non-Interest Expense” of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report.

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. Internet banking also competes with Huntington’s business. 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

     HPCI is subject to a number of risks, many of which are outside of Management’s control, though Management strives to manage those risks while optimizing returns. In addition to the other information included in this report, readers should carefully consider that the following important factors, among others, could materially impact HPCI’s business, future results of operations, and future cash flows.

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     HPCI relies on the Bank’s credit underwriting standards and on-going process of credit assessment; there can be no assurance that the Bank’s standards and assessments will protect HPCI from significant credit losses on loans underlying its participation interests.

     To date, HPCI has purchased, and intends to continue to purchase, all of its participation interests in loans originated by or through the Bank and its affiliates. After HPCI purchases the participation interests, the Bank continues to service the underlying loans. Accordingly, in managing its credit risk, HPCI relies on the Bank’s credit underwriting standards and on-going process of credit assessment. The Bank’s exposure to credit risk is managed through the use of consistent underwriting standards that emphasize “in-market” lending while avoiding highly leveraged transactions as well as excessive industry and other concentrations. The Bank’s credit administration function employs risk management techniques to ensure that underlying loans adhere to corporate policy and problem loans underlying HPCI’s participation interests are promptly identified. There can be no assurance that the Bank’s credit underwriting standards and its on-going process of credit assessment will protect HPCI from significant credit losses on loans underlying its participation interests.

     The loans underlying HPCI’s participation interests are concentrated in Ohio, Indiana, Kentucky, and Michigan, and adverse conditions in those states, in particular, could negatively impact result of operations and ability to pay dividends.

     At December 31, 2004, 96.6% 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. In the event of any adverse development or natural disaster, HPCI’s results of operations and ability to pay dividends on preferred and common securities could be adversely affected.

     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 HPCI’s 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.

     HPCI’s concentration in participation interests in commercial real estate loans is subject to certain risks inherent in the underlying commercial real estate assets.

     At December 31, 2004, 65.9% of HPCI’s assets, as measured by aggregate outstanding principal amount, consisted of participation interests in commercial real estate loans. Commercial real estate loans generally tend to have shorter maturities than residential real estate loans and may not be fully amortizing, meaning 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 real estate loans.

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     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.

     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 are entitled to priority in payment over the claims of holders of equity interests such as the Bank preferred securities, 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 have the right to examine HPCI and its activities and, under certain circumstances, 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 affect 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. The payment of dividends on the preferred securities could also be subject to regulatory limitations if the Bank becomes “under-capitalized” for purpose of regulations issued by the OCC, as described in this report under the heading “Dividend Policy and Restrictions”.

     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, HPCII, HPCH-III, 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.

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     Dividends are not cumulative; 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 and the Bank maintain internal operational controls. If HPCI’s and/or the Bank’s systems of internal controls should fail to work as expected, if their systems were to be used in an unauthorized manner, or if employees were to subvert the systems of internal controls, significant losses to HPCI could occur.

     HPCI, through the Bank, establishes and maintains systems of internal operational controls that provide Management with timely and accurate information about its level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. The Bank and HPCI have also established procedures that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. From time to time, HPCI experiences losses from operational risk, including the effects of operational errors.

     While Management continually monitors and improves their systems of internal controls, data processing systems, and corporate-wide processes and procedures, there can be no assurance that HPCI will not suffer such losses in the future.

     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. As of December 31, 2004, all of its officers and six of its nine directors are also officers or directors of the Bank and /or its affiliates. Officers that are common with the Bank devote less than a majority 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, HPCII, HPCH-III, and HPCI.

     The Bank administers HPCI’s day-to-day activities under the terms of participation and subparticipation agreements. The parties to these agreements are all affiliated and, 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 agreements requires the approval of a majority of independent directors, the Bank, through its ownership of Holdings’ and HPCH-III’s common stock and Holdings’ and HPCH-III’s ownership of HPCI’s common stock, controls the election of all of the directors, including independent directors. Therefore, HPCI cannot assure shareholders modifications to the participation and subparticipation agreements 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 direct and indirect ownership of HPCH-III’s and HPCII’s common stock and their ownership 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.

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     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. HPCI anticipates that it will continue to acquire all or substantially all of its assets from the Bank or its affiliates for the foreseeable future. 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 has 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. HPCI paid servicing fees of $9.9 million in 2004, $7.6 million in 2003, and $6.7 million in 2002.

     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 and government-sponsored agencies, such as the Federal Home Loan Bank (FHLB). Any such agency that makes advances to the Bank where HPCI has acted as a 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. HPCI is not required to obtain the consent of its shareholders in order to make such a pledge or act as co-borrower or guarantor.

     Currently, HPCI’s assets have been used to secure only one such facility. The Bank has obtained a line of credit from the FHLB, which line was capped by the Bank’s holdings of FHLB stock at $1.5 billion as December 31, 2004. As of that same date, the Bank had borrowings of $1.3 billion under the facility. HPCI has entered into an agreement with the Bank with respect to the pledge of HPCI’s assets to collateralize the Bank’s borrowings from the FHLB. The agreement provides that the Bank will not place at risk HPCI’s assets in excess of an aggregate amount or percentage of such assets established from time to time by HPCI’s board of directors, including a majority of HPCI’s independent directors. Prior to October 31, 2004, the aggregate FHLB advance limit established by HPCI’s board was $1.0 billion. Effective as of October 31, 2004, the limit was adjusted to 25% of total assets, or $1.4 billion as of December 31, 2004, as reflected in the Corporation’s month-end management report for the previous month. This limit may be changed in the future by the board of directors, including a majority of HPCI’s independent directors. As of December 31, 2004, HPCI’s total loans pledged were limited to one-to-four family residential mortgage portfolio and consumer second mortgage loans, which aggregated to $1.0 billion as of that same date. 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, standards, policies, and interpretations could significantly impact strategic initiatives, results of operations, cash flows, financial condition, and ability to pay dividends.

     Future governmental regulations could impose significant additional limitations on HPCI’s operations. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which companies conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on HPCI, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, Public Company Accounting Oversight Board, and various taxing authorities to respond by adopting

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and/or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. 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, 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 and the Bank’s infrastructure, including their equipment and facilities. Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking or viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of Huntington’s or the Bank’s control could have a material adverse impact on the financial services industry as a whole and on HPCI’s business, results of operations, cash flows, financial condition, and ability to pay dividends in particular. To mitigate this risk, Huntington has established a business recovery plan.

     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 and fees on loans underlying its participation interests. At December 31, 2004, 26.9% 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 associated with increases 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 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.

     HPCI’s financial statements must conform to accounting principles generally accepted in the United States (GAAP), which require Management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from those estimates.

     The preparation of financial statements in conformity with GAAP requires Management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates were used or if estimates changed from period to period. HPCI’s financial statements include estimates related to the allowance for loan loss reserves and accruals of income and expenses. These estimates are based on information available to Management 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.

     For further discussion, see “Critical Accounting Policies and Use of Significant Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report.

     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

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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 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 five 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, 2004, 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 of servicer, the Bank may be forced to foreclose on a defaulted commercial mortgage and/or residential mortgage loan underlying HPCI participation interest to recover HPCI’s 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.

     HPCI may redeem the Class C and Class D preferred securities upon the occurrence of certain special events and holders of such securities may receive a redemption amount that is less than the then current market price for the securities.

     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;

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	•	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).

     In the event HPCI redeems its Class C or Class D preferred securities, holders of such securities will be entitled to receive $25.00 per share plus accrued and unpaid dividends on such shares. The redemption amount may be significantly lower than the then current market price of the Class C preferred securities.

Formal Regulatory Supervisory Agreements

     On March 1, 2005, Huntington announced that it had entered into formal written agreements with its banking regulators, the Federal Reserve Bank of Cleveland (FRBC) and the Office of the Comptroller of the Currency (OCC), providing for a comprehensive action plan designed to enhance its corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. They call for independent third-party reviews, as well as the submission of written plans and progress reports by Huntington’s management. These written agreements remain in effect until terminated by the banking regulators.

     Huntington’s management has been working with its banking regulators over the past several months and has been taking actions and devoting significant resources to address all of the issues raised. Huntington’s management believes that the changes that it has already made, and is in the process of making, will address these issues fully and comprehensively. No assurances, however, can be provided as to the ultimate timing or outcome of these matters, including any effects on HPCI.

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.

Part II

Item 5: Market for Registrant’s Common Equity and Related Shareholder Matters

     There is no established public trading market for HPCI’s common stock. As of February 28, 2005, there were three common shareholders of record, all of which are affiliates of the Bank. During 2004, 2003, and 2002, dividends of $263.8 million, $289.6 million and $382.8 million were paid to common shareholders, respectively. These dividends were either accrued or paid by the last business day in each year.

     Information regarding restrictions on dividends, as required by this item, is set forth in Item 1 “Dividend Policy and Restrictions”.

     HPCI did not sell any unregistered equity securities during the year ended December 31, 2004. Neither HPCI nor any “affiliated purchaser” (as defined by Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) repurchased any equity securities of HPCI in any month within the fourth quarter ended December 31, 2004.

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Item 6: Selected Financial Data

     The table below represents selected financial data relative to HPCI as of and for the years ended December 31, 2004, 2003, 2002, 2001, and 2000.

N.M., Not a meaningful value.

     All of HPCI’s common stock is owned by Huntington, HPCII, and HPCH-III and, therefore, net income per common share information is not presented. At the end of all years presented, HPCI did not have any interest-bearing liabilities and, therefore, no liabilities are presented under this item.

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Item 7: Managements’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

     Huntington Preferred Capital, Inc. (HPCI) is an Ohio corporation operating as a real estate investment trust (REIT) for federal income tax purposes. 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.

     HPCI is a party to the Second Amended and Restated Loan Subparticipation Agreement with Holdings, an Amended and Restated Loan Subparticipation Agreement with HPCH-III, and an Amended and Restated Loan Participation Agreement with the Bank. The Bank is required, under the participation and/or subparticipation agreements, to service HPCI’s loan portfolio in a manner substantially the same as for similar work 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. In addition, the Bank 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. All of these participation interests to date were acquired directly or indirectly 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. These include descriptions of products or services, plans, or objectives of Management for future operations, and forecasts of its revenues, earnings, cash flows, 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 could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are 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 (SEC).

     Management encourages readers of this report to understand forward-looking statements to be strategic objectives rather than absolute forecasts of future performance. 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 were made or to reflect the occurrence of unanticipated events.

Formal Regulatory Supervisory Agreements

     On March 1, 2005, Huntington announced that it had entered into formal written agreements with its banking regulators, the Federal Reserve Bank of Cleveland (FRBC) and the Office of the Comptroller of the Currency (OCC), providing for a comprehensive action plan designed to enhance its corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. They call for independent third-party reviews, as well as the submission of written plans and progress reports by Huntington’s management. These written agreements remain in effect until terminated by the banking regulators.

     Huntington’s management has been working with its banking regulators over the past several months and has been taking actions and devoting significant resources to address all of the issues raised. Huntington’s management believes that the changes that it has already made, and is in the process of making, will address these issues fully and comprehensively. No assurances, however, can be provided as to the ultimate timing or outcome of these matters, including any effects on HPCI.

Critical Accounting Policies and Use of Significant Estimates

     HPCI’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with GAAP requires Management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded

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and reported in its financial statements. Note 1 to the consolidated financial statements included in this report lists significant accounting policies used by Management in the development and presentation of HPCI’s 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 the organization and its financial position, results of operations, and cash flows.

     An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this report should understand that estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. Management has identified the allowances for credit losses (ACL) as the most significant accounting estimate. At December 31, 2004, the ACL was $64.9 million and represented the sum of the allowance for loan losses (ALL) and allowance for unfunded loan participation commitments (AULPC). The ACL represents Management’s estimate as to the level of allowances considered appropriate to absorb probable inherent credit losses in the loan participation portfolio, as well as unfunded loan participation commitments. Many factors affect the ACL, some quantitative, some subjective. Management believes the process for determining the ACL considers the potential factors that could result in credit losses. However, the process includes judgment and quantitative elements that may be subject to significant change. To the extent actual outcomes differ from Management estimates, additional provision for credit losses could be required, which could adversely affect earnings or financial performance in future periods. At December 31, 2004, the ACL as a percent of total loan participation commitments was 1.33%. Based on the December 31, 2004 balance sheet, a 10 basis point increase in this ratio to 1.43% would require $4.9 million in additional provision for credit losses, and would also negatively impact 2004 net income by approximately $4.9 million. A discussion about the process used to estimate the ACL is presented in the Credit Risk section of Management’s Discussion and Analysis in this report.

Summary Discussion of Results

     HPCI’s income is primarily derived from its participation in loans acquired from the Bank and Holdings. Income varies based on the level of these assets and their respective 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 before preferred dividends of $284.5 million for 2004, $308.5 million for 2003, and $341.4 million for 2002. Net income available to common shares was $263.8 million, $289.6 million, and $317.6 million for the same respective periods. Return on average assets (ROA) was 5.1 5% for 2004, 5.46% for 2003, and 5.64% for 2002. Return on average equity (ROE) was 5.18% for 2004, 5.47% for 2003, and 5.65% for 2002.

     HPCI had total assets of $5.7 billion at December 31, 2004, a slight increase compared to the December 31, 2003 balance of $5.4 billion, primarily related to larger cash balances due to timing of the common dividend payment and capital distribution. At December 31, 2004 and 2003, an aggregate of $4.9 billion and $5.3 billion, respectively, consisted of participation interests in loans.

     The following table shows the composition of HPCI’s gross participation interests in loans at the end of the most recent five years.

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     HPCI’s participation interests in commercial loans represented 1.9% and 2.7% of total assets as of December 31, 2004 and 2003, respectively. The decrease was due to continued portfolio run off and asset sales in June 2004 of approximately $21.8 million. This decline was partially offset by the reclassification of commercial real estate loan participation interests to commercial loan participation interests of $55.9 million during September 2004 and $62.6 million in February 2004. These reclassifications were made to better reflect the loan participation interests based on the collateral underlying the loan. Participation interests in commercial real estate loans at December 31, 2004, which represented 65.9% of total assets, decreased compared to the same period last year primarily due to run off, reclassifications, and decreased new loan purchases during the second and third quarters of 2004. Consumer loan participation interests, which include any loan secured by an automobile, truck, equipment, or a first or junior mortgage on the borrower’s primary residence, were 14.4% of total assets at December 31, 2004, compared to 11.5% of total assets for the same date in 2003. This increase was due to purchases of consumer home equity loan participations and the $6.1 million reclassification from commercial real estate participations to consumer loan participations in September 2004. Residential real estate loan participation interests represented 4.0% and 5.3% of total assets as of December 31, 2004 and 2003, respectively. The balance decline of $63.3 million was related to portfolio run off as there were no additional loan purchases in 2004.

     Prior to July 1, 2003, HPCI did not defer origination fees and recognized the amounts in the period of origination. HPCI began to defer origination fees prospectively for all loans purchased after June 30, 2003. If HPCI had previously deferred these fees, the impacts on the prior period financial statements presented in this document would have been immaterial. Additionally, the decision to prospectively defer these fees will not materially impact HPCI’s future results of operations and will have no impact on its ability to pay operating expenses and dividends. HPCI incurs no direct loan origination costs. In lieu of paying higher servicing fees to the Bank with respect to commercial and commercial real estate loans, HPCI waived its right to receive any origination fees associated with participation interests in commercial and commercial real estate loans transferred on or after July 1, 2004, until such time as loan servicing fees are reviewed in 2005.

     Interest-bearing and non-interest bearing cash balances on deposit with the Bank totaled $800.3 million and $124.1 million at December 31, 2004 and 2003, respectively. The increased cash balances reflect accumulation of cash for common share dividend and capital distributions for 2004 that were paid on January 3, 2005. Typically, cash is invested with the Bank in an interest-bearing account. These interest-bearing balances are invested overnight or may be invested in Eurodollar deposits with the Bank for a term of not more than 30 days at market rates.

     At December 31, 2004 and 2003, amounts due from affiliates and the Bank were $175 thousand, and $13.7 million, respectively. The decline was related to a payment of accrued rents due between the Bank and HPCLI during the second quarter of 2004. Total liabilities were $603.8 million at December 31, 2004, which were primarily due to accrued dividends payable on common stock.

     Shareholders’ equity was $5.1 billion at December 31, 2004, compared to the December 31, 2003 balance of $5.4 billion. This decline reflected the aggregate dividend payments on the common and preferred securities and the return of capital to HPCI’s common shareholders during the recent year partially offset by the $284.5 million of net income in 2004.

QUALIFICATION TESTS

     Qualification as a REIT involves application of specific provisions of the Internal Revenue Code relating to various asset tests. A REIT must satisfy six asset tests quarterly: (1) 75% of the value of the REIT’s total assets must consist of real estate assets, cash and cash items, and government securities; (2) not more than 25% of the value of the REIT’s total assets may consist of securities, other than those includible under the 75% test; (3) not more than 5% of the value of its total assets may consist of securities of any one issuer, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (4) not more than 10% of the outstanding voting power of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (5) not more than 10% of the total value of the outstanding securities of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; and (6) a REIT cannot own securities in one or more taxable REIT subsidiaries which comprise more than 20% of its total assets. At December 31, 2004, HPCI met all of the quarterly asset tests.

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     Also, a REIT must annually satisfy two gross income tests: (1) 75% of its gross income must be from qualifying income closely connected with real estate activities; and (2) 95% of its gross income must be derived from sources qualifying for the 75% test plus dividends, interest, and gains from the sale of securities. In addition, a REIT must distribute 90% of the REIT’s taxable income for the taxable year, excluding any net capital gains, to maintain its non-taxable status for federal income tax purposes. For the tax year 2004, HPCI met all annual income and distribution tests.

     HPCI operates in a manner that will not cause it to be deemed an investment company under the Investment Company Act. The Investment Company Act exempts from registration as an investment company an entity that is primarily engaged in the business of “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate” (Qualifying Interests). Under positions taken by the SEC staff in no-action letters, in order to qualify for this exemption, HPCI must invest at least 55% of its assets in Qualifying Interests and an additional 25% of its assets in real estate-related assets, although this percentage may be reduced to the extent that more than 55% of its assets are invested in Qualifying Interests. The assets in which HPCI may invest under the Internal Revenue Code therefore may be further limited by the provisions of the Investment Company Act and positions taken by the SEC staff. At December 31, 2004, HPCI was exempt from registration as an investment company under the Investment Company Act and intends to operate its business in a manner that will maintain this exemption.

RESULTS OF OPERATIONS

Interest and Fee Income

     HPCI’s primary source of revenue is the interest and fee income on its participation interests in loans. At December 31, 2004 and 2003, HPCI did not have any interest-bearing liabilities or related interest expense. Interest income is impacted by changes in the levels of interest rates and earning assets. The yield on earning assets is the percentage of interest income to average earning assets.

     The table below shows HPCI’s average annual balances, interest and fee income, and yields for the twelve-month periods ending December 31:

Table 6 - Interest and Fee Income

     Interest and fee income for the twelve months ended December 31, 2004 and 2003 was $262.2 million and $274.4 million, respectively. The decline in interest and fee income was related to lower commercial and commercial real estate average loan participation balances, partially offset by higher interest income on variable rate loans in the last two quarters of 2004. For the twelve-months ended December 31, 2004 and 2003, the yield declined from 4.77% to 4.74%, while average participation balances slightly increased by $6.6 million. The tables above include interest received on participations in loans that are on a non-accrual status in the individual portfolios.

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The Provision (Reduction) in Allowance for Credit Losses

     The provision (reduction) in allowance for credit losses is the charge (or credit) to earnings necessary to maintain the ACL at a level adequate to absorb Management’s estimate of inherent probable losses in the loan portfolio. The reduction in allowance for credit losses was a credit of $31.6 million for 2004, versus a credit of $41.2 million and $0.2 million for 2003 and 2002, respectively. The continued reduction in the allowance was indicative of lower charge-offs, and lower non-performing asset (NPA) balances at December 31, 2004.

Non-Interest Income and Non-Interest Expense

     Non-interest income was $7.2 million, $6.9 million, and $6.8 million in 2004, 2003, and 2002, respectively. This income primarily represents rental income received from the Bank related to leasehold improvements owned by HPCLI. Also, non-interest income includes fees from the Bank for use of HPCI’s assets as collateral for the Bank’s advances from the Federal Home Loan Bank (FHLB). These fees totaled $0.7 million, $0.7 million, and $0.6 million in 2004, 2003, and 2002, respectively. See note 10 to the consolidated financial statements included in this report for more information regarding use of HPCI’s assets as collateral for the Bank’s advances from the FHLB.

     Non-interest expense was $16.3 million, $13.9 million, and $13.3 million in 2004, 2003, and 2002, respectively. The predominant components of HPCI’s non-interest expense are the fees paid to the Bank for servicing the loans underlying the participation interests and depreciation and amortization on its premises and equipment. The servicing costs for the twelve-month period ended December 31, 2004, 2003 and 2002 totaled $9.9 million, $7.6 million, and $6.7 million, respectively. The increases were due to higher service fee rates on loan participation balances. Depreciation and amortization expenses totaled $5.3 million, $5.5 million, and $5.8 million for the years ended December 31, 2004, 2003, and 2002, respectively.

     As of July 1, 2004, the annual servicing rates the Bank charged with respect to outstanding principal balances were:

	•	0.125% of the underlying commercial and commercial real estate loans,
	•	0.750% of the underlying consumer loans, and
	•	0.267% of the underlying residential real estate loans.

     Annual servicing rates the Bank charged for the periods prior to July 1, 2004, were:

	•	0.125% of the underlying commercial and commercial real estate loans,
	•	0.320% of the underlying consumer loans, and
	•	0.2997% of the underlying residential real estate loans.

     Pursuant to the existing participation and subparticipation agreements, the amount and terms of the loan-servicing fee between the Bank and HPCI are determined by mutual agreement from time to time during the terms of the agreements. Effective July 1, 2004, in lieu of paying higher servicing costs to the Bank with respect to commercial and commercial real estate loans, HPCI waived its right to receive any origination fees associated with participation interests in commercial and commercial real estate loans transferred on or after July 1, 2004, until such time as loan servicing fees are reviewed in 2005.

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 Internal Revenue 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 separate provision related to its income taxes is included in the accompanying consolidated financial statements.

MARKET RISK

     Interest rate risk is the primary market risk to which HPCI has exposure. If there is a decline in market interest rates, HPCI may experience a reduction in interest income on its participation interests and a corresponding decrease in funds available to be distributed to shareholders. Assuming a gradual decline in market interest rates by 100 basis points

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over the next 12 months, interest income would be expected to decline by roughly 4.1%. Huntington conducts its interest rate risk management on a centralized basis and does not manage HPCI’s interest rate risk separately.

     A key element used in Huntington’s interest rate risk management is an income simulation model, which includes, among other things, assumptions for loan prepayments on the existing portfolio and new loan volumes. Using that model for HPCI as of December 31, 2004, and assuming no new loan participation volumes, interest income for the next 12 month period would be expected to increase by 8.1% based on a gradual 200 basis point increase in rates above the forward rates implied in the December 31, 2004 yield curve. Interest income would be expected to decline 8.2% in the event of a gradual 200 basis point decline in rates from the forward rates implied in the December yield curve. As of December 31, 2004, approximately 73% of the loan participation portfolio had variable rates.

     The following table shows data with respect to interest rates of the loans underlying HPCI’s loan participations at December 31, 2004 and 2003, respectively.

Table 7 - Total Loan Participation Interests by Interest Rates

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CREDIT QUALITY

Credit Risk

     Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. Credit risk is mitigated through a combination of credit policies and processes and portfolio diversification. These include loan origination/underwriting criteria, portfolio monitoring processes, and effective problem asset management.

     HPCI’s exposure to credit risk is managed by personnel of the Bank through this credit risk management process. Based upon an assessment of the credit risk inherent in HPCI’s portfolio of loan participation interests, an ALL is transferred from the Bank to HPCI on loans underlying the participations at the time the participations are acquired.

     The maximum level of credit exposure to individual commercial borrowers is limited by policy guidelines based on the default probabilities associated with the credit facilities extended to each borrower or related group of borrowers. All authority to grant commitments is delegated through the Bank’s independent credit administration function, and is monitored and regularly updated in a centralized database.

     Concentration risk is managed with limits on loan type, geographic and industry diversification, country limits, and loan quality factors. The checks and balances in the credit process and the independence of the credit administration and risk management functions are designed to minimize problems and to facilitate the early recognition of problems when they do occur.

     The following table provides delinquency information for the loans underlying HPCI’s loan participations at December 31, 2004.

Table 8 - Loan Participation Interests Delinquencies

Commercial Credit

     Commercial credit approvals are made by the Bank and are based on, among other factors, the financial strength of the borrower, assessment of the borrower’s management, industry sector trends, type of exposure, transaction structure, and the general economic outlook. There are two processes for approving credit risk exposures. The first involves a centralized loan approval process for the standard products and structures utilized in small business lending, where individual credit authority is granted to certain individuals on a regional basis to preserve the Company’s local decision-making focus. The second, and more prevalent approach, involves individual approval of exposures. These approvals are consistent with the authority delegated to officers located in the geographic regions who are experienced in the industries and loan structures over which they have responsibility.

     All commercial (C&I) and commercial real estate (CRE) credit extensions are assigned internal risk ratings reflecting the borrower’s probability-of-default and loss-in-event-of-default. This two dimensional rating methodology, which has 192 individual loan grades, was implemented in 2003 and has provided improved granularity in the portfolio management process. The probability-of-default is rated on a scale of 1-12 and is applied at the borrower level. The

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loss-in-event-of-default is rated on a 1-16 scale and is associated with each individual credit exposure based on the type of credit extension and the underlying collateral.

     In commercial lending, ongoing credit management is dependent on the type and nature of the loan. In general, quarterly monitoring is normal for all significant exposures. The internal risk ratings are revised and updated with each periodic monitoring event. There is also extensive macro portfolio management analysis on an ongoing basis to continually update default probabilities and to estimate future losses.

     In addition to the initial credit analysis initiated by the portfolio manager during the underwriting process, the loan review group performs independent credit reviews. The loan review group reviews individual loans and credit processes and conducts a portfolio review at each of the regions on a regular basis.

     Borrower exposures may be designated as “watch list” accounts when warranted by individual company performance, or by industry and environmental factors. Such accounts are subjected to additional quarterly reviews by the business line management, the loan review group, and credit administration in order to adequately assess the borrower’s credit status and to take appropriate action.

     The Bank has also established a specialized credit workout group to manage problem credits. The group handles commercial recoveries, workouts, and problem loan sales, as well as the day-to-day management of relationships rated substandard or worse. The group is responsible for developing an action plan, assessing the risk rating, and determining the adequacy of the reserve, the accrual status, and the ultimate collectibility of the credits managed.

Consumer Credit

     Extensions of consumer credit by the Bank are based on, among other factors, the financial strength of the borrower, type of exposure, transaction structure, and the general economic outlook. Consumer credit decisions are generally made in a centralized environment utilizing decision models. Each credit extension is assigned a specific probability-of-default and loss-in-event-of-default. The probability-of-default is generally a function of the borrower’s credit bureau score, while the loss-in-event-of-default is related to the type of collateral and the loan-to-value ratio associated with the credit extension.

     In consumer lending, credit risk is managed from a loan type and vintage performance analysis. All portfolio segments are continuously monitored for changes in delinquency trends and other asset quality indicators. The Bank makes extensive use of portfolio assessment models to continuously monitor the quality of the portfolio and identify under-performing segments. This information is then incorporated into future origination strategies. The Bank’s independent risk management group has a consumer process review component to ensure the effectiveness and efficiency of the consumer credit processes.

Allowances for Credit Losses (ACL)

     HPCI maintains two reserves, both of which are available to absorb probable credit losses: the allowance for loan losses (ALL) and the allowance for unfunded loan participation commitments (AULPC). When summed together, these reserves constitute the total allowances for credit losses (ACL).

     The ALL represents the estimate of probable losses inherent in the loan portfolio at the balance sheet date. Additions to the ALL and AULPC result primarily from an allocation of the purchase price of participations acquired.

     It is HPCI’s policy to rely on the Bank’s detailed analysis as of the end of each quarter to estimate the required level of the ALL and AULPC. The Bank’s methodology to determine the adequacy of the ALL relies on a number of analytical tools and benchmarks. No single statistic or measurement, in itself, determines the adequacy of the allowance. For determination purposes, the allowance is comprised of three components: the transaction reserve, specific reserve, and the economic reserve.

     Transaction Reserve

     The transaction reserve component represents an estimate of loss based on characteristics of each commercial and consumer loan in the portfolio. Each loan is assigned a probability-of-default and a loss-in-event-of-default factor that are used to calculate the transaction reserve.

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     For commercial and commercial real estate loans, the calculation involves the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The reserve factors applied to these portfolios were developed based on internal credit migration models that track historical movements of loans between loan ratings over time and a combination of long-term average loss experience of the Bank’s own portfolio and external industry data.

     For consumer loans and residential real estate loans, the determination of the transaction component is conducted at an aggregate, or pooled, level. For such portfolios, the development of the reserve factors includes the use of forecasting models to measure inherent loss in these portfolios.

     Models and analyses are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in the loss mitigation or credit origination strategies. Adjustments to the reserve factors are made as needed based on observed results of the portfolio analytics.

     Specific Reserve

     The specific reserve component is associated only with the commercial and commercial real estate loans and is the result of credit-by-credit reserve decisions for individual loans when it is determined that the calculated transaction reserve component is insufficient to cover the estimated losses. Individual non-performing and substandard loans over $250,000 are analyzed for impairment and possible assignment of a specific reserve. The impairment tests are done in accordance with applicable accounting standards and regulations.

     Economic Reserve

     Changes in the economic environment are a significant judgmental factor Management considers in determining the appropriate level of the ACL. The economic reserve incorporates Management’s determination of the impact of risks associated with the general economic environment on the portfolio. The economic reserve is designed to address economic uncertainties and is determined based on a variety of economic factors that are correlated to the historical performance of the loan portfolio. Because of this more quantitative approach to recognizing risks in the general economy, the economic reserve may fluctuate from period-to-period.

     In an effort to be as quantitative as possible in the ALL calculation, Management developed a revised methodology for calculating the economic reserve portion of the ALL for implementation in 2004. The revised methodology is specifically tied to economic indices that have a high correlation to the Company’s historic charge-off variability. The indices currently in the model consist of the U.S. Index of Leading Economic Indicators, U.S. Profits Index, U.S. Unemployment Index, and the University of Michigan Current Consumer Confidence Index. Beginning in 2004, the calculated economic reserve was determined based upon the variability of credit losses over a credit cycle. The indices and time frame may be adjusted as actual portfolio performance changes over time. Management has the capability to judgmentally adjust the calculated economic reserve amount by a maximum of +/– 20% to reflect, among other factors, differences in local versus national economic conditions. This adjustment capability is deemed necessary given the newness of the model and the continuing uncertainty of forecasting economic environment changes.

     This change in methodology allows for a more meaningful discussion of the Bank’s view of the current economic conditions and the potential impact on HPCI’s credit losses. The continued use of quantitative methodologies for the transaction reserve and the introduction of the quantitative methodology for the economic component may have the impact of more period-to-period fluctuation in the absolute and relative level of the reserve than exhibited in prior-period results.

     The levels of the ALL and AULPC are adjusted based on the results of the above-mentioned detailed quarterly analysis. This adjustment may be either an increase (provision) or a reduction. Such adjustments for the twelve-month period ended December 31, 2004 resulted in reductions of the allowance of $31.6 million. These reductions compared to reductions of $41.2 million for the twelve-month period ended December 31, 2003. The continued reduction of the allowances for credit losses was indicative of Management’s judgement regarding the adequacy of those allowances particularly in light of lower net loan losses in the current year, lower non-performing asset (NPA) balances at December 31, 2004, and an improving economic environment.

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     The following table shows the activity in HPCI’s ALL and AULPC for the last five years:

Table 9 - Allowances for Credit Loss Activity

               Effective March 31, 2004, HPCI reclassified $4.3 million of its ALL to a separate liability on the balance sheet titled AULPC. The AULPC is based on expected losses derived from historical experience. HPCI believes that this reclassification better reflects the nature of this reserve and represents improved financial statement disclosure. Prior period financial statements have not been revised due to immateriality. Since March 31, 2004, AULPC has declined by $560 thousand due to lower unfunded loan participation commitment balances.

     In Management’s judgment, both the ALL and the AULPC are adequate at December 31, 2004, to cover probable credit losses inherent in the loan participation portfolio and loan commitments.

     HPCI, through reliance on methods utilized by the Bank, allocates the ALL to each loan participation category based on an expected loss ratio determined by continuous assessment of credit quality based 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 real estate loan participations, expected loss factors are assigned by credit grade at the individual underlying loan level at the time the loan is originated by the Bank. On a periodic basis, these credit grades are reevaluated. The aggregation of these factors represents an estimate of the probable inherent loss. The portion of the allowance allocated to the more homogeneous underlying consumer loan participations is determined by developing expected loss ratios based on the risk characteristics of the various portfolio segments and giving consideration to existing economic conditions and trends.

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     The following table shows the allocation in HPCI’s ALL and AULPC:

Table 10 - Allowance for Credit Losses by Product

Net Charge-offs

     Total net charge-offs were $9.2 million, or 0.18% of total average loan participations, for the year ended December 31, 2004, down from $60.0 million, or 1.17%, for the year ended December 31, 2003. The decline in net charge-offs reflects the improvements made in underwriting, the origination of higher quality loans, and the success in lowering individual concentrations in larger commercial and commercial real estate credits.

Table 11 - Net Charge-offs

Non-Performing Assets (NPAs)

     NPAs consist of participation interests in underlying loans that are no longer accruing interest. Underlying commercial and commercial real estate 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. Underlying residential real estate loans are generally placed on non-accrual status within 180 days past due as to principal and 210 days past due as to interest. 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 placed on non-accrual status within 180 days past due. At September 30, 2004, HPCI adopted a new policy of placing consumer home equity loan participations on non-accrual status when they exceed 180 days past due. Prior practice was to continue to accrue interest until collection or resolution of the loan participations. Such loan participations were previously classified as accruing loans past due 90 days or more.

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     The following table shows NPAs at the end of the most recent five years:

Table 12 - Non-Performing Assets

     Total NPAs declined to $14.3 million at the end of 2004 from $22.3 million at December 31, 2003, representing 0.29% and 0.42% of total participation interests, respectively. The increase in commercial non-accrual loans in 2001 was due to the acquisition of participation interests in performing and non-performing loans in the fourth quarter 2001, in exchange for preferred equity. In addition, the participation interests were acquired at a time when credit quality trends were deteriorating, particularly in the commercial and commercial real estate portfolio, caused by a deteriorating economy and previous decisions in credit underwriting. The Bank strengthened the independent loan review function and undertook an aggressive review of these portfolios to ensure that all credits were properly graded and action plans on individual credits were initiated, where appropriate. In addition, credit underwriting standards were tightened and the credit approval process was redesigned.

     In early 2002, the Bank’s credit workout group was further strengthened, with the objective of aggressively seeking economically advantageous opportunities to reduce the level of NPAs, including NPA sales. These efforts were reflected in NPA portfolio sales in 2002, 2003, and 2004. As a result, the 0.29% NPA ratio at the end of 2004 represented the lowest level since 1998. The Bank expects NPAs in 2005 to be comparable with year-end 2004 levels.

     Underlying loans past due ninety days or more but continuing to accrue interest were $11.7 million at the end of 2004 and $13.4 million at December 31, 2003.

     Under the participation and subparticipation agreements, the Bank may, in accordance with HPCI’s guidelines, 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, in accordance with HPCI’s guidelines, 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. Prior to completion of foreclosure or liquidation, the participation is sold to the Bank at fair market value. The Bank then incurs all costs associated with repossession and foreclosure.

OFF-BALANCE SHEET ARRANGEMENTS

     Under the terms of the participation and subparticipation agreements, HPCI is obligated to make funds or credit available to the Bank, either directly, indirectly through Holdings, or indirectly through Holdings and HPCH-III, so that the Bank may extend credit to any borrowers, or pay letters of credit issued for the account of any borrowers, to the extent provided in the loan agreements underlying HPCI’s participation interests. At December 31, 2004 and 2003, unfunded commitments totaled $761.4 million and $923.7 million, respectively. It is expected that cash flows generated by the existing portfolio will be sufficient to meet these obligations.

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LIQUIDITY AND CAPITAL RESOURCES

     The objective of HPCI’s liquidity management is to ensure the availability of sufficient cash flows to fund its existing loan participation commitments, to acquire additional participation interests, and to pay operating expenses and dividends. Unfunded commitments and additional participation interests in loans are funded with the proceeds from repayment of principal balances by individual borrowers, utilization of existing cash and cash equivalent funds, and if necessary, new capital contributions. Payment of operating expenses and dividends will be funded through cash generated by operations.

     In managing liquidity, HPCI takes into account forecasted principal and interest payments on loan participations as well as various legal limitations placed on a REIT. To the extent that additional funding is required, HPCI may raise such funds through retention of cash flow, debt financings, additional equity offerings, 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.

     At December 31, 2004 and 2003, HPCI maintained interest bearing and non-interest bearing cash balances with the Bank totaling $800.3 million and $124.1 million, respectively. The increase in interest bearing and non-interest bearing cash from 2003 to 2004, was a result of the dividend on common stock and return of capital declared in 2004, but not payable until January 2005. HPCI maintains and transacts all of its cash activity with the Bank and may invest available funds in Eurodollar deposits with the Bank for a term of not more than 30 days at market rates.

     At December 31, 2004, HPCI had no material liabilities other than unfunded loan commitments and dividends payable.

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RESULTS FOR THE FOURTH QUARTER

Table 13 - Quarterly Statements of Income